Guaranty Bank of Austin, Texas’s August 21, 2009 closure is the fourth-largest bank failure during the current wave of bank failures and the tenth largest bank failure in U.S. history. The bank’s failure, which came just 15 months after its publicly traded holding company spun out of Temple-Inland, Inc., was, the Treasury Department Office of Inspector General later concluded, due to the bank’s heavy investment in Option ARM mortgage-backed securities.

 

Though Guaranty Bank failed well over two years ago, and its holding company parent filed for bankruptcy an almost equally long time ago, its closure is only now giving rise to significant litigation based on the events surrounding the holding company’s December 2007 spin out from Temple-Inland and the bank’s August 2009 failure.

 

The latest of these recent lawsuits was filed on November 11, 2011, in the Northern District of Texas on behalf of the bank holding company’s shareholders who purchased their shares between December 12, 2007 and August 24, 2009 (that is, between the corporate spin out and the bankruptcy). The plaintiffs’ lawyers’ November 11, 2011 press release about the lawsuit can be found here.

 

The shareholders’ complaint, which can be found here, names Temple-Inland itself as a defendant, as well as five individuals: Kenneth Jastrow, who was Temple-Inland’s Chairman and CEO until December 28, 2007, and was also Chairman of both the bank and of the bank holding company until August 26, 2008; Randall Levy, Temple-Inland’s CFO; Kenneth Dubuque, who was the bank holding company’s and the bank’s CEO and director until November 19, 2008; Ronald Murff, the bank holding company’s CFO; and Craig Gifford, the holding company’s controller.

 

The complaint alleges that in the years prior to the holding company’s spin-off, the bank was required by a regulatory order to terminate its mortgage origination operations. In order to maintain its targeted rates of return, the bank “accumulated an unsafe and unsound concentration of higher yielding, but highly risky, homebuilder focused” Option ARM mortgage backed securities, largely originated in California.

 

The complaint alleges that Temple-Inland, which had previously wholly owned the bank holding company, recognized the threat that the bank posed to its own financial condition, and so devised the plan to spin off the bank holding company. The complaint alleges that during the period after the spin-out plan was devised and spin-out was completed, the defendants were aware that the real estate market’s conditions, particularly in California, were rapidly deteriorating and that delinquency rates there were “dramatically increasing.”

 

The defendants allegedly knew or recklessly ignored that the bank’s MBS portfolio was “materially impaired” and ignored questions asked prior to the spin-off about the adequacy of the bank’s capital. The complaint alleges that as of the date of the spin-off, the bank and its parent holding company were “insolvent and under-capitalized,” and that its financial statements did not reflect its true financial condition, largely as a result of its failure to properly value its impaired MBS assets.

 

The complaint alleges that the holding company did not fully recognize its losses on its MBS assets until later in 2009, shortly after which the bank was closed and put into FDIC receivership. The holding company’s bankruptcy followed within days thereafter.

 

The complaint alleges that the defendants’ misrepresented the holding company’s financial condition throughout the class period in violation of the Sections 10 and 20 of the Securities Exchange Act of 1934.

 

There are a number of interesting things about this lawsuit, the first of which is that it represents a late-arriving example of a basic subprime-related securities class action lawsuit. As I have documented on this site (refer here), there have been literally hundreds of subprime and credit crisis related securities class action lawsuits filed since the first of these cases was filed in February 2007. More recently, this wave of litigation seemingly has just about dwindled away. Yet here we are nearly five full years later, and subprime-related cases are still continuing to come in.

 

The belated arrival of this lawsuit raises yet another issue. Given that this lawsuit was filed well over two years after the bank’s failure and the holding company’s bankruptcy, it seems likely that the defendants will assert the statute of limitations as a defense. The complaint itself does not expressly address the possible statute of limitations issues, but the complaint does suggest at least a couple of factors on which the plaintiffs might try to rely in responding to statute of limitations issues.

 

That is, the complaint specifically cites two sources that only recently became available. These two sources are: the U.S. Treasury Department Office of Inspector General’s April 29, 2011 Material Loss Review of Guaranty Bank (here), which among other things, concluded that the bank failed because of its losses on its MBS portfolio; and the August 22, 2011 complaint filed in the Northern District of Texas by the trustee for the liquidation trust in the holding company’s bankruptcy (on behalf of the trust and as assignee of the FDIC) against Temple-Inland and five individual defendants, including  three of the individuals named as defendants in the recently filed shareholder suit. The complaint in the trustee’s lawsuit can be found here.

 

The trustee’s complaint makes for some interesting reading. Among other things, it accuses Temple-Inland of “fraudulently looting” the bank and the holding company of “assets exceeding one billion dollars,” and further alleges that “after fraudulently stripping” the bank and the holding company of assets “beyond the point of solvency and adequate capitalization,” the defendants came up with the plan of “spinning off the fatally crippled and doomed to fail” holding company.

 

The plaintiffs in the shareholder lawsuit may well contend that that until they were aware of the conclusions in the Inspector General’s report and of the allegations in the liquidation trustee’s complaint, they were not in a position to file their complaint, or were unaware of the allegations on which they based their complaint, and therefore that the statute of limitations should run from the disclosure of these allegations, rather than from the date of the bank failure. The defendants undoubtedly will contend that the circumstances that cause the bank’s demise were apparent at the time of its August 2009 failure and that the statute ought to run from that time.

 

Another interesting aspect of the shareholder’s complaint is the involvement corporate officials from the two separate companies, including one individual who is sued in dual capacities, as an officer and director of both companies. These allegations raise some potentially interesting questions about the extent to which each company’s respective D&O insurance programs are implicated by the claim. The liquidating trustee’s complaint presents the same issues. These issues are further complicated by the holding company’s August 2009 bankruptcy.

 

Temple-Inland likely has a current program of D&O insurance in force. The bank holding company’s D&O insurance likely lapsed some time shortly after the holding company’s bankruptcy. Unless there is some basis to relate the claim back to the holding company’s now lapsed policy, there may be no insurance available for the individuals defendants to defend themselves in their capacities as former directors and officers of the holding company – and given the bankruptcy, whatever limits there might even theoretically be available under the bankrupt holding company’s D&O program are likely to be significantly impaired.

 

With respect to Temple-Inland’s D&O insurance, there is an interesting question with respect to coverage for Temple-Inland itself. While most public company D&O insurance policies provide Securities Claim protection for corporate entity insureds — and while the claims alleged against Temple-Inland in the shareholder lawsuit are asserted under the federal securities laws — these allegations may or may not represent Securities Claims under the applicable insurance policy definition.

 

Many D&O insurance policies orient the definition of the term Securities Claim around allegations involving the securities of the insured corporate entity. The allegations in the recently filed shareholder lawsuit arguably pertain solely to the bank holding company’s securities, not to Temple-Inland’s securities (although the mechanics of the bank holding company’s spin-out from Temple-Inland fuzzies this up a little bit). There will be an interesting question as to whether or not the securities law allegations against Temple-Inland represent a Securities Claim within the meaning of the company’s D&O insurance policy. It is worth noting in that regard that the claims asserted against Temple-Inland in the trustee’s lawsuit are not based on alleged violations of the securities laws, and therefore also potentially might not trigger the entity coverage under the typical D&O insurance policy.

 

There obviously are many questions yet to come in these cases. At this point it may be sufficient to note that even after all this time, the litigation consequences of the subprime meltdown and of the bank failure wave are continuing to accumulate. Especially with respect to the failed banks, the litigation wave will continue to accumulate for years to come, and it will be an even longer time before all of the litigation has finally played out. Unfortunately it also looks like the economic consequences from the global financial crisis are also going to take many years finally to play out, as well.

 

Lehman Mortgage Backed Securities Lawsuit Settlement Depletes Remaining D&O Insurance Proceeds: Earlier this year, when the parties to the Lehman Brothers Equity and Debt Securitholders litigation announced that they had reached a $90 million, the amount of that settlement if approved appeared that it would deplete most but not all of the remaining limits under the Lehman Brothers’ D&O insurance program. As discussed at length here, I calculated that the $90 million settlement, together with other settlements and accumulated defense expenses, looked like it would leave about $25 million or so of insurance remaining in the $250 million program.

 

It now looks as there was slightly more left in the program than I had calculated. It also looks as if, based on the separate $40 million settlement of the Lehman Brothers Mortgage Backed Securities litigation, that whatever the amount of insurance that was remaining in the program, it has now been exhausted. According to a November 11, 2011 Reuters article (here), the D&O insurers will contribute a total of $31.7 million toward the$40 million settlement, an amount that should just about entirely deplete whatever was left in the program. Bankruptcy court approval is required.

 

I have added this Lehman Brothers Mortgage Backed Securities lawsuit settlement to my running tally of subprime and credit crisis securities class action lawsuit case resolutions, which can be accessed here.

 

MF Global’s D&O Insurance: I am sure many of you like me wondered which carriers were on the D&O insurance program for MF Global.  Judy Greenwald’s November 11, 2011 Business Insurance article (here), doesn’t list all of MF Global’ s D&O insurance carriers, but it does identify the primary carrier in the program, and it does reveal that MF Global carried a total of $250 million in D&O insurance. I am sure that a certain amount of the $250 million program is Excess Side A/DIC insurance, but given that MF Global has filed for bankruptcy even those Excess Side A/DIC layers would appear to be implicated by the claims arising from the company’s collapse.

 

Sometimes the World is a Very Strange Place: At least some of our country’s exports are succeeding in China, if this broadcast entitled “Lao Lai Qioa Gaga” from Hunan TV is representative. In this video, which really does have to be seen to be believed, a Chinese old folks choir belts out a spirited cover of Lady Gaga’s hit, “Bad Romance.” An unexpected interpretation of the work, I would say — although arguably not any more bizarre than Lady Gaga’s own video interpretataoin of the song.

 

For those of you who like me have been watching in disbelief as the accounting scandal engulfing Olympus Corp. has slowly unfolded like a slow-motion train wreck, I am sure you have many questions, but one that occurs to me in particular to ask is – why haven’t there been any lawsuits yet? After all, the company has lost over 70% of its market capitalization value (representing more than $6.4 billion) since the scandal first came to light in mid-October.

 

Not only that, but after weeks of denial, on November 8, 2011, the company admitted in a press release (here) that “it has been discovered that the Company had been engaging in deferring the posting of losses on investment securities, etc. since around the 1990s,” and that the fees the company paid to advisors in connection with three business acquisitions “had been, by means such as going through multiple funds, used in part to resolve unresolved losses on investment securities, etc., by such deferral in the posting of these losses.” The company also separately announces on November 8, 2011 (here) that its board had voted to dismiss a company officer whom the company said in a press release “was found to be involved in such deferral in posting of the losses.” In addition, the company also announced that its Standing Corporate Auditor had resigned.

 

A few facts start to fill in the explanation of why there have been no lawsuits yet, despite all of these circumstances and revelations, and despite the magnitude of the drop in the company’s market capitalization.

 

First, the company’s shares trade on the Tokyo Stock Exchange. While American Depositary Receipts trade on the Pink Sheets in the U.S., those securities, according to Jonathan Stempel’s November 9, 2011 Reuters article entitled “Olympus Investors May Find Courthouse Door Closed” (here), represent only about one percent of the company’s float, and no single investor has as much as even $1 million of the ADRs.

 

With the vast preponderance of the company’s shares trading on the Tokyo exchange, only a very small number of Olympus investors, representing a very small share of the company’s pre-loss market capitalization, would be able to assert claims in U.S. court under U.S. law, in light of the “transaction” test first articulated by the U.S. Supreme Court in its June 2010 holding in the Morrison v. National Australia Bank case (about which refer here). Under the Morrison holding, the U.S. securities laws simply do not apply with respect to the transactions in which those investors who bought their Olympus shares on the Tokyo exchange.

 

The investors might try to sue Olympus and its directors and officers in U.S. court under Japanese law, but that does not really seem like a realistic alternative. Toyota’s investors tried to assert  Japanese securities law claims in their securities class action lawsuit filed in the wake of that company’s sudden acceleration scandal. As discussed here, in July 2011, Central District of California Judge Dale Fischer rejected the argument that she had jurisdiction over the Toyota shareholders’ Japanese law securities claims. Among other things, she said that the requirements of comity strongly militated against her exercising jurisdiction over the Toyota shareholders’ Japanese law claims. 

 

While the Olympus shareholders might well consider the possibility of pursuing the claims under Japanese law in Japan, the problem they have is that Japan’s courts do not have a class action procedure like that in the U.S., and as the Reuters article linked above discusses, there may be questions about how damages would be calculated under Japanese law. (That said, prior corporate scandals in Japan have triggered securities litigation in that country, as discussed here.)

 

One alternative gambit the Olympus shareholder might try in order to be able to pursue claims in the U.S. is to try to assert claims under the law of one of the U.S. states. That is a maneuver the shareholder plaintiffs are trying to pull off in the BP shareholder litigation arising out of the Gulf oil spill, as discussed in Alison Frankel’s November 9, 2011 article on Thomson Reuters News and Insight about the BP case. But as Frankel discusses, this effort to try to assert class claims under state securities class is fraught with difficulties.

 

With all of these difficulties, we may not see any shareholder litigation arising out the Olympus scandal any time soon. In the meantime, though, there is a growing list of questions about this increasingly bizarre story, such as – what were the investment losses that the company was trying to mask, and how big were they? Exactly how were the merger transactions used to mask those losses? Are there other losses that have not been disclosed or were there other transactions used to mask those or other losses? Are there other inflated assets that have to be written off? Who among the company’s management were aware of these accounting maneuvers?

 

This is one of the more striking stories to come along in a long time, both in terms of the scale and the duration of the coverup, as well as the complexity of the means of the deception. It seems likely that whether or not there ultimately is any shareholder litigation, that there will (or should be) some type of regulatory action. (Refer here for the strory about the Tokyo Metropolitan Police investigation of the scandal.)

 

In any event, this case surely is another reminder of the impact of the Morrison decision. There is no doubt that if all of this had come up before Morrison, there would have been a raft of lawsuits in U.S court against Olympus and its directors and officers about all of this.

 

And speaking of the breadth of Morrison’s impact, Victor Li has a very interesting November 9, 2011 Am Law Litigation Daily article (here), describing how the lawyers for Aloca have successfully moved to reopen the bribery case brought against the company by Aluminum Bahrain, after the case had been administratively stayed to allow a criminal probe to go forward. The company recently sought to reopen the case in order to be able to move to dismiss it under Morrison. The company will now have a chance to try to have the claims, which are based on RICO, dismissed. (For more background about the Alcoa case, refer here.)

 

One final thought about the Olympus case. For those who have been trying to think about where the Dodd-Frank whistleblower provisions might lead, it is worth thinking about the fact that the scandal began with the company’s CEO confronting the board. It does not take too much imagination to picture someone like him or another officer of a company subject to the SEC’s jurisdiction running to the SEC with this story. The bounty provisions under the Dodd-Frank Act certainly would in these circumstances present a hefty incentive for the prospective whistleblowers.

 

When They Ask Later How Europe Went Bankrupt: There’s a scene in Ernest Hemingway’s novel, The Sun Also Rises, where Bill Gorton, the New York  friend of the book’s main character, Jake Barnes, asks Jake’s rival, Mike Campbell, “How did you go bankrupt?” Campbell responds, “Two ways. Gradually and then suddenly.”

 

I thought of this exchange as I was reading an article in the October 29, 2011 issue of The Economist about the euro crisis. I think the likely timing of the “suddenly” part of the euro crisis might be discerned in this sentence in the article: “[i]n the next three years Italy and Spain will have to refinance about €1 trillion-worth of bonds, not counting additional borrowing to finance their deficits.”  A three-year time frame may sound more like "gradually" — that is, unless bond investors start assessing how likely likely ithe refinancing really is. .

 

 

And Finally: How about a map of every McDonald’s in the United States?  (Did you know that the furthest you can get from a McDonald’s Restaurant in the Continental U.S. is 110 miles?) 

 

An inevitable part of the current wave of bank failures has been the FDIC’s filing of lawsuits against former directors and officers of the failed institutions. And though the FDIC’s initiation of this litigation has been gradual, the lawsuits have now started to accumulate in significant numbers. And just as this FDIC litigation was perhaps inevitable once the banks started to faile, so too it was also perhaps inevitable that the FDIC lawsuits would be accompanied by D&O insurance coverage litigation.

 

As discussed below, the failed bank insurance coverage lawsuits are now starting to arrive. If the initial cases are any indication, one of the main coverage battlegrounds will be the typical D&O insurance policy’s Insured vs. Insured exclusion. Specifically, the question will be whether the FDIC as receiver pursuing the failed bank’s claim against the bank’s former directors and officers is acting as an “insured” under the D&O policy so as to preclude coverage under the policy.

 

First up in this analysis is Michigan Heritage Bank of Farmington Hills, Michigan, which failed on August 29, 2009 (about which refer here). As discussed in greater detail here, on August 8, 2011, the FDIC, as the bank’s receiver, filed a lawsuits in the Eastern District of Michigan against a single former officer of the bank.

 

What followed next is that on November 1, 2011, Michigan Heritage’s D&O insurer filed an action in the Eastern District of Michigan seeking a judicial declaration that there is no coverage for the underlying lawsuit or for the bank officer’s defense expenses under the bank’s D&O policy. A copy of the insurer’s declaratory judgment complaint can be found here.

 

Among other things, the carrier seeks a judicial declaration that the policy’s Insured vs. Insured exclusion precludes coverage for the underlying lawsuit. The insurer’s argument is that as the bank’s receiver, the FDIC is asserting the bank’s own claims and is seeking to recover the bank’s losses. Therefore, the carrier contends, the FDIC’s lawsuit is a claim “by, on behalf of, or at the behest of” the bank, and as the bank and the defendant loan officer are both insureds under the policy, the policy’s Insured vs. Insured exclusion precludes coverage.

 

A very similar sequence has also followed with respect to Westernbank, of Mayaguez, Puerto Rico, which failed on April 30, 2010. As reflected here, on December 17, 2010, the FDIC, through its outside counsel, sent a letter to Westernbank’s D&O insurer asserting claims against the bank’s former directors and officers.

 

Westernbank’s directors and officers , in turn, on October 6, 2011, filed an action in local Puerto Rico court seeking judicial declaration that the FDIC’s claim is covered under the bank’s D&O policy. The complaint, which is in Spanish, can be found here. According to an October 14, 2011 press release from the direcrors and officers’ counsel, the complaint seeks a judicial declaration with respect to “the controversial and critical question whether the FDIC-R can be deemed an insured under the Policy so as to excuse [the carrier] from providing coverage.”

 

Though these declaratory judgment actions have only just been filed, they are in many ways a vestige of an earlier time. As I discussed in a blog post way back in August 2008, when the current bank wave was only just starting to unfold, the question whether the Insured vs. Insured exclusion precluded coverage for claims by the FDIC as receiver against former directors and officers of failed banks was hotly contested during the S&L crisis. As I said in my earlier post, and as appears likely now, the Insured vs. Insured exclusion could be a critical part of the failed bank insurance coverage litigation during the current round of bank failures as well.  

 

During the S&L crisis, where the FDIC had its greatest success in overcoming the Insured vs. Insured exclusion was where it was able to argue successfully that the Insured vs. Insured exclusion precluded coverage only with respect to collusive lawsuits. Because it was able to show that its claims and lawsuits were fully adversarial, it was able to establish that the exclusion did not apply.

 

The FDIC was not uniformly successful in arguing that the exclusion only precluded collusive claims, and there has in fact been some intervening case law to the effect that the Insured vs. Insured exclusion applies even when the underlying claim is not collusive.

 

It will in any event be interesting to see how these coverage cases develop. The one thing that seems certain is that as the FDIC failed bank litigation continues to accumulate, so too will the related coverage litigations. Many of the related coverage suits likely will also involve these same Insured vs. Insured issues.

 

Another issue that is likely to be litigated in coverage cases arising out of FDIC failed bank litigation is the enforceabilty of the so-called Regulatory Exclusion, which when present in the D&O policy precludes coverage for claims brought by the FDIC and other regulators. Not all policies implicated in the bank failures have these exclusions, but where they are present they are likely to be relied upon by the carriers to contest coverage. It is probably worth noting that these issues were fully litigated during the S&L crisis and the courts generally found that the regulatory exclusion precluded coverge for FDIC claims. My prior blog post about the regulatory exclusion can be found here.

 

A good summary of the D&O insurance coverage issues involved in FDIC failed bank litigation can be found here.

 

Special thanks to the several loyal readers who sent me links to ths source documents referenced above.

 

Overall levels of corporate and securities litigation declined during the third quarter of 2011 relative to recent quarters but 2011 annualized filings remain above historical levels, according to a recent report from the insurance information firm Advisen entitled “Securities Litigation Activity Dips, An Advisen Report: Q3 2011,” which can be found here. My own survey of the third quarter 2011 securities litigation filing activity can be found here.

 

Preliminary Notes

It is critically important to recognize that the Advisen report uses its own unique vocabulary to describe certain of the corporate and securities litigation categories.

 

The “securities litigation” and “securities suits” analyzed in the Advisen report include not only securities class action lawsuits, but a broad collection of other types of suits as well, including regulatory and enforcement actions, individual actions, derivative actions, collective actions filed outside the U.S. and allegations of breach of fiduciary duty. All of these various kinds of lawsuits — whether or not involving alleged violations of the securities laws — are referred to in the aggregate in the Advisen report as "securities suits."

 

One subset of the overall collection of "securities suits" is a category denominated as "securities fraud" lawsuits, which includes a combination of both regulatory and enforcement actions, on the one hand, and private securities lawsuits brought as individual actions, on the other hand. However, the category of "securities fraud" lawsuits does NOT include private securities class action lawsuits, which are in their own separate category ("SCAS").

 

Due to these unfamiliar usages and the confusing similarity of category names, considerable care is required in reading the Advisen report.

 

The Report’s Findings

There were 316 “securities suits” (as that phrase is used in the Advisen report) during the third quarter of 2011, which is down from the 367 “securities suits” filed in 2Q11 and 421 filed in 1Q11. This quarterly decline is attributable in part to the decline of breach of fiduciary duty suits (primarily merger objection suits) in 3Q11, when there were 76 breach of fiduciary duty suits filed, compared to 130 filed in the year’s second quarter.

 

In addition, the quarterly decline in overall corporate and securities lawsuit filing activity is also due in part to the decline in 3Q11 compared to 1Q11 in what the Advisen report calls “securities fraud suits” (which as noted above encompasses both regulatory actions as well as private securities lawsuits brought as individual rather than class actions). According to the study, the number of these so-called “securities fraud suits” declined to 109 in the third quarter, compared to 156 in the first quarter and 101 in the second quarter.

 

According to the Advisen study, the number of securities class action lawsuits filed during the third quarter was also down relative to the second quarter. The Advisen study reports that there were 56 securities class action lawsuits filed during 3Q11, compared to 61 during the second quarter. Though the third quarter filings were down relative to the prior quarter, the third quarter filing activity level was higher than the 2010 quarterly filing average of 47. Over 70 percent of Q311 class action lawsuit filings named companies in four sectors as defendants: information technology, healthcare, financial and industrial.

 

Litigation involving non-U.S. companies, filed both in the U.S. and elsewhere, was an important part of “securities suit” filings during the third quarter and overall during 2011. In the first three quarters of 2011, 16 percent of all “securities suits” were filed against non-U.S. companies, compared to 11 percent for both 2009 and 2010. During the third quarter, fifteen percent of all “securities suits” were filed against non-U.S. companies, down from 19 percent during the second quarter.

 

With respect to this activity involving non-U.S. companies, an increasing percentage of this “securities suit” activity is outside the U.S. The study reports that in the first three quarters of 2011, there were 55 “securities suits” filed in courts outside the U.S., 17 of which were filed during the third quarter. These 55 cases represent five percent of all YTD “securities suits,” which is “higher than the 3-percent level recorded in most recent years.”

 

Many of the cases involving non-U.S. companies in U.S. court involve Chinese companies. The number of “securities suits” filed in U.S. court involving Chinese companies has rise from five in 2009 to 24 in 2010, and up to 55 during the first three quarters of 2011.

 

Even though we are now well past the peak of the credit crisis (at least as a temporal matter if not as an economic matter), overall corporate and securities litigation activity remains highly concentrated in the financial sector. According to the Advisen report, 35 percent of all “securities suits” filed during the third quarter targeted companies in the financial sector. A large portion of the “securities suits” filed against financial companies in the third quarter involve regulatory actions, as 48 percent of all “securities suits” filed against financial companies involved regulatory actions.

 

But while the filing activity concentration in the financial sector remains elevated, the 3Q11 “securities suits” were “more broadly dispersed” during the quarter “than in previous years, especially compared to 2008 and 2009.” Suits against information technology firms and healthcare companies each represented 13 percent of all “securities suits,” while suits against industrials represented 11 percent of all such suits.

 

The average value of settlements of “securities suits” during the third quarter was $17.4 million, down from $22.8 million in the second quarter and from $18.2 million for all of 2010. The average securities class action lawsuit settlement during the quarter was $45.7 million.

 

Advisen 3Q11 Securities Litigation Webinar: On Thursday November 17, 2011 at 11:00 am EST, I will be participating in one-hour long Advisen webinar to discuss third quarter 2011 corporate and securities litigation filing activity. The panelists for this free webinar will also include Steve Gilford of the Proskauer law firm, Alliant Insurance’s Susanne Murray, and Advisen’s Dave Bradford. The panel will be moderated by Advisen’s Jim Blinn. More information about this free webinar, including registration information, can be found here.

 

One of the primary purposes for which policyholders purchase D&O insurance is to provide directors and officers with defense cost protection in the event claims are made against them. However, a September 15, 2011 decision by a justice of the New Zealand High Court in Auckland (here) found that former directors of the defunct Bridgecorp companies are not entitled to advancement under the companies’ D&O insurance policies of the costs of their criminal defense where the companies’ liquidators and receivers have raised (but not yet proven or even filed) claims against them exceeding the policy’s limits of liability.

 

Though the decision reflects a peculiar feature of New Zealand law, it nevertheless may have some noteworthy implications, particularly in light of the larger D&O insurance industry’s ongoing efforts to develop insurance solutions that operate globally and respond locally.

 

Background

The Bridgecorp group operated as a real estate development and investment firm. (For more information about the Bridgecorp group and its demise, refer here.) When it collapsed in July 2007, the group owed investors nearly NZ$500 million. The group’s former directors face numerous criminal and civil claims arising out of the collapse. Trial on the criminal charges was to take place this fall. The accompanying civil charges have been stayed pending the outcome of the criminal claims.

 

Separately, the liquidators and receivers for the Bridgecorp group companies have advised the directors that they intend to initiate civil proceedings against them, alleging that the directors breached their statutory and common law duties, and seeking an order requiring the directors to pay more than NZ$450 million.

 

At the time of its collapse, the Bridgecorp group carried NZ$20 million in D&O Insurance. The group also carried $2 million of statutory liability defense cost protection (the “SL policy”), but the limits of the SL policy have already been exhausted in payment of the directors’ attorneys’ fees. The directors now seek to have the D&O insurance fund their continuing criminal defense, which they estimate will amount to NZ$3 million through trial, exclusive of any post-trial proceedings.

 

The Bridgecorp group liquidators and receivers advised the group’s D&O insurer that they assert a “charge” under Section 9 of the Law Reform Act of 1936, which they contend creates a priority entitlement in claimants’ favor over monies that may be payable under any insurance policy held by the person against whom the claim is made. The Bridgecorp group directors in turn initiated an action seeking a judicial declaration that Section 9 does not prevent the insurer from meeting its contractual obligation under the D&O policy to reimburse them for their defense costs.

 

The September 15 Ruling

On September 15, 2011, New Zealand High Court (Auckland Registry) Justice Graham Lang ruled in favor of the Bridgecorp group’s liquidators and receivers, ruling that the receivers’ and liquidators’ “charge” on the D&O insurance policy’s limits of liability under Section 9 “prevents the directors from having access to the D&O policy to meet their defence costs.”

 

Section 9 (which is set out verbatim in paragraph 19 of Justice Lang’s opinion) arises out of the personal injury context and gives the claimant a “charge” over liability insurance policy proceeds as of the date the claimant’s injury arose. As Justice Lang stated, the provision provides a “procedural mechanism” to ensure that a claimant can “gain direct access to insurance monies that would have been available to the insured.”

 

Justice Lang acknowledged that the Bridgecorp group’s receivers’ and liquidators’ “charge” on the D&O policy’s proceeds is “conditional” upon the need for the prospective claimants’ ability to establish that the directors are liable, as well as upon the need for the directors or the claimants to establish that the directors are entitled to coverage under the policy.

 

Notwithstanding the fact that the receivers and liquidators claim on the policy proceeds is merely “conditional,” Justice Lang nevertheless held that it operated to bar the payment of the directors’ immediate criminal defense expenses. Justice Lang reasoned that because the receivers and liquidators claims are “for a sum significantly greater than the amount of cover available under the D&O policy,” the insurer is “bound to keep the insurance fund intact.”

 

Though the result might be different where the amount claimed is less than the limit of liability, where as here the amount of the claims exceed the limits of liability, any payments the insurer makes “must be for the purposes of satisfying any liability the directors may have to civil claimants,” to the point that if the insurer were to pay any defense costs, it “would be liable to restore the amount of any such payment to the pool of money available under the policy” in order to meet the claims of any claimants.

 

Justice Lang acknowledged that this result “may be harsh” for the directors, produces some “unsatisfactory consequences,” and may “seem unfair.” But he nevertheless reasoned that this result was “clearly in accordance with the object and purpose of [section] 9.” He added that the outcome was “partly the result of the fact that the Bridgecorp companies elected to take out an insurance policy that provided cover for both defence costs and claims for damages and compensation,” and is a “direct consequence of the statutory regime the Act introduced nearly 80 years ago.”

 

Discussion

At one level, this decision represents nothing more that the application of a peculiar feature of New Zealand statutory law. Moreover, informed sources advise me that the decision in under appeal, so it may or may not stand even within its own jurisdiction.

 

But at another level, this decision does raise some noteworthy implications of wider significance. The first and foremost is that it shows the significant danger that both policyholders and insurers may face with respect to the scope of D&O insurance coverage available around the world in the many jurisdictions where the interpretive case law is as yet undeveloped.

 

The threat of D&O claims throughout the world has expanded significantly in recent years, and with this increased exposure the potential significance of D&O insurance protection has also grown. Global companies increasingly seek to put in place D&O insurance protection applicable in the various countries in which they operate. But as this decision shows, D&O insureds facing claims in jurisdictions where the interpretive case law is undeveloped may not always know how the local courts will interpret and apply their policy.

 

One possible solution to this concern might be the inclusion in the D&O insurance policy of a choice of law provision designed to ensure that the policy will be interpreted according to the laws of jurisdictions where the coverage interpretations are more developed and therefore more predictable. Of course, this solution may be dependent upon the willingness of the court’s in the forum jurisdiction to recognize and apply the choice of law provision as written, as well as the apply the specified law according to expectations and assumptions. (Refer here for more thoughts about the potential need for choice of law provisions in D&O insurance policies.)

 

As Justice Lang himself acknowledged, there is something particularly “unsatisfying” about an outcome where the mere inchoate and as yet unfiled claim of a prospective claimant can take priority over the insured persons’ immediate need for criminal defense cost protection under the policy, particularly where, as Justice Lang also acknowledged “the Bridgecorp companies took the policy out at least in part for that specific purpose.”

 

In that regard, it is worth noting that this policy does not appear to contain so-called “entity coverage” (see paragraph 14 of the opinion). Accordingly, this policy clearly was intended solely for the protection of the insured directors and officers. Yet even though the policy for the individual insureds’ protection, Justice Lang’s interpretations of Section 9 subordinates the insureds’ immediate entitlement to the policy proceeds to the mere unproven claims of prospective claimants. The consequences of this topsy-turvy inversion is not just “harsh,” but grotesque as it leaves these individuals facing serious criminal charges without the very protection the insurance was designed to provide.

 

Justice Lang acknowledge that this result might not apply where the amount of the claims do not exceed the D&O insurance policy’s limits of liability, which would seem to suggest even more perversely that the more serious the claims against the directors and officers, the less likely they are to be able to rely on the defense protection under their D&O insurance policy.

 

The solution for the protection of corporate directors and officers in New Zealand would seem to be to separate out their defense cost coverage from the liability protection under their D&O insurance policy. If the Bridgecorp case is affirmed on appeal, it would seem that the New Zealand D&O insurance marketplace will have to evolve to provide a policy that avoids that pitfalls that this case presents — or seek to have Section 9 amended to recognize the need for corporate defendants to be able to rely on their D&O insurance to defend themselves.

 

One other possible solution to the problem presented by this case is to arrange for defense costs to be outside the limits of liabilty (that is, to structure the policy so that defense expenses do not erode the limit of liability). Although D&O insurance typically is not structured that way, it sometime is — indeed, if I am not mistaken, in Quebec it is required by applicable regulations that defense costs must be outside the limits of D&O insurance policies.

 

One thing this decision shows is how early the D&O insurance industry is in the process of trying to provide comprehensive global D&O insurance policies that will operate predictably in the various jurisdictions in which it may be applied. The D&O insurance industry has been working hard in recent years to develop policies that will operate globally and respond locally. The Bridgecorp decision underscores the significant challenge that the industry faces in trying to ensure that D&O insurance will predictably be available at the local level, particularly in jurisdictions where the coverage interpretations are as yet undeveloped. 

 

Perhaps it is owing to its antipodal provenance, but it seems to me that Section 9 (at least as interpreted by Justice Lang) stands the very idea of liability insurance on its head. Liability insurance does not exist to protect claimants, it exists to protect the insureds. Insurance buyers procure the insurance to protect themselves from third party lawsuits. The very idea that a mere assertion of a prospective claim, no matter how spurious, is enough to strip the insured under a liabiltiy policy of the proection they procured for themselves is questionable in its very approach to teh insurance equation. I hope that the appellate court (or if necessary the New Zealand Parliament)  will give due consideration to the nature and purposes of liabiltiy insurance and vacate the ruling of this case.

 

An October 4, 2011 memorandum about the Bridgecorp decision from the  Minter Ellison Rudd Watts law firm can be found here. An October 2011 Bulletin from Willis New Zealand about the decision can be found here.

 

Special thanks to the several loyal readers who sent me links about this opinion.

 

When MF Global filed for bankruptcy yesterday, it not only became the eighth largest corporate bankruptcy in U.S. history. It also became the first U.S. company taken down by the troubles afflicting European sovereign debt. How big of a problem all of this represents depends on whether or not you think the MF Global demise reflected a unique set of circumstances or whether it reflects something deeper. Either way, there are some things about MF Global’s collapse that are worth thinking about.

 

First, although MF Global is the first U.S. company claimed by the European Sovereign debt crisis, at least one other company has also been imperiled by these circumstances. MF Global’s bankruptcy comes just three weeks after the bailout and restructuring of Dexia, S.A., the Belgian-French banking institution became was the first casualty of the crisis after writing down the value of the Greek debt it held on its balance sheet.

 

Second, though like Dexia what took down MF Global was its exposure to European sovereign debt, unlike Dexia, MF Global was not exposed to Greek debt. MF Global held the debt of other European countries. Its assets include $6.3 billion of Italian, Spanish, Belgian Portuguese and Irish debt. More than half of the total was Italian. It was the company’s exposure to these debts that led to regulatory scrutiny, downgrades, and margin calls that threatened the company’s liquidity.

 

Third, MF Global is far from the only victim of its demise. Its shareholders likely have lost the full amount of their investment. (Refer here for a run down of affected investors). In addition, there are creditors and others who have suffered a loss as a result of MF Global’s bankruptcy. Among others, investment bank J.C. Flowers reportedly stands to lose about $48 million due to MF Global’s collapse.

 

Fourth, the collapse of both Dexia and MF Global came quickly. Dexia’s crisis came less than three months after European stress tests had found Dexia one of Europe’s safest banks. MF Global’s bankruptcy filing came only about a week after the rating agencies initiated a series of downgrades of MF Global.

 

The speed of these companies’ collapses adds a layer of urgency to asking the question whether or not there are other companies similarly exposed – and as MF Global’s example shows, not just exposed to Greek debt but exposed to any of the troubled economies on the Europe’s periphery. The fact MF Global’s exposure to debt from Italy, one of the world’s largest economies, contributed to its demise is particularly troublesome. For that matter, the list of European countries whose debt could be a problem may not be limited just to the countries whose debt MF Global had on its balance sheet. As this European crisis evolves, there could be other problem counties added to the list.

 

Moreover, in thinking about which companies will have problems from all of this, the inquiry cannot stop just at those companies with exposures to European sovereign debt. There is also the question of which companies are exposed to companies that are exposed to European sovereign debt.

 

It is possible that MF Global’s collapse represents a unique set of circumstances, unlikely to be repeated (particularly given the late developing reports of supposed deficiencies in customer accounts, the discovery of which may have hastened MF Global’s bankruptcy). On the other hand, it is possible there are other companies who may also suddenly be perceived as over exposed to European sovereign debt and that may collapse just as quickly as MF Global did.

 

The uncertainty over how big of a problem all of this represent is not just a difficulty for investors. It also poses a challenge for regulators – according to news reports, regulators may also be investigating MF Global’s collapse and may even face criticism for not acting more quickly.

 

And though the larger problems for the global financial marketplace clearly are of a higher order, it is also worth mentioning here that these issues also pose a challenge for D&O insurance underwriters. As noted above, there is not just the question of whether or not a company is exposed to European sovereign debt. There is also the far more difficult to discern question of whether or not a company is exposed to a company that is exposed to European sovereign debt.  As MF Global’s rapid demise illustrates, these concerns are sufficient to send a company into bankruptcy. My guess is that the events at MF Global sent a chill through all of the offices of D&O underwriters everywhere, particularly (but not exclusively) at those carriers that are active in the financial sector.

 

There is no way to know for sure, but I suspect that before all is said and done, there will be a lot more to be said here on the topic of European sovereign debt risk.

 

Archeologists Uncover Ancient Race in the Great Lakes Region: Remains Of Ancient Race Of Job Creators Found In Rust Belt. Read the story here.

 

This Week in San Diego: This week I will be in San Diego for the PLUS International Conference. I am looking forward to seeing many of you there. If you see me at the conference, I hope you will take the time to say hello, particularly if we have never met before. While I am in San Diego, the pace of blog post publication may slow down. The normal publication schedule will resume next week.

 

On October 25, 2011, the FDIC filed its latest failed bank lawsuit, in connection with events surrounding the July 2009 failure of Mutual Bank of Harvey, IL. The FDIC’s complaint, which was filed in the Northern District of Illinois, names as defendants eight former directors and two former officers of the bank. But in addition, the complaint also names as defendants the bank’s outside General Counsel, who was also a director of the bank, and well as the General Counsel’s law firm. There are a number of other interesting things about this complaint as well.

 

The FDIC’s complaint alleges that Mutual Bank’s failure has cost the FDIC’s deposit insurance fund an estimated $775 million in losses. In its lawsuit, the FDIC seeks to recover over $115 million in losses the bank suffered on twelve commercial real estate loans, $10.5 million in unlawful dividend payments and $1.09 million in wasted corporate assets.

 

The complaint asserts claims against the director defendants and the officer defendants for gross negligence, negligence, and breach of fiduciary duty. The complaint alleges that the directors and the officers approved high-risk loans to uncreditworthy borrowers. The complaint also asserts the directors failure to supervise the bank’s lending activities, approval of unlawful dividend payment and corporate waste.

 

The complaint also asserts claims against James Regas and his law firm, Regas Frezadas & Dallas, for legal malpractice, breach of fiduciary duty and aiding and abetting the director and officer defendants’ breaches of fiduciary duty. The lawyer and his firm are allege to have facilitated the unlawful payment of dividends; failed to counsel and prevent the bank’s board from making grossly imprudent loans; ignoring federal lending regulations; and facilitating bank transactions to entities in which one of the attorney defendants held an interest, despite the conflict of interest.

 

Interestingly, the roster of director defendants does not include Pethinaidu Velchamy, the bank’s former Chairman, or Parameswari Velchamy, the former Chairman’s wife, who was also a director of the bank. The complaint alleges that the two have each filed a petition under Chapter 7 of the bankruptcy code, and that “despite” their respective “culpability for the events described,” the stay in bankruptcy “precludes” naming them as a defendant “unless the stay is modified or lifted.”

 

Among other things, the Complaint alleges (in paragraph 34) that the former Chairman has filed a lawsuit against the bank’s former auditors, in which the Chairman supposedly alleges that “the Bank’s balance sheet contained hundreds of millions of dollars in loans that had been funded on the basis of substandard, if not reckless underwriting and … were not identified for corrective action because of critical failure in the Bank’s internal credit risk review function.”

 

Though the former Chairman and his wife are not named as defendants in the lawsuit, their son and daughter, both of whom served as members of the board of directors, were named as defendants.

 

These family connections are particularly interesting in relation to the FDIC’s waste allegations. Among other things, the FDIC alleges that board facilitated the payment of $250,000 in bank funds for the wedding of the Chairman’s daughter; authorized $495,000 in “bonuses” to pay the criminal defense costs of the bank President’s wife, who had been indicted for Medicaid fraud; and approving the use of $300,000 in bank funds to hold a board meeting in Monte Carlo.

 

Regas, the lawyer defendant, and his law firm, are alleged to have been aware that loans referenced in the complaint were “grossly deficient” but that despite the awareness of the “imprudence, and in some cases, unlawful nature of these transactions,” the lawyer and his firm failed to protect the bank from foreseeable injury inherent in these transactions. The law firm is alleged to have received over $3 million in fees between January 2007 and April 2009.

 

Regas is also alleged to have participated in a 2006 land loan transaction involving undeveloped real estate. The $28.5 million loan was originated by another bank for which Regas also served as director. The individual that sold the land to the borrower is described in the complaint as Regas’s “close friend and business colleague.” After the other bank made the loan, Regas allegedly arranged for Mutual Bank to acquire a $24.5 million participation in the loan. Regas allegedly steered the loan through the Mutual Bank approval process and did not abstain from voting to approve the loan. Regas is alleged to have abandoned his fiduciary duty to Mutual Bank in favor of the other bank and his friend. The loss to the bank from the loan is alleged to be approximately $24.5 million.

 

This latest complaint is the 16th lawsuit that the FDIC has filed in connection with the current wave of bank failures, but so far as I am aware, it is the first in which the FDIC has named a failed bank’s outside lawyer and law firm as defendants. During the last round of bank failures in the S&L crisis, the FDIC pursued an aggressive litigation approach and often included failed bank’s lawyers or law firms as defendant. In many of those cases, as here, the lawyer defendants had served on the failed bank’s board and were alleged to have engaged in conflicts of interest. That prior history and the presence of those types of allegations here suggests that we are not about to see a comprehensive campaign against the outside law firms of failed banks. The firms or their lawyers are relatively unlikely to get drawn into the type of failed bank litigation if the firm did not have an attorney on the failed bank’s board or did not otherwise allegedly engage in conflicts of interest.

 

Out of the 16 failed bank lawsuits the FDIC has filed so far, this is the fourth involving an Illinois Bank (there have also been four lawsuits so far involving failed banks in California and Georgia, respectively). Like many of the lawsuit filed so far, this one was not filed until more than two years had elapsed since the bank’s closure. Given the fact that the bank closures did not really peak until late 2009 and early 2010, and allowing for that two year plus lag time, we could start to see increasing numbers of additional FDIC failed bank lawsuits in the months ahead.

 

Special thanks to a loyal reader for providing a copy of the Mutual Bank complaint.

 

According to data from the American Bankruptcy Institute, the high water market for business bankruptcies during the financial crisis occurred during the second quarter of 2009, when there were 16,014 business bankruptcies. The number of business bankruptcies has declined each quarter since then.  During the second quarter of 2011, there were 12,304 business bankruptcies, representing a decline of about 23% from the quarterly high two years prior.

 

But while the quarterly business bankruptcy filings are down from the credit crisis highs, they still remain at elevated levels. If you compare the 12,304 business bankruptcy filings during the second quarter of 2011 to the quarterly filing levels prior to the fourth quarter of 2008, the 2Q11 filing levels are higher than any quarter since the first quarter of 1998 (when there were 12,410 business bankruptcy filings). So even though the number of bankruptcy filings has declined over the last two years, there are still very significant numbers of businesses filing for bankruptcy.

 

In addition, there are some concerns that we could be in for a new round of increased bankruptcy filings. In an October 10, 2011 Reuters article entitled “New U.S. Bankruptcy Ripples May Emerge in Tough Economy” (here) the authors suggest that “corporate failures may be about to pick up again, with some big-name companies struggling for survival.” Among the factors the authors cite as possible causes for a new round of bankruptcy filings are “the weak economy, lackluster consumer spending, a shaky junk-bond market and increasingly tight lending practices.”

 

The authors also suggest that some companies that managed to get through the last couple of years by restructuring may now have to face the music. The article’s authors note that “confidence in the economy and easy access to debt allowed companies to complete restructurings in 2009 and 2010 with business plans and debt loads that were based on an economic pickup that has now faltered.” These circumstances “could create the potential for trouble at companies that have already restructured once.”

 

An October 26, 2011 article in Corporate Counsel entitled “Bankruptcies Are Down, But the Business Picture Still Isn’t Rosy” (here) sounds many of the same themes. The article’s author notes that while business bankruptcy filings are down, many lenders are burdened with underperforming and nonperforming loans.  Eventually, push will come to shove on these loans.  The article quotes one leading practitioner as saying that activity is up and that 2012 “will be a busy year” and that 2013 and 2014 will be “extraordinarily busy year for restructurings.” In addition there are “huge maturities” coming due in 2014 and 2015. These circumstances could force many companies to seek protection under the bankruptcy laws.

 

The Reuters article linked above identifies a number of high profile companies, including American Airlines and Kodak, that could face bankruptcy filings. The article also references struggling companies in “industries as diverse as shipping, tourism, media, energy and real estate.”

 

Of course whether there actually will be an uptick in business bankruptcy filings remains to be seen.  But the concerns expressed above underscore the vulnerabilities that financially insecure companies may still be facing. Because of the high claims frequency associated with bankruptcy, these vulnerabilities also imply heightened liability exposures as well. Unless and until the financial recovery picks up sufficient steam to provide positive economic momentum even for financially weak companies, these companies will continue to face both the vulnerabilities and liability risks.  

 

Perspective on U.S. Securities Laws:  In an earlier post (here), I noted the dismissal that had been granted in one of the securities class action lawsuits brought against a U.S.-listed Chinese company, North East Petroleum Holdings, Ltd. An October 27, 2011 China Daily article (here) discusses the ruling in the case. The article also contains some interesting commentary from a U.S-based executive of the company.

 

The article quotes Choa Jiang, described as senior vice-president of the company’s New York City office, as saying that as a result of “internal control deficiencies” the company’s CEO, CFO and a director were asked to resign. The company, Chao says, experienced “growing pains” as it made the transition from a private, family-owned business in China to a U.S.-listed company. But, Chao adds, the company “has learned its lesson,” adding that the company is “learning that the laws regulations, operations and culture in the U.S. are different from those in China.” Chao says that “what’s important is that you correct your mistakes, learn from them and move on.” Chao also said that company wants “to encourage other Chinese companies not to lose faith but vigorously defend themselves with the very best professionals.”

 

It seems that a number of Chinese companies will have the opportunity to defend themselves vigorously, as lawsuits against U.S.-based Chinese companies continue to mount. Just in the last several days there have been new securities class actions brought against JinkoSolar Holding Co. (about which refer here) CNInsure (refer here) and China Automotive Systems (refer here), all three U.S. listed Chinese companies. With the addition of these three latest lawsuits, the number of U.S. –listed Chinese companies that have been named in securities class action lawsuits during 2011 now stands at 35. These companies, like North East Petroleum Holdings, also have the opportunity to learn that in the U.S., laws, regulations, operations and culture are different than those in China.

 

That’s Billion With a “B”: Those readers interested in Bank of America’s massive $8.5 billion mortgage put-back settlement will want to read the October 19,  2011 Forbes article about Kathy Patrick, the plaintiffs’ lawyer who negotiated the settlement on behalf of a large group of institutional investors. The article, entitled “Wall Street’s New Nightmare” (here) makes it clear that, as far as Patrick is concerned, the Bank of America settlement is merely round one. Among other things, Patrick states that the institutional investor plaintiffs in the case “did not come together just to deal with Bank of America. They came together because they wanted a comprehensive industry wide strategy and an industry wide solution. They started with Bank of America because they thought they could achieve a template that they could extend to other institutions. “

 

In other words, at least according to Patrick, she is just getting started. Of course there is the small matter of defending the $8.5 billion BofA settlement from the all comers assault it is currently under. 

 

Did you go to bed in the Seventh Inning when Adrian Beltre and Nelson Cruz hit back to back jacks for the Rangers and the Rangers also added an additional insurance run to go up 7-4 in the Seventh Inning?

 

Did you go to bed  in the Eighth Inning when Mike Adams of the Rangers retired Rafael Furcal with the bases loaded and the score 7-5?

 

Did you go to bed in the 10th Inning when Josh Hamilton hit a two run shot to put the Rangers up 9-7?

 

Did you think when the Cardinals were down to their last strike – their last strike – in both the ninth and tenth innings that the game was over? Or even worse, were you one of those baseball purists who thought this was a boring World Series and so you missed the whole thing?

 

Too bad if you missed this game. This game was a classic and will be remembered forever as one of the great World Series games. And when hometown hero David Freese hit the game winning walk off home run on a 3-2 pitch in the bottom of the 11th inning to send the Series to Game Seven, those of us who were still awake – who were rewarded for our belief that if we kept watching amazing things would keep happening – we saw one of the most astonishing clutch performances of all times. Not once, but several times.

 

Just to put this in perspective. Down 7-4 in the Seventh, the Cardinals scored in the Eighth (to make it 7-5), in the Ninth (to make it 7-7), in the Tenth (to come back to tie it 9-9 after Josh Hamilton’s two-run homer in the top of the inning had put the Rangers ahead, 9-7) and in the Eleventh (when David Freese hit a homer to straight-away center field to win the game, 10-9).

 

David Freese not only hit the game winner in the Eleventh Inning, but in the bottom of the Ninth, and when down to his last strike, he also hit a game tying two run triple. And in the bottom of the Tenth, Lance Berkman, grey beard and all, and also down to his last strike, hit a bullet into right center to tie the game yet again.

 

How many ties? How many lead changes? How many times when it looked like the Rangers had this game put away? So much more to talk about. Like pitcher Kyle Lohse, who came in to pinch hit for the Cardinals in the Tenth Inning because Tony LaRussa was completely out of bench position players, and who executed an absolutely perfect bunt in the teeth of the wheel play to put runners on second and third. Yes, there were a ton of errors early in the game. But still and all, this was October baseball at its finest.

 

Is there anything better than a World Series that goes to seven games?

 

One final thought. I have always wanted to be a major league baseball player. Rangers pitcher Derek Holland has always wanted a moustache. I would say we are dead even.

 

After the October 19, 2011 news that Citigroup  had reached an agreement to pay $285 million settle SEC charges that it had misled investors in a $1 billion collateralized debt obligation linked to risky mortgages, a number of commentators raised questions about the settlement.

 

Among other concerns noted was that neither the SEC’s action nor settlement targeted or even identified the senior level executives who were responsible for the alleged misconduct. The proposed settlement was also compared unfavorably with the much larger settlement amount to which Goldman Sachs had agreed to pay to settle similar allegations. Commentators also noted that though upper level executives were not charged in the action, like the Goldman case a lower level operative was targeted, seemingly for having had the misfortune of having sent an indiscrete email. A particularly good critique of the settlement appears in Jesse Eisenger’s October 26, 2011 post on the New York Times Dealbook blog (here).

 

As luck would have it, the settlement (supposedly as a result of a random lottery) landed on the desk of Southern District of New York Judge Jed Rakoff, who famously refused to accept a prior settlement of the SEC”s action against BofA (about which refer here). In March 2011, Rakoff also challenged the SEC’s settlement with Vitesse Semiconductor (about which refer here).

 

As it turns out, Judge Rakoff has some questions about this settlement, too – nine of them, to be precise.

 

In a very pointed October 27, 2011 order (here), Judge Rakoff scheduled a November 9, 2011 hearing at which the parties were directed to be prepared to answer nine specific questions about the settlement. He also said that the parties were “permitted, but not required” to file written answers to his questions in advance of the hearing.

 

Among other things, Rakoff has asked why he should enter judgment in a case “In which the S.E.C. alleges a serious securities fraud but the defendant neither admits nor denies wrongdoing?” He also asked whether the SEC’s mandate to ensure transparency in the financial markets might provide “an overriding public interest in determining whether the S.E.C.’s charges are true,” particularly “when there is no parallel criminal case?”

 

Like many of the commentators, Judge Rakoff also viewed this proposed settlement in contrast to the $535 million Goldman Sachs settlement. He asked specifically how the $95 million penalty portion of the proposed $285 million settlement was calculated, given that it is “less than one-fifth” of the penalty assessed in the Goldman Sachs case.  

 

Judge Rakoff also questioned why the penalty is to be “paid in large part by Citgroup and its shareholders rather than by the ‘culpable individual offenders acting for the corporation.’”

 

The most challenging question Rakoff posed was his final query: “How can a securities fraud of this nature and magnitude be the result simply of negligence?”

 

Many of Judge Rakoff’s questions might well be asked in connection with many SEC enforcement action settlements, in which corporate parties routinely settle the action pay paying specified sums out of corporate resources without admitting or denying wrongdoing. However, the parties to these settlements are rarely challenged as Judge Rakoff has challenged the parties here to justify the settlement. However it is worth noting that Judge Rakoff asked several similarly challenging questions when he rejected the BofA settlement in 2009, but he ultimately (“reluctantly”) approved a revised settlement that arguably presented many of the same features of the original settlement. (Judge Rakoff discussed the BofA settlement in a speech at the Stanford Directors’ College in June 2010, as noted here.)

 

There will be those who believe that it is about time that somebody started asking these kinds of questions. But at the same time, it is worth noting that if companies must admit to wrongdoing in order to settle SEC enforcement actions, or if senior executives’ complicity must be alleged or even established in order for a settlement to be approved, it will be far more difficult for SEC enforcement actions to be resolved. Indeed, one clear implication if more courts start asking these kinds of questions about proposed SEC enforcement action settlements is that fewer cases will settle and more will have to go to trial. Even if more trials would advance the truth-telling function of SEC enforcement, it would also add enormous costs both for the SEC and for the corporate defendants. Whether the SEC could sustain the same level of enforcement activity if it had to absorb the added burdens and expense involved with more trials is one question. The added burden and expense for the corporate defendants presents other questions.

 

As noted in a guest post on this blog by Maurice Pesso of the White & Williams firm (here), the potential barriers to settlement posed by the kinds of questions Judge Rakoff has asked here may also present some significant challenges for D&O insurers, who often are paying the costs of defense associated with SEC enforcement actions.

 

An October 27, 2011 Bloomberg article discussing Judge Rakoff’s questions about the Citigroup settlement can be found here. Peter Lattman’s October 27, 2011 post on the New York Times Dealbook blog about Rakoff’s questions can be found here.