According to news reports, on June 1, 2011, Alpha Natural Resources completed its $7.1 billion acquisition of Massey Energy Company. The deal went forward despite last minute efforts by groups of Massey shareholders proceeding in West Virginia and Delaware courts to try to enjoin the transaction on the grounds that the merger did not properly value the pending derivative claims against the company’s board, resulting in Alpha being able to acquire Massey without taking into account the fair economic value of the derivative claims.

 

The courts in both West Virginia and Delaware rejected the preliminary injunction motions. Delaware Vice Chancellor Leo E. Strine Jr.’s  81-page May 31, 2011 opinion (here) refusing to enjoin the merger makes for some extraordinarily interesting reading, as Susan Beck notes in her June 1, 2011 Am Law Litigation Daily article about the decision (here).

 

All of these events relate back to the April 5, 2010 disaster in Massey’s Upper Big Branch Mine in Montcoal, West Virginia, in which 29 miners were killed. In the wake of the disaster, the company’s share price declined, and the company struggled to deal with the fallout and scrutiny from the tragedy. These events set up a lengthy process that resulted in Alpha’s agreement to acquire Massey. During this process, Massey forced out its long-standing CEO, Don Blankenship.

 

Another thing that happened in the wake of the disaster (“inevitably,” Vice Chancellor Strine noted) is that Massey shareholders filed derivative suits seeking to ensure that to the extent Massey was harmed by the obligation to pay fines, judgments to the deceased miners’ families and lost cash flow from the damaged mine, the companies directors and officers should be held responsible for failing to make sure that Massey complied with mine safety regulations.

 

In addition to damages, the derivative plaintiffs sought a preliminary injunction against the merger, arguing among other things that the merger was an attempt by the board to evade its responsibilities for the harm to the company by means of a sale to Alpha.

 

In his May 31 opinion, Vice Chancellor Strine denied the plaintiffs’ motion for a preliminary injunction, holding that it is “highly doubtful” that the shareholders would be able to show that Massey’s board had sought to sell the company “solely, or even in a material way” to escape liability for the shareholder claims. He also said that to delay the deal would “threaten more harm to Massey shareholders than its potential benefits to them,” reasoning that Massey’s shareholders ought to be able to vote for against the merger on their own.

 

There are a host of interesting things about Vice Chancellor Strine’s highly readable 81-page opinion. Among them, in no particular order, are the following.

 

First, Vice Chancellor notes that it is “undisputed” “regrettable” “concerning” and “might even be characterized as a breach of the duty of care” that in connection with its consideration of the proposed Alpha merger the Massey board “failed to address the value” of the derivative claims, as the duties of a board in negotiating the sale of company are to consider and get full consideration for “all of the corporation’s material assets.” However, he added, that “does not much help the plaintiffs obtain an injunction,” as the record “does not support the inference that the Derivative Claims are material in comparison to the overall value of Massey as an entity.”

 

Second, as part of reaching the preceding conclusion, Vice Chancellor Strine noted that “the record does not persuade me that the Merger would, after trial, likely prove to be economically unfair to the Massey shareholders,” citing a number of considerations. In particular, with respect to the question whether or not the failure to separately negotiate value for the derivative claims harmed Massey shareholders, Strine noted numerous difficulties the claims face,  including the difficulty of showing that the defendants “acted with a wrongful state of mind, particularly given the exculpatory provision in Massey’s charter”; the possibility that “insurance proceeds may not be available to pay any judgment”; the questionable ability of even the wealthy board members to satisfy any judgment; and the fact that most of the individual defendants are independent directors whose “motivation to tolerate unsafe practices for the sake of profits would be tempered.” The value of the derivative claims might represent at most an opportunity for the company to recoup some of the costs for the disaster – and for that reason “it is unlikely that Alpha viewed these Claims as an asset at all, but merely as having some potential to reduce the gravity of the Disaster Fall-Out Alpha was inheriting.”

 

Third, though the Massey board itself might have been unclear on what the merger’s completion would mean for the derivative claims, Stine himself is very clear that the claims survive the merger (given his determination that the merger was not motivated primarily to avert the derivative suit liability). But with the merger’s completion, Alpha, as Massey’s successor in interest, controls the claims, putting the derivative plaintiffs in the position of having to prove demand excusal, and thus “receive leave to proceed in a double derivative action on behalf of Alpha” – an outcome Strine says “is not one an objective mind ought to consider probable” given that Alpha’s board has no exposure to the claims but “myriad of rational business reasons why Alpha may later decide that prosecuting these Claims does or does not make sense for Alpha.”

 

Nevertheless, Strine also notes that it is not a foregone conclusion that Alpha would not itself decide to pursue claims against the former fiduciaries of Massey. The fact is, as Strine notes, “Alpha will have to make a difficult business calculation about the extent to which it goes after Massey’s former management,” and its board will have to answer to Alpha’s own shareholders on their decision whether or not to pursue such claims. As Strine notes, “it is not clear why Alpha would not seek to offset the costs to itself of those violations by suing previous management if by doing so it had a realistic chance of obtaining some meaningful recovery.” That does not necessarily mean that Alpha will be able to effect a recovery commensurate with this costs (See the “second” item above and the “seventh” item below).

 

Fourth, Strine has some choice words to say about the Cravath law firm, which is not only acting as the board’s counsel in the derivative lawsuit, but also counseled the board on how it ought to consider the derivative suit in connection with the proposed merger. Strine characterized the law firm as being an “awkward source for advice” on this issue, and given the Cravath firm’s recommendation that the board not consider the existence of the derivative claims at all, “one cannot conclude that the Massey Board was presented with a reasoned analysis of the ‘value’ of the Derivative Claims." Strine also faulted Cravath for insufficiently explaining to the board what a survival of derivative claims means in the context of a merger. (Susan Beck’s Am Law Litigation Daily article linked above has more on this particular topic.)

 

Fifth, using language that is both noteworthy and striking, Strine went out of his way to excoriate former Massey CEO Don Blankenship, quoting descriptions of him as “autocratic” and describing him as having an “adversarial relationship” with the UAW and a “combative approach” to the federal mining regulator. He noted that Massey’s managers and employees understood that “if you wished to stay or get ahead at Massey under Blankenship, then the priority of profits over safety is one not to be questioned.” He also noted that in 2009, after President Obama’s election and a change in leadership at the mining regulator, and after Massey had sustained a number of losses in legal proceedings, Blankenship’s attitude toward regulators “deteriorated very sharply.”

 

Sixth, Strine makes it clear that he believes the real victims here are the deceased coal miners and their families – and in that regard, Strine is not prepared to let the shareholders off the hook. As he points out in a biting 1,071-word footnote (number 185), Massey’s shareholders not only had an annual opportunity to elect directors, but they “continued to invest in a company they say was well known to treat its workers and the environment poorly.” Indeed, “to the extent Massey kept costs lower and exposed miners to excess dangers, Massey’s stockholders enjoyed the short-term benefits in the form of higher profits.” The very practices of which the plaintiff shareholders now complain might rationally have been expected to act as a “goad” to shareholders to “give more weight to legal compliance and risk management in making investment decisions.” In the end, Strine notes, the “most sympathetic victims here were not shareholders, they were Massey’s workers and the families” and other constituencies who suffered while the company prospered and shareholders benefitted.

 

Seventh, readers of this blog will be interested in some parenthetical comments Strine has to make about D&O insurance. In noting the difficulties Alpha would have in collecting on any judgment entered in the derivative case, he notes that even if the derivative claims were to settle for the full amount of the D&O insurance, the total amount of coverage available is $95 million – not a “trifle,” but also not material in the context a merger valued over $ 7 billion. Also, Strine notes, showing that he has a keen appreciation for the D&O insurance market’s dark reality, “anyone who has dealt with coverage questions and insurance carriers would also tell you that a scenario in which the D&O insurers in the ‘tower’ would easily pay out anywhere near the full amount of the policy in a quick and low-cost way to Alpha is more the stuff of dreams than of real life.”

 

Eighth , it may not be entirely relevant to Vice Chancellor Strine’s decision or to the fact that the Alpha acquisition went forward as planned, but it is probably worth noting that among Massey’s former independent directors is another individual whose name has been in the news for entirely different reasons this week – that is, among the independent Massey directors named as defendants in the derivative litigation is Ohio State University President E. Gordon Gee. According to Wikipedia, Gee served on Massey’s board from 2000 until 2009 (that is, he resigned before the Big Branch Mines disaster, but during many of the prior safety and environmental problems the company faced.)

 

Now that the merger has been completed, the ball shifts to Alpha’s board to consider whether or not to pursue direct claims against the former Massey directors and officers. While Alpha might as Strine notes have substantial business reasons for wanting to close the book on the past and moving forward, the fact is that Alpha also inherited the wrongful death and regulatory claims that were pending against Massey. As much as Alpha might want to move on for business reasons, that may not be an available option.

 

To the extent Alpha must pay settlements, fines, and judgments, it will have to consider whether or not to pursue claims against the former Massey fiduciaries to try to recoup these costs. And in making that determination, the Alpha board will also have to consider its fiduciary duties to its own shareholders (some of whom now are former Massey shareholders.) I don’t know where any of this ultimately will lead, but the insurers in that $95 million insurance tower (whoever they may be, I have no idea) may find it prudent to wait a while before deciding whether or not to take down their reserves on this particular claim.

 

Special thanks to a loyal reader for providing me with a copy of Judge Strine’s opinion.

 

Yeah, I Really Hate it When the Guy in Front of Me Reclines His Seat Back, Too: On a May 29, 2011 United Airlines flight from Washington Dulles Airport to Ghana, one of the passengers decided to lower his seat back – which set in process a sequence of events that started with a scuffle on the plane and ended with Air Force F-16 fighter jets being scrambled. Because no one could make this up, you really have to read the Washington Post story (here) for yourself.

 

Just something to think about next time before reclining your seat back, O.K.?

 

On May 25, 2011, In the latest example of shareholders suing a company’s board following a negative “say on pay” vote, two union pension funds filed a shareholders’ derivative action claiming that Umpqua Holdings Corporation’s board violated its duties to investor by approving the2010 compensation plan despite the negative shareholder vote.. The lawsuit follows the April 19 annual meeting of the bank holding company, in which about 62% of shareholders voted “no” in the advisory shareholder vote on the company’s 2010 executive compensation plan. The claims asserted in the lawsuit rely directly on the negative note.

 

Background

As I discussed in a recent post (here), Section 951 of the Dodd-Frank Act expressly requires all but the smallest publicly traded companies to hold an advisory shareholder vote on executive compensation. This requirement has already started to have an impact on executive compensation practices, as many companies are adjusting certain compensation practices to avoid a negative vote. However, while the vast majority of companies have received shareholder support for their compensation practices, there are still some companieswhose shareholders have voted “no” on the shareholder resolution regarding executive compensation. (At last count, according to The CorporateCounsel.net,  there were over thirty companies whose “say on pay” resolutions had received a negative vote from a majority of their shareholders).

 

Umpqua’s “Say on Pay” Vote

As reflected in the company’s April 22, 2011 filing on Form 8-K, Umpqua is among those companies receiving a negative say on pay vote. The 8-K reflects that about 62% of shareholders voted against the company’s executive compensation shareholder resolution.

 

The 8-K explains that the negative vote followed a recommendation from Institutional Shareholder Services (ISS) that Umpqua’s shareholders vote against the resolution. The 8-K states that ISS found a “disconnect” between the company’s 2010 executive compensation and the company’s pay-for-performance standards. The 8-K states that the company takes the vote “seriously” and that it is committed to pay-for-performance principles. Nevertheless, the company takes exception to the ISS’s “formulaic” approach which, the company contends, inappropriately viewed 2010 compensation only by comparison to 2009 compensation, when the company’s executive compensation declined 29%. The company contended that the 2010 compensation plan is reasonable in light of prior compensation and in light of the company’s overall performance, particularly relative to its peers.

 

The Lawsuit

On May 25, 2011, two union pension funds filed a shareholder derivative lawsuit in the District of Oregon against the company, as nominal defendant; against the company’s individual board members; against four company executives; and against the company’s compensation consultant, PricewaterhouseCoopers. The complaint alleges that the Board’s “decisions to increase CEO and top executive pay in 2010, despite the Company’s severely impaired financial results, were disloyal, irrational, and unreasonable, and not the product of a valid exercise of business judgment.”

 

The complaint further asserts that the board’s approval of the 2010 pay hikes “violated its own pay-for-performance policy and, as intended, favored the interests of Umpqua’s CEO and top executives at the expense of the corporation and its shareholders.”

 

The complaint attempts to use the negative say on pay vote to try  to avert  the defendants’ reliance on the business judgment rule. The complaint states that the “adverse shareholder vote on the 2010 executive compensation is evidence which rebutted” the usual business judgment presumption. The complaint further states with reference to the negative shareholder vote that the company’s shareholders “concluded, in their independent business judgment, that the Umpqua Boar’s 2010 CEO and top executive pay hikes were not in the best interest of Umpqua and its shareholders.”

 

The complaint asserts a claim against the directors for breach of the duty of loyalty; against the compensation consultant for aiding and abetting breach of fiduciary duties and breach of contract; and against the four executive officers for unjust enrichment. The complaint seeks an award to Umpqua for damages; a declaration that the shareholder vote “rebutted the presumption of business judgment”; disgorgement of the allegedly excess compensation and implementation and administration of internal controls and systems to prevent excess executive compensation.

 

Discussion

At this point, it seems clear that plaintiffs’ bar intends to try to utilize a negative “say on pay” vote, in at least some instances, to try to bootstrap claims for allegedly excess executive compensation. At one level, this is hardly surprising, because the negative vote does create the possibility of the board appearing to be acting contrary to shareholders’ views. And executive pay unquestionably is a hot button issue right now.

 

But on the other hand, the vote required under the Dodd Frank is expressly and explicitly an “advisory” vote. Congress could have made the say on pay vote binding. The fact that Congress did not make it controlling but rather left the vote as advisory clearly allows for the possibility that the company and its board retained discretion and might elect to act contrary to the shareholder vote without acting improperly. Indeed, Section 951 (c) of the Dodd Frank Act expressly states that the say on pay requirement should not be interpreted to alter any existing fiduciary duties or to create any new fiduciary duties. Congress seemed to be going out of its way to try to avoid having the say on pay process to add compulsion or  to the legal exposures of directors and officers.

 

Indeed, given the express statutory provisions to make the vote advisory and to try to prevent against having the vote add to directors’ legal exposures, it seems clear that Congress was hoping that the vote, and the threat of the vote, would cause companies voluntarily to adjust their compensation practices, — not out of fear of liability but out of a desire to maintain the affirmative support of shareholders. Indeed, that in fact seems to be happening, as many companies have adjusted their practices in order to try to avoid a negative shareholder vote.

 

Despite Dodd-Frank’s express provisions designed to eliminate the possibility that the say on pay vote should alter the legal responsibilities of directors and officers, the plaintiffs in this case are seeking to rely on the negative say on pay vote to argue that the defendants are not entitled to the usual protections of the business judgment rule. The plaintiffs do not explain why a purely advisory vote, which by its own enacting provisions is not intended to alter or create additional legal duties, should nevertheless deprive the board of the usual protections to which they are entitled.

 

The lawsuit has only just been filed and it remains to be seen how it will progress. But it will be interesting to see if the plaintiffs are successful in having the defendants’ rights to rely on the business judgment rule suppressed.  

 

The company itself seems to think that the best defense is a good offense, as the company’s spokesperson is quoted in a May 27, 2011 Portland Business Journal article as saying with respect to the plaintiffs’ firm that brought the suit, “our understanding of this firm is they create fees by dragging the names of reputable companies through the mud.”

 

Our Solar System’s Family Album: A wide variety of probes and vessels have been cruising the planets, taking some amazing pictures in the process. The truly stunning highlights are compiled in a May 27, 2011 post (here), on the InFocus blog on the Atlantic Monthly’s website.

 

In a May 27, 2011 post on the FCPA Compliance and Ethics Blog (here), Tom Fox has some interesting observations about the ongoing FCPA gun sting trial. (Readers will recall that this prosecution involves numerous individuals from the armaments industry who were caught up in a government sting operation that included extensive wiretaps and an FBI agent posing as a representative of an African government.)

 

Among other things, Fox comments that this prosecution is a “game changer” because of the government’s use of “organized crime fighting techniques in very mundane white collar crime.”

 

Fox’s point is a serious one, particularly in view of the government’s use of wiretaps in several other recent high-profile prosecutions. The insider trading conviction of Raj Rajaratnam depended critically on extensive government wiretaps. The prosecution of the former big law associate who had passed along inside information gained from the law firms where he worked also relied on use of wiretaps.

 

The government’s use of these aggressive crime-fighting techniques underscores how seriously the government is taking its responsibility to enforce these laws. The government’s willingness to use these techniques also has important implications for anyone concerned about the potential exposures for companies and their executives. The most obvious lesson is that the government is vigilant and will actively pursue criminal activity. For that reason, corporate compliance efforts are critically important.

 

Another, perhaps more chilling implication is that presuming confidentiality for even the most private conversations and communications could be dangerous. There is probably a larger essay for another day here. Suffice it to say that the line between necessary vigilance and intrusive surveillance is a fine one, and the government’s involvement in monitoring its citizen’s activities is fraught with difficulties. Some might say it is only those involved in criminal activities that have any thing to fear.  I note that we only hear about the wiretaps that result in criminal prosecutions. One can only wonder about the extent of governmental intrusion into purely lawful communications.

 

Independent Director Liability Insurance: Do independent directors need a separate liability insurance policy? The IDL insurance product has been around for years, though relatively few companies buy it. The problem is that sometimes when things go wrong, things go catastrophically wrong. Though IDL continues to attract relatively few buyers, there are occasions when it could be critically important. A May 26, 2011 article from Corporate Secretary magazine (reprinted here) takes a closer look at the IDL product. (Full disclosure, I was interviewed for the article).

 

Take Two: Perhaps there are no panaceas, but there may be one thing Americans could do to solve many of their problems — everything “from stuck zippers to the national debt” — according to a recent report you might have missed.

 

The American Scene: A series of recent trips has reminded me that there are a multitude of beautiful places in this big country. Among other delightful places I have visited are several that are well worth the journey, including Davidson, North Carolina; Lake Tahoe, California; Denver, Colorado; and Lexington, Virginia.

 

My most recent sojourn, a Memorial Day weekend  trip to South Carolina for a wedding, introduced me to Greenville, which is yet another delightful surprise. The cluster of restored buildings and pedestrian bridges surrounding the waterfalls on the Reedy River and the blocks of shops and restaurants along the tree-lined Main Street make the town a pleasant and enjoyable place to explore. Greenville is only one of several U.S. cities that recently have made big investments in reorienting themselves toward their riverine setting, including Dubuque, Iowa and Jacksonville, Florida.

 

Travel has its stresses and headaches, but it also occasionally affords agreeable discoveries that reward the exertion. Truly, you could explore this country endlessly and never exhaust its aesthetic possibilities.    

 

 

Greenville, South Carolina  May 28, 2011

 

According to FDIC’s Quarterly Banking Profile, released on May 24, 2011 (refer here), the pace of bank failures slowed during the first quarter. However, both the absolute and relative number of problem institutions continued to increase, albeit at a reduced pace compared to recent quarters. The FDIC’s May 24, 2011 press release about the Quarterly Banking Profile can be found here.

 

During the first quarter of 2011, 26 banking institutions failed, compared to 41 in the first quarter of 2010. The total of 26 bank failures in the first quarter is the smallest quarterly number of bank failures in seven quarters.  (My prior post on the declining pace of bank closures can be found here.) A total of 43 banks have failed year to date in 2011 as of May 25, 2011.

 

As of the end of the first quarter 2011, there were 888 “problem institutions,” compared to 884 at the end of 2010 and 775 at the end of the first quarter 2010. The increase in the number of problem institutions during the twelve month period ending March 31, 2011 is 113, or about 14.5%. (The FDIC identifies banks as problem institutions as those that are graded a 4 or a 5 on a 1-to-5 scale as a result of “financial, operational, or managerial weaknesses that threat their continued financial viability.” The FDIC does not release the names of the individual problem institutions.)

 

 The increase of only four additional problem institutions since year-end 2010 represents only a slight increase in the number of problem institutions. In its press release, the FDIC noted that this increase is “the smallest increase in three and a half years.” However, the 888 problem institutions as of March 31, 2011 represent the larges number of problem institutions since March 31, 1993, when there were 928.

 

The number of problem institutions as a percentage of all reporting institutions has continued to increase. This is not only due to the increase in the absolute number of problem institutions but also because of the declining number of reporting institutions. The decline in the number of reporting institutions is not only due to bank failures, but also due to mergers and acquisitions.

 

The 888 problem institutions as of March 31, 2011 represent about 11.7% of all 7574 reporting institutions. By way of comparison, the 775 problem institutions as the end of the first quarter 2010 represented only about 9.7% of all 7,934 reporting institutions as of that date. So both the absolute and relative numbers of problem institutions has increased substantially during the 12 months ending March 31, 2011.

 

Though the number of problem institutions has continued to increase, the aggregate assets those problem institutions represent has decreased. Thus the 775 problem institutions as of March 31, 2010 represented assets of $431 billion, whereas the 888 problem institutions as of March 31, 2011 represented assets of $387 billion.

 

With all of the remaining numbers of problem institutions, there are still a lot of challenges in the banking industry. There may yet be more bank failures yet to come, perhaps many more. However, the overall message of the Quarterly Banking Profile is guardedly upbeat. The press release quotes the FDIC Chairman Sheila Bair as saying that “the industry shows signs of improvement, “ and adding that “the process of repairing bank balance sheets is well along, but is not yet complete.”

 

As I have noted elsewhere, the numbers of bank failures overall may be slowing, but the lawsuits involving directors and officers of failed institutions may just be ramping up – slowly

 

On May 25, 2011, the SEC adopted the final rules implementing the whistleblower provisions of the Dodd-Frank Act. The SEC declined to propose a rule that would have required whistleblowers to report first through internal corporate compliance programs. However, the SEC adopted changes that are intended to “incentivize whistleblowers to utilize their companies’ internal compliance and reporting systems when appropriate.”

 

The SEC’s May 25, 2011 press release about the final whistleblower rules can be found here. The SEC’s 305-page document describing the final rules can be found here. The SEC’s rules will be effective 60 days after they are submitted to Congress or published in the Federal Register.

 

Section 922 of the Dodd-Frank Act created certain new whistleblower incentives and protections. The section directs the SEC to pay awards to whistleblowers that provide the Commission with original information about a securities law violation that lead to the successful SEC enforcement action resulting in monetary sanctions over $1 million. The section also prohibits retaliation against whistleblowers.

 

The SEC released proposed rules to implement the whistleblower provisions in November 2010. The SEC received hundreds of comments on the proposed rules. The final rules document released yesterday describes many of the comments as well as the way that the SEC took the comments in to account in promulgating the final rules.

 

One of the most significant issues raise in the comments related to the impact of the whistleblower program on internal corporate compliance processes (refer here for a discussion of this issue). The gist of the concern is that the SEC whistleblower provisions would encourage the whistleblowers to bypass internal reporting mechanism (many of which have only recently been implemented pursuant to the requirements of Sarbanes Oxley). Though some commentators urged the Commission to require whistleblowers to report violations first internally, the SEC decided not to include this requirement. Rather, the SEC included in the final rules elements it hopes will encourage potential whistleblowers to use internal compliance processes.

 

Specifically, the rules make the whistleblower eligible for an award if the whistleblower reports the violation internally and the company informs the SEC about the violation. The SEC will also treat the informant as a whistleblower as of the date of an internal report of the employees provides the same information to the SEC within 120 days (this allows whistleblowers to save their “place in line” for a possible award). Finally, the informant’s voluntary participation in the company’s internal reporting program will be a factor the SEC will use to increase the amount of an award.

 

The SEC’s final rules also identify a number of categories of persons who will not be eligible for an award, including those with a preexisting legal or contractual duty to report their information; those who obtain their information either by privileged or illegal means; officers and directors who are informed by another person of the violations; compliance and audit personnel. (There are defined circumstances when compliance and audit personnel can be eligible.

 

The rules also clarify the whistleblowing procedures, and provide clarification of what constitutes a voluntary report; what constitutes original information; what constitutes a successful enforcement action and so on.

 

These rules will be effective shortly, most likely later in the summer. The ultimate practical effect of these new rules depends on how forthcoming prospective informants are; the quality of the information; and what the SEC does with the information.

 

The sheer scale of the prospective awards (from 10 to 30 percent of awards in excess of $1 million) is clearly designed to encourage whistleblowing, as indeed is the SEC’s final rule. For its part, the SEC has a huge incentive in the post-Madoff era to heed whistleblower’s warnings and to pursue the reported information. Just looking at the way the incentives and motivations line up, the most probable outcome here seems to be that there will be significant numbers of whistleblower reports and that these reports will trigger significant numbers of investigations and enforcement actions. These enforcement actions could well be followed by follow-on civil litigation, which could increase the potential exposure that companies and their senior officials could face as a result of the implementation of these rules.

 

It certainly appears that a portion of the plaintiffs’ bar things there is an opportunity here supporting prospective whistleblowers and perhaps using their reported information as the basis for separate civil suits – refer for example to this advertisement for the “SEC Whistleblower Claims Center.” The quick emergence of an opportunistic plaintiffs’ bar eager to try to turn these new rules to their advantage is hardly surprising. Enterprising plaintiffs’ lawyers have been profiting from the whistleblower incentives in the False Claims Act for years (refer, for example, here)

 

However these incentives may appear now, they will all be augmented exponentially once a whistleblower or two has garnered a significant award. Given the magnitude of some of the recent SEC enforcement actions (as for example in connection with SEC enforcement action under the FCPA, refer here) the likelihood that we might see some large awards seems high. Refer here for further discussion of the particular concerns surrounding the prospects for whistleblowing activity in the FCPA context.

 

The bottom line is that for those of us who worry about the potential exposures of directors and officers of public companies, there is a whole new category of concerns.

 

Special thanks to a loyal reader for the link to the whistleblower advertisement.

 

Yet another U.S.-traded Chinese-based company has been hit with an accounting fraud securities class action lawsuit. The latest lawsuit, involving Longtop Financial Technologies Limited, comes after a series of stunning announcements from the company earlier this week.

 

Longtop’s ADRs trade on the NYSE and until recently the company had a market cap in excess of $1 billion. Unlike many of U.S.-listed Chinese companies, it did not obtain its U.S. listing through a reverse merger, but instead it became public through a conventional IPO in 2007. Its financial statements were audited by the Chinese arm of Deloitte. Questions involving Longtop first arose when Citron Research published an April 26, 2011 online report critical of the company. Among other things, the report questioned the company’s “unconventional staffing model,” alleged prior undisclosed “misdeeds” involving management, and referenced “non-transparent” stock transactions involving the company’s chairman, among other things. Other critical research coverage followed.

 

Longtop’s problems took another turn for the worse when, in advance of the recent high profile IPO of Chinese social networking company, Renren Network, Longtop’s CFO, who sat on Renren’s board as chair of the audit committee, resigned to prevent the questions at Longtop from affecting Renren’s IPO.

 

The company defended itself from the charges (refer for example here). Nevertheless, NYSE halted trading in its shares last week pending news, a development that garnered an article in the May 18, 2011 Wall Street Journal (here).

 

Then on May 23, 2011, in a filing with the SEC on Form 8-K, the company announced that both its CFO and its outside auditor, Deloitte Touche Tomatsu (DTT) had resigned. In its accompanying press release (here), the company said that DTT stated that it in its May 22, 2011 letter of resignation that it was resigning as a result of, among other things,

 

(1) the recently identified falsity of the Company’s financial records in relation to cash at bank and loan balances (and possibly in sales revenue); (2) the deliberate interference by certain members of Longtop management in DTT’s audit process; and (3) the unlawful detention of DTT’s audit files.

 

DTT further stated that it was “no longer able to rely on management’s representation’s in relation to prior period financial reports, and that continued reliance should no longer be place on DTT’s audit reports on the previous financial statements.”

 

In the same press release, the company announced that it has been advised that by the SEC that the agency is conducting an inquiry; and that the company’s audit committee had retained U.S. counsel and authorized the retention of forensic accountants to investigate the matters in DTT’s resignation letter.

 

In their May 23, 2011 press release (here), plaintiffs’ counsel announced that they had filed a securities class action lawsuit against the company and certain of its directors and officers in the Central District of California. According to the press release, the complaint specifically references the resignation of DTT as Longtop’s auditor and the resignation of the company’s CFO.

 

With this latest lawsuit, there have now been a total of 22 securities class action lawsuits filed against Chinese and China-liked companies in 2011, out of a total of about 93 securities lawsuits that have filed so far this year —  meaning that the suits against Chinese companies represent about 23% of all securities lawsuits filed so far this year.

 

Signs are that the onslaught of accounting fraud lawsuits against Chinese companies will continue, as plaintiffs’ lawyers have also announced recently that they are “investigating” yet other Chinese companies (refer for example, here and here), which usually presages lawsuit filings.

 

The Latest in Securities Class Action Lawsuit Settlement Funding?: As I noted at the time in July 2010, there was just “one little problem” with the Ohio Attorney General’s announcement that the pending AIG securities class action lawsuit had been settled for $725 million — specifically, “AIG doesn’t have the money to pay for the settlement. The plan, such as it is, is that AIG is going to fund the first $175 million following the settlement’s preliminary approval. Then, AIG is going to try to conduct a stock offering to raise the remaining $550 million.”

 

According to AIG’s July 16, 2010 filing on Form 8-K, the settlement is conditioned on the company’s "having consummated one or more common stock offerings raising new proceeds of at least $550 million prior to court approval." 

 

Although I was skeptical at the time that investors would be interested in making an equity investment in order to provide securities class action litigation funding, with yesterday’s sale of AIG shares, the company may in fact be in a position to fulfill the outstanding settlement condition. According to a May 24, 2011 Bloomberg article entitled “AIG Share Sale Aids Ohio Firefighters Burned By Stock Losses Before Rescue” (here), AIG intends to use $550 million from the share sale to pay for the settlement announced last July. Assuming that there were no glitches involving with the offering that would interfere, or that the fact that the share sale came in at the low end of the anticipated pricing range is not a barrier, it looks as if AIG will now be able to fund the remainder of the settlement.

 

Even though if the funding mechanism  worked here, I doubt that equity financing as a way to raise funds for securities class action lawsuit settlements is likely to catch on as a general matter.

 

Subprime Lawsuit Dismissal Motion Rulings: There have been a couple more dismissal motion rulings in subprime-related securities class action lawsuits.

 

First, in a May 10, 2011 ruling (here), Southern District of New York Judge John G. Koeltl granted in part and denied in part the defendants’ motion to dismiss the complaint in the J.P. Morgan Acquisition Corp. Mortgage Pass-Through Certificate securities class action lawsuit. He granted the motion to dismiss for lack of standing as to ten of the eleven offerings reference in the complaint in which the named plaintiffs had not purchased securities. However, he denied the motion to dismiss as to the remaining offering, finding that the plaintiffs had adequately alleged securities law violations in connection with that offering.

 

Second, in a May 23, 2011 ruling (here), Southern District of New York Judge John F. Keenan granted the defendants’ motion to dismiss, without prejudice, in the Manulife Financial subprime related securities class action lawsuit, finding that the plaintiffs’ complaint did not meet the heightened pleading standard under the PSLRA and ignored "the massive economic and political changes taking place during the Class Period" in attempting to plead that the defendants acted with scienter. David Bario’s May 24, 2011 Am Law Litigation Daily article about the Manulife decision can be found here.

 

I have added these decisions to my running tally of the subprime lawsuit dismissal motion rulings, which can be accessed here.

 

Flash from the Past: Call it nostalgia for an earlier time, or simply mild interest that these kinds of cases are still kicking around, but I was interested to note that Fossil Inc. announced in a May 20, 2011 filing on Form 8-K that it had settled the options backdating –related derivative lawsuit that had been filed against the company, as nominal defendant, and certain of its directors and officers. According to the accompanying settlement documents, in order to settle the case, the company’s D&O insurers had agreed to pay $8.666 million. It appears that insurance will be funding the entire amount of the settlement.

 

I guess there may be a number of  these cases still kicking around, but this settlement sure does seem like a vestige from another time in place. In any event, I have added the settlement to my running tally of options backdating-related case resolutions, which can be accessed here.

 

The parties to two of the consolidated subprime-related securities lawsuits pending against Oppenheimer Funds have settled the case for a total of $100 million. This settlement has a number of interesting features, as discussed further below, including in particular aspects of the allocation of the total settlement amount between the two consolidated fund actions. The settlement also leaves the consolidated action filed against yet other Oppenheimer Funds pending.

 

In Spring and Summer 2009, a total of 32 class action lawsuits were filed against a number of the Oppenheimer Funds. These actions were brought by investors who had purchased shares of the Funds that were traceable to offering documents that allegedly contained misrepresentations and omissions. As a general matter, the investors alleged that the Funds had been marketed as representing investments that did not involve undue risk, but that beginning in 2006, the Funds had invested heavily in “risky” investments such as mortgage-backed securities, credit-default swaps and total-return swaps. When the financial crisis hit, these Funds later lost a substantial part of their net asset value.

 

As ultimately organized, the Oppenheimer Funds lawsuits were organized into three consolidated cases involving, respectively, the Oppenheimer Champion Income Fund; the Oppenheimer Core Bond Fund; and the consolidated “Rochester” cases (involving seven other Oppenheimer Funds).Background regarding the Core Bond Fund action can be found here. Background regarding the Oppenheimer Champion Income Fund can be found here. These two cases were consolidated  for discovery purposes. The Rochester cases proceeded independently. Background regarding the Rochester cases can be found here.

 

 The $100 million settlement involves only the Oppenheimer Champion Income Fund action and the Oppenheimer Core Bond Fund action. The consolidated Rochester Funds case is not part of this settlement, which apparently remains pending in the District of Colorado.

 

The $100 million settlement is described in various settlement documents filed with the District of Colorado on or about May 19, 2011. The stipulation of settlement in the Oppenheimer Champion Bond Fund case can be found here. The stipulation of settlement in the Oppenheimer Core Bond Fund case can be found here. The motions to court for preliminary approval of the settlements can be found here and here, respectively.

 

The parties’ settlement-related filings portray an interesting settlement process resulting in a settlement with a number of interesting features.

 

 First of all, the parties were able to reach this settlement while the motions to dismiss were fully briefed and pending, but before there had been any ruling on the motions.

 

Second, the settlement was the result of a protracted settlement mediation process that consumed a number of months. As a result of this process, the parties agreed to the $100 million settlement amount – but the parties were not done yet. They had to further agree on how the $100 million would be split, or allocated, between the Oppenheimer Champion Bond fund case, on the one hand, and the Oppenheimer Core Bond Fund case , on the other hand.

 

The parties entered a separate process for determining the allocation of the $100 million between the two cases. The parties entered a separate mediation process to determine the process, and for purposes of this separate process, the plaintiffs’ Lead Counsel brought in separate, independent counsel to represent each of the two respective Funds. Each side then presented mediation briefs to the mediator. On February 25, 2011, the mediator determined that the appropriate allocation between the two funds would be 47.5 percent for the Core Bond Fund Class and 52.5 percent for the Champion Income Class.

 

As a result of this allocation, the parties stipulated that the $100 million settlement amount is to be allocated between the two cases as follows: $52.5 million to the Champion Income Fund and $47.5 million to the Core Bond Fund class. Each of the two settlements is expressly condition on the approval of the settlement in the other case.

 

The settlement papers say relatively little with respect to the role that insurance may have played in the settlement. The settlement stipulations do specify that the parties to the settlement “understand and agree that any obligation of the Trustee Defendants [I.e., the individuals named as defendants in the suits who had served of trustees of the respective funds] hereunder will be satisfied by insurers or other Defendants and that no portion of the Settlement Amount is to be paid personally by the Trustee Defendants.”

 

There are a number of noteworthy aspects of this settlement. The first is that it was reached before the motions to dismiss had been ruling. Obviously there is no prohibition on settling cases before the dismissal motions rulings, as cases do settle prior to dismissal motion rulings from time to time. But it is relatively unusual, and the size of this settlement before the dismissal motion rulings is also noteworthy.

 

It is also noteworthy that these cases have been settled for a significant amount while the other Oppenheimer Fund cases involving the Rochester funds remain pending and unresolved. Those other cases remain on a different track, apparently, but the settlement does put those unresolved cases in an interesting light.

 

The subprime-related lawsuits against the Oppenheimer funds were only one among several sets of cases filed against mutual fund families or funds raising subprime related allegations. Another of these mutual fund cases, the Schwab Yield Plus case, settled previously for a total of $235 million (about which refer here). Many more of these mutual fund related cases also remain pending. This Oppenheimer Fund settlement put those other mutual fund cases in an interesting light, as well.

 

In any event, I have added the Oppenheimer Fund settlement to my running tally of subprime-related case resolutions, which can be accessed here. According to my data, the $100 million Oppenheimer Funds settlement represents the sixth largest subprime-related securities lawsuit settlement so far. (If the Rochester funds cases were to ultimately settle, the amount of any settlement of those cases would obviously increase Oppenheimer’s aggregate settlement amount.)

 

As I have noted before, many of the subprime-related cases remain pending and eventually they will be resolved. It is worth noting that as the various Oppenheimer cases went forward, they were consolidated in various ways, and it appears that other cases are being resolved on a consolidated basis as well. This consolidation processcould reduce the overall number of case resolutions while potentially increasing the total resolution amounts in connection with any one consolidated case.  

 

Nate Raymond’s May 22, 2011 Am Law Litigation Daily article about this settlement can be found here. The plaintiffs’ attorneys’ press release regarding the settlements can be found here. Special thanks to the readers who sent me information about this settlement.

 

SEC Investigations and D&O Insurance: There are three articles in this week’s National Underwriter that may be of interest to readers of this blog. The articles and their respective links are as follows: “A Newly Assertive SEC, Backed By Whistleblowers, Means Rise in Investigations – And Risks” (here); “As Investigation –Cost Coverage Evolve, Prices on Existing D&O Solutions Drop” (here); “Investigation Edge: Brokers Welcome New ‘Entity’ Product From Chartis” (here).

One of the most distinctive trends in corporate and securities litigation in recent years has been the rise in litigation related mergers and acquisition activity. Cornerstone Research’s most recent year-end litigation filing study, released in conjunction with the Stanford Law School Securities Class Action Clearinghouse, documented that in M&A litigation in 2010 increased at a much greater rate than did M&A activity during the year. .

 

One of the factors behind this accelerated litigation growth is the fact that increasingly a merger announcement triggers multiple different lawsuits, often filed in multiple jurisdictions. This proliferation of multi-jurisdiction litigation raises a host of procedural challenges, as the nominal corporate defendant is forced to litigate on multiple fronts while at the same time attempting to press ahead with the underlying transaction.

  

In an interesting post on The Harvard Law School Forum on Corporate Governance and Financial Regulation entitled “Improving Multi-Jurisdiction, Merger-Related Litigation” (here), Mark Lebovitch of the Bernstein Litowitz Berger & Grossman law firm takes a look at these problems and proposes a Delaware-court based procedural solution to try to address the issues.

 

The article first summarizes  the problems involved when mulit-jurisdiction M&A litigation arises. Lebovith states that “the current system is prone to manipulation and gamesmanship.” The defendants face duplicative costs; the shareholders interests may be subordinated as part of procedural jockeying between competing plaintiffs (and their lawyers); and plaintiffs’ lawyers may find themselves compelled to pay a “tax” to competing counsel in order to deliver a global settlement.

 

Lebovitch urges the adoption of “a system that centralizes deal-related litigation into a single forum.” Specially, he suggests “the adoption of an efficient, predictable and transparent rules-based system for appointing lead plaintiffs and lead counsel to settle organizational issues” in M&A litigation. He is not suggesting the approach embodied in the PSLRA, where the presumptive leadership goes to the claimant with the largest financial interest. Rather, he urges a process for the selection of lead plaintiff based on “anticipated ability to achieve the best results for the class.”

 

In the system Lebovitch proposes, the first plaintiff to file in the Delaware Court of Chancery would be required to publish a nationwide notice of class, which would trigger a 10-day period during which any other shareholder interested pursuing the claim would have the opportunity to submit a leadership motion detailed their theory of the case, case management plan and their counsel’s experience with similar claims. The materials would be reviewed in camera and the Court would select the lead plaintiff, with emphasis on “counsel’s track record and ability to represent the class, taking into account the nature of the action, the novelty of the issues raise, and the movant’s case-management plan.”

 

The contention is that with a clear, detailed and predictable leadership selection process, there would be less incentive for procedural jockeying between plaintiffs.

 

Lebovith correctly points out that though this approach would mitigate the problems with multijurisdictional litigation, the problems would not finally be solved. The proposed leadership selection process would ameliorate jockeying for position within Delaware but it would not eliminate the problems arising when plaintiffs in another jurisdiction attempt to press forward. The parties could still have to face a multi-front war, even if the process has been improved within Delaware.

 

One possible way to address these remaining issues was suggested by now-former Chancellor William Chandler in his March 28, 2011 opinion in the Allion Healthcare Shareholders Litigation. The Allion Healthcare case arose out of a proposed going-private transaction. After the transaction was announced, multiple lawsuits arose in Delaware and New York. Because the various plaintiffs refused to coordinate, the cases proceeded in both jurisdictions. After the transaction closed, the parties reached a settlement agreement, but the plaintiffs were unable to agree on allocation of fees, and the matter wound up before Chancellor Chandler.

 

Chandler noted at the outside the “increasingly problematic” challenges associated with multi-jurisdictional litigation, commenting that it forces defendants to “litigate the same case –often identical claims – in multiple courts.” In addition, judicial resources are “wasted” and there is a danger that different courts “would apply the law differently or otherwise reach different outcomes,” leaving “the law in a confused state and pose full fait and credit problems.”

 

Having posed the problem, Chandler then (in footnote 12 of the opinion) identified his own “personal preferred approach,” which is for “defense counsel to file motions in both (or however many) jurisdictions …explicitly asking the judges in each jurisdiction to confer with one another and agree upon where the case should go forward.”  Of course, as Chandler notes, “judges in different jurisdictions might not always find common ground on how to move the litigation forward. “ But this approach, Chandler contends is “one (if not the most) efficient and pragmatic method to deal with this increasing problem,” adding that “it is a method that has worked for me in every instance in which it was tried.”

 

The approach Chandler advocated in his Allion Healthcare opinion was endorsed by Theodore Mirvis of the Wachtell  Lipton law  firm on an April 12, 2011 post on the Harvard Law School Forum on Corporate Governance and Financial Regulation entitled “Delaware Court of Chancery Addresses Multi-Forum Deal Litigation” (here). Mirvis comments that Chandler’s opinion “indicates that Delaware Courts will apply their practical wisdom to combat the untenable burdens imposed by multi-forum deal litigation and remain receptive to new approaches to harmonize conflicting and duplicative merger litigation.”  

 

An additional comment about the Allion Healthcare opinion can be found on Peter Ladig’s April 25, 2011 post on the Delaware Business Litigation Report entitled “Multi-Jurisdictional Litigation a Rich Vein of Issues for Chancer Court” (here).

 

The two approaches are not mutually exclusive and they are not incompatible. Indeed, it would appear that the two approaches together would significantly advance the possibility of avoiding many of the ills associated with the multi-jurisdictional litigation. To be sure, as Chancellor Chandler noted in his Allion Healthcare opinion, the practical approach between courts might not always eliminate the possibility that identical cases could go forward in different jurisdictions. But the approach creates an opportunity to avoid the problem. And the procedural mechanism Lebovitch advocate would increase the likelihood that the proceeding in Delaware would go forward in an orderly way.

 

None of these procedural issues addresses the central underlying problem, which is that opportunistic plaintiffs’ lawyers have identified what seems like a sure-fire profit opportunity in creating litigation obstacles to announced transactions.  Lebovitch’s blog post explains the growth in this type of litigation as due to “the high-profile success achieved by certain members’ of the plaintiffs’ bar” which has “triggered a wave of new entrants to the field.” Moreover, “the dramatic decrease in securities class actions has further increased the number of firms willing to pursue M&A litigation.” As “more law firms enter this already crowded field” the consequence is that “the number of lawsuits stemming from each deal continues to increase.”

 

Reasonable minds may differ as to the value of the M&A litigation. But regardless of the theoretical value, the multiplication of costs and the imposition of increased procedural inefficiencies resulting from the escalating litigation activity represent an enormous burden on business. The concerns are all the more apparent when the increasing amounts of litigation is not the result of increased numbers of injustices crying out for redress but simply reflect increasing numbers of plaintiffs lawyers looking for a piece of the action.

 

Colonel Roosevelt: Colonel Roosevelt, the third and final volume of Edmund Morris’s epic biography of Theodore Roosevelt covers Roosevelt’s personal and professional life following the conclusion of his second term as President. Among other things, the book details Roosevelt’s ill-fated bid for the Presidency in 1912, in which his candidacy arguably succeeded in splitting the Republican vote sufficiently to ensure Woodrow Wilson’s election.

 

The political aspect of Roosevelt’s post-Presidency are interesting enough, but it is the personal side of the story that makes this fascinating and well-written book worth reading. Even though there are critical parts of Roosevelt’s persona that do not translate well into our culturally different era, what does come through in Morris’s account is what an extraordinary person Roosevelt was.

 

Roosevelt was a man of astonishing ambition. He was also a man of unusual personal courage, strength and perseverance. During the 1912 election, he was struck at close range by an assassin’s bullet (his folded speech and glasses case, stuffed in his breast pocket, probably saved his life). When he found that the shot had not killed him, he proceeded to deliver his planned speech, while bleeding from the gunshot wound, with the would-be assassin’s bullet lodged against his ribs.

 

Perhaps his most extraordinary feat of personal courage came during the scientific expedition in which he participated in 1913-14. Roosevelt was 55 years old at them. The 17-person expedition’s purpose was to map the Brazilian river ominously called Rio da Dúvida  — the River of Doubt.

 

Almost from the start, the expedition was plagued with problems. Insects, disease, unsuitable supplies and equipment created innumerable difficulties. The expedition’s long and troubled journey turned dangerous as the expedition encountered a seemingly endless series of cascades. The torrents required repeated portages through hostile, forbidding jungle and nearly impassible terrain. When they were able to return to the water, their canoes were battered and damaged. In the midst of these difficulties disaster struck. A canoe carrying Roosevelt’s son, Kermit, and another member of the expedition capsized in a whirlpool. Before help could arrive, the other man had drowned.

 

A few days later, when one of the expedition’s pontoon boats capsized in a rapid, several people, including Roosevelt, rushed to rescue the men who fell in the water. The men were saved, but Roosevelt cut his leg on a rock. The wound soon became infected. The infection led to coronary stress. Roosevelt was in mortal danger:

 

The next morning, Roosevelt had reason to believe he was in the valley of the shadow of death. … Rock walls that could have been sliced by civil engineers blocked the sky. Kermit and Lyra lost yet another canoe, reducing the flotilla once more to two pontoons. A reconnaissance party came back with news of rapids continuing as far as the eye could see.

 

At this very moment, the expedition was stunned by the sound of gunfire. A disaffected member of the support team, overcome by privation and stress, had ambushed another member of the team and shot him dead. The murderer fled into the jungle.

 

After they had buried the murder victim, Roosevelt was overcome with fever and he became delirious. Fortunately, the fever subsided but at the same time his son became ill. Roosevelt wrote in his journal “The expedition is in a state of peril.” With damaged canoes, diminished supplies, two men dead, one man missing and two others deathly ill, the expedition stumbled ahead. As the cascades finally diminished, the expedition was able to advance, and within a matter of days, the expedition reached a military outpost that had been established a month before in anticipation of their eventual arrival.

 

When Roosevelt finally arrived back in New York, he arrived “haggard, malaria-yellow, limping on a cane, his belt hauled in six inches.” Even so, just five weeks later, Roosevelt was in Madrid for Kermit’s wedding, finding time to meet with the King and Queen of Spain. He made time to meet with Wilson on his return to Washington.

 

The tale of the expedition’s survival of their ordeal on the River of Doubt (now renamed Rio Roosevelt), with its drowning, murder, privation and disease, is remarkable enough by itself. But the fact that this tragic, nearly disastrous mission included (and almost led to the death of) a former President of the United States, makes this story nothing short of astonishing. In our time, we have had some ex-Presidents attempt and even accomplish some remarkable things. But for my money, nothing compares to Roosevelt’s participation in the descent of the River of Doubt.

 

On May 18, 2011, the California Intermediate Court of Appeals held in the Luther v. Countrywide Financial Corporation case that state courts have concurrent jurisdiction with federal courts to hear liability lawsuits under the Securities Act of 1933, and that more recent legislative enactments did not eliminate the concurrent state court jurisdiction for the plaintiffs’ ’33 Act claims.

 

 I suspect that those of you who, like The D&O Diary, have been following the Luther case are going to say – wait a minute, didn’t the Ninth Circuit decide that very issue in that same case several years ago? Alas, it is not so simple, nor so straightforward.

 

For those of you who have not been following the Luther case, here’s the background. The claims are brought on behalf of purchasers of billions of dollars of mortgage pass-through certificates issued between June 2005 and June 2007. The securities were registered but not listed on any national exchange. The complaint alleges that the defendants violated Sections 11, 12 and 15 of the ’33 Act, essentially on the grounds that the risk of investing in the mortgage pass-through certificates was much greater than represented by the registration and prospectus supplements, which allegedly omitted and misstated the creditworthiness of the underlying borrowers.  The plaintiffs do not assert any state law claims. The Luther complaint names as defendants several Countrywide subsidiaries and affiliated individuals, multiple loan trusts, and Countrywide’s offering underwriters.

 

 

The plaintiffs originally filed their complaint in California Superior Court for Los Angeles County. The defendants, in reliance on the Class Action Fairness Act of 2005, removed the Luther case to federal court. The plaintiffs filed a motion to remand the case to state court. As discussed here, on February 28, 2008, Central District of California Judge Mariana R. Pfaelzer granted the plaintiffs’ motion to remand the case to state court, holding that the removal bar in Section 22(a) of the ’33 Act trumps CAFA’s general grant of diversity and removal jurisdiction. The defendants appealed.

 

In an opinion filed on July 16, 2008 (here), the Ninth Circuit affirmed the district court, specifically holding that Class Action Fairness Act, “which permits in general the removal to federal court of high-dollar class actions involving diverse parties, does not supersede Section 22(a)’s specific bar against removal of cases arising under the ’33 Act.”  

 

And with that it seemed, and I so concluded at the time, that what would happen next is that the Luther case would go forward in state court.

 

But that is not exactly what happened. As reflected in the May 18, 2011 opinion of the California Court of Appeal in the Luther case  when the case returned to state court, the defendants filed a demurrer on the ground that the California state court lacked jurisdiction under the ’33 Act as amended by the Securities Litigation Uniform Standards Act (SLUSA). The trial court agreed with the defendants and sustained their demurrer. The plaintiffs appealed.

 

Before getting to the Court of Appeals ruling, it is worth pausing to review the grounds on which the defendants had demurred. The defendants’ argument was based on the language of Section 22 of the ’33 Act, as amended by SLUSA, which provides in pertinent part:

 

The district courts of the United States and the United States courts of any Territory shall have jurisdiction of offenses and violations under this title and under the rules and regulations promulgated by the Commission in respect thereto, and, concurrent with State and Territorial courts, except as provided in section 16 with respect to covered class actions, of all suits in equity and actions at law brought to enforce any liability or duty created by this title.

 

The defendants’ argument is based on the phrase “except as provided in Section 16 with respect to covered class actions” which was added under SLUSA. The parties do not dispute that this case is a “covered class action” within the meaning of SLUSA (as it involves a suit in which damages are sought on behalf of more than 50 people). The question is whether the “except as provided” creates an exception to concurrent jurisdiction for all covered class action or only “as provided” in Section 16.

 

In the May 18 opinion, a three-judge panel of the Court of Appeals reversed the trial court’s ruling, concluding that SLUSA did not eliminate the concurrent state court jurisdiction in Section 22 of the ’33 Act. Specifically, Court of Appeals concluded that the “except as provided” language did not create an exception to concurrent provisions for all covered class action, but only according to the terms of Section 16. Based on its review of Section 16, the Court of Appeals concluded that “nothing” in Section 16 ”puts this case into the exception to the rule of concurrent jurisdiction,” adding that “the fact that the case is not precluded and can be maintained, but cannot be removed to federal court if filed in state court, tells us that the state court has jurisdiction to hear this action.” The Court of Appeal concluded that the concurrent state court jurisdiction survived the SLUSA amendments.

 

So, now we can all agree, there is concurrent state court jurisdiction for securities class action lawsuits under the ’33 Act, right? Well, maybe. Or maybe not.

 

For starters, other Circuit courts have not agreed with the Ninth Circuit’s conclusions regarding the impact of CAFA on the ’33 Act’s concurrent jurisdiction provision. As noted here, in a 2009 opinion in Katz v. Gerardi , the Seventh Circuit held here the provisions of the more recently enacted statutes, particularly CAFA, trump Section 22. The Seventh Circuit expressly rejected Luther v. Countrywide’s conclusion that the more specific securities statute prevailed. However, the Seventh Circuit’s  opinion, depended in part on the fact that the investment instruments involved are not "covered securities" (i.e., do not trade on a national exchange), and therefore did not come within one of CAFA’s removal exceptions. The Seventh Circuit held that the underlying mortgage securities-related class action lawsuit was properly removable to federal court.

 

Similarly, an October 2008 decision in the Second Circuit in the New Jersey Carpenters’ Fund v. Harborview Mortgage case had refused to remand to state court a ’33 Act case, as is more fully discussed on the 10b-5 Daily blog (here). The Harborview decision was primarily based on the fact that the underlying securities lawsuit did not involve "covered securities" for which SLUSA created an explicit removal exception; because the exception did not apply, the case could appropriately be removed to federal court notwithstanding the nonremoval provision in Section 22.

 

The Seventh Circuit’s  opinion, like the Second Circuit opinion in Harborview, depended in part on the fact that the investment instruments involved are not "covered securities" (i.e., do not trade on a national exchange), and therefore did not come within one of CAFA’s removal exceptions. Of course that was also the case with the securities in Luther – so where does that leave us?

 

I suppose where that leave us is that if you are a plaintiff hoping to pursue a ’33 Act claim in state court, your best bet is to file the lawsuit in California stat court. That is, in fact, exactly what the plaintiffs involved in a mortgage securities class action lawsuit filed against Morgan Stanley did. As discussed here, even though the plaintiff is a Mississippi pension fund and the defendant is a New York investment bank, the plaintiff filed lawsuit in Orange County, California, superior court. Clearly, at least one plaintiff concluded that, if there is a tactical advantage to being in state court, then California state court is the place to be.

 

To be sure, it is not as if pursuing a state court claim has proven to be all that rewarding for the Luther plaintiffs, at least not so far. The Luther plaintiffs filed their lawsuit years ago, they have been through not one but two appeals already, and they have only just now finally established their right to proceed in state court. Or, perhaps not. Who knows, maybe the next stop for this case is in California Supreme Court, And perhaps from there to the U.S. Supreme Court. The parties could be fighting for years before the jurisdictional question is finally decided.

 

There does seem to be something wrong with a system where what “concurrent jurisdiction” between state and federal courts winds up meaning concurrent jurisdiction in some states but not others. With everything that Congress has to worry about these days, this issue may not make it to the top of the list, but this really does seem like something that Congress ought to clean up. Regardless of where you come down on this issue, there seems to be a lot for both sides to argue about when it comes to concurrent jurisdiction, which is hardly a desirable state of affairs.

 

Nate Raymond’s May 19, 2011 Am Law Litigation Daily artilcle about the California appellate decision in the Luther case can be found here.

 

Special thanks to the several readers who sent me copies of the California appellate opinion.

 

One of the ways in which the current wave of bank failures is different from the failures during the S&L crisis is that this time around, by comparison to that prior period, a number of the bank closures have been accompanied by shareholder lawsuits brought  against the former directors and officers of the failed institutions. Some of these shareholder suits have survived dismissal motions, as was the case, for example, with the lawsuit involving Corus Bankshares, the recent settlement of which is discussed below.

 

But there have also been a number of these failed bank shareholder suits that have not survived the preliminary motions, as was the case with the shareholder suit involving UCBH Holdings, as also described below. To be sure, the court’s grant of the UCBH defendants’ motion to dismiss is without prejudice. But in view of the nature of the factual allegations involved, the dismissal motion ruling is noteworthy. In particular the court’s consideration of the FDIC’s regulatory actions regarding the bank are particularly interesting.

 

UCBH was the holding company of United Commercial Bank of San Francisco. The FDIC took control of United Commercial Bank on November 6, 2009 (refer here). Shareholders filed a securities class action lawsuit in the Northern District of California against eight officer defendants and six director defendants, as discussed at greater length here. Their complaint originally named UCBH  as well, but following UCBH’s November 25, 2009 bankruptcy filing, the claims against UCBH itself were stayed.

 

The plaintiffs allege that during the class period  the defendants issued false and misleading statements concerning UCBH’s allowances and provisions for loan loss and falsely represented that the company’s financial reporting controls were effective. The complaint further alleges that on May 8, 2009, the company’s auditor, KPMG, met with the FDIC and state banking authorities to discuss the deterioration in asset quality and overall deterioration of UCBH’s financial condition.

 

On May 13, 2009, KPMG alerted UCBH’s audit committee that illegal acts may have occurred relating to the overvaluation of impaired and real estate owned loans. The audit committee investigated. On September 8, 2009, the company announced that as a result of the investigation UCBH was required to restate its financial statements and that UCBH had reached a consent agreement with FDIC relating to a cease and desist order concerning alleged improprieties. UCBH’s  stock value fell and the bank ultimately was closed.

 

The defendants moved to dismiss the plaintiffs’ complaint. In a May 17, 2011 order (here), Northern District of California Judge Jeffrey S. White granted the defendants’ motion to dismiss without prejudice, on the grounds, inter alia, that the plaintiffs had not adequately alleged scienter.

 

In concluding that the plaintiffs allegations were insufficient to create a strong inference scienter, Judge While found that the plaintiffs allegations based on UCBH’s statements about the efforts of “senior management” to monitor and evaluate the bank’s loan portfolio did “not contain sufficiently particularized allegations to give rise to a strong inference of scienter.” Similarly, Judge Whit found that the plaintiffs’ allegations that the senior officers were motivated to conceal UCBH’s financial condition in order to obtain TARP funds also failed to allege that the these defendants had information about the bank’s financial condition that was withheld or falsely reported.

 

The more interesting part of Judge White’s scienter analysis concerned the plaintiffs’ efforts to rely on the FDIC’s actions and findings. In particular the plaintiffs sought to rely on the findings in the FDIC’s “material loss review” (MLR) that “senior executives” engaged in deliberate misconduct to conceal the Bank’s deteriorating financial condition by delaying risk downgrades and minimizing the bank’s loan loss allowance. Judge White observed that these allegations do not support a strong inference of fraud “as to any one Defendant,” since the MLR does not name “any particular individual as responsible for the alleged misconduct.”

 

The plaintiffs also sought to rely on the FDIC’s report of examination in April 2009 and KPMG’s May 2009 report to the company’s audit committee to establish scienter, but Judge White found that the allegations do not establish when the defendants became aware of the alleged misconduct and which defendants became aware.

 

Finally Judge White rejected plaintiffs attempt to rely on the “core operations inference” to satisfy the scienter pleading requirement, essentially arguing that the matters alleged to be misrepresented were so essential  to the bank’s core operations as to establish that the defendants had access to the disputed information. Judge White rejected this suggestion, concluding that the plaintiffs had not sufficiently alleged that the loan loss allowances and provisions were part of the bank’s “core operations.”

 

Judge White’s ruling in the defendants’ favor on the dismissal was without prejudice, and the plaintiffs were given leave to replead. It may be that the plaintiffs will overcome the pleading deficiencies in their amended complaint – indeed, in many respects Judge White’s opinion provides a roadmap for repeading.

 

Nevertheless it is striking that the dismissal motion was denied in a case where the company’s own auditor reported that illegal acts may have occurred and where company’s own audit committee investigation preceded a restatement and an entry into a cease and desist order, and where the FDIC itself concluded that the “senior executives” engaged in deliberate misconduct to conceal the bank’s deteriorating financial condition. Judge White’s analysis represents  a very demanding application of the PSLRA’s specificity requirement. In particular, his unwillingness to accept the FDIC’s conclusions of misconduct involving “senior executives” as sufficient allegations against any one individual defendant is a very exacting application of the standard — although certainly justified, from the defendants’ perspective.

 

It of course remains to be seen whether the plaintiffs will be able to cure the deficiencies on repleading.. But it is noteworthy that the UCBH is only one of several shareholder suits filed against directors and officers of failed banks that have faced difficulties overcoming the initial pleading hurdles. Motions to dismiss have been granted in a number of these cases, including for example the cases relating to Downey Financial (refer here), Fremont General (here) and Bank United (here — without prejudice).  But as noted below, a number of survived the dismissal motions as well.

 

I have in any event added the UCBH ruling to my running tally of credit crisis dismissal motion rulings, which can be accessed here.

 

Corus Bankshares: Among the failed bank securities class action lawsuit is the one filed against the former directors and officers of Corus Bankshares, the parent company of Corus Bank, which closed on September 11, 2009 (about which refer here). As discussed here, in April 2010, Northern District of Illinois Judge Elaine Bucklo denied the defendants’ motion to dismiss (The opinion that stands in interesting contrast to Judge White’s opinion in the UCBH case.)

 

On May 17, 2011, the parties to the Corus Bankshares case filed a stipulation of settlement (here) indicating that the case has been settled for $10 million, all which is to be paid for by company’s D&O insurance. I have added the Corus settlement to my list of credit crisis securities lawsuit settlements, which can be accessed here.

 

As a result of its relatively modest size, the Corus settlement may not seem particularly noteworthy, which may be a fair assessment. What strikes me about the Corus settlements is that it represents something that still seems to be surprisingly rare, which is a settlement of credit crisis-related securities class action lawsuit.

 

Even though there were well over 230 credit crisis-related securities class action lawsuits filed, there still have only been 20 settlements of the credit crisis securities suits. To be sure, a fair number of these cases were dismissed, but a substantial number (like the Corus case) were not dismissed. Even though many of these cases are now several years old only a very small number have settled so far – indeed the Corus settlement is only the third such settlement this year.

 

It seems to me that there is a substantial backlog of these as-yet unresolved cases, many of which are moving – apparently very slowly — toward settlement. Eventually these cases will settle in substantial numbers. Though many of the settlements will, like the Corus settlement, be relatively modest, some will not be so modest and in the aggregate the total settlements will likely represent a very large figure. Even though a large chunk of these settlements may not be insured, a big chunk will be insured. The collective cost to D&O insurers could represent an impressive total. Reasonable minds may question whether or not insurers are now fully reserved for this eventuality.