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

 

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

 

 

Here is Angelo’s guest post::

 

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Conclusion

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Discussion

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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.