Years from now, when the history of the Roberts Court is finally written, I hope that the historians will be able to explain why during the first dozen years of the 21st century, the U.S. Supreme Court seemed so eager to take up securities cases. But whatever the reason, on June 27, 2011, on the final day of a term in which the Court heard three different securities cases, the Supreme Court granted a petition for writ of certiorari to hear yet another securities case next term.

 

The case is styled as Credit Suisse Securities (USA) LLC v. Simmonds and the question that the Supreme Court will address has to do with the interpretation and application of the statute of limitations in Section 16(b) of the ’34 Act, relating to so-called “short swing profits.” Here is the Question Presented in the case:

 

 

Whether the two-year time limit for bringing an action under Section 16(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78p(b), is subject to tolling, and, if so, whether tolling continues even after the receipt of actual notice of the facts giving rise to the claim.

 

 

The litigation arises out of the IPO laddering scandal from the dot com era. The plaintiff filed fifty-four related derivative complaints under Section 16(b) in connection with 54 IPOs in 1999 and 2000. The gist of the plaintiff’s allegation is that the supposed arrangement whereby the underwriters had arranged for post-IPO stock purchases of the issuers’ securities at progressively higher prices (“laddering”) constituted prohibited short-swing profits. The plaintiff seeks to compel the underwriter defendants to disgorge their profits.

 

The District Court granted the defendants’ motions to dismiss. As to thirty of the cases, the district court granted the dismissal motion as to thirty of the companies based upon the inadequacy of the derivative demand letters the plaintiff had sent to the issuer companies. The District Court dismissed the remaining twenty-four cases on the basis of Section 16(b)’s two year statute of limitations. The plaintiff appealed.

 

In a December 2, 2010 opinion (as amended on January 18, 2011) written  by Judge Milan Smith a three-judge panel the Ninth Circuit affirmed the district court’s ruling as to the demand letters, but reversed the district court as to the statute of limitations issue. The specific issue the Ninth Circuit addressed was whether the two-year statute of limitations is a strict statute of repose, or whether it is a “notice” or “discovery” statute that is tolled until the claimant has sufficient information to be put on notice.

 

The Ninth Circuit, following its own prior precedent, held that the two-year statute operates as a “notice” statute, and the running of the statute is tolled until there has been adequate disclosure of the trade. Because the statute begins to run only when the defendant files a Section 16(a) disclosure statement, and because the defendants did not file a Section 16(a) statement, the Ninth Circuit held that the claims are not time-barred.

 

In an unusual twist, Judge Smith, the author of the opinion for the three judge panel, added an additional opinion “specially concurring” in the result and expressing his view that the two-year statute of limitations is a statute of repose, and that were it not for the prior Ninth Circuit precedent on which the court relied in deciding this case, he would have voted that the Section 16(b) cases could not be brought more than two years after the short-swing trades took place.

 

The defendants affected by the Court’s ruling on the statute of limitation filed a petition for a writ of certiorari with the United States Supreme Court and on June 27, 2011, the Court granted the petition.

 

Discussion

There was a time when the Supreme Court rarely took up securities cases. That time is long passed. The Court is not only routinely taking up securities cases, but it is even taking up routine matters – this is the second securities-related statute of limitations case the Court has taken up recently. Just last year the Court dealt with statute of limitations issues in the Merck case.

 

The Court has only just accepted this case and it has not yet been briefed, much less argued. The Supreme Court does not explain why it takes up the cases it takes up. But I have to say that it doesn’t seem very likely that the Supreme Court took up this case to affirm the Ninth Circuit’s holding. I have no idea how five or more votes on this case will line up, but if I had to predict I would guess that the Court will say that two –year statute of limitations in Section 16(b) operates as a statute of repose.

 

It seems that Judge Smith’s unusual appended opinion specially concurring in the holding but in effect dissenting from the Ninth Circuit’s precedent operated like an entreaty to the Supreme Court to clean up the situation.

 

The one wild card is that Chief Justice Roberts may not participate in this case. The Court’s June 27 order specifies that Roberts did not participate in consideration of the cert petition. He may be conflicted out, perhaps as a result of his prior activities while in private practice. If Roberts does not participate, the conservative majority that lined up together this past term on the Janus Capital (refer here) and Wal-Mart Stores case (here) may not be able to put together the five votes to control the outcome. In which case, the outcome of the Supreme Court review may be too close to call.

 

But in any event, next October we will enter yet another Supreme Court term with at least one securities case on the Court’s docket. I know for sure at least one blog post I will be writing somewhere between next October and next June.

 

Special thanks to a loyal reader for alerting me to the cert petition grant.  

 

A Year After Morrison: Speaking of the Supreme Court and securities cases, the first anniversary of the Morrison v. National Australia Bank case has just passed, and in recognition of the event, Luke Green had an interesting retrospective post on his ISS Securities Litigation InSights blog (here). I have long thought that the Morrison case was one of the most interesting developments in this area, and as Green’s post makes clear, the case has had a multitude of interesting implications.

 

Summertime: “Love to me is like a summer day/silent because there’s just too much to say./Still and warm and peaceful,/even clouds that may drift by can’t disturb our summer sky.”

 

Pentwater, Michigan  June 26, 2011

 

In the wake of the U.S. Supreme Court’s landmark June 20, 2011 decision in Wal-Mart Stores v. Dukes, numerous commentators have asserted that the case could have a significant impact on future class actions. For example, one law firm’s memo about the case stated that the decision “should limit the number of class actions that are certified.” Which inevitably leads to the question of what the impact of the Wal-Mart decision will be with respect to class certification in securities class action lawsuits.  This question seems all the more acute given the unanimous opinion the Court issued in the Erica P. John Fund, Inc. v. Halliburton case just days before it issued its opinion in the Wal-Mart case.

 

First, some background. The Wal-Mart case involves an employment discrimination lawsuit brought by three female Wal-Mart employees on behalf of all female Wal-Mart employees. The plaintiffs did not allege that Wal-Mart had an express discriminatory policy against the advancement of women. (Wal-Mart in fact had a nondiscrimination policy.) Rather, the claimed that local managers’ discretion over pay and promotions had an unlawful disparate impact on women, and that the company’s refusal to constrain its managers’ discretion amounted to disparate treatment.

 

In order to satisfy Fed. R. Civ. Proc. 23(a)(2)’s class certification prerequisite that “there are common questions of law or fact common to the class,” the plaintiffs argued that the discrimination to which they have been subjected is common to all female Wal-Mart employees. But the commonality of the 1.5 million class members’ claims derived from the local manager’s discretion. In effect, the plaintiffs were arging that the non-policy (allowing local manager discretion) was a policy.

 

In his majority opinion in the Wal-Mart case, Justice Scalia said (rejecting the statistical evidence and expert testimony on which plaintiffs sought to rely) that the plaintiffs “have not identified a common mode of exercising discretion that pervades the entire company.” He added that “other than the bare existence of delegated discretion, respondents have identified no ‘specific employment practice,’ much less one that ties all their 1.5 million claims together.” The majority concludes that because the plaintiffs “provide no convincing proof of a companywide discriminatory pay and promotion policy, we have concluded that they have not established the existence of any common question.”

 

In reaching this conclusion, the majority commented that Rule 23 “does not set forth a mere pleading standard”; rather a party seeking class certification “must affirmatively demonstrate his compliance with the Rule – that is, he must be prepared to prove that there are in fact sufficiently numerous parties, common questions of law or fact, etc.” The majority opinion goes on to state that the required “rigorous analysis” will “entail some overlap with the merits of the plaintiff’s underlying claim. That cannot be helped.”

 

So, it seems, courts determining whether or not to certify a class should not rely on plaintiff’s mere allegations alone, but must examine the merits in order to determine whether or not the plaintiff has met the certification requirements. The “rigorous analysis” requirement apparently applies whenever a claimant seeks to proceed in the form of a class action, regardless of the nature of the underlying claim – including even when the alleged injury is asserted under the securities laws.

 

So courts determining whether or not to certify a class in a securities lawsuit must examine the merits? As University of Illinois Law Professor Christine Hurt asked in the recent post on the Conglomerate blog (here), isn’t that basically what the Supreme Court just rejected a few days ago in the Erica P. John Fund, Inc. v. Halliburton Co. case?  As Professor Hurt put it, referring to the Halliburton case “we’ve already had this fight in securities law, and the plaintiffs won in a unanimous ruling.”

 

Just to review, in the Halliburton case, the Court held that a securities plaintiff relying on the “fraud-on-the-market” theory to establish reliance did not have to separately establish loss causation in order to obtain class certification.

 

As it happens, the majority opinion in Wal-Mart expressly discussed the Halliburton case, in footnote 6, which footnote accompanies the opinion text in which the majority discussed the need for courts to review the merits of the plaintiff’s underlying claim in determining whether or not to certify a class.

 

The footnote states, in pertinent part, that “perhaps the most common example of considering a merits question at Rule 23 stage arises in class-action suits for securities fraud.” The commonality requirement “would often be an insuperable barrier to class certification, since each of the individual investors would have to prove reliance on the alleged misrepresentation.” But the “problem dissipates” if the plaintiff relies on the fraud-on-the-market presumption, by which all traders in an efficient market are presumed to rely on the accuracy of the company’s statements. Citing Halliburton, the footnote states that “to invoke this presumption, the plaintiffs seeking 23(b)(3) certification must prove that their shares were traded in an efficient market,” adding after the citation that this is “an issue they will surely have to prove again at trial in order to make out their case on their merits.”

 

In light of this footnote, it seems in that in order to establish commonality and obtain class certification, a securities plaintiff must establish that their shares traded in an efficient market. Halliburton held that if a plaintiff has established the right to rely on the fraud on the market presumption, the plaintiff does not have to separately establish loss causation in order to obtain class certification. Footnote 6 in the Wal-Mart opinion seems to suggest that the entitlement to the fraud on the market presumption to establish reliance is sufficient to satisfy the commonality requirement, and no further merits determinations are required at that stage.

 

The answer to Professor Hurt’s question seems to be that the Court in Halliburton did not say that the merits were not to be considered at the class certification stage in a securities suit; rather, at least as interpreted in footnote 6 in the Wal-Mart decision, the merits determination at the class certification stage is limited to the requirement that securities plaintiffs establish entitlement to rely on the fraud on the market theory, as that is sufficient to establish commonality.

 

So my answer to Professor Hurt’s question is that Wal-Mart is (or at least can be read to be) consistent with Halliburton. My further view is that Wal-Mart didn’t change much at least when it comes to class certification in securities cases. To be sure, there undoubtedly will be defense attorneys who will attempt to use the Wal-Mart decision in opposition to class certification motions in securities cases. We must await another day to see if these likely efforts produce an impact. For now, my own view is that the impact of Wal-Mart is likely to be limited in the securities class action litigation class certification context.

 

I am interested in readers’ thoughts on whether Wal-Mart changes anything at the class certification stage for securities plaintiffs.

 

The one final observation about Wal-Mart relates to the final clause in footnote 6. The clause states that even if a securities plaintiff has established at the class certification stage their entitlement to rely on the fraud on the market presumption, that is “an issue they will surely have to prove again at trial on order to make out their case on the merits.”

 

In other words, establishing an efficient market at the class certification stage is not ultimately determinative of the issue. This obviously leaves open the door for a contrary determination at trial, with the attendant possibility that the basis for the certification of the class could be eliminated as well. That would seem like a pretty daunting prospect for many securities plaintiffs, at least where there is a real possibility of a trial determination that that the defendant company’s shares did not trade in an efficient market. Something I would think securities class action plaintiffs’ attorneys would have to think pretty hard about before pushing a case to trial.

 

Special thanks to a loyal reader with whom I exchanged emails about footnote 6.

 

As the worst days of the financial crisis (if not their ill effects) receded into the past, the accompanying credit crisis-related litigation wave appeared to lose its momentum. By late 2010, new credit crisis-related lawsuit filings seemingly had dwindled away. But now at the midpoint of 2011, two new credit crisis related lawsuit have arisen. These new lawsuits raise a number of interesting issues, as discussed below.

 

The Latest Filings

Deutsche Bank: According to their June 21, 2011 press release (here), plaintiffs’ lawyers have filed a securities class action lawsuit in the Southern District of New York against Deutsche Bank and four of its directors and officers. The complaint, which can be found here, purports to be filed on behalf Deutsche Bank common shareholders who purchased their shares between January 3, 2007 and January 16, 2009.

 

The complaint, which alleges that the defendants “concealed the Company’s failure to write down impaired securities containing mortgage-related debt,” asserts that the defendants concealed that:

 

(a) defendants failed to record adequate provisions for losses on the deterioration in mortgage assets and collateralized debt obligations on Deutsche Bank’s books caused by the high amount of non-collectible mortgages included in the Company’s portfolio; (b) Deutsche Bank’s MortgageIT subsidiary was issuing and had issued billions of dollars of mortgage loans which did not comply with stated lending practices, leading to thousands of defaults; (c) Deutsche Bank’s internal controls were inadequate to ensure that losses on residential mortgage-related assets were accounted for properly; and (d) Deutsche Bank had transferred billions of dollars in defaulting, or soon-to-default, mortgages to unwitting investors and government programs due to its disregard of adverse findings by outside consultants.

 

Carlyle Capital Corp.: On June 21, 2011, a plaintiff filed a securities class action complaint in the U.S. District for the District of Columbia against certain individual officers and directors of the now defunct Carlyle Capital Corp. (CCC), its investment manager and related entities. The complaint, which can be found here, purports to be filed on behalf of all those who purchased CCC shares between June 19, 2007 and through March 17, 2008.

 

The complaint alleges that CCC was organized under the laws of Guernsey to profit from the spread between the its portfolio of residential mortgage-backed securities (RMBS)and the cost of financing those assets through short term repurchase agreements and other forms of financing. Its principal place of business was in Washington, D.C. The complaint alleges that the entity was a “house of cards” because it was committed to acquiring “volatile, risk-securities that could only be purchased using massive borrowing with the securities purchased serving as collateral.” The company’s RMBS portfolio deteriorated during 2007, even prior to the company’s July 2007 IPO on Euronext. The complaint alleges that the deterioration and the liquidly issues associated with the companies repo agreement financing were not disclosed to investors.

 

The complaint alleges that following the offering, the defendants continued to misrepresent the company’s financial condition, particularly with respect to its RMBS portfolio. Despite the deteriorating market for RMBS, CCG continued to acquire additional RMBS. The complaint alleges that as the marketplace nearly reached a “meltdown” in August 2007, the company did not recognize its portfolio losses. In early 2008, a cascade of margin calls forced the company’s managers to put the company into liquidation under the authority of the Royal Court of Guernsey.

 

Discussion

These two cases have more in common than just the fact that they both related (each in their own way) to the global financial crisis. First, they both involve entities organized under the laws of non-U.S. jurisdictions. Second, the complaints were first filed well after the end of the purported class period. In each of these two cases, these case attributes may present some interesting challenges for the plaintiffs.

 

Deutsche Bank is of course a domiciled in Germany. However, the company’s Global Registered Shares are listed on the NYSE. Its shares also trade on the Frankfurt Stock Exchange. The complaint purports to represent all investors that purchased the company’s common shares during the class period. The complaint does not explicitly restrict its class to those investors that purchased their shares on the NYSE, but the question undoubtedly will arise under Morrison v. National Australia Bank whether the relief available under the U.S. securities laws will extend to those who purchased their shares outside the U.S.

 

Though CCC had its principle place of business in Washington, D.C., CCC was organized under laws of Guernsey and its shared traded on the Euronext Exchange. Euronext is based in Amsterdam and has affiliates in Belgium, France, Netherlands, Portugal and the U.K. The defendants undoubtedly will seek to argue, in reliance on Morrison v. National Australia Bank, that because the transactions in which the purported class of investors purchased their shares took place outside the U.S., their alleged injuries are not cognizable under the U.S. securities laws.

 

The plaintiff in the CCC case, no doubt anticipating this argument, alleges in his complaint that since April 2007 Euronext has been owned by the NYSE; that most of the alleged misconduct too place in the U.S.; that a substantial majority of the CCC shares were owned by U.S. residents, and that U.S. investors “with typical brokerage accounts” access Euronext shares the same as they would NYSE or NASDAQ shares. These considerations notwithstanding, the question under Morrison is where the “transaction “ took place, and in light of the post-Morrison case law, the CCC plaintiff may face significant challenges overcoming the defendants’ Morrison-based motion to dismiss. The defendants undoubtedly will argue that Morrison expressly rejected the very kind of “conduct and effects” arguments on which the plaintiff apparently intends to rely.

 

The belated nature of both of these cases also presents some rather interesting issues. The Deutsche Bank case was filed about two and a half years after then end of the purported class period. The CCC complaint is even more belated, having first been filed more than three years after the class period cut off.

 

The timing of the Deutsche Bank complaint may have to do with the timing of the U.S. Department of Justice’s recently announced suit against the bank related to the its  alleged misrepresentations about its mortgage loans. The recently filed class action complaint, specifically references the DOJ action and the May 4, 2011 Wall Street Journal article about the DOJ complaint. The securities class action complaint appears to have followed in the wake of and in reaction to the filing of the DOJ complaint. But while the timing of the filing of the class action complaint may be understood as related to the timing of the DOJ complaint, the plaintiffs should anticipate that the defendants’ dismissal motion will include a motion to dismiss the case on statute of limitations grounds.

 

The CCC plaintiff’s complaint expressly anticipates the likelihood of a statute of limitations dismissal motion. The complaint contains numerous paragraphs raising the delays that the Liquidation authority faced in trying to investigate the causes of CCC’s collapse. The complaint alleges that the defendants and other related Carlyle parties “undertook deliberate and affirmative steps to conceal… facts sufficient to apprise Plaintiff and the Class of the existence of potential claims against the Defendants.” The complaint cites purported statements of the Liquidator that the defendants “repeatedly obstructed their efforts” to obtain CCG’s books and records.

 

On July 7, 2010 the Liquidators commenced a civil action against the defendants in multiple jurisdictions, asserting that the defendants breached their fiduciary duties to CCC. The plaintiff alleges that the defendants’ “fraud was effectively and indefinitely concealed from the public at least until July 7, 2010.”

 

It remains to be seen whether the CCC plaintiff’s fraudulent concealment argument will prove sufficient to overcome statute of limitations concerns. But the belated nature of these cases and the presence of the statute of limitations concerns underscore why the credit crisis-related litigation wave has largely petered out, and why we are unlikely to see very many more credit crisis-related lawsuits. Even if these cases manage to overcome the statute of limitations hurdle, any other potential case that has not yet been filed will facing even more daunting timeliness problems.

 

It is interesting to note how both of these cases embody filing trends that seemed to have completely played out some time ago, or at least to have dwindled out. As I noted at the outset, both of these cases are credit crisis-related, a litigation trend that seemed to have mostly played out a year ago. But these cases are “flashes from the past” in other ways as well. They are both “belated” cases, in that they were filed more than a year after their purported class period cutoff. There were a host of “belated” cases in late 2009 and early 2010 (about which refer here), but the belated cases flings seemed to have gone away some time ago.

 

And both cases involved companies organized under the laws of non-U.S. jurisdictions, and whose shares trade in whole or in part on exchanges located outside the U.S. In the wake of the U.S. Supreme Court’s June 2010 Morrison v. National Australia Bank case, there was widespread speculation that filing of securities class action lawsuits in the U.S. against non-U.S. companies would become a thing of the past. Of course, lawsuits against foreign companies whose shares trade on the U.S. exchanges have continued, and that may explain the Deutsche Bank suit. The CCC case seems to be another matter.

 

It really is interesting that, notwithstanding Morrison, how many of the 2011 securities class action lawsuit filings involve non-U.S. companies. About 33 of the approximately 109 (roughly 30%) securities class action lawsuits filed so far during 2011 involve non-U.S. companies, compared to 15.9 percent during all of 2010. To be sure, a large part of the 2011 filings involve U.S.-listed Chinese companies. But regardless of the reason, the fact is that contrary to expectations, one year after the Morrison decision, the securities class action lawsuit filings against non-U.S. companies as a percentage of all filings has actually increased.

 

In any event because of the issues that these two recent cases present, they will interesting to follow. It will also be interesting to see if there are any more credit crisis related lawsuit filings ahead. I have in any event added these two cases to my running list of credit crisis-related lawsuit filings, which can be accessed here.

 

Final Notes:  Although the credit crisis related litigation wave largely played out early in 2010, a trickle of credit crisis-related cases has continued to come in. In fact the two cases above actually bring the number of credit crisis-related cases so far in 2011 to at least four (categorization issues of course always come into these kinds of analyses, but by my categorization there have been at least four, others may categorize and therefore count differently). The prior two 2011 credit crisis-related cases are the Bank of America foreclosure documentation case (refer here) and the United Western Bancorp case (refer here).

 

And finally, these two cases are not the only “belated” cases filed so far in 2011. By my count, there have been at least five “belated” cases far this year, counting these two. The other three belated cases are Frontpoint Partners (here), Oilsands Quest (here) and Elan Corp. (here)

 

I am still out in the field and on assignment in Palo Alto at the Stanford Law School Directors’ College. The keynote speaker on the first full day of the event was Myron Steele, the Chief Justice of the Delaware Supreme Court. Later in the morning, SEC Enforcement Director Robert Khuzami presented what the conference organizers called a “short shot.” Both speakers’ presentations were thoughtful and interesting.

 

Chief Justice Steele’s presentation addressed his concern about “the significant intrusion of the federal government into corporate governance.” The problem with the changes that both SOX and Dodd-Frank are bringing about is that the new federal statutory standards were enacted without proper appreciation of the possible “unintended consequences” and without a proper “cost/benefit analysis.”

 

Steele suggests that the Congress adopted the changes even though they were “missing an analytic basis” for the change. Steele described this approach as “faith-based corporate governance,” because the changes were imposed on “faith that changing the corporate governance will result in better corporate governance.” Rather than basing the changes on empirical proof that a certain practice would produce better governance, the changes were “dictated by the politics of the hour.”

 

Steele’s position is that “the federal government shouldn’t have a role in corporate governance of state-chartered system.” A state-based approach is preferable, according to Steele, because it allows different companies to choose and it allows experimentation, because what works for some may not work for others.

 

As examples of the alternatives available at the state level, Steele contrasted the approach of two other states, North Dakota and Nevada, with that of Delaware. The critical distinction, Steele asserted is the legal system that is available in Delaware, which provides “predictability, clarity and consistency.” The Delaware legal system provides reassurance to directors that if they act in the best interests of the corporation, then they won’t have to worry about “some bizarre result.”

 

Steele said that if he had to describe the Delaware judiciary in two words, they would be “prudence” and “reasonableness” – that is, that the courts would be “prudent” in their review and  the courts would apply a “reasonableness” test in their application of the laws. He said that the test of every judicial doctrine in Delaware comes down to that single word – reasonableness.

 

In answer to a question from the audience, Steele referred to the conduct of the Airgas board taken during the course of the recent attempt of Air Products for a hostile takeover of the company. After Airgas had first rejected Air Products buy out offer, Air Products had managed to bring about the election of a short slate of new directors to the Airgas Board. The reconstituted Airgas board then took up the question whether the date for the next director election should be accelerated, which theoretically could have allowed Air Products to control a majority of the Airgas board and then to have the Airgas poison pill provision set aside. However, the newly constituted board, included the short slate of Air Products designees, declined the election date change and also continued to reject the Air Products offer.

 

Steele said that the Airgas board’s performance “renewed his faith and confidence in the boards of publicly traded companies” because the newly elected board members did not come onto the Airgas board as “shills” for the would-be acquirer. Rather, when they took their seat on the Airgas board, they took their duties to Airgas seriously.

 

Khuzami on the SEC Whistleblower Rules: Robert Khuzami’s presentation essentially amounted to a defense of the approach the SEC took in the recently released Dodd-Frank whistleblower rules. Khuzami began by noting that under Dodd-Frank, the payment of the whistleblower bounties is not discretionary, as the statutory provision “requires” the SEC to pay a reward when a whistleblower’s information results in a fine or penalty meeting the statutory requirements.

 

 

Khuzami noted that the Commission received a large volume of comments about the SEC’s proposed rules and that many commentators were concerned that the rules will create incentives such that whistleblowers will report “out” rather than “up,” which could create prevent companies from remediating problems themselves. Although the Commission staff met frequently and discussed these concerns at length, in the end the decision was made not to include a requirement that whistleblowers would have to report their information internally first in order to qualify for the bounty, because such an absolute requirement would be inconsistent with Dodd-Frank itself, as the statute has no requirement that whistleblowers report internally first. The Commission was concerned that requiring internal reporting first might “chill” whistleblowers from coming forward, particularly where the person to whom the whistleblower might have to report the information is involved in the misconduct.

 

However, the Commission recognizes great value in internal compliance, and therefore adopted an approach that, rather than requiring internal reporting, provides incentives for internally reporting. First the final rules give a whistleblower a “120-day grace period,” within which the whistleblower might first report to the company and have the measurement date for determining whether or not the whistleblower was first to report to the SEC related back to the date of the internal report. Also, if the whistleblower reports to the company and the company accumulates information and then self-reports to the SEC, the whistleblower will get the benefit of the entire package of information reported in order to determine whether or not the other bounty requirements had been met.

 

Khuzami emphasized that the Commission did not want to undermine internal compliance efforts and processes, so there are certain types of whistleblowers who are disqualified from the bounty, including attorneys and internal compliance offices, as well as those who obtained those who obtained their information in violation of the law.

 

Khuzami said that the Commission and its staff are going to remain attentive and if what they see requires further changes. As for the Commission’s ability to handle the whistleblower reports, he expressed confidence that the Commission could handle the reports, although he added that he does not expect a “huge flood” of reports.

 

I am on the ground in Palo Alto this week at the annual Stanford Law School Directors’ College, where the opening speaker on Sunday night was SEC Commissioner Troy Paredes, whose presentation was in the form of a dialog with Stanford Law Professor and former SEC Commissioner Joseph Grundfest. The format lent itself to give and take and produced some interesting comments from both Paredes and Grundfest.

 

Much of the discussion was devoted to issues surrounding the Dodd-Frank whistleblower provisions. Paredes explained that he had voted against the adoption of the recently release SEC whistleblower rules (about which refer here) because of his “central concern” about “what the rules would do for internal compliance processes.” Because of the rules’ incentives, “when faced with a choice,” the whistleblower’s “rational financial interest will lead him to bypass the internal process.” (Parades’s comments in this respect echo the formal statement he made at the time he voted against the adoption of the rules. His statement can be found here.)

 

But Paredes added, now that we have the rules, rather than “throwing our hands up,” we should do what we can to “increase the chances that the whistleblower will report the information to the company,” which can best be accomplished by establishing a culture where “individuals feel it will be meaningful if you report problems to the company.” Of course, businesses can do the most by “reducing the chances that there will be something to blow the whistle about.”

 

Parades acknowledge that the likely influx of whistleblower reports to the agency will put pressure on the agency to “make sure that we have the people, processes and technology” so that when the information comes in, we “put it to good use.” He expressed his concern that if the agency falls short, it could “erode” the agency’s “legitimacy” and its “credibility.”

 

The challenge of course is that the SEC must accomplish this in the context of all of its other responsibilities, and at a time when the government generally is facing budget pressure, and while the agency is accommodating other increased responsibilities under the Dodd Frank Act.

 

In response to a question from the audience about what reforms he would have preferred in order to address the problems that came to light in the wake of the financial crisis, Paredes said that “to the extent the cause of the crisis was inadequate capital and liquidity….that’s where the change should have taken place.”

 

Grundfest had his own comments on the reform that followed the financial crisis. He said that many of the reforms presume that the problems arose because the regulators” lacked authority,” which Grundfest said is “false.” The problem is not one of authority but of “competence.” The real problem is that in many instances the regulators didn’t know what to do with the information available to them. The SEC’s specific problem is that it has “too many lawyers” and what the agency needs is a different “skill mix” to be able to process the information it receives.

 

In commenting on the government’s general competence issues, Grundfest added that the problem is that the U.S. government is “the world’s largest insurance company with the world’s largest military,” and the U.S.’s government insurance systems “have nothing to do with the way a rational insurance company would run its business.”

 

More notes about the conference will follow tomorrow. I must say that, Stanford University is a truly beautiful, impressive place.

 

As discussed in a prior post (here), the U.K Bribery Act of 2010 is now set to take effect on July 1, 2011. In a guest post below, Anjali Das, a partner in the Chicago office of the Wilson Elser law firm, takes a look at the Act’s key provisions and requirements and then reviews the Act’s D&O insurance implications. 

 

My thanks to Anjali for her willingness to publish her article as a 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,

 

 

Anajli’s guest post follows:

 

 

            As if companies and their directors and officers did not have enough to contend with in the wake of the global financial crisis and the U.S. government’s increasingly zealous prosecution of violations of the Foreign Corrupt Practices Act ("FCPA"), they will soon have to comply with the U.K. Bribery Act of 2010 ("Bribery Act") effective July 1, 2011, which far surpasses the FCPA in terms of potential liability exposure for bribery in the broadest sense of the word. In light of the potential long-arm reach of the Bribery Act, Directors and Officers ("D&O") liability carriers should familiarize themselves with the potential increased exposure to their insureds under the Bribery Act.

 

 

            This article discusses the following the issues related to the Bribery Act:

 

 

  • Four key bribery offenses under the Act: 
  • Imputation of bribery offenses by associated persons to the company;
  • Six guiding principles for implementing effective anti-bribery policies and procedures;
  • Potential coverage issues under D&O policies for investigations and proceedings under the Act

 

PART I: Overview of the Bribery Act

 

 

            On March 30, 2011, the U.K. Ministry of Justice ("MOJ") issued long-anticipated Guidance on the Bribery Act which provides an overview of the four key offenses under the statute and six guiding principles to prevent bribery in violation of the Act.

 

 

 Four Key Offenses Under the Act

 

 

            As discussed below, the key offenses under the Bribery Act include: (i) active bribery or offering bribes (Section 1), (ii) passive bribery or accepting bribes (Section 2), (iii) bribery of a foreign public official (Section 6), and (iv) a company’s failure to prevent bribery (Section 7).  

 

 

            Sections 1, 2 and 6 apply with respect to acts of bribery that take place in the U.K. or if the person committing the offense has a "close connection" to the U.K such as a British citizen, resident of the U.K., or entity incorporated under the laws of any part of the U.K. A company may also be liable under Sections 1, 2 or 6 if the offense was committed by or with the consent of a company’s senior officer. Section 7 applies to companies that are incorporated or formed in the U.K. or "carry on business" in the U.K., regardless of whether the bribery occurred in the U.K. or elsewhere. 

 

 

            Active and Passive Bribery: Section 1 of the Bribery Act prohibits "active bribery" and makes it an offense for a person to offer, promise, or give "financial or other advantage" to another person with the intent to induce "improper performance" of a relevant function or activity. Section 2 of the Bribery Act is the flip side of Section 1 and prohibits "passive bribery".   Section 2 makes it an offense for a person to accept or receive a financial or other advantage intended to induce or reward improper performance by the recipient or some other person. According to the MOJ’s Guidance, improper performance means "performance which amounts to a breach of an expectation that a person will act in good faith, impartially, or in accordance with a position of trust." 

 

 

            In the introduction to the MOJ’s Guidance, Kenneth Clarke, U.K. Secretary State for Justice, seeks to assuage businesses that the parameters of the Act are not intended to prohibit reasonable client development activities: "Rest assured, — no one wants to stop firms getting to know their clients by taking them to events like Wimbledon or the Grand Prix." Moreover, the Guidance itself suggests that "an invitation to attend a Six Nations match at Twickenham as part of a public relations exercise designed to cement good relations or enhance knowledge in the organisation’s field is extremely unlikely to engage section 1. . . ." However, more lavish hospitality intended as a quid pro quo to induce favorable treatment in a pending business deal (i.e., to get new business, keep business, or get some other business advantage) could be subject to greater scrutiny under the Act. The test is what a "reasonable person" in the U.K. would expect under the circumstances, and whether the prosecution can demonstrate evidence of intent to induce improper performance as defined by the Act.

 

 

            Bribery of Foreign Officials: Section 6 of the Bribery Act, which resembles the anti-bribery provisions in the FCPA, prohibits the bribery of a foreign public official. As explained in the MOJ’s Guidance, an offense is committed when a person offers, promises or gives a foreign public official a financial or other advantage with the intent of: (i) influencing the official in the performance of his or her official duties, and (ii) obtaining or retaining business or other advantage in the conduct of business by offering the bribe. A foreign official includes any person who performs public functions in any branch of national, local, or municipal government in any country or territory outside the U.K.   An example in the MOJ’s Guidance of a permissible transaction with foreign officials is a U.K. mining company’s offer to pay for reasonable travel and accommodation to enable the foreign officials to inspect the standard and safety of the company’s distant mining operations. In contrast, an offer to pay the foreign officials’ "five-star holiday" in an unrelated destination is questionable. 

 

 

            Failure to Prevent Bribery :Section 7 of the Bribery Act creates a new offense for corporate liability for failing to prevent bribery in the first instance. Under this section of the Act, a company will be liable if a person associated with it bribes another person with the intention of obtaining or retaining business or other advantage. Liability under this section applies to "relevant commercial organizations" which include: (1) entities incorporated or formed in the U.K., regardless of whether the entity conducts business in the U.K., and (2) entities that "carry on business" in the U.K., regardless of the place of incorporation or formation. The Act itself does not define the term "carry on business," and the MOJ’s Guidance merely states that this interpretation is subject to a "common sense approach". While the MOJ notes that the courts are the final arbiter of this determination, the Government itself does not expect that companies merely listed on the London Stock Exchange without a "demonstrable business presence" in the U.K. are subject to liability under Section 7 of the Act. 

 

 

 Imputation of Acts by Associated Persons

 

 

            Corporate liability under Section 7 of the Act may be established through bribery conducted by "associated persons" which broadly encompasses any person or entity that "performs services" for the company. An associated person may include the company’s employees, agents, subsidiaries, or any other party that performs services for or on behalf of the company regardless of the "capacity" in which such services are performed. Significantly, this may include the company’s suppliers (that do more than merely sell goods) and direct contractors (as opposed to sub-contractors). As a result, there is an increased burden on companies to examine their supply chain and external business relationships with third parties for potential risk of bribery and imputation of corporate liability under the Act.

 

 

 Ministry of Justice’s Six Guiding Principles

 

 

            The MOJ has identified six "guiding principles" to assist companies in adopting effective policies, and procedures to prevent bribery. If a company can demonstrate that it has adequate anti-bribery procedures in place, this could be a complete defense to violation of Section 7 of the Bribery Act. These guiding principles include:

 

(1) Proportionality: The company’s anti-bribery policies and procedures should be "proportionate" to the size of the company and the perceived risks it faces. The procedures should be designed to mitigate identified risks and prevent deliberate unethical conduct on the part of associated persons.

 

 

(2) Top Level Commitment: The message of zero tolerance for bribery should be adopted, implemented, and/or communicated by individuals at the highest levels of the organization such as the board of directors.

 

 

(3) Risk Assessment: The company should periodically assess and document its perceived exposure to internal and external risks of bribery, including an analysis of bribery risk in the markets in which it conducts business (for country risk, sector risk, transaction risk, and business opportunity risk) and risk presented by various business partners/associates.

 

 

(4) Due Diligence: The company should conduct appropriate due diligence either internally or by external consultants prior to hiring and engaging other persons, third party intermediaries, agents, or business partners/associates to represent the company in its business dealings.

 

 

(5) Commmunication: The company’s anti-bribery policies and procedures should be communicated internally to staff and employees and externally to all business partners/associates that perform services for the company. Such communications may be made orally, in writing, and/or through training sessions.

 

 

(6)    Monitoring and Review: The company should periodically evaluate its anti-bribery policies and procedures for effectiveness in light of changing business or political environments that may increase the company’s bribery risk in certain markets. These periodic reviews may be conducted through special internal systems such as internal financial control mechanisms, staff surveys, formal reviews by top-level management, and/or external verification of the effectiveness of the company’s anti-bribery procedures. 

 

 

            It is important to recognize that the MOJ’s guidelines for anti-bribery policies and procedures are not "prescriptive," and there is no "one- size-fits-all" approach that applies to all companies. 

 

 

PART II:     Potential Coverage Issues Under D&O Policies 

 

 

            These days, D&O policies routinely afford "worldwide" coverage, including coverage for foreign (non U.S.) proceedings against a company’s foreign subsidiaries and directors and officers of these subsidiaries.   Therefore, U.S. companies that do business in the U.K., have subsidiaries, directors and officers, employees or agents in the U.K. may be subject to violations of the Bribery Act. As such, D&O insurers would be well-advised to consider the potential coverage implications under their policies for claims and investigations under the Bribery Act.

 

 

            Potential coverage issues that might arise under D&O policies for Bribery Act violations, investigations and proceedings include, but are not necessarily limited to:

 

 

·        Coverage for investigations

 

 

·        Covered claims against a D&O versus uncovered claims against the company

 

 

·        Allocation of defense costs

 

 

·        Insured subsidiaries and their directors and officers

 

 

·        Coverage for collateral litigation arising from Bribery Act violations

 

 

·        Dishonesty and Personal Profit Exclusions

 

 

·        Coverage for fines and penalties

 

 

 Coverage for Investigations

 

 

            Initially, it is important to consider whether a government investigation for potential violations of the Bribery Act gives rise to an insurer’s obligation to pay or advance the insured’s legal fees and expenses under a D&O policy. Like FCPA investigations, investigation costs for Bribery Act violations could be substantial – potentially exceeding millions of dollars. Consider for example the ongoing FCPA investigation of Avon Products, Inc. where the company reportedly spent $96 million in 2010 and $35 million in 2009 for legal fees related to its FCPA investigation. 

 

 

            Coverage for investigations under D&O policies has evolved dramatically in recent years. In some instances, the D&O policy definition of a Claim has expanded to encompass investigations of directors and officers by various government or regulatory authorities. Some D&O policies only afford coverage for formal investigations if a director or officer is served with a "subpoena" or identified as a "target" of an investigation by a governmental investigative authority. More recently, some insurers have expanded coverage to include informal investigations of directors and officers which do not require the issuance of a subpoena.  Such informal investigations may include a voluntary request for production of documents, interviews, or testimony.  This year, for the first time, a new generation of D&O coverage affords entity coverage for investigations "of the company" itself.  However, entity coverage for investigations under these newest policies may be limited to claims for violations of securities laws and/or expressly exclude FCPA and Bribery Act claims. Thus, it is critical to analyze the specific policy wording to determine the scope of coverage for investigations. 

 

 

            Undoubtedly, there are numerous cases finding both in favor of and against coverage for investigations under D&O policies. This is a fact-sensitive analysis dictated in part by the precise policy wording and the circumstances surrounding the investigation.  

 

 

            For instance, a number of courts have held that subpoenas and/or Civil Investigative Orders issued by the SEC, DOJ, or other government authorities are covered claims under a D&O policy – particularly where the definition of a claim expressly includes an "investigative order". In MBIA, Inc. v. Federal Ins. Co., 2009 U.S. Dist. LEXIS 124335 (S.D.N.Y. 2009), the court held that subpoenas issued by the SEC and New York Attorney General ("NYAG") in connection with their investigations of MBIA constituted a Securities Claim which was defined 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 court rejected the insurer’s argument that a subpoena was not an investigative "order". At a minimum, the subpoenas were "similar documents" that triggered coverage under the policies. 

 

 

            In Ace American Ins. Co. v. Ascend One Corp., 570 F.Supp.2d 789 (D. Maryland 2008), the court held that an administrative subpoena issued by the Maryland Attorney General and a Civil Investigative Demand issued by the Texas Attorney General constituted a Claim which was defined by the policy as "a civil, administrative or regulatory investigation against any Insured commenced by the filing of a notice of charges, investigative order, or similar document". The court also rejected the Insured’s argument that the subpoena and Investigative Demand failed to allege a Wrongful Act. The court observed that the Maryland and Texas Attorney General’s Office were investigating violations of their respective state Consumer Protection Acts in connection with the company’s business activities. 

 

 

            In National Stock Exchange v. Federal Ins. Co., 2007 U.S. Dist. LEXIS 23876 (N.D. Ill. 2007), the court held that an SEC investigation commenced by a formal order of investigation was a Claim under the policy. In that case, the definition of a Claim included "a formal administrative or regulatory proceeding commenced by the filing of a notice of charges, formal investigative order or similar document". It was undisputed that the SEC issued an order directing a private investigation and designating officers to take testimony. The court rejected the insurer’s argument that the SEC investigation was not a Claim "against an Insured Person for a Wrongful Act". The court observed that the scope of the SEC’s investigation included the company and its directors and officers for possible violations of securities laws. 

 

 

            In contrast, other cases have held that government investigations are not a claim under a D&O policy. In Office Depot, Inc. v. National Union Fire Ins. Co., 734 F. Supp. 2d 1304 (S.D. Fla. 2010), the court held that the D&O insurer was not liable to pay legal fees and costs incurred by the company in connection with: (1) the SEC’s investigation, or (2) the company’s internal investigation by its Audit Committee. First, the court opined that the SEC investigation was not a covered Securities Claim against the Company since the definition expressly excluded "an administrative or regulatory proceeding against, or investigation" of the company. Second, the court concluded that the SEC investigation was not a Claim against an Insured Person (D&O). The definition of a Claim included "a civil, criminal, administrative or regulatory, proceeding" or "investigation . . . commenced by service of a subpoena" or identifying an Insured Person in writing as the target of an investigation. Here, however, the SEC investigation was directed to the company – not to an Insured Person. The SEC’s formal order of investigation did not identify any specific D&Os or any specific wrongdoing by any of the D&Os. Third, the court found that the insurer was not liable for the company’s internal investigation because they were not a covered "loss" "arising from" a Claim or Securities Claim. Instead, the internal investigation, which preceded subsequent shareholder suits, was triggered by a whistleblower complaint regarding various accounting irregularities. Fourth, the court observed that the internal investigation costs did not "result solely from investigation or defense" of a covered Claim as contemplated by the policy definition of Defense Costs. The court held that the insurer was not liable for the legal fees and costs incurred by the company in response to: (i) the SEC informal inquiry, (ii) SEC formal investigation prior to the issuance of a subpoena or Wells notice on an Insured Person, or (iii) internal investigation by the Audit Committee. 

 

 

            In Diamond Glass Companies, Inc. v. Twin City Fire Ins. Co., 2008 U.S. Dist. LEXIS 86752 (S.D.N.Y. 2008) , the court held that expenses incurred by the insured in responding to a federal grand jury investigation were not covered under the insured’s D&O policy. In that case, the court opined that the investigation was not a "criminal proceeding . . . commenced by the return of an indictment, filing of a notice of charges, or similar document" as defined by the policy. The court observed that there was no claim against an individual insured, because the policy expressly stated that the individual must receive "written notice from an investigating authority specifically identifying such Insured Person as a target against whom formal charges may be commenced". 

 

 

            Of course, if prosecutors ultimately sue any directors or officers for violations of the Bribery Act, such a legal proceeding might be covered if the D&O policy broadly defines a Claim to include any civil, criminal, administrative or regulatory proceeding. On the other hand, if the company alone is the subject of a legal proceeding for violation of Section 7 of the Bribery Act, this may not constitute a covered Claim. Under many D&O policies entity coverage is limited to a Securities Claim against the company such as a lawsuit by shareholders in connection with the purchase or sale of the company’s securities. Such a narrow definition of Securities Claim may not apply to a company sued for violations of the Bribery Act to the extent the bribery does not involve a violation of securities laws, does not arise out of the purchase or sale of a company’s securities, or is not brought by a company’s shareholders. 

 

 

Identifying the Insured

 

 

            It is also critical to determine whether an "insured" is the subject of an investigation. As noted herein, many D&O policies offer worldwide coverage for a company, its subsidiaries, and their directors and officers. However, a subsidiary is a defined term that may be limited to entities in which the company owns a specified percentage of the subsidiary’s stock. Consider, for example, a company that has an overseas U.K. affiliate in which it owns 40% of the voting stock. That affiliate and its directors and officers are the subject of an investigation or proceeding for violations of the Bribery Act. However, if the D&O policy only affords coverage to subsidiaries in which the company owns 50% or more of the voting stock, then the affiliate and its directors and officers are not insureds. 

 

 

            However, if both a covered subsidiary and one of its officers are sued for violations of the Bribery Act, this could give rise to a covered claim against the subsidiary’s officer and an uncovered claim against the company (assuming the policy does not afford entity coverage for investigations). In that event, the insurer may need to seek an allocation of covered defense costs (for the officer) versus uncovered defense costs (for the company). Some D&O policies contain express allocation language which state that the parties will make a reasonable effort to arrive at a fair allocation for covered versus uncovered defense costs and, in the event of a dispute, the insurer will advance those amounts which it determines are covered until the coverage dispute is ultimately resolved by negotiation, arbitration, litigation, mediation, or otherwise. 

 

 

Collateral Litigation

           

            It is possible that Bribery Act violations may spur collateral litigation against a company and/or its directors and officers by shareholders, employees, customers, competitors, or other third parties. By comparison, FCPA violations have prompted a number of shareholder suits in the U.S. which may give rise to a covered Securities Claim.  In addition, in the case of multinational corporations, Bribery Act investigations by U.K. authorities might provoke similar investigations or legal proceedings by foreign governments or U.S. authorities under the FCPA or other anti-bribery laws. Many D&O policies are claims made and reported policies. In other words, a claim is covered if it first made during the policy period and timely reported to the insurer. When there is a chain of bribery-related investigations or legal proceedings, potential coverage issues include the date the initial bribery claim was first made (and reported), and whether subsequent bribery claims are deemed to be related to the initial claim such that they are all covered under a single policy period.  

 

           

D&O Policy Exclusions 

 

 

            Common exclusions in D&O policies include the fraud, dishonesty, and personal profit exclusions. These exclusions might be implicated if an insured is found to have engaged in intentional misconduct or unlawfully profited from his wrongdoing.   Oftentimes, however, such exclusions are subject to a final adverse adjudication establishing that the insured engaged in such wrongdoing. In addition, such exclusions may be "severable" such that the wrongful acts of one insured cannot be imputed to another for purposes of triggering an exclusion.

 

 

            Companies and individuals may be subject to imprisonment and/or fines for violations of the Bribery Act. As a general rule, most D&O policies do not afford coverage for fines or penalties. However, some D&O policies now afford very limited coverage for fines imposed under the FCPA. Thus, it is possible that similar coverage for limited fines or penalties might be offered for Bribery Act violations in the future.

 

 

Conclusion 

 

 

            Without a doubt, governments are demonstrating increasing intolerance of bribery in the corporate world by individuals and companies alike. To date, the Bribery Act far surpasses other anti-bribery laws, including the FCPA, in identifying the breadth of unacceptable business practices in both the private and public sectors that are subject to prosecution. U.K. enforcement authorities have emphasized the strong public policy rationale for adopting the Act’s stringent measures which are designed to encourage "free and fair competition," and have outright rejected the notion of greasing the wheels of commerce by so-called facilitation payments which are considered commonplace in some parts of the world. If the rigorous enforcement and prosecution of FCPA violations in the U.S. has caused companies pause for concern, the Bribery Act might possibly signal just cause for companies to scrutinize and re-think their transnational business activities to avoid future claims, prosecution, and legal expenses for potential violations of the Act.

             

Even though the story has been brewing for months, the mainstream media and the SEC suddenly seem to have decided that the alleged accounting frauds involving certain U.S.-traded Chinese companies are the central story of the moment. You can hardly pick up the business papers or turn on the television these days without encountering some coverage of this  issue. One  problem with this sudden torrent of coverage is that there are now so many items and events that it is easy to fall behind. To make sure that everyone is on top of the latest, here is a round up of the most recent news and developments about this continuing story.

 

Time to Hit Pause on the Litigation Onslaught?: Plaintiffs’ lawyers seem to be engaged in an old-fashioned race to the courthouse in connection with each new Chinese company swept up in this story. But when it comes to trying to litigate against companies based in China, there arguably are some practical reasons to move with greater deliberation, at least given problems that are likely to arise. Here, I have in mind not only the distances involved and language barriers, but even more basic issues – like service of process, for instance.

 

According to a June 15, 2011 ThompsonReuters News & Insight article entitled “Plaintiffs Hit First Roadblock in China Fraud Case,” (here) the plaintiffs in the Duoyuan Printing Inc. securities class action lawsuit (about which refer here) have not been able to effect service of process on five of the company’s current and former directors and officers named as defendants in the suit.  The plaintiffs lack the personal addresses for the individuals, who reside in China. As the story notes, “serving individuals in China is an arduous and costly process and requires a central Chinese authority to forward any requests to local Chinese courts.”

 

From the article’s account of a recent hearing in the case, it appears that there may be procedural alternatives available that could help address this issue in that case. But even if plaintiffs in this and other cases can overcome the service of process hurdle, there are other issues. As the article notes, “plaintiffs face numerous obstacles, such as difficulty in pursuing evidence-gathering in China and limitations on their ability to collect judgments or legal awards.”

 

This latter point, about the ability to collect any awards, seems particularly salient. As this wave of accounting scandals has unfolded, I have frequently wondered whether the plaintiffs’ lawyers who are now rushing into court will see any reward for their labors. Earlier securities class action lawsuits filed against Chinese companies have hardly resulted in any sort of massive bonanza. For example, earlier this week, NYSE-traded and China-based agricultural company Agria Corporation announced (here) that it had settled the securities class action lawsuit that had been filed against the company, in exchange for a payment by the company’s D&O insurers of $3.75 million. While $3.75 million is a respectable sum, it does raise the question whether, if that amount is representative of the settlement range for these kinds of suits, these cases will wind up being worth it for the plaintiffs’ lawyers, given the practical, logistical and legal barriers these cases entail.

 

Of course, the plaintiffs’ lawyers intend to engage in a for-profit enterprise, so they clearly must think these cases will prove worth pursuing. We shall see. From what I have seen of the D&O limits that many of these companies carry, it could all turn out otherwise.

 

The Role of the Auditors: In a June 13, 2011 post on the New York Times Dealbook blog, Wayne State University Law Professor Peter Henning wrote an interesting column entitled “The Importance of Being Audited,” (here), in which he examines the critical role the auditors have played in raising questions about many of these companies. A problem that can arise when the auditors raise questions or even resign is that the companies involved may delay reporting these auditor actions. As Henning details in his column, these delays have in some cases been substantial.  

 

But while the auditors have served a key role identifying many of the companies that have accounting concerns, some auditors have also found themselves targeted for alleged complicity in the misstatements. As detailed in a June 9, 2011 Reuters article entitled “Auditors Face Suits Over U.S.-Listed Chinese Blowups” (here), recent securities lawsuits involving Chinese companies have in some instances also included the companies’ auditors as defendants. Among the recent cases cited in the article are those involving Puda Coal and China Integrated Energy. Other case mentioned in which the auditors have been sued include those involving China MediaExpress and Orient Paper.

 

In addition, the recent lawsuit filed in Ontario involving Sino-Forest also named the company’s auditor as a defendant. In a June 9, 2011 New York Times article entitled “Troubled Audit Opinions” (here), Floyd Norris examined the role of Sino-Forest’s auditor, the Toronto office of Ernst & Young, in the accounting questions surrounding the company. On the one hand, the audit firm issued a clean audit opinion. On the other hand, serious questions have been raised in the media about Sino-Forest (see below). Which, for Norris, raises question not just about the audit, but raises questions about what investors realistically can expect from an audit, the purpose of which is not necessarily to detect fraud.

 

As the questions swirl about the veracity of the Chinese companies financial statements, fundamental questions about the reliability of the financial statements are inevitable. Which in turn will lead to questions about the auditors’ role in the process, and to questions whether the auditors were complicit in the financial misstatements.

 

Securities Analysts or Short-sellers?: Many of the accounting concerns involving Chinese companies have come to light through on-line postings by supposed securities analysts. But as I noted in an earlier post (here), some Chinese companies have gone on the offensive, charging that the supposed analysis is really just an attack job by financially motivated short-sellers seeking to undercut the companies’ share prices.

 

The most recent company to raise this assertion is Sino-Forest, which has attacked Muddy Waters Research, the financial analyst responsible for the first report questioning the company’s financial statements. The June 9 Floyd Norris column I referenced in the preceding section specifically discussed the role of Muddy Waters Research in the controversy surrounding Sino Forest. Similarly, a June 9, 2011 Wall Street Journal article entitled “’Backdoor’ China Plays Under Fire” (here) described the questions surrounding China Media Express, the questions about which also first arose following the publication by Muddy Waters of a report raising concerns about the company’s financial statements.

 

On June 9, 2011 the New York Times DealBook blog  ran an article entitled “Muddy Waters Research Is a Thorn to Some Chinese Companies”(here), describing Muddy Waters Research’s founder, Carson C. Block, who is “delivering a controversial message to investors enamored with Chinese companies: buyer beware.” The article cites critics of these kinds of firms, whom the critics allege, are “rumor-mongering” because they hope to profit by shorting the stocks of the companies they are attacking.

 

And the SEC Gets Into the Act: As I noted in an earlier post (here) , the SEC seems to have found itself once again in a reactive mode, this time on the question of whether or not it is adequately protecting investors with respect to the potential dangers of reverse merger companies. With the onslaught of media coverage , the SEC is stepping forward, trying to assert itself into the dialog and to establish that it is on patrol and looking for problems.

 

For starters, on June 9, 2011, the SEC released an Investor Bulletin (refer here) cautioning investors about companies that entered the U.S. markets through a “reverse merger” with a U.S. listed shell company. Among other things, the SEC cautioned in its press release regarding the Bulletin, that “investors should be especially careful when considering investing in the stock of reverse merger companies.” The Bulletin also details enforcement actions the agency has taken just since March 2011 against six companies that obtained their U.S. listing through a reverse merger. These companies had either failed to maintain current financial statements or questions had arisen about the accuracy or completeness of the company’s financial statements.

 

In addition, on June 13, 2011, the SEC announced (here) that it had instituted proceedings to determine whether stop orders should be issued suspending the effectiveness of registration statements filed by two companies – China Intelligent Lighting and Electronics Inc. (CIL) and China Century Dragon Media Inc. (CDM). The purpose of a stop order is to prevent a company or its selling shareholders from selling their privately-held shares to the public under a registration statement that is materially misleading or deficient. The agency said that it initiated these proceedings after the companies’ independent auditor resigned and withdrew its audit opinions on the financial statements included in the companies’ registration statements.

 

A Final Comment: I started this news roundup by saying that one problem with the torrent of information is that it is getting hard to keep up. Another problem is that the coverage is getting overheated. There are over 500 U.S.-listed Chinese companies and the questions that have been raised so far have involved only a small number of these companies. The concerns are now being generalized to all of the Chinese companies.

 

This very large group of companies is unfairly being swept with the same broad brush. That is not only unfortunate from an investment perspective, but also from a D&O insurance perspective. This has turned into the classic contagion event, where every company in the entire category is being treated as if it were plague-infested.

 

The media may now have switched to an “all China, all the time” mode on this topic, but that does not mean that this story relates to all U.S.-listed Chinese companies. A discerning underwriter that understands the difference could profit from these circumstances.

 

In an unpublished per curiam opinion dated May 24, 2011, the United States Court of Appeals for the Eleventh Circuit affirmed the district court’s dismissal of the credit crisis-related securities class action lawsuit pending against certain former officers of the bankrupt mortgage REIT, HomeBanc. A copy of the Eleventh Circuit’s opinion can be found here.

 

Background

HomeBanc was an Atlanta-based real estate investment trust in the business of investing in and originating residential mortgage loans. In their consolidated amended complaint, the plaintiffs alleged that prior to the company’s August 9, 2007 bankruptcy the defendants projected an "overly rosy picture" of the company’s finances, and misrepresented the company’s underwriting practices, loan loss reserve model, and other aspects of the company’s lending and mortgage investment operations. The plaintiffs alleged that the company "loosened its underwriting standards and policies in response to slowing loan originations and shifted from its stated focus on conservative risk management to attempting to profit by selling poor quality loans." The defendants moved to dismiss.

 

As discussed here (scroll down), on April 13, 2010, Northern District of Georgia Judge Timothy Batten granted the defendants’ motion to dismiss. Judge Batten agreed with the defendants’ position that "the bulk of the statements upon which Plaintiff relies fail to satisfy the …standards for materiality." Among other things he found that the complaint "makes conclusory allegations of falsity without establishing contrary true facts." He also said that the complaint is "rife with forward-looking statements made by HomeBanc that were accompanied by meaningful risk disclosures."

 

Judge Batten also concluded that the plaintiff "has failed to allege sufficient facts to demonstrate a cogent and compelling inference of scienter," noting that "the complaint cites differences of opinion, conjecture and innuendo in an attempt to make the Defendants’ behavior look suspicious, but it conspicuously omits any facts that would require one to rule out an innocent explanation for the alleged behavior." Judge Batten also held that the plaintiff had not sufficiently pled loss causation. The plaintiffs appealed.

 

The May 24 Decision

In their May 24 per curiam opinion, a three judge panel of the Eleventh Circuit affirmed the district court. The panel agreed with the district court that the plaintiffs’ amended complaint’s scienter allegations were not sufficient to meet the pleading requirements of the PSLRA. The panel stated that

 

Although the Complaint alleges that the appellees expressed mistaken confidence in HomeBanc’s financial well-being and furthermore engaged in business practices that contributed to HomeBanc’s demise, the facts alleged do not give rise to a strong inference that appellees knew that their statements were fraudulent or were reckless in light of actual knowledge.

 

Rather the stronger inference is that appellees simply failed to predict the eventual collapse of the housing and subprime market, and, as a result, were ill-prepared to respond when the markets crashed. Indeed, as the district court explained “[t]he Complaint cites differences of opinion, conjecture and innuendo in an attempt to make [appellees’] behavior look suspicious, but it conspicuously omits any facts that would require one to rule out an innocent explanation for the alleged behavior.” Moreover, the public disclosures identified in the Complaint are replete with myriad warnings and other cautionary statements, which significantly undermines any inference that appellees intended to mislead HomeBanc’s investors.

 

Discussion

The Eleventh Circuit’s opinion in the HomeBanc case is the latest in a series of decisions in which the appellate courts have affirmed the district court’s dismissals of subprime or credit crisis-related securities class action lawsuits. Earlier example include the NovaStar Financial case (about which refer here), the Centerline Holdings case (refer here) and the Impac Mortgage Holdings case (refer here). At this point, it seems clear the appellate courts are reluctant to setting aside the dismissal motion rulings of the district courts in these cases.

 

However, there has been at least one exception to the pattern of appellate rulings; as discussed here, in connection with the Nomura Subprime Securities Suit, the First Circuit affirmed in part and reversed in part the lower court’s dismissal of the case. With the Eleventh Circuit’s affirmance in the HomeBanc case, the Nomura decision remains the only appellate ruling remains the only appellate ruling in which the lower court’s dismissal was not affirmed, even if the ruling reversed the lower court in that case only in part.

 

The Eleventh Circuit’s designation of its HomeBanc decision as “not for publication” compels me to return to one of my recurring gripes. In this day of universal Internet availability of all appellate rulings, isn’t the notion that any opinion is “not for publication” rather illusory, not to say anachronistic? Not only that, but the Eleventh Circuit cannot bar participants from referencing the case, as Federal Rule of Appellate Procedure 32.1 expressly provides that courts may not "prohibit or restrict" the citation to appellate opinions by designating them as, for example, "not for publication." So why bother designating an opinion as not for publication?

 

I have also always worried about what the “not for publication” designation implies. It sort of sounds like, well, here’s our ruling, but we really don’t want anybody to see it. Or maybe, here it is, we really don’t think of much of it, this opinion really doesn’t represent our best work. What are the parties to think of the fact that the appellate panel doesn’t think an opinion is worthy of publication—that their dispute wasn’t sufficient to command the effort required to produce a published opinion?  I think the very idea that an appellate court would designate an opinion as not for publication is a poor practice and sends the wrong messages.

 

I have in any event updated my running tally of subprime and credit crisis-related securities lawsuit case resolutions to reflect the Eleventh Circuit’s opinion in the HomeBanc case. My tally can be accessed here.

 

Special thanks to a loyal reader for alerting me to the Eleventh Circuit’s opinion.

 

More Litigation Following a “Say on Pay” No Vote: Yet another shareholder lawsuit has been filed following a “no” vote from shareholders on executive compensation. As reported here, at the company’s May 10, 2011 shareholder meeting, holders of a majority of shares of Hercules Offshore Corporation voted against the advisory executive compensation resolution. And then, according to press reports, on June 13, 2011, plaintiffs purporting to act of behalf of the company filed a shareholders’ derivative suit in Texas state court against the company’s board alleging breach of fiduciary duty.

 

As I have previously noted (here and here), one of the follow on effects of the advisory say on pay vote required by the Dodd-Frank Act has been the outbreak of investor litigation following a ‘no” vote of shareholders on the executive compensation resolution. Though the number of companies whose executive compensation resolutions have been voted down by shareholder is still relatively small, a relatively high number of companies receiving negative votes have been hit with the follow on shareholder suits.

 

Speakers’ Corner: Next week I will be attending the Stanford Law School Directors’ College in Palo Alto California. I will also be speaking on the topic of “Indemnification and D&O Insurance” on a panel with my friends Priya Cherian Huskins of Woodruff-Sawyer and Anthony Tatulli of Chartis. If it works out as planned, I hope to be publishing blog posts about the conference while I am there. Information about the conference can be found here.

 

In a June 13, 2011 opinion written by Justice Clarence Thomas, the United States Supreme Court held, by a 5-4 margin, in the Janus Capital Group, Inc. v. First Derivative Traders case,  that a mutual fund management company cannot be held liable for the alleged misstatements in the prospectuses of the mutual funds that the management company administered. Justices Ginsberg, Sotomayor and Kagan joined in Justice Stephen Breyer’s dissent. A copy of the June 13 opinion can be found here.

 

Background

Janus Capital Group (JCG) is the holding company for a family of mutual funds. Janus Capital Management (JCM) is the funds’ investment advisor. In November 2003, JCG investors filed a complaint in the District of Maryland alleging that the two firms were responsible for misleading statements in the certain funds’ prospectuses. The allegedly misleading statements represented that the funds’ managers did not permit, and took active measure to prevent, "market timing" of the funds. The investors claim they lost money when market timing practices JCG and JCM allegedly authorized were made public.

 

In 2004, JCM reached a settlement with the SEC in connection with the market timing allegations in which the firm paid a disgorgement of $50 million and an additional $50 million in civil penalties. Information regarding the settlement can be found here.

 

The district court dismissed the shareholders suit in May 2007. The shareholders appealed to the United States Court of Appeals for the Fourth Circuit. In a May 7, 2009 opinion (here), the Fourth Circuit reversed the district court, finding that the shareholders had adequately stated a claim under the securities laws. The defendants’ filed a petition for writ of certiorari, which the Supreme Court granted on June 28, 2010. Refer here for further background regarding the case

 

The June 13 Opinion

The fundamental question before the court is whether or not the management company could be said to have made the statements in the funds’ prospectuses. The Court held that because the management company did not make the statement, it could not be held liable, reversing the Fourth Circuit.

 

Justice Thomas, writing for the majority, said that “one ‘makes’ a statement by stating it” and that for purposes of Rule 10b-5, “the maker of the statement is the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it.”

 

With this analysis as the starting point, and following the Court’s prior decisions in the Central Bank and Stoneridge cases (about which refer here), the majority adopted the rule that “the maker of the statement is the entity with authority over the content of the statement and whether or how to communicate it. Without such authority, it is not ‘necessary or inevitable’ that the falsehood will be contained in the statement.”  

 

The majority opinion went on to state that even if the management company may have been “significantly involved” in preparing the prospectus, this “assistance” was still subject to the ultimate control of the funds and their trustees. The majority analogized the management company’s role to that of a speechwriter; the ultimate speaker is the one that makes the speech. Because the management company did not make the alleged misstatements, they could not be held liable under Rule 10b-5.

 

In his dissent, Justice Breyer contended that that the majority “has incorrectly interpreted the Rule’s word ‘make.’” He argued that “both language and case law indicate that, depending on the circumstances, a management company, a board of trustees, individual company officers, or others, separately or together, might ‘make’ statements contained in a firm’s prospectus, even if a board of directors has ultimate content-related responsibilities.” Breyer further argued that Central Bank and Stoneridge were not controlling, as they concerned only secondary liability, whereas this case concerned primary liability.

 

Discussion

Despite the narrow 5-4 split, this decision comes as no surprise (at least to me). The argument that a legally separate entity that assists with but does not actually make the statement would be very hard to distinguish from the kind of “aiding and abetting” liability the Court rejected in the Stoneridge case. Indeed, as I noted at the time, that may well be why the Supreme Court took this case, to clarify that the “substantial participation” test that the Fourth Circuit had enunciated was inconsistent not only with the holdings of the other Circuit courts but also with the Supreme Court’s precedents in Stoneridge and Central Bank.

 

The case does break the short streak the plaintiffs had been enjoying before the Court. Earlier in the term, the Court had ruled favorably to plaintiffs in the Matrixx Initiatives case (refer here) and more recently in the Halliburton case (refer here). 

 

But while this case is favorable to the defendants, I don’t think it will result in any huge transformation in other cases going forward. The Fourth Circuit’s holding in this case was out of step with the holdings in the other circuits. While the outcome at the Supreme Court level might eliminate a pleading advantage the plaintiffs might have enjoyed in the Fourth Circuit, the result of this decision will really not change things elsewhere. Had the plaintiffs prevailed before the Supreme Court, the outcome would have had a significant impact on future cases. However, because the defendants instead prevailed, the impact of this decision will be limited and largely confined to the Fourth Circuit.

 

One final note for those readers who might have read the guest post of Brian Lehman published last Friday on this blog, in which Lehman attempted to predict the outcome of the Janus case, the case did not turn out as he had prognosticated. He had suggested that the Court might defer to the SEC’s interpretation, which the majority expressly declined to do in footnote 8, because the Court did not find the word “make” to be ambiguous.

 

In an interesting and provocative June 7, 2011 post on the DealBook blog (here), University of Connecticut Law Professor Steven Davidoff voiced his frustration that public company directors are not held liable more often for problems at their companies. Directors, he says, “have about the same chance of being held liable for the poor management of a public firm as they have of being struck by lightning.”

 

Davidoff goes on to note that the Delaware courts set “an extraordinarily high standard for finding directors liable for a company’s mismanagement” adding that “a Delaware court is not going to find them liable no matter how stupid their decisions are,” but will only find them liable “if they intentionally acted wrongfully or were so oblivious that it was essentially the same thing.” The bottom line for Davidoff is that while the “upside” for board member is “huge,” their downside is “very limited.” 

 

I have some thoughts and comments about Davidoff’s column. My purpose is not to dispute his thesis or even necessarily to disagree with him, but rather to try to sharpen the focus of the discussion. My fundamental concern is that I think that there are already many more lawsuits against boards than there are companies engaged in corporate misconduct.

 

My fear, given the civil litigation resources our society already has deployed, is that more dramatic sanctions against corporate board members could result only in unintended collateral damage rather than greater traction in the fight against corporate misconduct. To me, a demand that all directors must face greater financial consequences in civil litigation is akin to a proposal that we must use more powerful rat poison in the kitchen – it is just as likely that we will wind up killing off the family pets and Grandma as it is that we will eliminate any greater number of rats. To be specific, if we are going to employ more potent means of controlling corporate misconduct, let us take great care to understand what our goals are and make certain the means are well calculated to achieve the intended goal.

 

Let me just say at the outset that I have nothing but respect for Professor Davidoff. His posts on the Dealbook blog are among the best out there. By raising the questions as I do below, I am merely hoping to consider his assumptions, not to disrespect his work in any way. I also should probably declare my biases at the outset, as well. I have spent most of my career worrying about the interests of corporate directors and officers. There is no doubt that I come at these issues from the perspective of the corporate officials, and with their interests in mind. However, I believe that even if it may the product of a bias, this perspective still affords an important take on these issues.

 

Davidoff seems very sure that directors are not being held liable often enough. However, it is not clear why he thinks directors should be held liable more often. Upon reflection, I can think of three possible reasons why it might be argued that directors ought to face civil liability more frequently: recompense; retribution; and deterrence. I examine each of these three reasons below and consider whether or not they substantiate the need for directors to face civil liability more frequently.

 

Recompense: Davidoff addresses the issue of recompense, at least inferentially. After identifying the two Delaware court cases in which directors have been held liable, and reviewing the amounts paid in those two cases, he aggregates the amounts paid and comments, with obvious derision, these payments amount to “no more than $8.35 million in personal payments by directors over the 26 years.”

 

While the cited figure may indeed represent the total amount that directors have themselves paid during that period in Delaware cases, it is hardly an accurate picture of the total amount of recompense paid to investors or to companies during that period. There have of course been many other cases settled during that period in which the settlement amounts were funded by D&O insurance or other sources.

 

Davidoff briefly acknowledges the role that D&O insurance plays, by stating that “even if there is a liability or a settlement, it is almost always covered by insurance of directors and officers.” But if the goal is recompense, what difference should it make whether that the funds were provided by insurance? The directors may not have paid these other settlements out of their own assets, but the settlements have provided extensive additional recompense to companies or to investors. Moreover, as I have noted on this blog (most recently here), the frequency of very large cash payments in Delaware cases and other derivative suits has become increasingly common in recent years.

 

In addition, though Davidoff briefly refers in his column to cases involving potential liability under the federal securities laws, he omits to mention that there have been billions of dollars of recoveries in these cases in recent years. Yes, as Davidoff notes, settlements in those cases rarely include amounts paid personally by directors, but if the goal is recompense (rather than retribution), the source of funds should be irrelevant.  

 

The omission of any reference to these many other settlements suggests that the real objection may not be that the cases do not produce enough recompense, but that these case resolutions do not produce enough pain for directors, because the funds did not come out of the directors’ pockets. But if the absence of pain is the problem, then the issue seems to be retribution, not recompense.

 

Retribution: Perhaps I am reading too much into Davidoff’s words, but I do not think I am being unfair in suggesting that behind Davidoff’s words is a belief that directors should face a greater threat of punishment, and specifically that their personal assets ought to be on the line.

 

In considering whether or not directors should face a greater threat of punishment, I think it is critical to note that in his column Davidoff only refers to civil litigation (specifically, Delaware state court litigation and federal securities litigation). His column does not address, discuss or mention criminal or enforcement actions.

 

There unquestionably are occasions when retribution against corporate officials may be appropriate. But the proper vehicles for retributive justice are criminal actions and enforcement proceedings, which are the appropriate means for enforcing societal values and imposing punishments.

 

There is and should be an entirely different discussion whether or not the criminal and enforcement authorities have sufficiently exercised their prosecutorial responsibilities in connection with corporate misconduct. But Davidoff’s column was restricted just to civil litigation. Civil litigation may well serve the goals of recompense (as discussed above) and deterrence (as discussed below), but I would contend that it is not the purpose of civil litigation to serve the goal of retribution, which is the goal of criminal and enforcement procedures.

 

Deterrence: Which brings us to the question of deterrence. I understand the argument that if directors faced a greater likelihood of being personally liable financially, there would be greater deterrence of corporate misconduct. But before examining this question, I want to make a few points about deterrence as it currently operates.

 

The problem with most analyses of the deterrent effect of corporate and securities litigation is that it usually assumes that the only effective deterrence is through financial consequences, and it overlooks other possibilities. My own experience is that the threat of civil litigation (as well as the possibility of criminal and enforcement proceedings) provides a powerful deterrent effect, separate and apart from the threat of financial liability.

 

My experience is that most corporate directors have a deep and abiding aversion to becoming associated with any type of corporate scandal. The prospect of seeing their name in the media paired with the word “fraud” or even “mismanagement” is a truly detestable possibility and one they are deeply committed to trying to avoid. These individuals value their reputations. They are keenly interested in avoiding the types of situations that would draw them into scandal and tarnish their personal or professional standing.

 

The individual directors are also highly motivated to avoid the burden, disruption and expense of civil litigation. And with regard to expense, I think it is critically important to note that Davidoff’s analysis of how often directors have been required to pay settlements or judgments themselves omits to consider how often directors are compelled to fund their defenses out of their own pockets.

 

Defending these kinds of suits can be hideously expensive, and if indemnification is unavailable and insurance is inadequate, directors can (and sometimes do) find themselves forced to draw on their own assets to mount their defense. Directors are well aware of these possibilities and they are highly motivated to avoid them.

 

In short, I believe that even conceding all of the points in Davidoff’s column about the infrequency of personal civil liability for directors, the threat of civil litigation still provides a powerful deterrent to corporate boards.

 

There are of course boards or individual directors to whom these deterrents are not sufficient. However, there is nothing that says that imposing greater financial liability in civil litigation would deter these undeterrable boards and individuals. Very significant personal liability was imposed on the boards of Enron, WorldCom and Tyco, but I would argue that perhaps other than with respect to the specific individuals involved these individuals’ settlement contributions otherwise had absolutely no measurable deterrent effect.

 

I can anticipate the argument that three cases alone is not enough, that personal liability must be imposed more generally in more civil cases in order to generate enough deterrent effect. But if personal liability in three cases was not enough, how many will be enough? How do we know? Doesn’t this all seem rather speculative?

 

My fear is that in the highly charged current environment, the generalized notion that individuals ought to be compelled to pay more out of their personal assets could wind up imposing costs and burdens in ways that far exceed the intended purposes – indeed, without any substantiation that it would even potentially produce the intended benefit. And likely imposing enormous costs on many of the wrong people.

 

Let me put it another way. The suggestion that individuals ought to be held personally liable is a far more comfortable notion if you are sure that the liability will never be imposed on you personally. It is an easy assertion to make against a group from which you have not only dissociated yourself, but that you have comprehensively demonized. However, you would take a far different perspective if the question involved your own personal assets. Particularly in our litigious society where sensational and even outrageous allegations can be made with impunity and where the high costs of litigation often can compel settlements simply as a way to avoid financial ruin. In these circumstances, the insistence on personal director liability looks to many directors like nothing more than a legally sanctioned predicate for future hostage crises.

 

I know that in taking this position, I may well be flying in the face of conventional wisdom. My purpose here is to provoke discussion and to make sure that before we move on to what actions we should take, we make sure that we identify our goals and ensure that the actions are well matched to the intended goals. Stronger rat poison undoubtedly will produce many effects, but there is nothing that it ensures that it will result in fewer rats.

 

My own view is that there are already far too many civil lawsuits against corporate boards, most of them involving circumstances where nothing improper has occurred. The law has evolved in response to the excess of litigation, and that is the reason for the barriers to liability that Davidoff bemoans. A welcome and interesting discussion would be one that addresses the question of how we can develop a more concentrated system of civil litigation, in which meritorious cases are resolved and fewer of the other kind are filed.

 

More About Delaware: This must have been the week to raise doubts about Delaware’s courts. In her June 9, 2011 “Summary Judgment” column on the Am Law Litigation Daily (here), which included her remarks on the nomination of Delaware Vice Chancellor Leo Strine to take the position of Chancellor of the Court, she commented, among other things, that Delaware is “soft on Corporate America” adding that corporate directors “have little to fear in terms of being held accountable when they do a lousy job and harm a lot of people in the process.” She concluded by calling on Strine to reconsider the words of the courts critics, adding that the Court “can and should send a much stronger message.”

 

In Case You Missed It: I hope readers had a chance to read the interesting guest post I published late last Friday afternoon (here), in which Bernstein Liebhardt attorney Brian Lehman presents his prediction of the outcome the Janus Capital case now pending before the U.S. Supreme Court. Lehman’s interesting prognosis is worth a look, particularly given that the Court is likely to release its decision in the Janus Capital case any day now.