The U.S. Supreme Court’s June 2010 decision in Morrison v. National Australia Bank looked like the end of securities claims in U.S. courts on behalf so-called “f-cubed” claimants – that is, foreign shareholders of foreign-domiciled companies who bought their shares on foreign exchanges. In the aftermath of Morrison, these foreign claimants have pursued a number of avenues to pursue their claims, including, for example, initiating litigation in the defendant company’s home jurisdiction.

 

Among the more creative approaches was the attempt to pursue – in U.S. courts – claims on behalf of non-U.S. claimants under the laws of the claimants’ home country. The highest-profile attempt along these lines emerged in the Toyota shareholder litigation pending in the Central District of California, where the plaintiffs had amended their complaint in shareholder arising from the company’s sudden acceleration problems to assert claims under the Japanese Financial Instruments and Exchange Act.  The plaintiffs had substantial incentive to pursue this approach since only a small fraction of the company’s shares (less than 10 percent) trade in the U.S. as American Depositary Shares.

 

However, in a July 7, 2011 opinion (here), Central District of California Dale Fischer made short work of this attempt to circumvent the impact of the Morrison decision. In her July 7 ruling, Judge Fischer rejected the plaintiffs’ argument that the court had original jurisdiction over plaintiffs’ Japanese law claims under the Class Action Fairness Act (CAFA). She further declined to exercise the court’s supplemental jurisdiction over the claimants’ Japanese law claims. He dismissed the plaintiffs’ Japanese law claims with prejudice.

 

In seeking to argue that the court had original jurisdiction over their Japanese law claims, the plaintiffs’ had contended that because Toyota shares were listed but did not trade on the New York Stock Exchange, they were not a “covered” security to which CAFA applied, and, because CAFA did not apply, they could assert claims in U.S. court under Japanese law even though they could not otherwise assert claims under U.S. law. (I have attempted to summarize the plaintiffs’ CAFA arguments as best I could; Alison Frankel has a more thorough discussion of these issues in her July 11, 2011 Thomson Reuters News & Insight article entitled “Morrison End Run Hits Brick Wall in Toyota Case” (here)). Judge Fischer declined to read into CAFA the requirements that plaintiffs urged, as “to do so would ignore the plain language of the statute.”

 

Judge Fischer’s refusal to exercise supplemental jurisdiction over the Japanese law claims is even more interesting, and is likely to spell the end of most future attempts by f-cubed claimants to try to assert claims in U.S. under foreign law. Among other things, because of the vast predominance of Japanese holders, “the damages analysis would focus overwhelmingly on these claims” and the Japanese law claims “unquestionably would dominate the litigation.”

 

Judge Fischer also found that the requirement of comity to Japanese courts “strongly argues against the exercise of supplemental jurisdiction.” He added that the respect for the rights of other countries to regulate their own securities markets “would be subverted if foreign claims were allowed to be piggybacked into virtually every American securities fraud case,” which would result in “imposing American procedures, requirements and interpretations likely never contemplated by the drafters of the foreign law.”

 

Judge Fischer did not say that there would never be an occasion when a U.S. court could properly exercise supplemental jurisdiction over foreign securities fraud claims. However, he specifically noted that “any reasonable reading of Morrison suggests that those instances will be rare.”

 

Whether or not any readers consider this outcome unexpected, the one thing that is clear is that the U.S. District Courts continue to take an expansive reading of Morrison. As Frankel put it in her article to which I linked above, the Toyota plaintiffs “fared no better than everyone else who’s tried to find any vulnerability in the Supreme Court’s ruling.”

 

M&A Litigation Soaring, For Sure: In my first half 2011 securities litigation analysis (here) one of the most distinctive trends I noted was the rise of M&A related litigation. Fox Business News has a July 12, 2011 article entitled “M&A Lawsuit Skyrocket as Fee-Hungry Law Firms Smell Easy Money” (here) which takes a closer look at the subject.

 

The article sounds themes that will be familiar to readers of this blog. However, the article is accompanied by a startling graphic that dramatically illustrates how massively the M&A-related litigation has ramped up since 2008. The article graphics also show how the M&A-related litigation has grown relative to M&A-related activity. In addition, the article provides numerical substantiation for the generalizations about the rising levels of M&A litigation.

 

I continue to believe that in the aggregate, these cases represent a serious problem for the D&O insurance industry, or at least for the carriers that are most active as primary carriers. I expect the increasing frequency of M&A –related litigation will be of increasing focus in the months ahead.

 

Second Quarter Litigation Update Webinar: And speaking of first half 2011 litigation filing trends, on Tuesday July 19, 2011 at 11 a.m. EDT, I will be participating in the Advisen’s "Q2 Securities Litigation Webinar."  My fellow panelists will include Anderson Kill’s Bill Passanante, Navigators’ Scott Misson, and  Willis’ John Connolly. The panel will be moderted by Advisen’s Jim Blinn. Information about registering for this event, which is free, can be found here.

 

Parting Thought: Am I the only one that finds the new nickels, with Thomas Jefferson’s oversized and distorted face looming off to one side, weird and creepy?

 

Largely due to last summer’s enactment of the Dodd-Frank Act, we have entered a watershed period of corporate governance reform. Processes already underway have transformed the relations between corporate boards and corporate shareholders. Even further changes loom. In a July 2011 article entitled “Corporate Governance Perspective: Current Bearings, Future Directions”  in the latest issue of InSights (here),  I  take a look at where we are now with respect to the current round of corporate governance reforms , what lies ahead, and what it all means.

The short week after the July 4th holiday is usually quiet. There certainly did seem to be less traffic on the roads. But nevertheless, there was news of note this past week on several stories we have been following, as discussed below. The traffic on the roads may have slowed but the circulation on the information superhighway continued unabated.

 

Pace of Bank Failures Slows – But More Closures Loom: Earlier this year (refer here), I had noted that it seemed as if the pace of bank failures had finally started to decline. As discussed in a July 9, 2011 Wall Street Journal article (here), the pace of bank failures did indeed slow  in the first half of 2011, compared both to the equivalent period a year ago as well as to the second half of last year. There were 48 bank failures in the first half of 2011, compared to 74 in the second half of 2010 and 86 in the first half of 2010.

 

This slowdown is consistent with the FDIC’s projections. The agency had previously indicated that it believed 2010 would represent a high water mark for bank failures. But while the pace of bank closures has finally started to slow, the wave of bank failures is far from finished. As I noted here, the FDIC’s most recent Quarterly Banking Profile, released in May, showed that the number of “problem institutions” was a record levels, a situation that the Journal article characterized as representing a “backlog” of troubled banks. The FDIC reported that as of the end of March 31, 2011 there were 888 “problem institutions.”

 

And while the 48 bank failures in the year’s first half represents a decrease compared to recent periods, that figure still represents a sizeable number. By way of comparison, in 2008, when the financial crisis reached its crescendo, there were only 25 bank failures. Moreover, it is clear that bank failures will continue for the foreseeable future, even if at reduced levels from a year ago. Indeed, on Friday evening – the first Friday of the year’s second half – the FDIC took control of three more institutions.

 

The Journal article quotes one commentator as saying that historically about 19% of the banks on the FDIC’s problem list wind up failing, which implies about 169 bank failures after March 31, 2011. Since 22 banks failed in the second quarter of 2011, that would suggest that there may be about 147 bank failures yet to go. The completion of the current  bank closure process could, according to a source cited in the Journal article, take about two more years. As another commentator quoted in the article put it, the process is about in “the seventh inning” of the cycle of failures.

 

Though the bank closure process may now be slowing and will run its course in time, the mopping up process may only have just begun. Allowing for the extensive post-mortem that follows each failure, and the attendant lag time before the FDIC initiates litigation against the directors and officers of failed banks, the era of failed bank litigation may just be getting started. If the wave of bank failures is in the seventh inning, we are much earlier in the bank litigation wave ball game. Refer here for my recent review of the details surrounding the failed bank litigation.

 

U.S. Investors Are Not the Only Ones Concerned About Chinese Company Accounting Scandals: As various accounting scandals involving U.S.-listed Chinese companies have emerged, shareholders have launched a series of lawsuits in the U.S. against the companies and their senior officials, as I have previously noted on this blog. It turns out that U.S. investors are not the only ones upset about the problem involving Chinese companies.

 

A July 8, 2011 Bloomberg article (here) examines the concern that investors in Singapore have about Chinese companies, based on the various accounting issues that have come to light. Among other things, the article states that since 2008, more than ten percent of the Chinese companies listed on the Singapore stock exchange have been delisted or had trading in their shares suspended. The article also reviews investor concerns that executives of Chinese companies are outside the reach of Singapore enforcement authorities.

 

The crescendo of voices raising concerns about the Chinese companies may be being heard in China itself. News reports this past week (refer here) suggest that officials from the SEC and the PCAOB will be meeting with their Chinese counterparts this upcoming week to discuss the possibility of allowing the U.S. regulators to investigate Chinese companies and Chinese audit firms for the first time.

 

In the meantime, however, the wave of lawsuits in the U.S. involving U.S.-listed Chinese companies continues to mount. The latest lawsuit involves A-Power Energy Generation Company, which obtained its U.S. listing by way of a reverse merger with a U.S. listed publicly traded shell company. According to their July 5, 2011 press release (here), plaintiffs’ counsel have filed a securities class action lawsuit in the District of Nevada against the company and certain of its officers. The complaint (which can be found here), refers to published reports describing the company’s auditors concerns about weaknesses in the company’s internal controls and differences between financial figures the company reported to Chinese regulatory source compared to those reported in the company’s SEC filings. On June 28, 2011, the company announced (here) that its auditor had resigned because of the company’s failure to hire an independent forensic accountant to investigate certain business transactions.

 

With the arrival of this latest lawsuit, there have now been a total of 27 securities class action lawsuits filed against U.S. listed Chinese companies so far in 2011, representing about one-quarter of all 2011 securities lawsuit filings in the U.S.

 

One variation on this litigation theme has arisen in a separately filed securities suit that has been brought as an individual action rather than as a class action. As discussed in Jan Wolfe’s July 5, 2011 Am Law Litigation Daily article (here). Starr International has amended its securities suit against China MediaExpress Holdings and certain of its directors and officers to include as defendants three American businessmen who helped the company obtain its U.S. listing by way of reverse merger.

 

While there have been calls to reform the reverse merger process, particularly for foreign companies, if the functionaries that make the process possible are going to find themselves hauled into litigation involving the companies they help to go public, the reverse merger process may cease to exist as a means for non-U.S. companies to use in order to process the more conventional method of going public. In any event, in the current climate, it seems likely that there would be much investor interest in shares of foreign domiciled companies that obtained their U.S. listings by way of a reverse merger.

 

Variation on the Auction Rate Securities Concerns: There have been extensive developments recently involving financial companies involved with marketing or selling auction rate securities, as Tom Gorman summarized in a July 5, 2011 post on his SEC Actions blog. But a new adversary action filed in the Land American Financial Group bankruptcy proceeding shows an interesting variation on the usual auction rate securities litigation theme.

 

As discussed at length in the bankruptcy trustee’s June 24, 2011 complaint (here), Land America had a division (“LES”) whose purpose was to facilitate tax-advantaged land swaps. In essence, a property seller could “park” the proceeds of a land sale with LES until an appropriate land swap counterparty emerged, allowing the “exchange” to take place. The property sales proceeds were invested during the holding period. According to the complaint, beginning in about 2003, LES invested a substantial portion of the proceeds in auction rate securities. When the auction rate securities market froze up in 2008, 41% of LES’s assets were tied up in auction rate securities. The failure of the auction rate securities market eventually created a liquidity crisis for LES and for its parent company. The liquidity crisis, according to the complaint, was a substantial cause in the demise of the parent company.

 

According to the complaint, the parent company (LFG) “met its demise because the LFG and LES directors and officers failed to properly inform themselves and failed to consider and implement any timely action to mitigate the effects of the LES liquidity crisis. These failures caused LFG and its stakeholders to incur hundreds of millions of dollars in damages.”

 

As discussed in this July 8, 2011 Richmond Biz Sense article (here), the bankruptcy trustee is seeking damages of $365 million in the action , which names 21 former Land America directors and officers as defendants. The article quotes sources as saying that “the purpose of the suit is to trigger insurance policies that protect executives and directors in such instances.” 

 

Though the lawsuit itself may be an unremarkable bankruptcy-related effort to snare D&O insurance proceeds for the benefit of the bankruptcy estate, the allegations themselves represent an interesting variation from the usual action rate securities allegations. The typical auction rate securities lawsuit involves allegations by the securities buyer against the firm that sold the securities. Here the allegations are brought against the buyer’s own company officials in connection with the purchases.

 

These kinds of auction rate securities allegations are not unprecedented – as I have previously noted (for example, here), there have been prior lawsuits brought against the auction rate securities buyers rather than the sellers. The fact that these kinds of complaints are continuing to arise even critical events of the financial crisis continue to recede into the past suggests that while time may have passed, the critical effects of the crisis remain. And the lawsuits continue to mount.

 

Special thanks to a loyal reader for forwarding the news article about the Land America case.  

 

Second Circuit Rules out RICO Claims Against Securities Fraud Aiders and Abettors: One of the interesting questions is whether private claimants, foreclosed from pursuing claims against third parties for aiding and abetting securities law violation, could pursue their aiding and abetting claims against the third parties under RICO. In a July 7 decision (here), in a case captioned MLSMK Investment Company v. J.P. Morgan, the Second Circuit held that the aggrieved investors cannot pursue the aiding and abetting claims under RICO.

 

Alison Frankel has an excellent summary of the legal issues and of the holding in her July 8, 2011 article on Thompson Reuters News & Insight (here). As Frankel’s article discusses, the case has mostly drawn attention for its connection to the Madoff scandal and for its implications for the Madoff trustee’s pending claims against certain litigation targets. However, as she notes, the case does “far more” – it “forecloses the only possible route to recovery through federal court for securities investors suing defendants who help a company engage in securities fraud.” Frankel’s interesting article details the larger significance of the decision.

 

Special thanks to the several loyal readers who called this decision to my attention and for sending me a link to Frankel’s article.

 

Apologies: I would like to extend my regrets that on two occasions this part week there were duplicative email distributions in connection with a single new blog post publication. I am very sorry to have burdened anyone’s email box with duplicative email distributions. The duplicate emails were an unfortunate byproduct of an error I made in putting content up on my site for publication. It really was a rookie mistake, and even worse, I made the same mistake twice in the same week. Some readers may have found that they were unable to access the links in the initial email distributions.

 

The good news is that I know what caused the duplicate email distributions and I will take steps to try to ensure that the duplicate distributions do not recur.

 

I really feel bad about the duplicate email distributions. I really want to make it up to everyone. So what I have decided to do is to send everyone a bunch of roses. Wild roses. Please accept these flowers with my sincerest apologies.

 

 

Wild Roses

Shaker Heights, OH, Bicycle Path

July 6, 2011

In what is as far as I know the first settlement of a securities class action lawsuit brought by mortgage-backed securities investors as part of the subprime and credit crisis-related litigation wave, the parties to the Wells Fargo Mortgage-Backed Certificates securities litigation have agreed to settle the case for $125 million. The lead plaintiffs’ July 6, 2011 motion for preliminary approval can be found here, and the stipulation of settlement can be found here. A July 7, 2011 Bloomberg article describing the settlement can be found here.

 

Bank of America last week announced an $8.5 billion settlement with Countrywide mortgage-backed securities investors, but as discussed here, that settlement involved only the investors’ repurchase claims under the documents governing the securities and expressly did not  resolve investors’ separate claims with respect to the Countrywide mortgage-backed securities under the federal securities laws.

 

As detailed here, purchasers of the mortgage pass-through certificates filed their initial lawsuit in March 2009, asserting claims under Sections 11, 12 and 15 of the Securities Act of 1933 and alleging that the Certificates’ offering documents contained misrepresentations and omissions. The plaintiffs alleged that the documents misstated Wells Fargo’s underwriting processes and loan standards; falsely stated the appraisal value of the underlying mortgaged properties; and misstated the investment quality of the securities, which had been assigned the highest ratings regardless of the lower quality of the underlying mortgages.

 

In an April 22, 2010 order (here), Northern District of California Judge Susan Illston granted in part and denied in part the defendants’ motions to dismiss. She dismissed, for lack of standing, plaintiffs’ claims based relating to 37 out of the 54 referenced offerings in which the named plaintiffs had not purchased securities. She denied the motion to dismiss as to the 17 remaining offerings at issue, holding that the plaintiffs, in reliance on confidential witness testimony, had adequately alleged misrepresentations in connection with the defendants’ underwriting practices, improper appraisal practices, and the process by which the securities obtained their investment ratings. Further discussion of the dismissal motion ruling can be found here.

 

In an October 5, 2010 order (here), Northern District of California Judge Lucy Koh (to whom the case was reassigned) granted the defendants’ motion to dismiss the plaintiffs’ amended Section 12(a)(2) allegations as well as certain other factual allegations. In a separate order (here), Judge Koh granted the motion to dismiss of certain underwriter defendants. The same order also dismissed as untimely the claims pursued by additional plaintiffs as to a total of eleven additional offerings.

 

The final settlement relates to a total of 28 different offerings. The settlement has been reached on behalf of not only Wells Fargo itself and related Wells Fargo entities, but also nine offering underwriters and four individual defendants. The settlement stipulation does not indicate whether or to what extent any of the other defendants are contributing toward the settlement amount. Indeed paragraph 6 of the settlement stipulation expressly states that “other than the obligation of Wells Fargo to cause to be paid [the settlement amount] to the Escrow Agent, no Defendant shall have any obligation to make any payment into the Escrow Account.”

 

There is nothing in the settlement stipulation to suggest, one way or the other, whether or not there is  any to insurance payment or reimbursement for any portion of the settlement amounts. The operative release provisions in the stipulation recites that the release parties shall include the defendants’ “related parties” which are defined to include “insurers and reinsurers,” but there is otherwise no reference in the stipulation to any insurance payment.

 

The Wells Fargo settlement comes close on the heels of the $208.5 million settlement in the WaMu securities suit (about which refer here). But there still have been only 24 settlements out of the over 230 credit crisis-related securities lawsuits filed between 2007 and now. I have long thought that the apparent settlement logjam in the credit crisis securities litigation would eventually break and that the settlements would then quickly start to accumulate. With these two recent substantial settlements, it may be the settlements will now start to quickly pile up.

 

As I mentioned at the outset, this settlement is as far as I know the first settlement of a subprime meltdown or credit crisis-related securities class action lawsuit brought on behalf of investors in mortgage backed securities. There were squadrons of other securities lawsuits filed on behalf of various mortgage backed securities investors, many of which have survived dismissal motions in whole or in part. It may be that we will start to see settlements in the other various mortgage backed securities cases shortly.

 

I have in any event added the $125 million Wells Fargo settlement to my running list of subprime meltdown and credit crisis-related lawsuit resolutions, which can be accessed here.

 

Special thanks to a loyal reader for alerting me to this settlement.

 

Quick Hits: A number of interesting law firm memos have come across our desk in recent days here at The D&O Diary. Here’s a quick list.

 

First, the Lowenstein law firm has issued an interesting July 1, 2011 memorandum discussing the perennial issues involving D&O insurance in the bankruptcy context. The memo, entitled “Navigating the Intersection of Bankruptcy and Insurance,” can be found here.

 

Second, I have had several posts on this site discussing the U.K Bribery Act (most recently here), which became effective July 1, 2011. With respect to possible D&O insurance issues arising in connection with the Act, the Pillsbury law firm published a July 5, 2011 memo entitled “U.K. Bribery Act: Consider Your Directors and Officers Insurance?” (here).

 

Third, readers may recall my recent post discussing the phenomenon of shareholder litigation arising after a negative “say on pay” vote. The Drinker Biddle law firm has a June 2011 memo about these lawsuits, entitled “Lawsuits in the Wake of Say on Pay” (here). The Bingham McCutchen law firm also has a July 7,2011 memo on the same topic, entitled "’Say on Pay’: Shareholder ‘No’ Votes Now Leading to Derivative Actions Challenging Executive Compensation," (here).

 

In the eighth lawsuit that the FDIC has filed so far as part of the current round of bank failures, on July 6, 2011, the FDIC filed suit in the Central District of California against former IndyMac CEO, Michael Perry. The FDIC’s complaint can be found here.  

IndyMac failed nearly three years ago, on July 11, 2008, as discussed here. The FDIC’s complaint against Perry alleges that he caused over $600 million in losses by causing the bank to purchase mortgage loans in 2007, just as the mortgage marketplace was destabilizing. The complaint alleges that Perry acted negligently when he allowed IndyMac to generate and purchase $10 billion in loans when the secondary mortgage market was becoming illiquid. When IndyMac was later unable to sell the loans, the bank transferred them to its own investment portfolio, which then caused over $600 million in losses.

 

The news articles report that the Complaint alleges the “instead of enforcing credit standards, Perry chose to roll the dice in an aggressive gamble to increase market share while sacrificing credit standards.”

 

Even though its complaint against Perry is only the eighth so far during the current banking crisis, the lawsuit is the second that the FDIC has filed against former IndyMac executives. As discussed at length here, the first lawsuit the FDIC filed during the current round was filed in July 2010 against four former officers of IndyMac’s Homebuilder Division.

 

The FDIC’s concentration on IndyMac likely has something to do with the fact that the bank’s closure represented the second largest bank failure as part of the current banking crisis, following only the massive WaMu failure. (IndyMac has assets of about $32 billion at the time of its closure). IndyMac was also one of the earliest banks to fail – it was just the fifth bank to fail during 2008, while there have been well over 300 bank failures since then. So the FDIC’s post-mortem processes may be further along on IndyMac than with respect to the many other bank failures that have followed.

 

The FDIC’s lawsuit is far from the first legal imbroglio in which Perry has become involved. As discussed here, on February 11, 2011, the SEC filed a lawsuit against Perry and two other former IndyMac officers, accusing them of “misleading investors about the mortgage lender’s deteriorating financial condition.”

 

Perry is also one of the defendants named in the consolidated securities class action lawsuit first brought in the Central District of California in 2007 by IndyMac shareholders. The shareholder suit has a long and involved history, as discussed here. On March 29, 2010, Central District of California Judge George Wu denied the defendants’ motion to dismiss the plaintiffs’ sixth amended complaint, while at the same time certifying the case for interlocutory appeal to the Ninth Circuit. Judge Wu’s order can be found here.

 

In any event, a list of the eight lawsuits that the FDIC has filed can be found on the FDIC’s website, here. As noted on the same page, as of July 7, 2011, the FDIC “has authorized suits in connection with 28 failed institutions against 248 individuals for D&O liability with damage claims of at least $6.8 billion.” Since the eight lawsuits filed so far involve only seven institutions and only 53 former directors and officers, there clearly are many more lawsuits (perhaps as many as 21 or more) the FDIC is preparing to file. In all likelihood, even further lawsuits will be approved in the future as well. All of which means that we could be heading into a period of very significant failed bank litigation.

 

Readers who scan the FDIC’s website closely will undoubtedly notice that one of the eight lawsuits has already settled. The settled case  is the lawsuit the agency filed in March 2011 in connection with Corn Belt Bank and Trust Company (about which here). As reflected in the FDIC’s May 10, 2011 motion (here), the parties settled the case. However, the court records do not reveal any of the details of the settlement.

 

The Name Game:  As far as I am aware, Michael Perry, the former Indy Mac CEO, is not related to Michael Dean Perry, who played football in the NFL, for the Cleveland Browns among others, during the 80s and 90s. According to Wikipedia (here), Michael Dean Perry had a McDonald’s hamburger sandwich named after him – the “MDP,” which was only served in Cleveland-area McDonald’s while Perry played for the Browns. As far as I am aware, the former IndyMac CEO did not have a sandwich named after him.

 

In a sweeping July 1, 2011 opinion in MBIA’s favor, the Second Circuit held that the company’s D&O insurance policies cover the investigative and special litigation expense the company incurred during a regulatory investigation of its accounting practices. This case had been closely watched in the D&O insurance community because of widespread carrier concerns over the district court’s coverage findings. The insurers had hoped for relief on appeal. But the Second Circuit’s decision, if anything, is even more expansive in favor of coverage than was the district court.  

 

Background

For the policy period February 15, 2004 to August 15, 2005, MBIA carried $30 million of D&O insurance, arranged in a primary layer of $15 million and an additional $15 million layer of excess insurance.

 

In 2001, prior to the policy period, the SEC had issued an Order Directing Private Investigation in connection with certain of insurance industry accounting practices. In November and December 2004, the SEC issued subpoenas to MBIA concerning "nontraditional products." The New York Attorney General also issued subpoenas in November and December 2004 regarding nontraditional products. Both the SEC and the NYAG issues additional subpoenas in March 2005. In spring 2005, MBIA, because of concerns about the cumulative impact in the marketplace, asked regulators to forbear from issuing additional subpoenas and agreed to comply voluntarily with informal document requests.

 

The investigation ultimately narrowed to three MBIA transactions. The first involved MBIA’s retroactive purchase of reinsurance on it guarantee of bonds issued by an Allegheny Health hospital group (knows as “AHERF”). The regulators latter contended that MBIA’s retroactive reinsurance purchase allowed MBIA to avoid recognizing a large ($170 mm) one-time loss. In the second transaction involving General Asset Holdings GP, the allegation was that MBIA transferred its risk of an investment loss to an MBIA subsidiary, allowing the parent company to avoid reporting the loss. The third transaction involved MBIA’s guarantee of securities US Airways issued to purchase aircraft. When US Airways went bankrupt, MBIA foreclosed on the aircraft, and treated the transaction as an “investment” rather than a “loss.”

 

In October 2005, MBIA submitted an offer of settlement to SEC. In the offer of settlement, MBIA undertook to retain an independent consultant to review MBIA’s accounting for the transactions. In January 2007, the SEC entered a Cease and Desist Order and the NYAG entered an Assurance of Discontinuance, both of which documents largely incorporated the company’s prior offer of settlement. Thereafter the company hired a consultant to undertake the proposed review. The independent consultant found no wrongdoing in connection with the Capital Asset and US Airways transactions.

 

In addition to the regulatory investigations, the company, as nominal defendant, was also sued in two derivative lawsuits. Prior to filing the suits, the shareholder plaintiffs had sent demand letters to MBIA asking the board to file suit against the directors and officers for the alleged wrongdoing. The company organized a demand investigative committee (“DIC”) to investigate the demands, but the DIC failed to act within the statutory time limit. The shareholders then filed suit, as a result of which the company organized a Special Litigation Committee (“the SLC”). The SLC hired an outside law firm, which investigated the derivative lawsuit allegations. Following its investigation, the SLC determined that maintaining the lawsuits was not in the company’s interest and recommended that the derivative lawsuits be dismissed. The derivative suits ultimately were dismissed.

 

MBIA claimed that it has spent $29.5 million in defending or responding to the regulatory investigations and the follow-on litigation. The primary insurer had agreed it was obligated to pay the costs associated with the SEC’s AHERF investigation and also its $200,000 sublimit for the DIC investigation. The primary insurer disputed that it was obliged to reimburse other amounts incurred. Specifically the primary insurer disputed that it was obligated to reimburse the costs associated with NYAG’s AHERF subpoena; the Capital Asset and US Airways transaction investigations; the SLC expenses; and the independent consultant’s expenses. The primary carrier reimbursed MBIA $6.4 million.

 

MBIA filed an action against the two insurers alleging breach of contract and seeking a judicial declaration that the insurers were obligated to reimburse the company for legal fees and other costs associated with the regulatory investigations and the derivative actions. The parties filed cross motions for summary judgment.

 

In December 30, 2009 opinion (discussed here), District Judge Richard M. Berman held that the policies covered all of the investigative costs and the special litigation committee counsel’s expenses, but that they did not cover the independent consultant’s post-settlement investigation. The parties cross appealed.

 

The July 1 Second Circuit Opinion

In a 43-page July 1, 2011 opinion for a three-judge panel of the Second Circuit, Southern District of New York Chief Judge Loretta Preska (sitting by designation) affirmed the district court’s holdings finding coverage for the investigative expenses and for the special litigation committed expenses. However, the Second Circuit reversed the district court with respect to the independent consultant’s expenses, holding that the policies covered this category of expense as well. In short, the Second Circuit found for MBIA with respect to all items in dispute.

 

The insurers argued that NYAG’s AHERF subpoena did not represent a covered “Securities Claim” within the meaning of the primary policy. The primary policy defined a “Securities Claim,” inter alia, as “a formal or informal administrative or regulatory proceeding or inquiry commenced by the filing of a notice of charges, formal or informal investigative order or similar document.”

 

The Second Circuit agreed with the district court’s “sensible intuition that a businessperson would view a subpoena as a ‘formal or informal investigative order’ based on the common understanding of these words,” adding that in any event a “subpoena is a ‘similar document’ to those listed the definition of a ‘Securities Claim’ because it is similar to other forms of investigative demands made by the regulators.” The Court rejected the insurer’s “crabbed view” that a subpoena is a “mere discovery device” that is “not even ‘similar’ to an investigative order.”  Rather, it is the “primary investigative implement in the NYAG’s toolshed.”

 

The coverage debate with respect to the Capital Asset and US Airways transactions was whether or not the transactions fell within scope of the SEC’s formal order and the NYAG’s AHERF subpoena. The insurers had argued that descriptive limitations in the formal order’s caption put these matters outside the scope of the SEC’s order and NYAG subpoena. The Second Circuit rejected this argument holding that the order “announced a broad but definite investigative scope that includes these transactions.” It reached a similar conclusion with respect to the NYAG subpoena.

 

In addition, the Second Circuit rejected the insurers’ arguments that because the investigative documents connected with these matters were produced voluntarily by oral request rather than by subpoena or other formal process, there was no coverage in connection with the related investigation. The Second Circuit found this argument “meritless” since the investigations were connected with the formal order. The Second Circuit added that “insurers cannot require that as an investigation proceeds, a company must suffer extra public relations damage to avail itself of overage.”

 

The Second Circuit also rejected the insurers’ argument that the SLC expenses were not covered. The insurers had argued that the SLC was “independent” of MBIA and therefore was not an insured person under the policy. The Second Circuit observed that “MBIA formed the SLC to determine MBIA’s response to this litigation, and the SLC decided to terminate the litigation. The SLC entered appearances for MBIA and filed motions to dismiss on it behalf in both the state and federal cases.” Because “the dismissal of the suits was MBIA’s decision, undertaken pursuant to the powers granted to MBIA under Connecticut law,” the Second Circuit rejected the insurers’ argument that the SLC was not an “Insured Person” under the policy.

 

The Second Circuit further  rejected the insurers’ argument that because the SLC was required by law to operate “independently” of MBIA, it took on a separate identity and operated separately from MBIA. The Second Circuit characterized this as “sleight of hand,” because “independent” in this context means “independence of judgment,” a “lack of conflict of interest.” The Court noted that “independence of judgment does not generate a new source of authority to terminate derivative litigation; that authority is still exercised by the corporation, which can only act through its agents.”

 

Similarly, the Second Circuit rejected the insurers’ attempt to rely on the $200,000 sublimited coverage for investigative costs. The Court found that this sublimit related solely to pre-litigation demands. However the SLC’s activities were, consistent with Connecticut law, post-litigation, as a result of which the operative policy provisions were the general policy provisions relating to litigated matters, rather than the narrow sublimit relating to pre-litigation demands.

 

Finally, the Second Circuit rejected the insurers’ argument that against coverage for the post-settlement consultant’s investigation expenses. In a highly fact-based analysis, the Court determined that the insurers had been given adequate notice of these expenses and that MBIA’s provision of information relating to these expenses had not violated any of its notice or settlement consent obligations under the policy.

 

Discussion

The Second Circuit’s MBIA opinion is an important decision addressing many recurring D&O insurance coverage issues, Because of the Second Circuit’s reasoning and the breadth of its language, policyholders will undoubtedly seek to rely heavily on this opinion in connection with the perennial issues such as coverage for costs associated with responding to a subpoena and special litigation committee expenses.

 

The Second Circuit’s opinion largely mirrored the district court with respect to the issue of the policy’s coverage for costs associated with responding to the NYAG’s subpoena – although even there, policyholders may find the Second Circuit’s language useful.

 

But the Second Circuit’s reasoning on the question of coverage for the SLC expenses goes further than the district court did. Judge Berman had found coverage for the SLC’s outside counsel’s expenses largely because of his specific factual determination that the SLC’s counsel had appeared on behalf of MBIA to have the derivative suits dismissed. The Second Circuit’s logic was more basic, having to do with the fundamental character of the SLC and its relation to the company under Connecticut law. The Court’s rejection of the insurers’ argument that the SLC was “independent” of the company seems particularly critical.

 

Another aspect of the opinion that many policyholders may find helpful is the section where the Second Circuit found coverage for the company’s expenses incurred in voluntarily providing investigative material to the regulators. Companies are often fighting with carriers over whether there is coverage for voluntary or cooperative efforts, which are often undertaken in an effort to fend off more formal regulatory action. Insurers can expect to have quoted back to them frequently the Second Circuit’s words that “the insurers cannot require that as an investigation proceeds, a company must suffer public relations damage to avail itself of coverage a reasonable person would think was triggered by the initial investigation.”

 

From the carrier’s perspective, this is a very fact-specific opinion that in many ways is largely a reflection of the unusual circumstance that all of the investigation followed the SEC’s issuance of its very broad formal investigative order. Much of the coverage analysis, including for example the court’s discussion of coverage for the voluntarily produced information, is merely  a reflection of the fact that the disputed expenses arose  after the formal order of investigation.

 

The much more frequent dispute involves costs incurred before the issuance of a formal order of investigation, a circumstance that was not involved here.  In that respect, it is critical to note that as broad as the Second Circuit’s opinion is, the decision has nothing to say concerning the recurring question of policy coverage for expenses incurred in connection with an informal investigation.

 

In addition to being fact-specific, the Second Circuit’s analysis, particularly in connection with the SLC expenses, is very law-specific too, depending narrowly on the details of Connecticut corporate law. Carriers can be expected to argue when the laws of other jurisdictions are applicable, the Second Circuit’s determination in the MBIA case is inapplicable.

 

While there are ways that the carriers can try to narrow the application of the Second Circuit’s MBIA decision, the fact is that this decision is a strong one for policyholders. This may be one of those instances where the carriers, if they really didn’t intend to cover these things and really don’t want to cover these things, may have to go back and look at their policy language. But since the general marketplace trend recently has been toward increased investigative cost coverage, the carriers may find that they lack sufficient marketplace room to maneuver on these issues from a policy language standpoint.

 

UPDATE: Joe Monteleone has an interesting July 6, 2011 post about the SLC portion of the Second Circuit’s MBIA opinion on his The D&O E&O Monitor blog, here.

 

Same Name, Different Reference: I may be the only one that cares, but there is a Camaroonian soccer player named Stephane Mbia, who plays in the French top flight soccer league, League 1, for the Olympique de Marseille club.

 

I am pleased to present below a guest post from Angelo G. Savino of the Cozen O’Connor law firm discussing the Southern District of New York’s application of the Morrison decision in an SEC enforcement action pending against Goldman Sachs employee Fabrice Tourre. This guest post will also be published and distributed in the future as a Client Alert from the Cozen law firm.

 

My thanks to Angelo for his willingness to publish his guest post here. I welcome guest posts from responsible commentators on topics relevant to this blog. Any readers who are interested in publishing a guest post on this site are encouraged to contact me directly.

 

 

Here is Angelo’s guest post::

 

 

On June 10, 2011, Judge Barbara Jones of the United States District Court for the Southern District of New York issued a decision in a case entitled SEC v. Goldman Sachs & Co., No. 10-3229 (“Goldman Sachs”), that applied the Supreme Court’s Morrison decision to claims by the SEC under both the Securities Exchange Act of 1934 and the Securities Act of 1933. Goldman had previously settled the claims against it for $550 million, but left Fabrice Tourre, a Goldman Vice President who had worked at its New York headquarters, to face the SEC’s claims. 

 

The decision is noteworthy because it is the first to apply Morrison, which held that section 10(b) of the Exchange Act does not apply extraterritorially, to claims by the SEC. It is also the first decision to provide a detailed analysis of the second prong of Morrison’s transactional test involving domestic transactions in securities that are not listed on an exchange. Lastly, the decision is the first to apply Morrison to section 17(a) of the Securities Act. 

 

The SEC alleged that in 2007, Goldman structured and marketed a synthetic collateralized debt obligation (“CDO”) called Abacus 2007-ACI (“Abacus”) that was based on the performance of subprime residential mortgage-backed securities (“RMBS”). CDOs are debt securities collateralized by other debt obligations such as, in this case, RMBSs. The complaint also alleged that Goldman was assisted by a hedge fund, Paulson & Co. Inc. (“Paulson”) in selecting the RMBSs that would collateralize the CDO. At the same time, Paulson allegedly entered into a credit default swap (“CDS”) that essentially bet that the RMBSs would perform poorly. According to the SEC, Goldman and Tourre marketed the CDOs without disclosing to investors that the underlying portfolio of mortgage-backed securities had been selected by Paulson while Paulson was betting against their performance. Tourre was allegedly the Goldman employee principally responsible for structuring and marketing the Abacus securities. 

 

The SEC also alleged that Goldman and Tourre marketed and sold $150 million worth of Abacus notes to IKB, a German commercial bank, and $42 million worth of notes to ACA Capital Holdings, Inc. (“ACA Capital”), a U.S.-based entity. ACA Capital also entered into a credit default swap involving a $909 million super senior tranche of Abacus. Essentially, ACA Capital assumed the credit risk associated with that portion of Abacus’s capital structure in exchange for premium payments. Thereafter, through a series of credit default swaps among ABN, Goldman, and ACA Capital, ABN assumed the credit risk regarding that $909 million tranche. ABN is a Dutch bank.

 

The closing for Abacus occurred in New York City and Goldman delivered the notes through the book entry facilities of Depository Trust Company in New York City. Tourre, however, provided the court with trade confirmation indicating that Goldman Sachs International, located in London, was listed as the seller of the notes to an IKB affiliate based on the Island of Jersey, a British dependency. Similarly, the CDS confirmations regarding the ABN transaction listed the seller as Goldman Sachs International and the purchaser as the London branch of ABN. 

 

The SEC claimed that Tourre had violated section 17(a) of the Securities Act and section 10(b) of the Exchange Act, Rule 10b-5 thereunder, and aided and abetted violations of section 10(b). Tourre moved to dismiss and for judgment on the pleadings based on Morrison on the ground that the complaint failed to state a claim because it did not allege securities transactions that took place in the United States. 

 

Judge Jones first analyzed the SEC’s Exchange Act claims against Tourre. She noted that the Supreme Court, in Morrison, had adopted a clear transactional test: “whether the purchase or sale is made in the United States, or involves a security listed on a domestic exchange.” Nevertheless, Judge Jones also noted that, because the securities at issue in Morrison were traded only on foreign exchanges, the Supreme Court was largely silent regarding how lower courts should determine whether a purchase or sale is made in the United States. That, however, was the issue she faced because the Abacus securities were not traded on an exchange. 

 

The court began its analysis of the issue by looking to the statutory definitions of “purchase” and “sale” in the Exchange Act, which were relatively “unhelpful.” The court then turned to case law and determined that the concept of “irrevocable liability” was at the core of both a “sale” and a “purchase.” The court noted that at some time a purchaser incurs irrevocable liability to take and pay for a security while a seller incurs irrevocable liability to deliver a security. 

 

In applying this concept to the IKB transaction, the court rejected the SEC’s arguments based on Tourre’s presence in New York while he engaged in structuring and marketing of Abacus on the grounds that it was merely conduct, which had been rejected as the determinative factor in Morrison. Judge Jones also rejected the SEC’s argument that courts must look to the “entire selling process” to determine whether a securities transaction is foreign or domestic. The court observed “in reality, the SEC’s ‘entire selling process’ argument is an invitation for this court to disregard Morrison and return to the ‘conduct’ and ‘effects’ tests.” 

 

The SEC had also conceded at oral argument that the closing in New York, by itself, was not sufficient to make IKB note purchases domestic transactions for purposes of Morrison. For good measure, however, the court noted Quail Cruises Ship Mgmt. v. Agencia De Viagens CVC Tur Limitada, which also rejected the place of closing as determinative under Morrison. Accordingly, the court concluded as follows: 

 

In view of the fact that none of the conduct or activities alleged by the SEC, including the closing, constitute facts that demonstrate where any party to the IKB note purchases incurred “‘irrevocable liability[,]’” . . . the SEC fails to provide sufficient facts that allow the court to draw the reasonable inference that the IKB note “purchase[s] or sale[s were] made in the United States.” 

 

Turning to the ABN transaction, the court stated that the SEC provided no facts from which the court could draw the reasonable inference that any party to the ABN CDS transaction incurred “irrevocable liability” in the United States. Thus, Judge Jones ruled that the SEC failed to allege that the ABN CDS transaction constituted a domestic transaction under Morrison for the same reasons as the IKB purchases. 

 

Because AKA Capital was based in the United States, there appears to have been no opportunity for the court to apply Morrison to those transactions. Instead, the court analyzed whether the SEC had sufficiently pled the elements of a violation of section 10(b), and found that it had. 

 

The court also analyzed the sufficiency of the SEC’s claim under section 17(a) of the Securities Act, and whether Morrison applied to that statutory section. The court observed that Morrison did not involve or consider section 17(a), none of the parties had cited any cases applying Morrison to section 17(a), and the court was not aware of any such case. Judge Jones observed that In re Royal Bank of Scotland Grp. PLC. Litig. applied Morrison to sections 11, 12 and 15 of the Securities Act, but did not address section 17(a). Nevertheless, the court agreed with Tourre that Morrison applies to section 17(a), stating that “Morrison itself expressly states that the Exchange Act and the Securities Act share ‘[t]he same focus on domestic transactions.’” Because Morrison focused on whether sales of securities were domestic or foreign, Judge Jones concluded that, to the extent section 17(a) applied to sales, it does not apply to sales that occur outside the United States. The court therefore dismissed the section 17(a) claim, but only to the extent that it was based on sales to IKB and ABN. 

 

The court continued its analysis, however, observing that section 17(a), unlike section 10(b), applies not only to sales of securities, but also to offers to sell securities. The court examined the definition of the term “offer” in the Securities Act, which states that an offer includes “every attempt to offer or dispose of, or solicitation of an offer to buy, a security or interest in a security, for value.” The court stated that this definition left no doubt that the focus of “offer,” under the Securities Act, was on the person or entity attempting, or offering, to dispose of, or soliciting an offer to buy, securities. Applying this definition to the allegations of the complaint, the court noted that the SEC alleged Tourre, acting from New York City, offered Abacus notes to IKB and solicited ABN’s participation in Abacus CDSs. The court observed that Tourre allegedly engaged in numerous communications from New York City that constituted domestic offers of securities or swaps. Thus, Judge Jones permitted the section 17(a) claim to survive to the extent that it was based on such “offers.” 

 

Conclusion

This case adds significantly to the jurisprudence applying the Supreme Court’s Morrison decision. As an initial matter, the case represents the first time that any court has applied Morrison to claims by the SEC. Because this action was brought prior to the enactment of Dodd-Frank, which purports to grant subject matter jurisdiction over extraterritorial claims by the SEC, it remains to be seen whether subsequent post-enactment SEC cases will follow this decision. It is arguable that Dodd-Frank should not change the Morrison analysis as applied to the SEC. Although Dodd-Frank purports to grant subject matter jurisdiction over extraterritorial securities claims by the SEC, the Supreme Court, in Morrison, held that district courts already had subject matter jurisdiction, but that section 10(b) itself had no extraterritorial reach. Nothing in Dodd-Frank modified section 10(b) in that regard. Thus, courts in post-enactment cases may conclude that they are able to follow Judge Jones’s decision in Goldman Sachs. 

 

In addition, the Goldman Sachs decision is significant for its analysis of how Morrison applies to transactions in securities that are not listed on an exchange. As Judge Jones noted, because Morrison involved securities traded on foreign exchanges, the decision is essentially silent on the second prong of its transactional test involving the purchase or sale of any other security in the United States. The Goldman Sachs decision furnishes a well reasoned analytical roadmap for other courts to follow in this respect. 

 

Lastly, the decision is noteworthy for its articulation of the applicability of Morrison to claims under section 17(a) of the Securities Act involving sales of securities, and to the Securities Act generally. 

 

The parties to the consolidated class action litigation arising out of the collapse of Washington Mutual – the largest bank failure in U.S. history — have agreed to settle the suit for a combined $208.5 million. The settlement, which has a number of interesting features, actually consists of three separate agreements: one agreement to pay $105 on behalf of the individual defendants; another to pay $85 million on behalf of the underwriter defendants; and a third to pay $18.5 million on behalf of the company’s auditor, Deloitte & Touche. The settlement is subject to court approvals.

 

As reflected here, the first of the consolidated lawsuits was first filed in November 2007. Additional suits followed as the subprime meltdown continued to unfold during 2007 and 2008. Further suits followed WaMu’s September 2008 collapse (about which refer here).

 

The cases were consolidated in the Western District of Washington before Judge Marsh Pechman. The plaintiffs’ sprawling complaint asserted numerous allegations, but the gist is that the defendants: "(1) deliberately and secretly decreased the efficacy of WaMu’s risk management policies; (2) corrupted WaMu’s appraisal process; (3) abandoned appropriate underwriting standards; and (4) misrepresented both WaMus’ financial results and internal controls." Judge Pechman initially granted the defendants’ motions to dismiss (refer here), but she denied the defendants’ renewed motion to dismiss the plaintiffs’ amended consolidated complaints (refer here).

 

Following class certification as well as additional procedural wrangling well-detailed in Alison Frankel’s July 1, 2011 Thompson Reuters News & Insight article about the settlement (here) , the parties entered mediation, which ultimately resulted in the settlement  

 

The settlement stipulation entered on behalf of the individual director and officer defendants (the “D&O settlement agreement”) can be found here; the underwriters’ settlement stipulation can be found here; and the Deloitte & Touche settlement stipulation can be found here.

 

The $105 million D&O settlement on behalf of seven officer defendants and 13 outside director defendants apparently will be funded entirely by D&O insurance. The bank’s D&O insurers for the May 1, 2007 to May 8, 2008 policy period are identified in the definition of the term “Directors’ and Officers’ Liability Insurance Policies” on pages 14-15 of the D&O settlement agreement. The bank’s 2007-2008 insurance program apparently consisted of $150 million of traditional D&O insurance (arranged in eleven layers), with an additional $100 million of Excess Side A DIC insurance (arranged in six layers). Given the bank’s holding company’s bankruptcy, presumably the full $250 was at least theoretically available for defense and settlement of claims against the insured persons.

 

The parties released in the D&O settlement agreement include the “Contributing Insurers” who are not themselves identified by name, but are described as those insurers that have exhausted their respective limits of liability in payment of defense expense, that were contributing their limits of liability in connection with this settlement; or that had exhausted their limit in settlement of other claims against the insured persons. The settlement agreement does not clarify whether the D&O settlement will exhaust the D&O limits that remain after payment of the individuals’ defense expenses.

 

The question whether or not the insurance is exhausted is a potentially important issue, as numerous other claims remain pending against various of the WaMu directors and officers, most notably the claim that the FDIC filed against three former WaMu offices and their spouses in March 2011 (refer here). As far as I could tell, the D&O settlement stipulation in the consolidate securities suit does not mention the pending FDIC action, which reportedly is moving toward settlement itself. According to news reports about the efforts to settle the FDIC action, the prospective settlement requires the approval of third parties, which could possibly refer to the D&O insurers.

 

There is no doubt that the FDIC and the shareholder plaintiffs are potentially in competition for scarce D&O insurance funds. It is probably not a coincidence that, at least according to news reports, the parties to the consolidated securities suit first reached their settlement in principle to resolve the securities suit within a week of the filing of the FDIC action.

 

If the March 2011 FDIC suit “relates back” to the policy period of the bank’s 2007-2008 program, the funds remaining for any FDIC settlement would appear to be substantially depleted by the consolidated securities suit settlement, as well as by defense expenses. On the other hand, if the FDIC suit triggered a later or a different insurance program, there may well be additional insurance funds available. Of course, the individual defendants to the FDIC action may also be compelled to contribute toward any FDIC settlement out of their own funds.

 

In any event, the aggregate WaMu settlement is the fourth largest securities lawsuit settlement so far as part of the wave of securities litigation that followed the subprime meltdown and the credit crisis. As reflected in my table of the credit crisis lawsuit resolutions, which can be accessed here, the only three larger settlements are the over $600 million Countrywide settlement (refer here), the $475 million Merrill Lynch settlement (refer here), and the Charles Schwab settlement, which as revised amounted to $235 million.The three larger settlements all involve either solvent companies or at least sovlent successors in interest. Due to WaMu’s bankruptcy, its settlement was restricted by the amount of available insurance. 

 

According to Alison Frankel’s Thompson Reuters article linked above, the $85 million underwriters’ settlement is the largest offering underwriter settlement of Section 11 claims since the $6 billion WorldCom settlement. According to a July 1, 2011 Seattle Times article (here), the WaMu settlement is the largest securities class action settlement ever in the Western District of Washington – although, according to the article, the WaMu investors stand to realize no more than 5 cents on the dollar through the settlement. The Seattle Times article also reports that the under the settlement agreements, the plaintiffs’ lawyers are to receive fees of $46.9 million and expense reimbursement of $5.8 million.

 

Special thanks to the several readers who sent me links about the WaMu settlement.

 

Yet Another Failed Bank Securities Lawsuit Settlement: On June 27, 2011, lead plaintiffs in the securities class action lawsuit filed in the Southern District of Florida on behalf of shareholders of the BankUnited Financial Corporation, the bankrupt holding company for the failed BankUnited FSB, filed a notice that the parties had reached an agreement to settle the case for $3 million. There are a number of interesting things about this notice and about the case in general.

 

First, the notice states that “the settlement of this case is part of a larger settlement that includes the FDIC and others who are not parties to this case.” The reference to the FDIC is interesting because as far as I know, the FDIC has not yet filed a civil action against BankUnited’s former directors and officers. (The FDIC’s online list of failed bank lawsuits it has filed as part of the current wave of bank failures does not list a lawsuit involving BankUnited.).

 

However, readers may recall my prior post (here), in which I discussed the November 5, 2009 demand letter that the FDIC had sent to BankUnited’s former directors and officers. In the letter, the FDIC presented its "demand for civil damages arising out of losses suffered as a result of wrongful acts and omissions committed by the named Directors and Officers." The letter explains that the demand for civil damages is "based on the breach of duty, failure to supervise, negligence, and/or gross negligence of the named Directors and Officers." Though the letter was nominally sent to the individual directors and officers, the message in the letter was clearly intended for the bank’s D&O liability insurance carriers.

 

Which brings us to the second interesting thing about the lead plaintiffs’ June 27 notice in the shareholder lawsuit. The notice specifically says that the parties’ settlement in principle is “subject to the approval of the Travelers Insurance Company, as primary directors and officers liability insurance carrier.” What makes the reference to the bank’s primary D&O insurer interesting is the combination of this reference to the insurer together with the reference to the fact that there is a larger settlement involving the FDIC.

 

As appears to be the case in connection with WaMu, the FDIC and the BankUnited shareholders were essentially competing with each other for the same pool of insurance dollars. In addition, defense expenses incurred were reducing the pool, and the longer the various proceedings dragged on the smaller would be the pool of available proceeds.

 

As discussed in my prior post about the FDIC’s demand letter, according to court filings in the bankruptcy proceedings, BankUnited carried $50 million in directors’ and officers’ liability insurance, arranged in four layers. The FDIC’s motion papers in the bankruptcy proceeding explain that the FDIC sent the demand  letter to the bank’s primary and first level excess D&O insurers, but not to the second and third level excess D&O insurers, because the second and third level excess insurer’s policies "contain a regulatory exclusion." In other words, the FDIC’s prospective recovery (if any) in these circumstances was even further constrained by possible constraints on the availability of the insurance to provide coverage for any claims it might bring.

 

These circumstance illustrate the kinds of challenges the FDIC will face as it tries to salvage losses the bank failures have caused the FDIC  insurance fund. In the S&L crisis, the FDIC faced some of these same challenges – for example, there were coverage issues then, too. But during the S&L crisis, the FDIC was rarely competing with shareholder claimants for scarce D&O insurance proceeds.

 

Most of the financial institutions that failed during the S&L crisis were small and very few were publicly traded. By contrast, many of the failed institutions involved in the current round of bank failures are larger, quite a few are publicly traded, and the ownership of many of the privately held institutions is widely distributed. The greater spread of ownership (particularly where the shares are publicly traded) increases the likelihood that following a bank failure, shareholders might pursue their own claims, putting them – as was the case with BankUnited – in competition for scarce and dwindling D&O insurance proceeds. These circumstances clearly represent a complicating factor for the FDIC as it seeks to try to recover the losses associated with the current wave of bank failures.

 

I have in any event added the BankUnited settlement to my list of credit crisis-related lawsuit resolutions, which can be accessed here.

 

And Speaking of Failed Bank Shareholder Lawsuits: According to the June 29, 2011 Santa Rosa Press Democrat (here), shareholders of the failed Sonoma Valley Bank have filed a class action shareholder lawsuit in Sonoma County (Calif.) Superior Court against eight former director s and officers of the bank. The lawsuit accuses the defendants of mismanaging over $40 million in loans. An earlier article about the shareholders claim (here) makes it clear that the purpose of the shareholder suit is to try to recover from the bank’s $20 million D&O insurance policy.

 

As I said, shareholder suits against the former directors and officers of failed financial institutions are a feature of the current wave of bank failures. The news coverage about the Sonoma Valley Bank lawsuit underscores that the litigation is all about trying to snag a recovery from the insurance proceeds. And as the BankUnited example above underscores, the shareholders’ efforts in that regard put them in competition with the FDIC for scarce and dwindling D&O insurance proceeds.

 

There are in any event many more FDIC lawsuits yet to be filed. The FDIC’s online page describing the agency’s efforts to pursue professional liability states that as of June 14, 2011, the FDIC has authorized lawsuits against 238 directors and officers of failed banks. However, as of that date the FDIC had only actually filed a total of seven lawsuits involving only 52 directors and officers. The difference of 186 directors and officers suggests that there are many more lawsuits yet to come.

 

While You Were Out: In case you missed it, on Friday July 1, 2011, I published my analysis of  securities class action lawsuit filing trends for the second quarter and for the first half of the year. Refer here.

 

Largely driven by M&A-related litigation and securities suits against U.S.-listed Chinese companies, federal securities class action lawsuit filings continued to mount during the second quarter of 2011. With 48 new securities suits during the second quarter, the year-to-date total mid-way through the year stands at 105. The 2011 filings are on pace to finish the year with about 210 new lawsuits, which is well above the 1997-2009 average of 195.

 

The M&A lawsuits included in my tally are those that were filed in federal court and that allege a violation of federal securities laws. There were ten M&A-related federal securities lawsuits during the second quarter, or about 20% of all second quarter filings.  

 

Many of the M&A-related lawsuits are being filed in state court and so don’t enter into the count of federal securities suits. In addition, there are a number of federal court M&A-related lawsuits that don’t allege violations of the federal securities laws; these suits typically allege breaches of fiduciary duties.

 

M&A-related litigation overall, including all state and federal court suits, continues to surge. Because many of these suits are filed in state court, it is difficult to get complete information. But based on the filings I have been able to track, and counting all state and federal suits of which I am aware, there have been a total of at least 125 merger-related lawsuits YTD involving as many as 90 transactions (some transactions have drawn multiple lawsuits). While this information may be incomplete, it is clear that there are many more merger-related lawsuits now being filed than traditional securities class action lawsuits. This mix of litigation has some important implications, discussed below.

 

But the most interesting story line relating to 2011 securities class action lawsuit filings is the number of new filings involving U.S.-listed Chinese companies. As I have previously noted (most recently here), lawsuits filings against these Chinese companies have been surging, particularly during the second quarter. There have been a total of 26 securities suits against Chinese companies so far in 2011, 19 of them filed during the second quarter. The 26 lawsuits represent almost one-quarter of all 2011 securities class action lawsuit filings. The 19 securities suits filed against Chinese companies during the second quarter represent almost 40% of all new securities lawsuit filings during that period.

 

Signs are that the lawsuit filings against U.S.-listed companies will continue as we head into the year’s second half. Plaintiffs’ lawyers have published news releases that they are “investigating” additional U.S.-listed Chinese companies (refer for example, here). These types of releases usually precede lawsuit filings.

 

Lawsuit filings against foreign companies in general have been a significant part of the 2011 securities lawsuit filings. Although the vast majority of the suits against foreign companies have involved Chinese companies, lawsuits have been filed against a number of companies from other non-U.S. jurisdictions. There have been a total of 34 lawsuits against foreign companies so far this year (about 32% of all YTD 2011 filings), involving companies from eight different countries.

 

These filings against non-U.S. companies are all the more notable given the U.S. Supreme Court’s June 2010 decision in the Morrison v. National Australia Bank case, which seemingly would have produced a decline in the number of new securities suits involving non-U.S. companies. But because the shares of most of these foreign company defendants trade on U.S. securities exchanges, the Morrison decision poses no barrier to the shareholder plaintiffs suing these foreign companies in U.S. courts.

 

Although the year-to-date filings are largely characterized by the features noted above, the suits are in other ways remarkably diverse. For example, the 105 companies named as defendants represent 70 different Standard Industrial Classification (SIC) Code categories. The SIC Codes with the highest number of filings are SIC Code Category 7372 (prepackaged software), and SIC Code Category 6022 (state commercial banks), each of which has had six securities suits during the first six months of 2011.

 

Though there were a number of filings in the year’s first half against banking institutions, overall far fewer of the first half filings involved financial institutions than was the case in recent years in the wake of the credit crisis. However, as I noted in a recent post, there are still lawsuits coming in that are based on credit crisis-related events. By my count, there were at least four credit crisis-related lawsuits in the year’s first half.

 

The first half lawsuit filings were also quite dispersed geographically. The securities suits in the year’s first six months were filed in 32 different U.S. districts. The districts with the highest number of filings in the first half were the Central District of California, with 24 filings, and the Southern District of New York, which had 19.

 

Discussion

As is always the case and as I have frequently noted, definitional issues significantly affect the lawsuit count. For example, if I were to include the federal court M&A lawsuits that do not involve securities law allegations, I would be reporting 113 first half lawsuits, rather than 105. On the other hand, by including the federal court merger objection suits that have securities allegations, the count arguably is inflated in the other direction. (I have struggled for some time to decide whether or not the merger objection suits properly belong in this tally.) In other words, my count may vary from other published figures, largely due to these kinds of definitional issues.

 

The growing wave of M&A litigation is an under-discussed issue. Even though the M&A cases cases tend to be resolved quickly and usually don’t involve significant financial settlements, taken collectively they still impose an enormous cost on the system. Even if the settlement in any one case is modest (usually just the payment of the plaintiffs’ attorneys fees), there are still the defense expenses to consider. In the aggregate this litigation imposes a huge expense on the financial system. In the aggregate they are also imposing significant costs on D&O insurers, or at least those that are most active as primary insurers. Sooner or later these kinds of costs have to start taking a toll on the carriers.

 

The burden these costs represent may be all the more painful for the carriers because the exposures involved with these kinds of suits likely are not priced into the risk premium. In addition, it is tough to underwrite the likelihood that any one company will be acquired. But because the discussion of carriers’ loss exposures tends to focus on the higher severity risk of securities class action litigation, there is relatively little consideration given to the higher frequency exposure that these merger objection lawsuit represent. This is one of those issues that just doesn’t get the airtime it deserves – at least not so far.

 

The Internet is buzzing over Bank of America’s June 29, 2011announcement (here) of its eye-popping $8.5 billion settlement to resolve “nearly all” of the repurchase claims involving legacy Countrywide-issued residential mortgage-backed securities (RMBS). The company’s press release and accompanying June 29, 2011 filing on form 8-K contain a lot of information about the underlying dispute and the settlement, but the deal has many moving parts and there is a lot to absorb here.

 

From a survey of the settlement documents, it appears that, among other things, the settlement resolves only the investors’ repurchase claims under the documents governing the securities but apparently does not resolve the investors’ separate claims under the federal securities laws, as discussed below.

 

The deal itself involves a settlement with the Bank of New York Mellon as trustee to 530 RMBS trusts having an original principal balance of $424 billion and unpaid principal balance of $221 billion. According to the Wall Street Journal’s account of the deal, the dispute had begun with a demand last October from a law firm representing 22 institutional investors. 

 

The investors had demanded that BofA repurchase mortgages that had been packaged into securities, basing their demand on allegations of   “breaches of representations and warranties contained in the Governing Agreements with respect to the Covered Trusts (including alleged failure to comply with underwriting guidelines (including limitations on underwriting exceptions), to comply with required loan-to-value and debt-to-income ratios, to ensure appropriate appraisals of mortgaged properties, and to verify appropriate owner-occupancy status),  and of the repurchase provisions contained in the Governing Agreements. ”Although the original demand was on behalf only of the 22 investors, the settlement is on behalf of virtually all investors in the trusts.

 

The settlement agreement can be found here. The plaintiffs’ firms press June 29, 2011 press release about the settlement can be found here. The basic framework of the settlement is straightforward – BofA will pay $8.5 billion to settle the claims. But there is more to it than that.

 

First, the settlement requires court approval. The settlement agreement explains that the Trustee will initiate an “Article 77 proceeding” in order to obtain the necessary approval. An article 77 proceeding is an action provided for under the New York Civil Practice Law and Rules, refer here. All costs associated with the Article 77 proceedings are to be borne by BofA. The 8-K specifically warns that given the number of trusts and investors and the complexity of the settlement “it is not possible to predict whether and to what extent challenges will be made to the settlement.”  The settlement is also conditioned on the receipt of tax rulings from the IRS and New York.

 

Second, on its face, the settlement involves a lot more than $8.5 billion. The 8-K says that” in addition to” the $8.5 billion settlement payment, BofA is “obligated to pay attorneys’ fees and costs to the Investor Group’s counsel as well as all fees and expenses incurred by the Trustee in connection with the settlement, including fees and expenses related to obtaining final court approval.” According to the exhibits to the settlement agreement, the plaintiffs’ firm is to receive $85 million in fees and costs.. As Susan Beck points out on the Am Law Litigation Daily, that may only represent one percent of the settlement, but it is still a respectable chunk of change.

 

Third, although the settlement is intended to be broad, there are a number of matters that the settlement does not resolve. For example, the settlement does not cover “a small number” of legacy transactions, including six transactions in which BNY Mellon did not act as Trustee.

 

Perhaps even more interestingly, the settlement does not resolve the investors’ claims under the securities laws. As the 8-K states, “because the settlement is with the Trustee on behalf of the Covered Trusts and releases rights under the governing agreements for the Covered Trusts, the settlement does not release investors’ securities law or fraud claims based upon disclosures made in connection with their decision to purchase, sell or hold securities issued by the trusts.”

 

Specifically, Paragraph 10 of the Settlement Agreement states that “release and waiver in Paragraph 9 does not include any direct claims held by Investors or their clients that do not seek to enforce any rights under the terms of the Governing Agreements but rather are based on disclosures made (or failed to be made) in connection with their decision to purchase, sell, or hold securities issued by any Covered Trust, including claims under the securities or anti-fraud laws of the United States or of any state; provided, however, that the question of the extent to which any payment made or benefit conferred pursuant to this Settlement Agreement may constitute an offset or credit against, or a reduction in the gross amount of, any such claim shall be determined in the action in which such claim is raised, and the Parties reserve all rights with respect to the position they may take on that question in those actions and acknowledge that all other Persons similarly reserve such rights.”

 

Fourth, beyond the $8.5 billion settlement, BofA will also record an additional 2Q11 charge of $5.5 billion additional representations and warranties exposure to non-government sponsored entities “and to a lesser extent GSE exposures.” Despite the sizeable amount of this charge, the 8-K specifies that the amount is not intended to include a variety of other costs, including “potential claims under securities laws.” The 8-K adds that the company is “not able to reasonably estimate the amount of any possible loss” concerning these other matters (including securities claims), noting that “such loss could be material.”

 

The settlement documents do not indicate whether any portion of the settlement will be funded by insurance. Given the nature of the settlement and of the underlying claims, the settlement would not appear to be a matter than would involve D&O insurance. At least one reader has raised the question whether or not the settlement might involve BofA’s E&O insurance. Much would depend on the nature of the coverage the bank has purchased. I welcome readers’ thoughts on the possibility of insurance coverage availability for this type of a settlement.

 

In any event, as massive as the settlement and the separate charge are, they do not and not intended to relate to the investor claims asserted under federal securities laws or state laws. As for those claims, I guess we will all just have to stay tuned…

 

Readers will of course recall that the parties to the securities class action lawsuit brought by shareholders of Countrywide against Countrywide and certain of its directors and officers previously announced a more than $600 million settlement (refer here). There are many other pending suits brought on behalf of investors who purchased Countrywide-issued mortgage backed securities. 

 

UPDATE: There is even more to this deal than I discussed above. If you have read this far, you will really want to take the time to read Susan Beck’s excellent detailed analysis of the settlement in the Am Law LItigation Daily,here.