A federal court has denied the motion of former IndyMac CEO Matthew Perry to dismiss the action that the FDIC, as the failed bank’s receiver, had filed against him. In a December 13, 2011 order (here), Central District of California Judge Otis D. Wright II held that under California law the business judgment rule does not protect officers’ corporate decisions and accordingly he rejected Perry’s argument that the FDIC’s complaint must be dismissed for failure to plead around the business judgment rule.

 

As discussed here, in July 2011, the FDIC as receiver for the failed IndyMac bank sued Perry alleging that as the bank’s CEO he had breached his duties to IndyMac and acted negligently in allowing IndyMac to continue to generate and acquire more than $10 billion in risky residential loans for sale into the secondary market. As the secondary market became unstable, the bank was forced to take the loans into its own investment portfolio, where the generated substantial losses, allegedly in excess of $600 million. IndyMac failed on July 11, 2008 and the FDIC was appointed as the bank’s receiver.

 

Perry moved to dismiss the FDIC’s complaint, arguing that the FDIC failed to allege facts sufficient to overcome the business judgment rule. Perry argued that the business judgment rule applies and insulates him from personal liability for his actions prior to IndyMac’s demise.

 

In opposing Perry’s motion, the FDIC argued that under California law the business judgment rule does not apply to officers. Judge Wright agreed. He concluded that the relevant legal authority does not support a conclusion that common law business judgment rule encompassing the general judicial policy of deference to business decisions should apply to officers. He also found that California’s statutory business judgment rule does not extend its protection to corporate officers. After reviewing the statute, applicable legislative history and relevant case law, he concluded that when the California legislature codified the business judgment rule, “it purposely excluded its application to corporate officers.” Because the FDIC’s allegations against Perry in his capacity as an office, Judge Wright denied his motion to dismiss.

 

Discussion

Historically, courts in applying the business judgment rule have not always carefully examined whether or not the rule’s protection should apply to officers as well as to directors. Over time, some have argued rather vigorously that the rule should not apply to officers. Others have argued that officers should be entitled to rely on the business judgment rule. Certainly it would seem that in those jurisdictions where officers and directors are held to have the same duties then they should be entitled to the same protections.

 

In any event, the question of whether or not an officer is entitled to the same protection under the business judgment rule as a director is a question of state law on which state law will control. Judge Wright’s decision is clearly reflection of his analysis under California state law. But though it is limited on that basis, his conclusion nevertheless highlights the interesting question whether as a matter of public policy the decisions and actions of corporate officers should enjoy the same protection under the business judgment rule as directors.

 

Setting aside the question of whether or not officers are entitled to the protection of the business judgment rule is the question of whether or not questions involving the applicability of the protections should be addressed at the motion to dismiss stage. There is the further procedural question of whether the plaintiffs must be expected to plead around the defense in order for their case to go forward, or whether the protections are in their nature more in the form of an affirmative defense to be invoked and substantiated by the defendant as the case goes forward. Judge Wright’s analysis does not examine these issues in detail but they present and added level of inquiry beyond the issues Judge Wright does address.

In any event, special thanks to a loyal reader for providing me with a copy of Judge Wright’s decision.

 

More About the FDIC’s Settlement with WaMu Executives: As was widely reported yesterday, the FDIC has settled the action it brought as receiver for the failed Washington Mutual bank against three former WaMu executives and their wives.  The early reports did not specify the amount of the settlement, but a December 14, 2011 Wall Street Journal article (here) fills in some of the missing details.

 

The total amount of the settlement is $64 million, consisting of about $400,000 from the settling parties themselves, and the balance of the cash amount to be paid by insurance. The executives are also to forego a total of $24 million in retirement benefits and bonus claims.

 

The Journal article also makes a tantalizingly brief mention of a prior $125 million settlement that the FDIC previously reached “to release claims against other former outside directors and officers.” As I noted here, there had been some suggestion in the press when the FDIC first filed its action against the three executives that the agency had separately settled or reached an agreement with the failed bank’s outside directors, but the brief mention in the Journal article is the first affirmative substantiation I have seen since that time referencing this separate settlement. Any readers that can shed light on this separate settlement are encouraged to pass along whatever information they can.

 

Whether the process is just winding down for the year or the process is actually winding down for good, the bank closure rate has recently fallen off dramatically. The FDIC has not taken over any banks for three weeks straight, with no bank closure at all so far during the month of December. And there were only five bank closures in November, after eleven in October.

 

With 90 bank failures so far in 2011, the total number of failed banks since January 1, 2008 stands at 412. The monthly high water mark during that four year period occured in July 2009, when the FDIC took control of 24 banks. More recently, the monthly numbers of bank failures has been well below the monthly high. But even if the rate of bank failures has more recently been down from those higher levels, the overall 2011 bank failure levels remain well above 2008 levels, when only 25 banks failed.

 

More than half of the bank failures so far this year have been concentrated in just four states, Georgia (which has had 23) and Florida (12), Illinois (9) and Colorado (6). The number of 2011 closures Colorado is a little bit unexpected, as during the preceding three years between 2008 and 2010, the state had a total of only three bank failures. The other three states, by contrast, have pretty much led the way throughout the current bank failure wave. Since 2008, Georgia has had a total of 74 bank failures; Florida has had 57; and Illinois has had 43. Bank closures in those three states, plus California (38) represent more than half (209) of the 412 bank failures between January 1, 2008 and today.

 

The number of lawsuits that the FDIC has filed so far against the former directors and officers of failed banks as part of the current bank failure wave currently stands at 17 (about which refer here, scroll down). The FDIC has maintained its very deliberate pace in initiating new lawsuits. However, this past week the agency did update the page on its website on which it discloses the number of lawsuits that has been authorized.

 

According to the FDIC’s site, as of December 8, 2011, the FDIC has authorized suits in connection with 41 failed institutions against 373 individuals for D&O liability for damage claims of at least $7.6 billion. These figures representing the authorized lawsuits contrast starkly with number of lawsuits that the agency has actually filed: So far, the agency has filed only 17 lawsuits against 135 former directors and officers of 16 failed financial institutions. Given the discrepancy between the number of suits authorized and the number of suits filed, there clearly are many more suits in the pipeline, with even more lawsuits likely to be authorized in the months ahead.

 

The FDIC’s website also mentions that that two of the 17 lawsuits it has filed so far already have settled. One of the two settlements occurred in the lawsuit the FDIC filed in connection with the failed First National Bank of Nevada. As discussed here, the FDIC and the defendants in that case settled for a stipulated judgment, the individual defendants’ assignment to the FDIC of their rights under the bank’s D&O insurance policy, a release of claims and the FDIC’s covenant not to execute the judgment against the individuals. The other of the other of the two settlements was entered in the lawsuits the FDIC had filed on connection with the failed Corn Belt Bank and Trust. In May 2011, the parties advised the court that they had settled the case, but the court file does not reflect the details of the settlement.

 

Though only two settlements have been announced, there are stories circulating that the FDIC has settled the lawsuit that the agency filed against three former directors and officers of failed Washington Mutual bank and their wives. Indeed, in an October 27, 2011 order in the case (here), Western District of Washington Marsha Pechman stayed all pending deadlines in the case, after noting that the parties had advised the court that the case had settled. (She gave the parties 60 days to complete their settlement and to file their settlement papers with the court.)

 

The amount of the purported WaMu settlement has not yet been disclosed, but there are a number of relevant data points that may suggest the likely settlement range. The recently announced $208.5 million settlement of the WaMu securities class action lawsuit included a $105 million settlement contribution on behalf of the individual director and officer defendants, to be funded entirely by D&O insurance.

 

In the settlement papers filed in connection with the WaMu securities class action settlement, it was disclosed that the $105 million in insurance proceeds were to be drawn from a D&O insurance tower (including both traditional and Excess Side A insurance) of $250 million. The $105 million contribution toward the WaMu securities class action settlement materially reduced the amount of insurance remaining in the tower, and it is likely the defense costs in the various actions pending against the former WaMu officers and directors further depleted the amount of insurance remaining.

 

The amount of the any settlement in the WaMu FDIC lawsuit remains to be seen and it also remains to be seen whether and to what extent the individuals might contribute toward the settlement out of their own assets. But the amount of insurance remaining is at this point likely to be under $100 million, so in the absence of any significant contribution from the individuals the amount of any cash settlement in the WaMu case is likely to be below $100 million. Given that the collapse of Washington Mutual was the largest bank failure in U.S. history, it will be interesting to see the amount of any settlement that ultimately does emerge.

 

The American Civil War Viewed from Other Shores: As detailed in Amanda Foreman’s massive book A World on Fire: Britain’s Crucial Role in the American Civil War, many individual Britons were so taken up with the apparently romantic appeal of the Confederacy that they enlisted in the Confederate Army. Many were convinced that the South would win its independence, and one Englishman was so certain that he converted “his entire savings into Confederate currency, while it was still cheap to buy.”

 

The British sympathies for the Southern Cause had many sources, but one of the most important was economic, as a significant part of the British mill industry was dependent on the import of cotton from the Southern States. But despite this obvious financial pull toward the Confederacy, the British Government remained officially neutral, in part because the government did not want to be drawn into the war, on either side. As the war progressed and the appalling numbers of casualties began to accumulate, a vocal peace party began to form in England, in the interests of stopping the carnage. Most of the supporters of this position believed (without any particular evidence) that the Confederacy would have to abandon slavery anyway, after the war ended.

 

It took two developments, both of which were agonizingly long in coming, for British sentiment to begin running in favor of the North and of the Union. The first was Lincoln’s Emancipation Proclamation, which allowed Northern supporters to contend that the purpose of the war was to end slavery. The real problem the supporters of the North faced was that for the first two years of the war, the North looked incapable of winning. Finally, after the tide finally turned at Gettysburg, the increasing likelihood of a Northern victory allowed the British political elites to begin to envision the possibility of a re-united country after the war concluded.

 

What Foreman does particularly well in this interesting and detailed book is to tell the tale of the battle for the hearts and minds of the British people while the actual war went forward back in the States. The British government’s official position may have been one of neutrality but it seems as if no one in Britain was personally neutral. After the surrender at Appomattox and shock of Lincoln’s assassination, the Britons rediscovered their natural affinities for their American cousins, and the groundwork was laid for a relationship that has ever since been described as “special.”

 

I heartily recommend this book, which the New York Times selected as one of the Ten Best Books of 2011.

 

With the addition of a $417 million settlement involving Lehman Brothers’ offering underwriters, the pending settlements in the Lehman Brothers securities class action lawsuit now total $507 million. Nate Raymond’s December 6, 2011 Am Law Litigation Daily article discussing the underwriters’ settlement can be found here. A copy of the December 2, 2011 settlement stipulation in the underwriter’s settlement can be found here.

 

As discussed at length here, earlier this year the former Lehman executives who were defendants in the securities class action lawsuit reached an agreement to settle the claims against them in the suit for $90 million. The executives’ settlement, if approved, is to be funded entirely with D&O insurance. The plaintiffs’ motion to the court for approval of the settlements can be found here.

 

The motion papers explain that the $417 million settlement with the underwriters was the result of mediation and over six months’ negotiation. The participants in the underwriter settlement include over 40 offering underwriters. The settling underwriters are listed in footnote 2 of the motion papers. The lineup makes for some interesting reading, as it almost reads like a casualty list from the credit crisis. Not only is Lehman Brothers not around any more, but neither are many of its underwriters. Some have been merged out of existence, and among the survivors are many that are only around as a result of the kind of massive government bailout that Lehman alone was forced to do without.

 

The settlement does not include Lehman’s auditor, Ernst & Young. As discussed here, Lehman’s accounting was the subject of sharp criticism in the report of bankruptcy examiner. The examiner referred to the companies now infamous “Repo 105” transactions as “balance sheet manipulation.” The examiner’s report also states that there may be a “colorable claim” against the company’s auditor on the grounds that it "did not meet professional standards" for its "failure to question and challenge improper or inadequate as disclosures."

 

According to the Am Law Litigation Daily article, the settlement also does not include UBS, which according to the article, “is facing different allegations than other underwriters because it underwrote principal protected notes, structured investment products that [the plaintiffs’ claim] were guaranteed regardless of Lehman’s bankruptcy.”

 

The stipulation does not state whether or not any portion of the $417 million is to be paid by insurance. I was also not able to find in the settlement stipulation how the amount is to be divided among the participating underwriters.

 

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

 

Readers interested in subprime and credit crisis-related securities class action lawsuit settlements will also want to take a look at Alison Frankel’s December 6, 2011 post on Thomson Reuters News & Insight (here) about the recent $315 Merrill Lynch MBS securities class action lawsuit. Frankel read the settlement-related filings very carefully, and she has a number of interesting observations about the methodology for calculating damages in the MBS securities cases, which in turn helps to explain how the parties reached their $315 million settlement.

 

D&O Insurance: Investigative Cost Coverage: As I have frequently noted on this blog, one of the recurring D&O insurance issues is the question of coverage for costs incurred in connection with SEC investigations, particularly with respect to costs before the SEC investigation has become formal.

 

In a November 21, 2011 memo entitled “When is an SEC Investigation a ‘Claim” for Purposes of D&O Coverage?” (here), attorney Joan L. Lewis of the Dickstein Shapiro firm takes a look at these recurring questions, and she compares two recent cases presenting these issues, the Office Depot case (about which refer here) and the MBIA case (refer here).

 

With a relatively recent purchase of an iPad 2, I have made a quantum leap in technology utilization. The iPad is not only a brilliant piece of technology in and of itself, but it is also a platform for a host of brilliant applications. Indeed, there are so many nifty applications that using my iPad has become a process of continuing discovery as I encounter new ways of using the device on virtually a daily basis.

 

In this post, I share the best applications I have discovered so far. My purposes are two-fold. First, I simply want to pass along the best of my discoveries – some of them are so cool. Second, I want to encourage readers to share with me and with the rest of The D&O Diary community their own iPad application discoveries. With as many as 70,000 apps available for the iPad now and more available every day, there have to been many more brilliant applications out there that I simply haven’t discovered yet.

 

Before I get into my apps review, I should clarify what in my view makes an application great. First it has to take advantage of the iPad itself, to do something more or better than a website alone can do. Second, it has to be free (or at least at no additional cost). As I discuss below, there are at least some apps for which I am willing to pay, but mostly my cheapskate requirements control. Third, the application has to be easy to install and to use.

 

I should also add that I am not a gamer, and so I don’t have any opinions about game applications. Readers who want game app recommendations will have to look elsewhere (like here for instance).

 

So without further ado, here is my list of favorite iPad apps (so far):

 

News: All of the leading news outlets have iPad apps. I have installed apps for the Wall Street Journal, the New York Times, the Financial Times, and the Economist. They are all pretty good and convenient when I find myself somewhere without access to the print editions of those publications. Overall, though, I prefer reading the print versions. On the other hand, I don’t have print subscriptions to all of them, and it is convenient to be able to browse through them through a single device in one easy to navigate environment. There is something tidy and comfortable about sitting in my easy chair and accessing all of these publications using a single device.

 

But something better than a bunch of separate applications is a single application that assembles the news in one easy to access and navigate environment. The best iPad news application along these lines is Flipboard. This application has an elegant interface that you can flick through like pages of a magazine. The application assembles news headlines from a host of publications around the world and displays them in an attractive, easy to read format. You can also have your Facebook and Twitter feeds forwarded into the application so that they are presented in the same attractive format.

 

Music: One of the things that the iPad does particularly well is provide a platform for listening to music. I use a couple of different music apps, and I like them for slightly different reasons.

 

I like to listen to classical music when I am working, so using the Pandora application, I have assembled a group of “stations” all built around one of the classical music composer (Mozart, Chopin, Telemann, etc.). Then when I access Pandora, I set the “play” function on “Quick Mix” so that the playlist draws randomly from the various stations. (You can do the same thing for contemporary artists, too.) There are occasional short commercials on Pandora, which I don’t particularly like but don’t particularly mind either.

 

When I ride the exercycle, I like to listen to classic rock and alternative rock. For this type of music, I prefer the I Heart Radio application, which has a directory of radio stations from around the country, organized by genre. I have assembled a group of favorite stations that I regularly listen to. The directory also includes a number of commercial free stations as well, which I particularly like. One cool feature of this application is that you can touch the icon for any particular station and a bubble will appear above the station showing  the title and artist of the song playing on the station at that moment. This feature allows you to quickly move between songs and stations to hear the music you want to hear.

 

Sports: Some of the best applications I have found are sports-related. I should add that one of my goals in getting the iPad in the first place was to be able to watch sports on the road while I am traveling. I particularly hoped to be able to have access to European soccer. The good news is that there are some terrific sports applications out there.

 

By far the best application available for the iPad in my humble opinion is the Watch ESPN app. Not only does the app allow you to watch the various ESPN channels live, but it also provides live programming that the usual ESPN cable service line up doesn’t include. (The service is free but in order to access it, you have to subscribe to a participating cable service.)

 

The best part of the Watch ESPN app is a feature that you might not even find unless you were looking for it. On the page for ESPN Channel 3, there is a “Replay” tab, where all of the accumulated ESPN sports event broadcasts are archived. The archive operates real time, so as soon as a program has concluded, it is available in the archive. The archive includes ESPN programming from around the world, and so the list of replays available is exponentially greater than the small handful of games and shows you might be able to watch on the ESPN channels on your TV.

 

The programming available using the Replay tab is incredibly diverse, and pertinent to my purposes, includes a wealth of European soccer games. (It also includes, for example, Rugby, Cricket, European Hockey, Polo, and many other sports as well.) I am able to follow and watch complete games from all of the top European soccer leagues, including the Premier League, La Liga, Serie A, Eredivisie, the Bundesliga, and Ligue 1. The replays also include some Euro 2012 qualifying games and some UEFA Champions League games, usually the ones that I want to see anyway. Some international friendly competitions are also included. Though these games are not shown live, given the time difference between Europe and the US, I would rarely be able to watch these games live anyway. The ability to watch these complete games in crystal clear quality – and for free – is absolutely fantastic.

 

There are some other apps that are particularly good for following European soccer. The Fox Soccer 2Go application allows you to watch short, same-day highlight videos of all of the English Premier League games, and some other European leagues as well. The video highlights also include same-day UEFA Champions league games and Euro 2010 qualifiers. Fox Soccer also has a fee-service that allows you to access live game day broadcasts of many European league games, but the monthly $19.99 access fee violates all of my cheapskate principles.

 

Another site I can recommend for following European soccer is actually available only through a conventional web browser, not as an iPad application, but the site is formatted so that it performs well on the iPad. The site is GOL TV, the Spanish-language soccer network. The site hosts game day video highlights of a number of the European leagues, including some (like the Portuguese league) that ESPN and Fox Soccer don’t follow as closely. The site’s video replay function has a full-screen feature that adapts particularly well to the iPad.

 

One of the most remarkable applications I have discovered – and the only one for which I have been willing to pay more than a nominal fee – is the Sling Player app. This app must be used in conjunction with the Slingbox, which is a device that attaches to your TV set top cable box. The Slingbox takes your cable TV signal and makes it available on the Internet, so that you can watch television on any Internet-connected device. (A tip of the hat here to my friend Rick Bortnick, who is the one who first told me about Slingbox.)

 

Using the SlingPlayer application, I can now watch “my TV” on my iPad, anywhere in the world. Say, I am stuck in an airport on a flight delay; I can watch any basketball, or football, or whatever game that is showing on my TV. Or, as I did during a flight delay on Monday, I can watch a replay of “The Hangover,” sitting at the gate waiting for my flight to board.

 

The idea that you don’t need a TV to watch TV is absolutely fantastic. This is one of the things I was thinking of when I said at the outset of this post that I have made a quantum leap in technology utilization. The lines between devices and functions have been reduced to the point of meaninglessness. And for anybody who is thinking, geez, I could do all that with my laptop, all I can say is you are not visualizing the ease of use and flexibility of the iPad (for example, its instant on/instant off capability, and the absence of any need for an operating system and all of your programs to load before you can even use the device).

 

Cool Apps: Finally there are some apps that are just cool. Trying to list them all here would be impossible. I have included just four here, really by way of illustration, and as part of the invitation to others to share their favorite apps with me and with other readers:  National Geographic World Atlas: Provides access to an entire library of maps (worth the $1.99 charge); Marvel Comics: Yes, you can use your iPad to read Shakespeare, but isn’t it cool that you can also use it to read comics (for free!): Epicurious: Access over 30,000 recipes displayed in a beautiful format; Google Translate: provides translations for over 60 languages, including spoken translations for many languages.

 

So I have been happy to share my favorite applications here; I hope readers out there with their own favorite apps will share them with me and with the rest of The D&O Diary community using the comment feature. I have to go now, there’s a game on….

 

In an interesting twist on a long –running credit-crisis related securities suit, Wells Fargo has agreed to pay $75 million to settle the Wachovia equity investor securities class action lawsuit, even though their suit had been dismissed at the district court level and was on appeal at the time of the settlement. The parties’ November 21, 2011 notification of the settlement to Southern District of New York Judge Richard Sullivan can be found here. Victor Li’s December 3, 2011 Am Law Litigation Daily article about the settlement can be found here.

 

The settlement relates to litigation brought by former equity shareholders and bondholders of Wachovia Corporation.  The equity securities holders’ and bondholders’ actions arise from  financial disintegration Wachovia experienced between its 2006 purchase of Golden West Financial Corporation and its 2008 merger with Wells Fargo & Company. The allegations are based on the difficulties Wachovia experienced as a result of the Golden West “Pick-A-Pay” mortgage portfolio. Further background regarding the equity securities litigation can be found here and background regarding the bondholders’ litigation can be found here.

 

As discussed here, on March 31, 2011, Southern District of New York Judge Richard Sullivan granted the defendants’ motions to dismiss the equity securities litigation, but he denied the motion to dismiss the bondholders’ action, other than with respect to certain bond offerings in which the plaintiffs had not actually purchased any securities. A copy of Judge Sullivan’s opinion can be found (here),

 

Judge Sullivan granted the defendants’ motions to dismiss the equity securities plaintiffs’ ’34 Act claims, finding that the plaintiffs had not sufficiently alleged scienter. Judge Sullivan concluded that the “more compelling inference” is that “Defendants simply did not anticipate the full extent of the mortgage crisis and the resulting implications for the Pick-A-Pay loan portfolio. Although a colossal blunder with grave consequences for many, such a failure is simply not enough to support a claim for securities fraud.” He added that “bad judgment and poor management are not fraud, even when they lead to the demise of a once venerable financial institution.”

 

Judge Sullivan also granted the defendants’ motion to dismiss the equity securities plaintiffs’ ’33 Act claims, finding that their “scattershot pleadings” failed to “afford proper notice, much less provide facially plausible factual allegations.” He added that he could not conclude “that the relevant offering documents contained material omissions in violation of affirmative disclosure obligations.”

 

Thereafter, the bondholders, whose case survived Judge Sullivan’s dismissal motion rulings, went on to settle their lawsuit for a total of $627 million, which, as discussed here, is the largest settlement to date as part of the subprime and credit crisis-related litigation wave. The settlement amount of $627 million represented two different settlement funds: $590 million on behalf of the Wachovia defendants, including 25 former directors and officers of Wachovia, as well as 72 different financial firms that underwrote bond offerings for Wachovia between 2006 and 2008; and $37 million on behalf of Wachovia’s auditor, KPMG.

 

Meanwhile, the Wachovia equity investors, whose action Judge Sullivan had dismissed, had appealed the dismissal to the Second Circuit. In an apparent move to avoid having the case revived on appeal, Wells Fargo has now agreed to pay $75 million to settle the equity investors’ suit. The case must be remanded from the Second Circuit in order for the settlement to be presented to the district court for approval.

 

As I noted at the time of the $627 million settlement with the Wachovia bondholders, Wachovia’s purchase of Golden West has to be one of the leading candidates for the title of worst deal leading into or as part of the credit crisis-related financial transactions. There is a lot of competition in the worst transaction category, including Bank of America’s purchase of Countrywide. But there is no doubt that the Golden West deal is one of the real stinkers.

 

From the perspective of Wells Fargo, the litigation consequences for the bank from the mortgage meltdown are becoming rather impressive. When you consider this $75 million settlement and he Wachovia defendants’ $590 contribution to the bondholders’ settlement, which came on the heels of the $125 million Wells Fargo mortgage backed securities settlement (about which refer here), it looks like the financial crisis litigation consequences for Wells Fargo have been massive . The bank’s current aggregate settlement costs of $790 million may provide some explanation why it preferred to settle this case than to run the risk that the securityholders might succeed in having the dismissal of their case overturned on appeal.

 

The $75 million Wachovia equity investors’ settlement comes on the heels of the public disclosure of the $315 million Merrill Lynch mortgage-backed securities settlement, which Alison Frankel first reported in a November 18, 2011 article on Thomson Reuters News & Insight (here). Though the fact and amount of the settlement have been public for a couple of weeks, the parties have only just now filed their actual stipulation of settlement, dated December 5, 2011 (here). The $315 Merrill settlement dwarfs Wells Fargo’s earlier $125 million MBS settlement, which has stood as the largest MBS-related settlement so far.

 

In the Merrill Lynch MBS lawsuit, the plaintiffs alleged that the defendants (Merrill Lynch and related Merrill entities; certain other underwriter defendants and certain Merrill officers) had mislead investors who purchased the MBS securities, through statements in the securities’ offering documents that misrepresented the quality of the loans and the adequacy of the collateral within the loan pools.

 

Like Wells Fargo, Merrill and its acquirer Bank of America have also now paid out or at least agreed to pay out an impressive aggregate amount in subprime and credit crisis-related securities lawsuit settlements. As discussed here, Merrill had previously settled the subprime-related securities lawsuit brought by its shareholders for $475 mm, and had also settled the related ERISA lawsuit for $75 million.   Merrill separately settled the subprime-related lawsuit brought by its bondholders for $150 million (refer here). With the addition of the recent $315 MBS settlement, Merrill’s aggregate settlements are now up to $1.015 bb.

 

And to line up everything in its proper category, the $624 million Countrywide settlement, in addition to the $1.015 bb of Merrill settlements, all arguably belong on BofA’s ledger. The Merrill and Countrywide settlements altogether total about $1.639 billion, or fully 40 percent of all of the subprime and credit crisis related lawsuit settlement amounts so far (which total about $3.913 billion). These Merrill and Countrywide settlements plus the Wells Fargo settlements total $2.48 billion, which reresents almost 64% of the aggregate amount of the subprime and credit crisis related lawsuits settlements to date

 

What the Merrill, Countrywide and Wachovia/Wells Fargo settlements have in common, in addition to representing the largest of the subprime and credit crisis related lawsuit settlements, is that in each case the corporate defendant is now part of a financially strong successor in interest. This circumstance contrasts significantly with other subprime and credit crisis cases – like those involving Lehman Brothers and Washington Mutual, for instance – where the corporate defendants are defunct and there is no solvent successor in interest. Securities suits involving these defunct companies have settled for much smaller amounts that those involving solvent companies.

 

I have in any event added the Wachovia equity investors’ settlement and the Merrill MBS settlement to my running tally of subprime and credit crisis-related securities class action lawsuit case resolutions, which can be accessed here.

 

Despite marked alleged differences between revenues and profits reported in China Century Dragon Media’s U.S. IPO prospectus and the equivalent figures reported in its Chinese operations’ filings in China, a federal court has granted the dismissal motion in the securities class action lawsuit filed against the U.S.-listed Chinese company.

 

On November 30, 2011, Central District of California Judge John Kronstadt granted China Century Dragon Media’s motion to dismiss (without prejudice, it should be noted), finding that the plaintiffs had not sufficiently alleged that the figures the company reported in its offering documents were false. Although this is not the first time a dismissal motion has been granted in a securities suit involving a U.S.-listed Chinese company, Judge Kronstadt’s ruling may represent the first time a motion to dismiss was granted in a securities suit against one of the Chinese companies based on a assessment of the sufficiency of the factual allegations. A copy of Judge Kronstadt’s ruling can be found here.

  

Background

China Century Dragon Media sells advertising on Chinese television. Its Chinese operations are conducted through Beijing CD Media Advertising Co. China Century Dragon Media controls all of Beijing CD Media Advertising through contractual relationships between subsidiaries of China Century Dragon Media and Beijing CD Media Advertising.

 

China Century Dragon Media conducted an IPO in the NYSE Amex exchange on February 7, 2011. On March 28, 2011, the company announced that its auditor, MaloneBailey had submitted a resignation letter in which the auditor cited “discrepancies,” “irregularities” and the possibility that the company’s accounting records may have been “falsified.” Amex halted trading in the company’s shares. Shareholder litigation ensued. Separately, on June 21, 2011, the SEC initiated proceedings to dtetermine whether or not it should issue a stop order suspending the effectiveness of the company’s registration statement (refer here).

 

In their amended complaint, the plaintiffs allege, among other things that the revenue and profit figures the company reported in its Prospectus differed substantially from figures that Beijing CD Media Advertising reported to the Chinese State Administration for Industry and Commerce (SAIC). The plaintiffs allege that the Prospectus reports, for fiscal year 2008, that the company had revenues $45 million and profits of more than $8 million, and for fiscal year 2009, the company had revenues of about $75 million and profits of nearly $15 million. By contrast, the plaintiffs allege, Beijing CD Media Advertising’s filings with the SAIC reported FY 2008 revenues of $15 million and profits of only about $360,000, and FY 2009 revenues of only $9.5 million and profits of only $260,000.

 

The plaintiffs allege that because all of China Century Media Dragon’s operations run though Beijing CD Media Advertising, the financial information reported to the SEC and to the SAIC should be substantially the same. The plaintiffs allege that the lesser figures reported to the SAIC are the true figures and that the figures reported in China Century Media Dragon’s prospectus were false and misleading. The defendants moved to dismiss.

 

The November 30 Order

In his November 30 order granting the defendants’ motion to dismiss, Judge Kronstadt first determined that though the plaintiffs asserted claims only under the ’33 Act, their claims “sound in fraud” and therefore must meet the heightened standards for pleading fraud under Fed.R.Civ.P 9(b).

 

Judge Kronstadt found that the plaintiffs’ allegations “fail to meet the heightened standard of pleading with respect to the claim that the profit and revenue reports in the SEC filings were false.” Though the CSAIC numbers and the SEC numbers were different, that is “merely consistent with” the possibility that the SEC figures were false, but “does not suffice to make that claim plausible.” In order to establish that the SEC figures and not the CSAIC figures are false, the plaintiffs must “plead with greater specificity.”

 

In order to establish the requisite specificity, the plaintiffs could, Judge Kronstadt suggested, allege that “Chinese and American accounting standards are sufficiently similar such that the SAIC and SEC numbers should be substantially the same,” or that “Defendants relied on the same underlying financial data in preparing the SEC and SAIC reports.”

 

Accordingly, Judge Kronstadt granted the defendants’ motion to dismiss, with leave to amend

.

Discussion

Judge Kronstadt’s ruling does not represent the first occasion on which the motion to dismiss has been granted in one of the many securities suits that have been filed against U.S.-listed Chinese companies since the beginning of 2010. For example, as noted here, in October 2011, the motion to dismiss was granted in the securities lawsuit involving China North East Petroleum. However the dismissal of that case, on loss causation grounds, was based on the fact that the plaintiffs had failed to sell their shares at a profit when the company’s share price spiked after its initial plunge on disappointing news. The dismissal in the China North East Petroleum case was due to the unusual circumstances surrounding the movement of the company’s share price. The ruling in the China North East Petroleum case did not address the sufficiency of the plaintiffs’ substantive allegations.

 

So Judge Kronstadt’s ruling apparently represents the first occasion as part of the current wave of securities suits against U.S.-listed Chinese companies when a dismissal motion was granted based on the insufficiency of the substantive factual allegations. This ruling is all the more striking given the circumstances surrounding the resignation of the company’s auditor, which came just weeks after the company’s U.S. IPO.

 

It should be emphasized, however, that the dismissal was without prejudice; the plaintiffs were given leave to replead their allegations. In preparing the amended pleadings, the plaintiffs will be aided by Judge Kronstadt’s observations about what kinds of factual allegations would be sufficient to establish that the financial figures reported in the company’s prospectus were false. Although it remains to be seen, the plaintiffs may well be able to overcome the initial pleading threshold after they amend their complaint.

 

And while the motions to dismiss were granted in this case and the China North East Petroleum cases, the dismissal motions have been denied in other securities suits involving U.S.-listed Chinese companies, including in the case involving Orient Paper (refer here); and in the case involving China Educational Alliance (refer here). To be sure, even in those cases in which the plaintiffs’ claims survive the initial pleading threshold, their claims stiff face substantial challenges, not the least of which are problems involved with effecting service of process and in conducting discovery in China, as well as deriving from the geographic distances and language issues involved. (Refer here)

 

Notwithstanding these challenges involved, plaintiffs’ lawyers continue to pursue claims involving U.S.-listed Chinese companies. For example, during November 2011, two more securities suits were filed involving Chinese companies: On November 16, 2011, a lawsuit was filed involving Keyuan Pharmaceuticals (about which refer here), and on November 29, 2011, an action was filed involving China Organic Agriculture (refer here).

 

With these latest lawsuits, there have now been a total of 37 cases filed so far this year against U.S.-listed Chinese companies, and since January 1, 2010, there have been a total of 48, representing a significant part of all class action securities lawsuit filings during that period.

 

 

What Better Place to Sink Your Money than a Publicly Traded Hole in the Ground?: There are many reasons why the various Chinese companies are running into difficulties in the U.S. Many of the companies may not have been prepared for the burdens and responsibilities involved with a U.S.-listing. For other companies, there may be a question whether or not the company should have been publicly listed in the first place.

 

Many of these questions may well be asked about the U.S.-listing of cave near the remote village of Yishui, in China. As discussed in a December 2, 2011 New Yorker online article entitled “China’s Cave, Inc.” (here), the cave bills itself as one of the “Top Ten Tourist Attractions in Shandong” and China’s “Underground Grand Canyon.” The cave company, BHTC XV, obtained a U.S.-listing through a reverse merger with a public traded shell; its shares trade over-the-counter.

 

There are no financial or accounting issues involving this company, and the cave may be a stellar tourist attraction. But one may well ask whether a U.S. listing really is a good idea for a company like this. The mere fact that a company like this went through the reverse merger whirlygig underscores how out of hand the whole process became. No wonder there were some problems when the music stopped. 

 

Finally ending a case first filed back in October 2004 and that involved one of the few securities lawsuits to go to trial, the parties to the long-running Apollo Group securities suit have reached an agreement to settle the case for $145 million. This resolution is interesting not only because it concludes a long- running case with a complex procedural history, but also because the settlement amount appears to represent substantially less than the $277.5 million value that observers had placed on the plaintiffs’ January 2008 jury verdict.

 

District of Arizona Judge James A. Teilborg’s November 29, 2011 order preliminarily approving the $145 million settlement can be found here. The parties’ stipulation of settlement is attached to the November 29 order. David Bario’s December 2, 2011 Am Law Litigation Daily article, in which the settlement was first reported, can be found here.

 

It would be quite an understatement to say that this case has had a long and complex procedural history.

 

As detailed in greater length here, plaintiffs filed the suit after the company’s share price declined following the disclosure of a U.S. Department of Education report alleging that the company had violated DOE rules. On September 7, 2004, the company agreed to pay $9.8 million to settle the allegations. News of the settlement first became public on September 14, 2004, but the company’s share price did not actually decline until September 21, 2004, when a securities analyst issued a report expressing concern about the company’s possible exposure to future regulatory issues.

　

On January 16, 2008, a civil jury entered a verdict in favor of the plaintiff class on all counts, awarding damages of $5.55 per share, estimated at the time to represent $277.5 million. Under the verdict, Apollo is responsible for 60 percent of the plaintiffs’ losses, former Apollo CEO Tony Nelson is responsible for 30 percent, and former CFO Kenda Gonzales is responsible for 10 percent. The jury verdict is discussed at greater length here.

　

As discussed in greater length here, on August 4, 2008, Judge Teilborg entered an order (here) granting the defendants’ motion for judgment as a matter of law, based on his finding that the trial testimony did not support the jury’s finding of loss causation. Judge Teilborg’s order vacated the judgment and entered judgment in defendants’ favor.

 

In its post-trial motion, Apollo argued that the evidence at trial was insufficient to support a finding that the analyst reports represented "corrective disclosure," because they did not contain any new fraud-revealing information. Judge Teilborg found that "the evidence at trial undercut all bases on which [the plaintiff] claimed the (analyst) reports were corrective."　

 

Accordingly, Judge Teilborg concluded that although the plaintiff "demonstrated that Apollo misled the markets in various ways concerning the DoE program review," the plaintiff "failed to prove that Apollo’s actions caused investors to suffer harm." The court therefore concluded that "Apollo is entitled to judgment as a matter of law."

 

In a June 23, 2010 opinion (here), a three-judge panel of the Ninth Circuit held that the district court "erred in granting Apollo judgment as a matter of law." The opinion states that "the jury could have reasonably found that the (analyst) reports following various newspaper articles were ‘corrective disclosures’ providing additional or more authoritative fraud-related information that deflated the stock price."

　

The Ninth Circuit further held that Apollo is not entitled to a new trial and that there is no basis for remittitur (reduction of the verdict). The Ninth Circuit reversed and remanded the case with "instructions that the district court enter judgment in accordance with the jury’s verdict."

 

The company filed a petition for writ of certiorari to the U.S. Supreme Court. As discussed here, on March 7, 2011, the Supreme Court denied Apollo Group’s petition for writ of certiorari, leaving the Ninth Circuit’s decision standing. The case then returned to the district court for further proceedings.

 

Upon the case’s return to the District Court, the defendants’ raised a number of issues in connection with the entry of judgment in the case. For example the defendants raised issues with respect to the individual eligibility of class members to secure recovery, the calculation and assessment of damages per claimant and the procedures with respect to claims administration and processing for resolution by the District Court. The defendants also maintained that they are entitled to conduct individual discovery and, potentially, jury or bench trials, to rebut the presumption of reliance on the integrity of the market price with respect to individual class members, among other things.

 

In light of the potential for these disputes to prolong the case and postpone the ultimate payment of to the plaintiff class, the parties agreed to enter mediation proceedings that ultimately resulted in the settlement of the case.

 

According to the parties’ settlement stipulation, the settlement amount of $145 million is to be paid by Apollo Group. The settlement stipulation does not mention any payment into the settlement by the individual defendants. The settlement stipulation does not indicate whether any of the $145 million is to be paid or reimbursed by insurance. The stipulation of settlement states that the lead plaintiffs may seek an award from the fund of up to 33.33% of the amount of the fund, plus expenses of $1.875 million. (A one-third fee award would amount to about $48.33 million). Defendants agreed in the stipulation that they will take no position with respect to the fee request.

 

The apparent gap between the $145 million settlement and the reported $277.5 million value of the jury verdict is hard to figure, especially since both amounts purportedly represented a value of $5.55 per share. In the Am Law Litigation Daily article linked above, defense counsel is quoted as saying that he doesn’t know where the original estimate of the value of the jury verdict came from, particularly given that predicting the number of damaged shares that would actually be claimed would be unknown until the claims process had played out — particularly given the defenses the defendants asserted to various of the potential individual claims. In other words, the jury verdict may never actually have been worth anything near the reported $277.5 million.

 

The significance of the settlement may be only that it finally brings an end to this long-running case. On the other hand, the amount and fact of the settlement may stand as a cautionary warning to any securities litigation defendants that are thinking about forcing their case to trial. To be sure, some of the post-PSLRA securities cases that have gone to trial have resulted in defense verdicts (most notably, the JDS Uniphase case, about which refer here). But as reflected in the securities case trial scoreboard maintained by Adam Savett, the current tally of post-PSLRA securities trials stands at 6 wins for plaintiffs, 5 for defendants (assuming that the Apollo Group case is still counted as a plaintiff win, even though it ultimately settled). With that tally, and in light of the magnitude of the Apollo Group post-appeals settlement, any defendant contemplating a trial would have to think hard about the downside of taking their case to the jury. 

 

Apollo Group has probably more than had its fill of securities class action litigation. The company not only had this case to contend with, but in November 2006, it got hit with an options backdating-related securities class action lawsuit. The options backdating securities case was ultimately dismissed, as reported here. Not only that, but in August 2010, Apollo Group was one of several for-profit education companies hit with shareholder suits in connection with an industry scandal involving student recruiting and student loans. That case remains pending in the District of Arizona, before Judge Teilborg. (The deadline for the plaintiffs to file their amended complaint is December 6, 2012.)

 

In a November 30, 2011 order (here), Central District of California Judge R. Gary Klausner has denied the motion of the FDIC as receiver of the failed IndyMac Bank to intervene in a declaratory judgment action involving IndyMac’s D&O insurance. The FDIC sought to intervene because of its interest in recovering under the policies in connection with two lawsuits it filed as IndyMac’s receiver against former IndyMac directors and officers. Judge Klausner’s denial of the FDIC’s intervention motion may be relevant in other failed bank coverage disputes where the FDIC is interested in preserving D&O insurance policy proceeds for its claims in competition with claims of claimants to the policy proceeds.

 

Background

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

 

As I detailed in a prior post (here), the bank’s collapse triggered a wave of litigation. The lawsuits include a securities class action lawsuit against certain former directors and officers of the bank; lawsuits brought by the FDIC and by the SEC against the bank’s former President; and a separate FDIC lawsuit against four former officers of Indy Mac’s homebuilders division. There are a total of twelve separate lawsuits pending. The underlying actions allege various improprieties, mostly centering around mortgage backed securities.

 

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

 

As I also noted in a prior post (here), in early 2011, a unit of IndyMac had filed a declaratory judgment action seeking to establish coverage under the various policies in connection with claims that had been filed against the unit. In an August 2011 order, discussed in the prior blog post, Central District of California Judge R. Gary Klausner granted the defendants’ motion to dismiss the action as premature.

 

Separately, in March 2011, the four Side A carriers in the second of the two insurance towers filed their own separate declaratory judgment proceedings, against certain former IndyMac directors and officers, seeking to establish that terms in their policies preclude coverage for the various lawsuits. The directors and officers counterclaimed and also added as counter-defendants the four traditional ABC carriers in the second tower.

 

In October 2011, the FDIC, which in its capacity as IndyMac’s receiver has initiated two lawsuits against certain former IndyMac directors and officers of IndyMac, moved to intervene in the separate coverage action that the Side A carriers had initiated. The FDIC had moved to intervene on alternative grounds under the Federal Rules of Civil Procedure — as of right; and alternatively under permissive intervention. The FDIC argued that because it is a plaintiff in the two underlying actions, it has an interest in seeing that the coverage dispute is resolved so that it can recover any eventual judgment in those actions out of the insurance proceeds.

 

The November 30 Ruling

In his November 30 opinion, Judge Klausner denied the FDIC’s motion to intervene. Judge Klausner held that the FDIC had not established its entitlement to intervene as of right because it “has not obtained a judgment against the Insured Defendants and may never do so,” and so presently it has at most “the hope of an eventual judgment.” Accordingly, he held, the FDIC has “no legally protected interest” in the coverage dispute.” He added that even if it had a legally protected interest, that interest is not related to the subject matter of the coverage lawsuit. Because the FDIC’s lawsuit against the former directors and officers and the separate insurance coverage action “involve different legal issues,” they are “not related for purposes of mandatory intervention.”

 

Judge Klausner held that FDIC’s alternative motion for permissive intervention also fails because the FDIC’s action against the former directors and officers, on the one hand, and the separate insurance coverage dispute, on the other hand,  do “not present common questions of law or fact.” He added that because the FDIC has not yet obtained a judgment against the Insured Defendants it “does not have an interest that it needs to protect” and its claims “are not yet ripe for adjudication” and therefore it does “not have standing as a permissive intervenor.”

 

Discussion

The FDIC’s interest in preserving its ability to collect the proceeds of a failed bank’s D&O insurance is not limited to this case. In connection with a host of other failed banks, the FDIC’s interest in the D&O insurance policy proceeds is in competition with the interests of a variety of other claimants, including in particular shareholders of the holding companies of the failed banks.  The various parties will be in a race to try to see who gets there first, and if they can get there before the insurance is substantially or entirely depleted by defense expenses. The FDIC’s interest in taking part in coverage litigation makes perfect sense.

 

But so too does Judge Klausner’s ruling here. It appears that until the FDIC has reduced its claims to a judgment it may have difficulty presenting its purported claims to the D&O insurance policy proceeds in a coverage action. The question of whether or not there is coverage under a D&O policy for a given claim scenario is different from the question whether or not the FDIC has any entitlement to the policy proceeds.

 

Special thanks to my friends at Bates Carey Nicolaides LLP for providing me with a copy of Judge Klausner’s opinion. Bates Carey represents one of the insurers in the pending coverage action.

 

ABA Journal Top 100  Blawgs: The D&O Diary is proud to have been selected as one of ABA Journal’s Blawg 100 for 2011, the Journal‘s fifth annual list of the best blogs about lawyers and the law. This year’s Top 100 designees were selected from over 1,300 nominees. It is a particular honor to be selected along with the other five business law designees, which include some of the best blogs on the Internet: Professor Jay Brown’s Race to the Bottom Blog; Broc Romanek’s The CorporateCounsel.net blog; Professor Stephen Bainbridge’s ProfessorBainbridge.com; the Truth on the Market blog, which is maintained by a number of academics; and Francis Pileggi’s Delaware Corporate and Commercial Litigation blog .

 

Between now and December 31, 2011, you can vote for your favorite among the top six business law blogs, by clicking on the ABA Journal Blawg 100 badge in the right hand column. Everyone here at The D&O Diary would appreciate your support. Thanks to the readers who make this blog possible and worthwhile.

 

In a strongly worded November 28, 2011 opinion (here), Southern District of New York Judge Jed Rakoff rejected the proposed $285 million settlement of the enforcement action that the SEC brought against Citigroup Capital Markets. But while he emphatically rejected the proposed settlement, his opinion may also suggest how the SEC might salvage this situation without a trial and even how it might structure settlements in the future in order to avoid the kind of blistering criticism that Rakoff administered in his November 28 opinion.

 

In October 2011, the SEC filed a civil enforcement action against Citigroup in the Southern District of New York and simultaneously filed a proposed Consent Judgment in which Citigroup offered to pay a total of $285 million (consisting of a disgorgement of profits of $160 million, plus $30 million in interest, and a civil penalty of $95 million). The complaint related to a billion-dollar fund that Citigroup created that allowed the company “to dump some dubious assets on misinformed investors.” The fund was marketed as consisting of attractive assets, whereas the fund was arranged to include a “substantial percentage of negatively projected assets.” Citigroup had then taken a substantial short position in the assets. Citigroup realized profits of $160 million, while investors lost more than $700 million.

 

Because Citigroup had agreed to the proposed settlement and Consent Judgment “without admitting or denying the allegations in the complaint,” Judge Rakoff had in an October 27, 2011 opinion raised a number of pointed questions about the proposed settlement (about which refer here).

 

In his November 28, 2011 opinion, Judge Rakoff stated that he was “forced to conclude that proposed Consent Judgment that asks the Court to impose substantial injunctive relief, enforced by the Court’s own contempt power, on the basis of allegations unsupported by and proven or acknowledged facts whatsoever, is neither reasonable, nor fair, nor adequate, nor in the public interest.” Judge Rakoff emphatically rejected the SEC’s argument that the public interest was not an appropriate consideration in his assessment of the proposed settlement.

 

He concluded that the settlement was not in the public interest because it “asks the Court to employ its power and assert its authority when it does not know the facts.” He added that “an application of judicial power that does not rest on the facts is worse than mindless, it is inherently dangerous.”

 

Judge Rakoff added that in a case like this that “touches on the transparency of financial markets have so depressed our economy and debilitated our lives,” there is “an overriding public interest in knowing the truth.” But instead of establishing what had gone wrong here, the SEC entered a settlement in which the defendant company neither admitted nor denied the allegations. He added that the SEC “of all agencies” has “a duty inherent in its statutory mission to see that truth prevails.” The Court, he said, “must not in the name of deference or convenience, grant judicial enforcement to the agency’s contrivances.”

 

Several different times, Judge Rakoff emphasized the paramount importance of judicial independence, particularly when it is called upon to exercise its injunctive power, which, he added, “is not a free-roaming remedy to be invoked at the whim of a regulatory agency, even with the consent of the regulated.” Without facts, established either by admission or denials, the use of the court’s injunctive powers “serves no lawful purpose and is simply an engine of oppression.”  

 

Judge Rakoff also noted that the proposed settlement left the defrauded investors “substantially short-changed” as it “deals a double blow to any assistance the defrauded investors might seek to derive from the SEC litigation in attempting to recoup their losses through private litigation” since they “cannot derive any collateral estoppel assistance from Citigroup’s non-admission/non-denial of the SEC’s allegations.”

 

Judge Rakoff concluded his opinion by consolidating the case with a parallel action against the Citigroup official responsible for the toxic fund and scheduling the case for trial on July 16, 2012.

 

At lease according to the November 28, 2011 statement of SEC Enforcement Division Director Robert Khuzami about the opinion, here, the SEC Enforcement Division is deeply aggrieved by Judge Rakoff’s rejection of the settlement. Judge Rakoff’s blistering opinion certainly leaves the parties with some unattractive choices.  It also raises a larger concern that the SEC might not only have to take this case to trial, but in general might have to be prepared to take more cases to trial. This could threaten to overwhelm the SEC’s resources and ultimately even lead to less vigorous enforcement as the increased trial load forces the SEC to conserve resources by bringing fewer cases.

 

But on further reflection and on closer review, Judge Rakoff’s opinion may offer a way out, both for these parties and for the SEC in general. In footnote 7 on page 13 of the opinion, Judge Rakoff draws a sharp contrast between this settlement involving Citigroup and the SEC’s earlier settlement with Goldman Sachs, which Judge Rakoff noted “involved a similar but arguably less egregious scenario.” (For a detailed background on Goldman’s settlement of the SEC action, refer here.)

 

The Goldman settlement, he noted, involved a substantially higher civil penalty (i.e., a $535 million penalty on only $15 million in profits, compared to the proposed Citigroup settlement in which the company agreed to pay a $90 million penalty on $160 million of profits). But even more importantly, as Judge Rakoff noted, the consent judgment in the Goldman case involved an “express admission” from Goldman that the marketing materials for its toxic securities “contained incomplete information.” Judge Rakoff also noted that the Goldman consent judgment involved remedial measures beyond those to which Citigroup agreed, and also involved Goldman’s undertaking to cooperate with the SEC in ways in which Citigroup had not.

 

The contrast that Judge Rakoff drew between the Goldman settlement and the Citigroup settlement may suggest a way that the SEC and Citigroup may yet be able to settle this case (and for that matter, for future parties to try to avoid the objections that Judge Rakoff raised in connection with this proposed settlement).  

 

First, just as when the SEC and the Bank of America previously faced Judge Rakoff’s rejection of the proposed settlement of the SEC’s action against BofA, it seems that Citigroup is going to have to make a greater monetary contribution for a proposed settlement to pass Judge Rakoff’s scrutiny. (Judge Rakoff’s summary of the sequence of events surrounding the SEC’s settlement with BofA is described here.)

 

But if the parties want to avoid the July 2012 trial date, they are also going to have to work out a deal that omits the “neither admits nor denies” formulation. Judge Rakoff disparaged the SEC’s long-standing practice of including formulations of this type in its enforcement action settlements as “hallowed by history but not by reason.” 

 

In order to reach a settlement that will pass muster with Judge Rakoff, Citigroup apparently also will have to agree to express admissions of the type included in the Goldman consent judgment. Citigroup has an obvious interest in avoiding any admissions, not the least because of the impact the admissions might have on pending investor litigation. But it is worth noting that Goldman’s admissions to which Judge Rakoff referred approvingly may not be prohibitive. Goldman admitted only that its marketing materials contained “incomplete information,” and that it was a “mistake” that the materials did not explain the role of Paulson & Co. in selecting the assets underlying the toxic securities. As distasteful as Citigroup might find it to make this type of admission, it would have to be far preferable to facing trial.

 

Whether or not the parties are able to work out a formulation that is mutually acceptable and that satisfies Judge Rakoff remains to be seen. The one thing that is for sure is that if the parties are not able to work out a revised deal that passes Judge Rakoff’s muster, there will be a very interesting trial in his courtroom next July.

 

One final thought. I found it particularly interesting that one of Judge Rakoff’s objections to the absence of any factual admission as part of the settlement was that this absence deprived the investor plaintiffs the benefit they might hope to derive from the SEC litigation. I am sure the private plaintiffs’ securities bar was heartened by this comment. No doubt the litigants in this case will be interested to see if there are any helpful admissions in any forthcoming settlement – as will private litigants with respect to SEC enforcement action settlements going forward.

 

Wayne State University Law Professor Peter Henning has an interesting November 28, 2011 post about Judge Rakoff’s opinion on the Dealbook blog (here). Among other things, Professor Henning questions whether admissions on the order of Goldman’s would be enough to satisfy Judge Rakoff. David Bario’s November 28, 2011 Am Law Litigation Daily article about Judge Rakoff’s opinion can be found here. Alison Frankel’s November 28, 2011 post about the opinion on Thomson Reuters News & Insight can be found here.

 

Special thanks to the several readers who sent me links to Judge Rakoff’s opinion.

 

Here’s One for My Friends at the SEC (Who Could Probably Use a Little Cheering Up): So, a lawyer dies and goes to heaven. (I know, I know, an implausible opening, but bear with me.) The lawyer has just walked through the pearly gates and she’s surveying the scene. She sees an old man walking down the street in judicial robes. So she says to St. Peter, “Who’s the old guy in the robes?” And St. Peter says, “Oh, that’s just God. He thinks he’s a federal judge.”

 

One of the most noteworthy recent trends in corporate and securities litigation has been the dramatic growth in the frequency of lawsuits relating to mergers and acquisitions activity. These lawsuits are not only becoming increasingly more common, but also increasingly more costly. The growth in this litigation activity has been so rapid that the significance of these trends may remain underappreciated.

 

In this post, I first set the stage to examine these trends by reviewing the current landscape for traditional securities class action litigation, which differs in many ways from current conventional wisdom, and which provides a context for assessing the merger-related litigation trends. I then review important recent developments in M&A related litigation activity, both in terms of increasing frequency and escalating severity. I conclude with a review of the implications of these developments.

 

The Current Securities Class Action Litigation Environment

Traditionally, any discussion of corporate and securities litigation focused primarily (and sometimes exclusively) on securities class action litigation. In many ways, this makes perfect sense, as these kinds of lawsuits were for many years the most frequent and the most severe type of corporate and securities lawsuit.

 

More recently, the relative significance of securities class action litigation as a percentage of all corporate and securities litigation risks has shifted. As the insurance information firm Advisen has well-documented (refer here), securities class action litigation activity as a percentage of all corporate and securities litigation has declined dramatically over the past several years. Whereas securities class action lawsuits once represented among the most likely sources of litigation, in 2010 securities class action lawsuits represented less than 16% of all corporate and securities lawsuit filings.

 

As Advisen has also documented and as is discussed below, one reason for this relative decline is the growth in M&A-related litigation filings. Moreover, as is also discussed below, securities class action litigation is not the only source of corporate and securities litigation severity exposure; M&A-related lawsuits also represent a growing severity risk.

 

But, to set the stage for the discussion of M&A-related litigation trends and their significance, there are some important misperceptions about traditional securities class action litigation activity that I want to address.

 

A frequently recurring question is whether overall securities class action litigation filings are declining. Usually this discussion focuses exclusively on the absolute number of annual new securities class action lawsuit filings. In 2010, depending on the source to which you are referring, the absolute number of new lawsuit filings either declined compared to historical averages ( e.g., refer here regarding  the 2010 Cornerstone Research study) or held steady or perhaps grew (refer here regarding  the 2010 NERA Economic Consulting  study). The reasons these studies reach different conclusions are worthy topics for a separate blog post. But regardless of the conclusions about the absolute numbers of annual lawsuit filings, the key fact often  missing from the analysis is a consideration of how the absolute number of filings relates to the changing number of public companies.

 

The fact is, since, 1999, the number of companies listed on U.S. exchanges has declined every year. If you refer to the annual data from the World Federation of Exchanges (here), you will see that the number of companies listed on U.S. exchanges has declined from over 8,500 in 1999 to about 5,100 in 2010 – a decline of about 40%.

 

When the absolute number of annual lawsuits is compared to the declining number of companies trading on U.S. exchanges, it is clear that the frequency of securities class action lawsuit filings has not declined, but arguably is increasing, and at a minimum is at least holding steady.

 

But while frequency has not declined, median severity has increased. In 2010, the median securities class action settlement was $11.1 million, which is well over double the 1999 median settlement of $5.0 million and triple the 1996 median settlement of $3.7 million. These figures are not adjusted to account for the effect of economic inflation, but these figures nevertheless reflect a  substantial increase.

 

In short, even amidst the changing litigation landscape in which securities class action lawsuit filings have declined as a percentage of all corporate and securities litigation, the threat of securities class action litigation remains a very serious litigation exposure for publicly traded companies.

 

It is against this backdrop that the growth in M&A litigation must be considered.

 

The Exploding Growth in M&A-Related Litigation

Whatever else you want to say about M&A-related litigation, it is clear that there is a lot more of it now than there used to be, both in terms of absolute numbers of lawsuits filings and also relative to the number of merger transactions. Indeed, Advisen has commented that the number of M&A-related lawsuits has “skyrocketed “in recent years.

 

Reported data (refer for example here and here) show that as recently as ten years ago, there were only a handful of M&A related lawsuits filed each year. For example, in 2001, there were only four M&A related lawsuits filed, compared to the 341 filed in 2010 (up from “only” 191 the year prior). Just in the four- year period ending in 2010, the annual number of merger-related lawsuit filings has increased over 600%.

 

These numbers are even more startling when it is considered that these lawsuit filings are increasing even as the number of merger transactions is declining. The number of merger targeted companies declined in each of the three years from 2008 to 2010, yet the absolute number of merger-related lawsuits increased in each of those three years relative to the prior year. In 2010, there were 214 fewer companies targeted for mergers than there were in 2007, representing a decline of over 37%. Yet the number of merger-related lawsuits filed in 2010 was more than triple the number filed in 2007. Today, one out of every two companies announcing an acquisition is sued, and that is true whether or not the acquisition is friendly or hostile, and even whether or not the board of the target company has accepted or rejected the proposed acquisition.

 

There are a host of possible explanations for these filing trends. The first is that a changing case law environment has made securities class action litigation a more challenging game for plaintiffs (for example, as a result of the U.S. Supreme Court’s holdings in the Tellabs case and the Morrison case). In addition, the declining number of public companies over the past several years means that there are fewer prospective securities class action litigation targets. These developments may have encouraged plaintiffs’ lawyers to seek out an alternative business model.

 

And in the M&A related litigation, the plaintiffs’ attorneys seem to have found relatively easy money, as these cases often involve a quick resolution (due to the fact that the parties are often highly motivated to complete the underlying transaction) and the payment of plaintiffs’ attorneys’ fees, which average around $400,000 per case. These attributes of M&A related litigation were discussed in an August 27, 2011 Wall Street Journal article, written from the shareholders’ perspective, entitled “Why Merger Lawsuits Don’t Pay” (here) and in a July 12, 2011 Fox Business article entitled “M&A Lawsuits Skyrocket as Fee-Hungry Law Firms Smell Easy Money” (here).

 

The surest sign that M&A-related litigation represents an attractive proposition for the plaintiffs’ lawyers is the level of lawsuit competition that merger transactions increasingly are engendering. Increasingly, the announcement of a merger can trigger multiple separate lawsuits filed by separate plaintiffs’ firms in multiple separate jurisdictions, producing complicated procedural and jurisdictional issues (refer for example here and here) and also adding dramatically to the cost of litigation.

 

This latter point, about the costs involved, brings us to the heart of the matter. Not only are M&A cases increasingly more frequent, they are increasingly more costly, in a number of ways. I emphasize the costs involved because there is a perception in certain quarters that while M&A lawsuits may be numerous, they represent only a minor nuisance. To put this in insurance terms, M&A lawsuits are described as a high frequency, low severity risk. In fact, this is something I myself have said in the past. However, the truth now is, when all of the costs are considered on an all-in basis, that the cases actually are quite expensive, and increasingly are becoming more so.

 

Start with defense expenses. Because these cases often involve high stakes and short fuses, their defense often can trigger an explosion of legal fees. When you add in the additional expense involved when there are multiple cases in multiple jurisdictions, the expenses multiply. And when you add in the fact that these cases increasingly are continuing on even after the underlying merger transaction has closed, the defense costs can increase exponentially. Much of the time, these defense expenses are borne by the target company’s D&O insurer.

 

The D&O Insurers not only absorb the sometimes massive defense expenses, but they also often have to absorb the plaintiffs’ fees as well, as the payment of the plaintiffs’ attorneys’ fees often is a covered component of the case settlement. (Refer here for a recent discussion of the issues surrounding D&O coverage for a plaintiffs’ fee request in a derivative lawsuit settlement.)

 

The plaintiffs’ fees alone can sometimes be staggering. In the August 2010 Morgan Kinder lawsuit, the plaintiffs’ fee requests amounted to as much as $50 million (that is, 25% of the $200 million settlement, refer here). The plaintiffs’ fee request in the September 2011 Del Monte settlement was $22.3 million (refer here). And in the May 2010 settlement of the Atlas Energy case, the plaintiffs’ fee request was as much as $17.25 million ($25% of the $69 million settlement, refer here).

 

It should be emphasized that the plaintiffs’ fee request can be substantial even where there is otherwise no cash component to the settlement. For example, in the April 2010 XTO Energy settlement, in which there otherwise was no cash component, the plaintiffs’ fee request was $8.8 million (refer here) . In the September 2009 Pepsi Bottling settlement, which otherwise did not involve a cash payment the plaintiffs’ fee request was $7.7 million (refer here). Similarly in the February 2011 Atlas Energy case, the fee request was $4.0 million (refer here).

 

And beyond that – and the most important point here – it is increasingly common for the settlement of these cases to also involve significant cash payments. Indeed, the settlements in many of these cases suddenly are starting to resemble in order of magnitude the settlements of securities class action lawsuits. Thus, the Kinder Morgan case, as referenced above,  settled in August 2010 for $200 million (refer here); the Del Monte case, as noted above,  settled in September 2011 for $89 million (refer here); the May 2010 ACS settlement was $69 million (refer here); and the 2011 Intermix Media settlement was $45 million (refer here). In many instances, where these settlement amounts are not designated as an increase in the acquisition price, these settlement amounts may be insurable.

 

And not only have these cases become more expensive in every way, there are signs that the competition between jurisdictions could even further exacerbate this situation. At November 11, 2011 Columbia Law School conference about the Delaware Chancery Court, various observers commented on the question of whether the Delaware courts, the traditional forum for this type of litigation, were losing “market share” to other jurisdictions’ courts, possibly because plaintiffs’ lawyers believe they (and their clients too, don’t forget) think they can do better elsewhere.  Francis Pileggi has a good summary of the discussion at the conference in a November 11, 2011 post on his Delaware Corporate & Commercial Litigation blog (here).

 

As Alison Frankel discussed in a November 14, 2011 post on her Thomson Reuters News and Insight blog, here, this debate compelled one Delaware jurist to conduct a visual demonstration to try to prove that plaintiffs’ lawyers can expect to recover substantial fees in Delaware courts. It is an obvious concern if Delaware’s judges feel obliged — in order remain competitive in the jurisdictional competition and to try to preserve declining market share — to prove that plaintiffs’ lawyers will be rewarded for resorting to the state’s courts.

 

Discussion

Contrary to popular perception, the new M&A litigation model represents both a high frequency and a high severity risk. The severity risk is particularly acute given the exacerbating effects of escalating defense expenses and rising plaintiffs’ attorneys’ fees. Increasingly, M&A litigation is a recurring and very expensive feast for which D&O insurers are picking up increasingly larger tabs.

 

Another important point that should not be lost here is what the increasing risk of M&A related litigation means in combination with the ongoing risk of securities class action litigation. When all of the factors are considered – including the declining number of public companies and the increasing absolute number of lawsuits – it is apparent that publicly traded companies today  face a significantly increased risk of serious corporate and securities litigation than they did in the recent past.

 

Indeed, the probability of a U.S.-exchange listed company facing a merger lawsuit or a securities class action lawsuit in 2010 was more than double what the equivalent probability was as recently as 2006, as the number of public companies has declined and the number of lawsuits has increased. To be specific, the probability in 2006 that any given public company would get hit with a merger lawsuit or securities class action lawsuit was 2.8%; the equivalent probability in 2010 was 5.7%.  The probability of any given company being involved in serious corporate and securities litigation has never been greater.

 

All of these developments mean that publicly traded companies’ litigation risks represent an increasingly  serious and expensive problem, and that M&A-related litigation is increasingly a big part of that problem – in general, of course, but also for the companies’ D&O liability insurers as well.

 

Now, I am not the first to make some of these points about M&A-related litigation. But I think there still is a perception that if M&A-related litigation represents a problem for the D&O insurance industry, it is principally a problem for the insurers that are active in providing primary D&O insurance (refer for example here), and that this is not a problem for the carriers that confine their public company D&O exposures to the excess layers. The point I hope the above analysis gets across is that when you take into account the defense expenses, the plaintiffs’ fees and the M&A related indemnity exposure, the M&A-related litigation increasingly represents a risk for all of the carriers in companies’ D&O insurance programs. M&A litigation increasingly involves a threat of a flame-through loss, increasingly approaching the order of magnitude of securities class action litigation.

 

With both increasing frequency and severity, the casual observer might well assume that pricing for D&O insurance would also be increasing. The casual observer’s assumption would, however, fail to take into account the iron laws of supply and demand. There are more D&O insurers now than there were ten years ago, representing in the aggregate much greater levels of insurance capacity, while at the same time, there are many fewer public companies. What you have are increasing numbers of D&O insurers chasing decreasing numbers of public company D&O insurance buyers.  As a result, overall industry pricing has declined steadily since 2003.

 

It might well be asked how long this combination of circumstances in the D&O insurance marketplace can continue. Some commentators are already proclaiming that they thing they see a market turn on the horizon. I am making no predictions. I have been in this business one way or the other for nearly three decades and I think that every single day during that period someone has been predicting a hard market. We are still waiting. All I know is that if someone were looking around for reasons to explain increasing D&O insurance pricing (if it were in fact increasing), they wouldn’t have to struggle to find explanations. However, I also know that the insurance industry rarely changes as an act of will – it usually changes only as a matter of necessity. Until necessity requires, then, the D&O insurance industry likely will continue on in the same direction – even as the dashboard indicator lights flash caution.