One of the most challenging assignments for those of us in the D&O insurance business is to try to explain to those outside the industry how D&O insurance pricing works. The explanation is difficult enough as a general matter, but it is often even more difficult to explain in connection with a specific transaction. The difficulty of the explanation is itself a reflection of a number of features of the current marketplace for D&O insurance.

 

Among the reason for the difficulty of the explanation are the expectations of many insurance buyers. Because of superabundant capacity and rampant competition, D&O insurers have managed to create an environment where many buyers simply expect a price reduction every year.

 

But for all the downward pricing pressures in a  competitive insurance environment, some insurance underwriters at least some of the time still try to segment applicants by risk and price accordingly. There are corporate attributes that even in today’s hyper competitive insurance marketplace will militate against aggressive pricing competition. These factors include, for example, financial instability, past litigation or regulatory activity, adverse business developments, management changes, and maturing debt. By the same token, relatively young companies or development stage companies will always be viewed differently than more mature companies, and companies in certain industries will always be considered more risky than other companies.

 

Looking at it objectively, it makes perfect sense that D&O underwriters might want to try to segment applicants by their relative risk exposures and price accordingly. D&O insurance remains a high severity product. Insured companies and their management are often blindsided by the bad news that leads to claims. The claims can be enormously expensive to defend and settle – in fact, they have been becoming more expensive to defend and settle for years, and at a rate much greater than the rate of general economic inflation.

 

The astonishing thing about the D&O insurance marketplace is that despite the pervasiveness and unpredictability of the risk exposure, the marketplace continues to attract new competitors. In a field where there has been abundant insurance capacity and downward pressure on prices for years, new players still continue to appear and existing players continue to try to expand their portfolios.

 

Growing capacity chasing a finite number of opportunities means that there inevitably will be further downward pressure on prices, despite an adverse claims environment. In addition to downward pricing pressure, there is also outward pressure on the expansiveness of available terms and conditions. As a result, many D&O insurance buyers continue to enjoy the ability to purchase relatively favorable insurance protection at relatively attractive prices.

 

However, even in today’s competitive marketplace, not every company will see only  reduced costs. The D&O insurance marketplace can sometimes seem completely crazy, but it is not always completely illogical. From time to time, the marketplace even manifests that most remote and elusive of all insurance industry phenomena – “underwriting discipline.”

 

The point is that even in a highly competitive insurance marketplace, some insurance buyers are going to pay more for their D&O insurance than other buyers. And even in a competitive insurance marketplace, companies whose risk profiles changed during the policy year may well find themselves paying more for their renewal policy than they did for their current policy. Companies perceived as riskier may not see their insurance cost decline, even if the companies operating history during the policy year generally has been positive.

 

The chronic lack of discipline that so often characterizes the D&O insurance marketplace makes the occasional outbreak of underwriting discipline that much harder to explain when it makes one of its sporadic appearances. For that reason, it can be critically important for companies’ insurance advisors to set expectations at the outset of the insurance placement process.

 

Insurance advisors also have a role to play in helping buyers to understand the pricing alternatives available in the marketplace, particularly if the pricing available reflects something other than a pricing decrease.

 

But the advisors’ efforts to explain marketplace pricing can be completely undercut by a couple of kinds of marketplace unpredictability. The first involves carriers whose pricing decisions are inconsistent and therefore challenging to anticipate. The second involves carriers whose different individual underwriters produce differing pricing determinations. Both of these types of inconsistencies can be difficult to explain, but the problems arising when the same carriers’ underwriters are inconsistent among themselves can be a particularly vexing.

 

No one likes surprises, and that is particularly so when it comes to big ticket expenses like D&O insurance. It is unlikely that pricing surprises can ever be completely eliminated, particularly because the surprise can be the result of expectations and assumptions that might not have been realistic to start with. The possibility for unwelcome pricing surprises be reduces by focused efforts to match expectations the marketplace realities. And finally, carriers can do their part too though the consistency with which they conduct themselves in the marketplace.

 

The Name Game: I am sure I am not alone among Americans who find place names in England particularly interesting. For example, one of the pleasures of the London underground is the memorable names of many of the stops. I am not only thinking here of the splendor of some of the more  triumphant names, like “Elephant and Castle,” “Knightsbridge,” or “Vauxhall.”  I am thinking more of the  names that have that particularly British distinctiveness, such as the termination point of the Piccadilly line service, which is announced by a business-like female voice this way:  “This is the Piccadilly line service to Cockfosters.  (Pause.)  Please mind the gap (pause) between the train (pause) and the platform.” Or on another line: “This is the District line service to Barking. (Pause.) Please mind the gap (pause) between the train (pause) and the platform.”

 

My fascination with interesting names is among the reasons why I feel compelled to follow English football. The pervasive presence of international players in the English premier league contributes a certain musicality to many of the team rosters.

 

Among the names I often wind up repeating to myself is that of the Ivorian defenseman playing for Manchester City, Yaya Touré. Another name with the same kind of pleasing musicality is that of the Cameroonian now playing for Tottenham Hotspur, Benôit Assou-Ekotto. Other names that I find oddly compelling are those of Peter Odomwinge, a Nigerian now playing for West Bromwich Albion, and José Bosingwa, the Portuguese player for Chelsea. There are also the players whose names convey a definite staccato rhythm, like the Bulgarian player for Manchester United, Dimitar Berbatov, or drumbeat finality, like the Dutch wingman for Liverpool, Dirk Kuyt (“kowt”).

 

(Just as an aside, it is worth noting that Silicon Valley venture capitalist Michael Moritz wrote an April 4, 2011 editorial in the Wall Street Journal about the immigration lessons of English Premier League football.)

 

The aural magic of so many of these names is enhanced by the way the TV announcers will track the progress of the ball during the game by simply stating the last names of the players involved. An example involving, say, an offensive set by Chelsea, might go something like this “Cech …Essien … Anelka … Kalou …Malouda …Drogba. Malouda. Drogba!!!!” (The enjoyment of this litany is significantly enhanced when accompanied by ritually appropriate quantities of beer.)

 

And then there are the players’ nicknames. For example, the back of the jersey of Manchester United forward Javier Hernández bears his nickname, “Chicharito” (“little pea”). The second best all time nickname is that of Fitz Hall, who plays for the Queens Park Rangers in the npower Championship League. His nickname is “One Size.”

 

Which brings me to the all time, indoor/outdoor world champion nickname. The nickname does not in fact have anything to do with English football, but it is simply too good to omit from this discussion. The nickname is that of my college classmate, Tom Glasscock, who was known as “STP” (for “See-Through P—s.’ )

 

Blog Update: Some readers may have seen my recent post (here) in which I raised the question of whether or not the Berkshire board could really be held liable for David Sokol’s trades in Lubrizol shares. UCLA Law Professor Stepen Bainbridge has added a post to his blog (here), in which he answers my qustion. The answer according to Bainbridge is "no" for reasons he explains furhter on his site, with reference to the attempts a few years ago to hold the board of Martha Stewart’s  company liable for Stewart’s own insider trading.

 

Berkshire Hathaway Chairman Warren Buffett was not exaggerating when he stated at the opening of the company’s March 30, 2011 press release (here) that the release “will be unusual.” Not only did Buffett disclose the resignation of David Sokol as Chairman and CEO of several subsidiaries, but the release also revealed that Sokol had acquired shares of Lubrizol before bringing the idea to Buffett that Berkshire should acquire Lubrizol. (Berkshire had announced its intention to acquire Lubrizol just days earlier.)

 

As odd and inexplicable as were the events described in the March 30 Berkshire press release, the story became even odder and more inexplicable as information came out that Sokol acquired Lubrizol shares after specifically discussing — apparently as a representative for Berkshire — with investment bankers that possibility that Lubrizol might be an appropriate acquisition target for Berkshire. Sokol also apparently acted as a representative for Berkshire in connection with negotiations with Lubrizol about a possible Berkshire acquisition.

 

Given the high-profile and sensational nature of these allegations, it was perhaps inevitable that litigation would follow. Indeed, a lawsuit was duly filed in Delaware Chancery Court on April 18, 2011. The complaint, which can be found here, presents a shareholders’ derivative claim against Berkshire, as nominal defendant, as well as against Sokol and against the twelve individual members of Berkshire’s board – including not only Buffett, but his chum Charlie Munger and his fellow billionaire Bill Gates. The complaint asserts two substantive claims, one against all of the individual defendants for breach of fiduciary duty and one against Sokol for disgorgement.

 

As a Berkshire shareholder myself as well as a long time Buffett devotee, I have to admit I winced – hard—when reading the March 30 press release. Just the same, the lawsuit makes me uneasy too. Perhaps my long devotion to Buffett biases my view. I confess that I have been unable to bring myself to write about the lawsuit until now because of my conflicted feelings. I do have to admit that the complaint does make for some interesting reading. The time line of events portrayed in the complaint does not reflect well on Sokol, to say the least.

 

The Complaint is less compelling when it tries to detail the specific harms these events have caused the Company. Among other things, the Complaint cites credit analysts to the effect that these events “could result in a negative credit rating for Berkshire” and that have “flagged concerns over the Company’s lack of traditional corporate infrastructure.” The Complaint also cites the decline in Berkshire’s share price that following the March 30 disclosure.

 

One threshold problem the claimant will face is showing that the requisite demand on Berkshire’s board would have been futile. In order to try to establish demand futility, the complaint alleges that the board could not be relied upon to “take proper action on behalf of the Company” due to their “inter-related business, professional and personal relationships” as well as “debilitating conflicts of interest” arising from “prejudicial entanglements and transactions which compromise their independence.” (Francine McKenna’s blog post about the demand futility issue on her Accounting Watchdog blog at Forbes.com can be found here. )

 

But assuming for the sake of argument that the plaintiff can overcome the demand futility hurdles there is the question of whether or not the plaintiff can hope to prevail on the merits.

 

Over at the Delaware Corporate and Commercial Litigation Blog (here), esteemed fellow blogger Francis Pileggi has assembled a host of helpful links and commentaries about the lawsuit. (I would be remiss if I did not also mention here my thanks to Francis for his blog’s provision of a link to the Complaint, as well.) Among the more interesting sources he cites is UCLA Law Professor Stephen Bainbridge’s thorough analysis of the possible merits of the claim, which can be found here and here.

 

Among other things, in the second of his two posts, Professor Bainbridge expressly raises the problems that the plaintiff will have meeting the demand futility test. More interestingly, in both posts, Bainbridge elaborates on the view that the disgorgement claim against Sokol seems to be supported under existing Delaware case law.

 

Professor Bainbridge’s analysis is interesting and persuasive. But it doesn’t answer what is for me the even more interesting question this lawsuit presents, which relates to the breach of fiduciary duty claim alleged against the Berkshire directors. Can the directors – or any one of them (say, for example, Buffett) — possibly be held liable for failing to take actions that allegedly could have prevented supposed harm to the company?

 

UPDATE:In a subsequent post (here), Professor Baibridge has answered my question about the possibility that the Berkshire board could be liable for failing to supervise Sokol’s trades. In Bainbridge’s view, the answer to the question is "no," for reasons he explains in his post.

 

I guess I have too much of a practical habit of mind. Or perhaps it is just because I am a Berkshire shareholder. But I do have to wonder what this lawsuit ultimately is going to produce, other than the generation of massive amounts of legal fees (as if that were something that would be in any company’s interest). Sure, sure, if Professor Bainbridge is right, the disgorgement claim against Sokol might be meritorious, in which case Sokol would have to disgorge h is trading profits to Berkshire. Even so, the most that would garner for the company is about $3 million or so, as I understand it, at the cost of God know how much in legal fees (plus of course the payment of plaintiff’s  attorneys fees —  or at least so  the plaintiff’s  attorneys’ hope).

 

If all this case is about is the disgorgement claim, this sure seems like an enormous waste of everybody’s time. (Indeed, Sokol could save himself and everyone else a whole lot of aggravation if her were to just take out his checkbook and write Berkshire a check for his trading profits.)

 

Of course, there is always at least the theoretical possibility of damages for the breach of fiduciary duty claim against the other directors. It is only really conceivable to even think about this possibility by overlooking the highly speculative nature of the alleged harms the company sustained and the evanescence of the share price decline. And even then — perhaps others can form a picture of say, Buffett, paying money to Berkshire, but it would take a lot more to persuade me that that could happen here and if it could that it would remotely make sense.

 

One other possibility that does come to mind is that, if the case gets that far, perhaps the resolution of this case, like the resolution of many shareholder derivative lawsuits, will include the company’s agreement to adopt certain corporate governance reforms. There would be something highly ironic about Berkshire, of all companies, taking on, say, board oversight obligations. However, the original source of the irony is in the events that led to all of this, which is that, at least as the plaintiff would have you believe, Buffett failed to follow the company’s own existing internal guidelines on these types of matters.  

 

There would be something ironic indeed if Berkshire were to have to implement more “traditional governance infrastructure.” I appreciate irony as much as anybody. But as a shareholder I do wonder whether that would actually be good for the company.

 

One final thought. To paraphrase a recent post on the Deal Journal blog (here) — You don’t suppose there might be a question or two about all of this at next week’s meeting of Berkshire’s shareholder, do you?

 

Where are Today’s Tsunami Stones?: The April 21, 2011 New York Times has a fascinating article entitled “Tsunami Warning for the Ages, Carved in Stone” (here). The article is about the small village of Aneyoshi, Japan, where an aging stone marker set into the hills warns “Do not build your homes below this point!”  Village residents say this warning kept their homes safely out of reach of the deadly tsunami last month.

 

There apparently are hundreds of these stones scattered throughout Japan. Sadly, in modern times, residents came to put more faith in advanced technology and higher sea walls, and many of the warning were ignored.

 

The stones were meant to communicate a critically important message. But their very existence suggests something deeper. The people who put those stones up were capable of thinking very concretely about future generations. They were able to envision the people 80 or 100 years in the future who might need to know what they knew. The erection of the tsunami stones was an act of incredible foresight and incredible generosity.

 

Toward its end the article quotes a Japanese scientist as saying “We need a modern version of the tsunami stones.” The scientist was thinking specifically about potential harm from future tsunamis. But I think the need for warnings to future generations is not limited just to Japan and not just to tsunamis. There are so many things that future generations will need to know. I wonder whether we are able to look forward as those who built the original tsunami stones did. What are we willing to do to protect those unborn people who need to know what we have seen? I sometimes worry that we are incapable of thinking about the needs of those who will be living their lives 80 or 100 years from now.

 

And then finally, there is the lesson of the tsunami stones that were disregarded. As long as people insist on building in flood planes, for example, there will be people who suffer because they choose to disregard the evidence. And as someone who works in the insurance industry, I know all too well how significant economic activity can be carried out in complete obliviousness to the stark warnings of the past. . The landscape of the insurance industry is littered with its own version of tsunami stones yet the warnings of the past are so often disregarded.

 

Cases alleging violations of wage and hour laws have been a growing source of litigation activity in recent years. These cases present a variety of allegations, such as unpaid overtime, employee misclassification, and failure to pay minimum wage. A March 21, 2011 NERA Economic Consulting publication entitled “Recent Trends in Wage and Hour Settlements” takes a look at evolving settlement patterns in these cases. The report, which can be found here, contains a number of interesting observations and underscores the litigation risk that these cases present. The report’s findings have a number of important Employment Practices Liability implications, as discussed below.

 

The report examines 187 wage and hour case settlements reported between 2007 and 2010. The report notes in a footnote that the settlement data, derived from a number of sources, while inclusive of a large number of settlements, “is not likely to be comprehensive.” In addition, some potentially significant settlements were excluded due to incomplete information. Moreover, the settlement information regarding 48 of the 187 cases studied is confidential. For that reason, many of the observations in the study may be more a reflection of the data available that of the overall trends. Notwithstanding the possible data constraints, the report reflects a number of interesting observations.

 

Over the entire four year period of the study, the average settlement per case was $12.8 million and the median settlement was $4.3 million. However, these summary statistics “mask a large range of settlement values.” About 25% of all settlements were under $1 million, while about 20% settled for $20 million or more.

 

In addition, the report reflects a “sharp decrease “in both the average and median settlements in 2009 and 2010 relative to 2007 and 2008. This apparent difference may be a reflection of the data available. For example, in the first two years of the period there were very few reported settlements under $1 million, while in the last two years there was an increased proportion of these smaller settlements. The low number of these smaller settlements in the first two years “may be a result of data limitations.” The pattern in the data could be explained “if lower-value settlements were systematically less publicized in earlier years’”

 

Of course, the relative absence of lower settlements in the two earlier years may also reflect “differences in the underlying characteristics” of the cases during that period. The study does reflect that the nature of the cases shifted in the second two years of the study period. There were more overtime and off-the-clock allegations in the second two years and relatively fewer misclassification cases in those years than in 2007 and 2008. The report notes that “cases with overtime allegations tend to settle for lower amounts,” when controlling for other factors.

 

Two specific factors seem most determinative of settlement size, the number of class members participating and the duration of the class period. The number of plaintiffs involved in the cases varied widely, with about 80 cases involving fewer that 1,000 plaintiffs while six cases had more than 100,000 plaintiffs. The average per-plaintiff settlement amount was $5,700 and the median amount was $3,500. The average settlement amount per year of the class period was $1.2 million. The average settlement amount per plaintiff-year was about $1,000. Consistent with the overall settlement trends, the average per plaintiff settlement and the average per year settlement amount declined in the second two years of the four year study period.  

 

Discussion

The NERA study provides a detailed if not entirely comprehensive overview of the severity risks associated with these kinds of cases. It is apparent that the settlements examined in the NERA study were largely class or at least mass actions involving large numbers of plaintiffs acting collectively. Nevertheless the per plaintiff settlement data may be useful in assessing wage and hour cases that are not presented as collective actions.

 

The study certainly does underscore the seriousness that wage and hour collective actions may represent to employers. The settlement amounts obviously do not include the costs that the various defendant companies incurred in defending these actions. But taking the additional if not precisely known costs of defense in account, it is clear that these kinds of cases represent a serious exposure for the defendant companies.

 

The typical Employment Practices Liability (EPL) insurance policy contains exclusions for wage and hour cases. The usual carrier explanation for these exclusions is something along the lines that insurance for this liability would create a moral hazard, as it might otherwise encourage employers to withhold pay owed to employees with the idea of shifting the compensation expense to the insurer. A June 2010 National Underwriter article discussing EPL coverage issues involving these types of claims can be found here.

 

But while the liability for these cases is typically excluded, EPL policies increasingly include some defense cost protection for these kinds of claims, often on a sublimited basis. The NERA report underscores the seriousness of these kinds of claims, which in turn highlights the importance for the defendant companies of mounting an effective defense. For that reason, the inclusion of the defense cost coverage for wage and hour claims, even if sublimited and even if subject to a self insured retention, could represent a valuable coverage extension for insured companies.

 

It is important to note that not all EPL policies contain this coverage extension, and that some carriers will provide this extension only upon request. This issue represents one more reason why it is critically important for insurance buyers to retain knowledgeable and experienced brokers in their insurance purchases.  

 

Among the reasons frequently cited for the higher incidence of litigation in the United States compared to the rest of the world is the acceptability of contingent fees for plaintiffs’ counsel and general rules that each party to a lawsuit in the U.S. bears its own costs. Many other countries have a “loser pays” model and also have restrictions or prohibitions on contingency fees, both of which may have the effect of discouraging  the filing of claims.

 

One development that has been emerging in some jurisdictions recently and that may overcome these claims obstacles is the rise of litigation funding arrangements. A March 21, 2011 opinion (here) by Ontario Superior Court Justice George R. Strathy examined the litigation funding agreement that the plaintiffs had entered in connection with their putative securities class action claims against Manulife Financial Corporation.  Justice Strathy’s tentative approval of the arrangement, subject to two specific concerns, may provide encouragement for other prospective plaintiffs and litigation funders, which in turn potentially could lead to increased litigation in Ontario and perhaps elsewhere in Canada.

 

Plaintiffs had filed a putative class action in Ontario Superior Court against Manulife and certain of its directors and officers seeking damages under the Ontario securities laws for alleged misrepresentations in the company’s public disclosures. The plaintiffs claim that Manulife represented that it “had in place enterprise-wide risk management systems, policies and practices that were effective, rigorous, disciplined, and prudent”. They claim that, contrary to these representations, Manulife failed to have appropriate risk-management systems for its segregated funds and variable annuities. When the equities markets collapsed in the fourth quarter of 2008, Manulife increased its reserves by almost $5 billion to cover its contingent liabilities under these financial products, triggering a sharp decline in the price of its securities.

 

Justice Strathy’s March 21 ruling relates to the plaintiffs’ motion for court approval of a litigation funding agreement the plaintiffs had entered with Claims Funding International, an Irish Corporation, pursuant to which CFI will pay any adverse costs award made against the plaintiffs in return for a commission of 7% on any settlement or judgment. The arrangement also provides for a cap on the commission of $5 million if the case if resolved at pre-trial stage and $10 million if resolved thereafter. The agreement specifies that counsel’s duties are to the plaintiffs not to CFI. The agreement is subject to court approval, but if approved it is binding on the parties and the class.

 

Justice Strathy first considered whether or not had jurisdiction to consider the agreement event though no class had yet been certified in the case. In considering this question, Justice Strathy noted that the plaintiffs had notified 25 institutional investors of the arrangement as well as 68 other potential class members of the arrangement, and that none of these prospective class members were opposed to the funding agreement. Justice Strathy concluded that “a part of the court’s responsibility in class actions is to protect the rights of prospective class members” and “to postpone the decision to post-certification, when the views of class members can be sought, could very well spell the end of this proceeding, because the plaintiffs cannot withstand an adverse costs award on certification.” Justice Strathy determined that he was entitled to “ask whether the agreement is fair and reasonable.”

 

The defendants opposed the plaintiffs’ motion for approval on the ground that it violated the Ontario statute barring “champertous” agreements. (The Ontario statute is a model of brevity, specifying that “All champertous agreements are forbidden and invalid.”) The prohibitions on Champerty are “designed to protect the administration of justice from abuse by the exploitation of vulnerable litigants.” Justice Strathy cited authority that a funding agreement will be champertous “if it is spurred by some improper motive,” such as “exacting an unfair price” which would result in “unfairness to the litigant.”

 

Justice Strathy then surveyed the case authority on litigation funding agreements. He found that courts in Alberta and Nova Scotia had approved litigation funding agreements, albeit without explanation. He also cited cases from England and Australia where agreements had also been approved.

 

Justice Strathy then considered some “practical concerns” with the “loser pays” model in the class action context, as a result of which the costs of losing could be “astronomical” and “well beyond the reach of all but the powerful and very wealthy” who are “not exactly the group the legislature had in mind” when the relevant statutes were enacted. He noted that: 

 

The grim reality is that no person in their right mind would accept the role of representative plaintiff if he or she were at risk of losing everything they own. No one, no matter how altruistic, would risk such a loss over a modest claim. Indeed, no rational person would risk an adverse costs award of several million dollars to recover several thousand dollars or even several tens of thousands of dollars.

 

Justice Strathy noted that while counsel may provide certain indemnities, those types of agreements “impose onerous financial burdens on counsel and risk compromising the independence of counsel.” He also noted that disbursements available from the Class Proceedings Fund established under statute by the Law Foundation of Ontario may or may not be available and may or may not be adequate.

 

In light of these considerations, Justice Strathy approved the agreement, ruling that it promotes the statutory goals by “providing access to justice.” This goal would be “illusory” if “access to justice were deterred by the prospect of a crushing costs award.” The presence of these kinds of agreements may actually be “beneficial to the proper administration of justice” because they “can avoid the unfortunate result that individuals with potentially meritorious claims cannot bring them because they are unable to withstand the risk of loss.”

 

Justice Strathy found that this specific agreement was appropriate because it left control of litigation in the hands of the representative plaintiff and because the commissions and caps are “reasonable” and “represent a fair reflection of the potential downside risk.”

 

He did note that he would not finally approve the agreement unless and until the defendants are “provided adequate security” that any costs award can and will be funded, and unless and until appropriate arrangements are made for “reasonable controls on the provision of information to the funder. “ Justice Strathy’s said that his approval of the finding agreement is subject to “satisfactory amendments to address” these concerns.

 

Discussion

As reflected in Justice Strathy’s opinion, there have been prior occasions on which Canadian courts have approved litigation funding agreements. However, his opinion may represent the most detailed explanation of the basis on which such agreements may be approved. His reference to the advantages these types of arrangements may have in the class action context could prove persuasive to other judges, and his analysis could encourage other prospective plaintiffs and litigation funders to enter similar agreements.

 

To be sure, any parties contemplating entering into litigation funding arrangements will have to heed the concerns noted in Justice Strathy’s opinion. He was clear that he was approving this agreement only because the commissions were reasonable and because the controls were appropriately kept with the named plaintiffs and are not with the litigation funder. Moreover, his final approval ultimately will depend on the plaintiffs adopting appropriate amendments to address the court’s security and information concerns.

 

But while any future litigation funding agreements will undoubtedly be subject to similar scrutiny, the fact is that the door seems to be opened to the use of this type of litigation funding mechanism in Ontario at least if not elsewhere in Canada, at least when appropriately structured. The ability to address the impediments of the “loser pays” model could encourage other litigants to come forward, or at least remove disincentives that might otherwise discourage prospective future litigants from coming forward.

 

The prospect that the availability of litigation funding might lead to increased litigation is not just conjecture. As NERA Economic Consulting noted in its 2010 study of Australian securities class action litigation (about which refer here) , among the most significant explanations for the reported increase in the number of securities class action lawsuits in Australia is the “emergence of commercial litigation funding” which removed financial barriers to pursuing litigation.

 

Of course, it remains to be seen whether or not other Canadian courts will follow Justice Strathy and approve similar litigation funding arrangements, and whether the availability of this type of arrangements leads to increased litigation levels. There are of course many possibilities, including the possibility that litigation funding does not catch on or become an important factor. On the other hand, it is possible that Canada might see the emergence a litigation funding industry that has developed in Australia, where there are even publicly traded litigation financing companies.

 

The development of these types of arrangements to overcome the limitations of the “loser pays” model is particularly interesting now, when as a result of the U.S. Supreme Court’s ruling in the Morrison v. National Australia Bank case, investors in non-U.S. companies may find themselves unable to resort to U.S. court to pursue damages claims. These investors may increasingly be turning to their home courts for relief. In the past, limitations such as the “loser pays” model have served as a litigation deterrent in many countries. But if these limitations can be overcome, for example through the use of a litigation funding mechanism, investors may be increasingly motivated to pursue claims in their own home jurisdictions. Just as in Australia, the availability of litigation funding could lead to increased securities litigation activity.

 

It probably should be noted in closing that litigation is not only catching on outside the U.S, but it also gaining traction in side the U.S. as well, at least according to June 4, 2010 New York Law Journal article (here). An October 2009 U.S. Chamber Institute of Legal Reform publication entitled “Selling Lawsuits, Buying Trouble” (here) proposes that third-party litigation finding in the United States be prohibited. The Institute for Legal Reform publication provides a comprehensive overview of recent developments in litigation funding.

 

Special thanks to loyal reader Greg Shields, who is a contributor at the Mitchell Sandham blog (here), for sending me a link to Justice Strathy’s ruling.

 

A Story You Might Have Missed: According to sources (here), The Economist magazine is temporarily suspending publication to allow its readers a chance to catch up. (They must have seen my coffee table.) The same source reports that ESPN The Magazine is suspending publication indefinitely to allow its readers a chance to learn how to read.

 

Apologies: My apologies to readers who may have tried to access this blog between 3:30 6:00 pm EDT yesterday. My hosting service was having server issues that interrupted accessibility. I am assured the problems will not recur. Technology is great when it works. But otherwise, not so much.

 

Corporate and securities litigation filing activity reached a “crescendo” in the first quarter of 2011, according to the most recent quarterly report from Advisen, the insurance information firm. The filing rate in the year’s first three months if annualized would represent a record –settling annual level of corporate and securities litigation activity. A copy of the Advisen report can be found here. My own survey of the first quarter 2011 securities class action lawsuits filings can be found here.

 

Preliminary Notes

In considering the Advisen report, it is critically important to recognize that the report uses its own unique vocabulary to describe certain of the litigation categories.

 

The “securities” litigation analyzed in the Advisen report includes not only securities class action litigation, but a broad collection of other types of suits as well, including regulatory and enforcement actions, individual actions, derivative actions, collective actions filed outside the U.S. and allegations of breach of fiduciary duty. All of these various kinds of lawsuits, whether or not involving alleged violations of the securities laws, are referred to in the aggregate in the Advisen report as "securities suits."

 

One subset of the overall collection of "securities suits" is a category denominated as "securities fraud" lawsuits, which includes a combination of both regulatory and enforcement actions, on the one hand, and private securities lawsuits brought as individual actions, on the other hand. However, the category of "securities fraud" lawsuits does NOT include private securities class action lawsuits, which are in their own separate category ("SCAS").

 

Due to these unfamiliar usages and the confusing similarity of category names, considerable care is required in reading the report.

 

The Report’s Findings

According to the report there were a total of 363 corporate and securities lawsuits filed in the first quarter of 2011, which is up from the 342 filed in the fourth quarter of 2010 but below the quarterly record level of 386 set in the third quarter 2010. If the first quarter filing levels were to continue for the rest of the year, that would imply a 2011 year-end total of 1,448 corporate and securities lawsuits, which, according to Advisen would represent a “record-setting year.” Just to put this level of filing activity into perspective, prior to the credit crisis “new filings averaged less than two-thirds of this annualized level.”

 

According to Advisen’s tally, there were 61 securities class action lawsuits in the first quarter of 2011. However, securities class action lawsuits as a percentage of all corporate and securities lawsuit filings continue to decline. As recently as 2006, corporate and securities lawsuits represented as much as one third of all corporate and securities litigation, but in the first quarter of 2011, the securities class action suits represented only 17 percent of all corporate and securities lawsuit filings.

 

With respect to the securities class action lawsuit filings, 85 percent of the suits were filed against companies in just five sectors: financial, information technology, consumer discretionary, energy and industrial. With respect to all corporate and securities litigation generally, financial firms continue to be the most frequently sued albeit at a lower level in recent years. Financial firms were named as defendant in 34 percent of all corporate and securities lawsuits in the first quarter, compared to 45 percent in 2008 and 40 percent in 2009.

 

Breach of fiduciary duty suits, many of which are filed in state court and many of which are filed shortly after the announcement of a proposed merger or acquisition, represent a growing area of corporate and securities litigation. These breach of fiduciary duty suits represent about a third of all corporate and securities lawsuit filings in the first quarter of 2011, up from only eight percent of all corporate and securities filings as recently as 2004. Over 60 percent of the first quarter breach of fiduciary duty suits were filed in the state court.

 

Corporate and securities litigation activity outside the U.S. has also been on the increase. During the first quarter of 2011, Advisen recorded 17 of the corporate and securities lawsuits filed outside of the United States.

 

By the same token, 16 percent of all corporate and securities lawsuits filed during the first quarter involved non-US companies, compared to only 11 percent in 2009 and 2010. These figures were largely driven by cases involving Chinese companies whose shares trade on the U.S. exchanges. Cases against Chinese companies in U.S. courts “mushroomed” in 2010, and continued in the first quarter, when there were 11 new securities lawsuits in the U.S. against Chinese companies. (This trend of filings against Chinese companies has continued into the second quarter as well, as I noted in my recent posts, here and here.)

 

Finally, with respect to settlements, the Advisen report notes that the average securities class action lawsuit settlement announced during the first quarter of 2011 was $54.6.

 

Quarterly Advisen Conference Call: On Thursday, April 21, 2011, I will be participating in an Advisen conference call to discuss the first quarter 2011 filing statistics and trends. The free one-hour conference call will take place at 11 am EDT. The conference call panel will include a number of distinguished speakers, including Dan Bailey from the Bailey Cavalieri law firm, Carol Zacharias from ACE, Carolyn Polikoff from the Woodruff Sawyer firm and David Bradford from Advisen. Information about the session including registration information can be found here.

 

For several years, Friday has been the day when the latest bank closures are announced (about which see further below). More recently, Friday also seems to be the day when the latest securities class actions involving Chinese companies are announced. This past Friday alone, three more securities suits involving Chinese companies were announced. Signs are that there are more to come. A brief description of the three latest cases follows.

 

Puda Coal: The first of the three latest Chinese suits involves Puda Coal, Inc., an NYSE company that is a Delaware corporation but which has its headquarters in Shanxi Province in China. There have actually been two separate lawsuits filed against Puda, one in the Southern District of New York (refer to the complaint here), and one in the Central District of California (here).

 

As reflected in plaintiffs’ counsel’s press release (here), the allegation is that Puda’s assets were transferred to a subsidiary of which Puda’s Chairman of the Board obtained control through a series of transactions, enabling the Chairman to profit personally from the sale of a minority interest in the subsidiary to a private equity firm. Following an internet website’s disclosures of the transactions, the company’s share price declined. In an April 11, 2011 press release (here), the company announced that its board had adopted the recommendation of the company’s audit committee to investigate the Chairman’s “unauthorized” transactions involving the subsidiary.

 

Subaye, Inc.: According to their April 15, 2011 press release (here), plaintiffs’ lawyers have initiated a securities class action lawsuit in the Southern District of New York against Subaye, Inc. and certain of its directors and officers. Subaye is a Delaware Corporation with its headquarters in Guangdong, China.

 

According to the press release, the complaint (which can be found here) was filed in the wake of the company’s April 7, 2011 announcement that its auditor PricewaterhouseCoopers Hong Kong had withdrawn and that prior to its resignation the audit firm had identified matters that might affect the fairness of the company’s previously issued financial statements. The press release states that

 

PwC’s was unable to obtain information and supporting documentation to verify: (a) cash settlements from sales agents to Subaye, (b) the end customer subscriptions for the Company’s services and the services rendered to the end customers, (c) marketing and promotion activities performed by sales agents in return for fees paid to such agents and recorded as expenses of the Company. PwC also stated that Subaye provided insufficient explanations regarding commonalities between certain customers and vendors. Lastly, PwC could find no evidence of any business tax payments by the Company for services rendered in China.

 

Universal Travel Group: According to their April 15, 2011 press release (here), plaintiffs’ lawyers have filed a securities class action lawsuit in the District of New Jersey against Universal Travel Group and certain of its directors and officers. Universal Travel is a Nevada corporation based in Shenzen, China.

 

The Universal Travel group lawsuit follows a March 2011 securities analyst’s report raising questions about the company’s business, its reported cash balances and revenues, and its relationship with an online travel service. The report stated that there were large differences between the revenues that a newly acquired subsidiary had reported to Chinese authorities and the revenues that Universal Travel reported.

 

 In an April 14, 2011 press release (here), the Company announced that it had hired a new auditor after its prior auditor resigned because “it was no longer able to complete the audit process” due to “the Company’s management and/or the Audit Committee being non-responsive, unwilling or reluctant to proceed in good faith and imposing scope limitations on [the auditor’s] audit procedures.”

 

These three new securities class action lawsuits follow closely on the heels of the four accounting-related  lawsuits involving Chinese companies filed earlier this month, as I noted in a prior blog post (here). With these three  latest lawsuits, there have now been a total of 14 securities class action lawsuits filed against Chinese and China-liked companies in 2011, out of a total of about 61 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. Ten of these have been filed just in the last 30 days.

 

The signs are that this recent outburst  of new lawsuit filings involving Chinese companies will likely continue. Plaintiffs’ law firms continue to publish press releases that they are “investigating” still other Chinese companies (refer for example, here and here) For that matter, the cascade of news raising questions about accounting practices involving some Chinese companies shows no signs of abating.

 

As Walter Pavlo notes on his White-Collar Crime blog on Forbes.com (here), many of the Chinese  companies involved in this rash of lawsuits obtained their U.S. listings through reverse mergers with a publicly traded U.S. shell company. In a later post (here), he also noted that many of these firms have the same auditors and used the same investment bank in their reverse merger transaction.

 

In an April 4, 2011 speech (here), SEC Commissioner Luis Aguilar noted that the problems arising involving Chinese companies that have obtained U.S. listing are a serious concern and that the SEC in cooperation with other organizations including the PCAOB is investigating the concerns that have arisen. Among other things, he noted that “a growing number” of these companies “are proving to have significant accounting deficiencies or being vessels of outright fraud.”

 

According to Commission Aguilar, since January 2007 over 150 Chinese companies have obtained U.S. listings using what he characterized as “backdoor registrations.” While not all of these companies are engaged in the kinds of activities described in the case summaries above, there definitely seems to be a pattern of involvement in conflicts of interest or accounting issues. The rash of recent resignations of the outside auditors from these companies suggests that the audit firms have had their consciences   raised about the dangers of becoming associated with these kinds of firms and accounting issues they may be having.

 

In any event, it seems likely that there will be further lawsuits involving these Chinese companies. David Bario’s April 4, 2011 Am Law Litigation Daily article profiling the plaintiffs’ lawyer behind many of these lawsuits can be found here.

 

Bank Failures Not Over Yet: Speaking of bank failures (as I was at the outset of this post), it now appears that my recent prediction that the bank failure wave may finally be over might have been premature. This past Friday night, the FDIC closed six more banks, bringing the year to date total number of bank closures to 34. While that is fewer than the 49 banks that had been closed at this point last year, the closure of six banks at one time does cut against the suggestion that the FDIC is winding down its bank closure activities.

 

With the addition of the latest six bank closures, the total number of banks that have failed since January 1, 2008 stands at 356. Of this total, 51 involve banks located in Georgia (including two of the six banks closed this past Friday night). After a while you do start to wonder if there how there could be any banks left in Georgia.

 

As I have noted elsewhere, the FDIC has still only brought a total of six lawsuits involving former directors and officers of the bank. However, on April 13, 2011, the FDIC did update the Professional Liability Lawsuits page on its website, to indicate the number of persons against who lawsuits have been authorized has been increased by 187 (up from the prior month’s total of 158). However, the six lawsuits filed to date involved only 42 individual defendants, which suggests that there are quite a number of lawsuit in the pipeline and yet to be filed. The updated page also notes that the FDIC has also authorized “11 fidelity bond, attorney malpractice, and appraiser malpractice lawsuits.”

 

Special thanks to the loyal readers who alerted me to the most recent bank closures and to the recent update to the FDIC website.

 

105 Years Ago Today: A rare 35 mm film of San Francisco just four days before the April 18, 1906 earthquake has been “found.” The person that send me a YouTube link to the file reports that “This film was originally thought to be from 1905 until David Kiehn with the Niles Essanay Silent Film Museum figured out exactly when it was shot –from New York trade papers announcing the film showing, to the wet streets from recent heavy rainfall & shadows indicating time of year & actual weather and conditions on historical record, even when the cars were registered (he even knows who owned them and when the plates were issued!).”

 

The film, which was shot by mounting a camera on the front end of a cable car, is simply amazing. The clock tower at the end of Market Street at the Embarcadero wharf is still there. The number of automobiles on the road in 1906 is staggering. The absolute chaotic traffic suggests that rules of the road were a later invention.

 

There is an element of sadness too in the film, as so much of the city was destroyed days later and as many as 3000 people died in the quake and in the fire that followed. The film is a remarkable piece of history. Special thanks to the loyal reader who sent me the link.

 

https://youtube.com/watch?v=NINOxRxze9k

A number of trends that had predominated in recent years diminished during 2010 while new trends emerged, according to PwC’s 2010 Securities Litigation Study, which can be found here. 2010 may also mark “the start of a new era” as a consequences of a new regulatory and enforcement environment take effect, which “could lead to a reinvigorated volume of reported securities violations and associated class actions.” PwC’s April 7, 2011 press release about its report can be found here.

 

In many ways the 2010 securities litigation filing activity was characterized by the  reversal of a number of trends. Thus, for example, the declining numbers of credit crisis related cases meant that fewer cases were filed against financially related companies than in the immediately preceding three years (although financial companies remained the most frequent litigation target in 2010). In addition, accounting-related cases continued to decline in 2010, as did the number of new cases against Fortune 500 companies.

 

On the other hand, the reversal of these trends was “offset” by other trends that emerged during the year, leading to an overall jump in the number of cases. The focus of activity shifted from an “overwhelming focus on the financial services industry” to a “medley of issues across a variety of industries.”  Increasing numbers of cases against companies in the health industry, a surge in M&A related cases, a jump in cases against Chinese companies and a rash of cases against for-profit education companies all contributed to the increased litigation activity.

 

Overall, the total number of federal securities class action filings rose 12 percent during 2010 compared to 2009, from 155 to 174. (PwC’s count may vary from other published reports as a result of its counting methodology, pursuant to which “multiple filings against the same defendant with similar allegations are counted as one case.”). There were more filings in the third and fourth quarters of 2010 than in either of the first two quarters. Among other things, the increase in filings in the year’s second half reflected the “increasing domination o f non-financial crisis-related cases and the decline in financial-crisis related cases.”

 

Among the principle drivers of the increased number of filing in the second half of 2010 was the increase in the number of M&A related cases. Overall, M&A cases represented 24 percent of all securities filings in 2010, compared to only 4 percent in 2009.

 

Health industry cases increased from 17 percent in 2009 to 21 percent in 2010, representing the second highest percentage of for any industry in 2010. The filings included cases against pharmaceutical, medical device and health services companies. (My recent post discussing 2010 securities filings against life sciences companies can be found here.)

 

The percentage of cases raising accounting-related allegations (including overstatement of revenues, understatement of expenses and liabilities and overstatement of assets) fell from 37 percent in 2009 to 35 percent in 2010, which represents the lowest level of accounting-related cases in 15 years. The report speculates that one possible reason for this decline in accounting-related cases could be “the effectiveness of SOX in combating accounting fraud.” On the other hand, the decline in the number of cases involving accounting allegations could also just be a reflection of the changing mix of cases; the options backdating cases that predominated a few years ago were replete with accounting-related issues, but the increasing numbers of M&A cases in 2010 rarely involved accounting allegations.

 

Surprisingly, in light of the U.S. Supreme Court’s June 2010 decision in Morrison v. National Australia Bank, the number of filings involving foreign issuers increased during 2010 by 35 percent, and of the 27 cases filed in 2010 involving foreign issuers, 16 (or 59 percent) were filed after the Morrison decision was announced. The percentage of cases involving foreign issuers as a percentage of all filings increased during 2010 from 13 percent in 2009 to 16 percent in 2010.

 

Of these 27 cases involving foreign issuers, 12 cases (44 percent) involved Chinese companies. Eleven of the 12 cases against Chinese companies involved accounting allegations.

 

The average settlement of securities related cases during 2010 decreased by 11 percent compared to 2009, from $34 million to $30.1 million.(PwC ‘s figures may differ from other published reports as PwC assigns the settlement to the year of the “primary settlement announcement,” and any subsequent announcements are attributed to the primary announcement year.” PwC also excludes zero dollar settlements.)

 

 However, the average settlement value of cases settled for more than $1 million and less than $50 million increased by 21 percent, from $10.7 million in 2009 to $12.9 million. In addition, median settlements increased by nearly 35 percent, from $7.5 million to $10.1 million.

 

The PwC report concludes with a survey of the changing liability  environment arising from  the new regulatory mandates introduced by the Dodd-Frank Act. Because enforcement activities “are likely to increase” and the new Dodd-Frank whistleblower provisions “could produce a surge in allegations of securities violations,” the financial regulatory environment is “vastly different in 2011 from what it was just one year ago, and companies will have to devote significant resources to understanding and adapting to its new topography.”  The decade ahead has “the potential to yield yet more transformations.”

 

My analysis of the 2010 securities class action litigation filing can be found here. My more recent study of first quarter 2011 filings (here) shows that many of the trends that emerged in 2010 continued in the first quarter, including in particular the heightened level of M&A related litigation. In addition, as I recently noted (here), the wave of accounting-related litigation involving Chinese and China-linked companies has also continued in 2011.

 

WaMu Subprime-Related Securities Lawsuit Settlement in the Works: In case you missed the news last week, the WaMu subprime-related securities lawsuit apparently has settled. According to the Court’s  April 6, 2011 minute order (here), the parties have advised the court that the lead case has settled, and the Court has suspended all of the schedules dates and motions. The settlement papers have not yet been filed so the details of the settlement are not yet known, but an April 6, 2011 Seattle Times article by Sanjay Bhatt (here) reports that the amount of the settlement “is in excess of $200 million.”

 

The WaMu case, of course, relates to the facts and circumstances surrounding the largest bank failure in U.S. history. The case itself did not necessarily unfold smoothly from the plaintiffs’ perspective. In a May 2009 opinion that was sharply critical of the plaintiffs’ pleadings (about which refer here) , Western District of Washington Judge Marsha Pechman has initially granted the defendants’ motion to dismiss. However, the plaintiffs’ amended pleadings survived the renewed motion, and now the parties apparently have settled the case.

 

The details of the settlement, once they are finally released, will be interesting in and of themselves, but they may be even more interesting in light of the recent action that the FDIC filed against three former WaMu executives and the wives of two of the officials (about which refer here). The possibility that the WaMu securities suit settlement could involve the payment of  hundreds of millions of dollars raises the possibility that the settlement would consume the remaining limits of WaMu’s D&O insurance policy, possibly leaving the defendants in the FDIC without insurance remaining for them to defend themselves against and to try and settle the FDIC claims.

 

So The D&O Diary is interested in a number of details about the settlement, beyond just the settlement’s dollar value. We are interested to see how much of the settlement will be funded by D&O insurance, and whether any of the settlement is to be funded out of the individual defendants’ assets. We are also interested to see if the settlement documents show whether the settlement exhausts the remaining D&O insurance limits. Along the same lines, it will be interesting to see (if possible) what kind of a release the insurers are getting in exchange for the insurance payment, if any, and whether it is a policy release or just a claim release.

 

In any event, the WaMu settlement is just the first of what I think will be a wave of subprime-related securities lawsuit settlements during the course of 2011. The WaMu settlement also vividly illustrates the competition for insurance policy proceeds that the FDIC will face as it seeks to pursue lawsuits against directors and officers of failed banks, particularly as in many cases the shareholders have been actively pursuing their claims while the FDIC has proceeded much more deliberately.

 

Speakers’ Corner: On Thursday April 14, 2011, I will be a panelist at the Professional Liability Underwriting Society Southwest Chapter’s Educational Event in Englewood, Colorado. The title of the even t is “Winds of Change in Executive and Professional Liability,” and I will be speaking on panels on the topics of Governmental Investigations and D&O Liability Developments. Information about the event can be found here.

 

If you are a part of the Southwest Chapter, I hope you are planning on attending. And if you are attending I hope you will take a moment to say hello, particularly if we have never met before.

 

When the FDIC released its Quarterly Banking Profile for the fourth quarter 2010, it included a statement from FDIC Chairman Sheila Bair that the agency believes “the number of failures peaked in 2010.” However, at least through the end of February 2011, the evidence was to the contrary, as the number of bank failures during the first two months of 2011 (23), exceed the number through the end of February 2010 (22).

 

However, since the end of February 2011, the number of bank failures has declined sharply. The FDIC closed only three banks during March 2011, and only one since March 11, 2011. As of April 1, 2011, there have been a total of 26 bank failures this year. By the same point in 2010, there had been a total of 41 failed banks.

 

The difference between the two year-to-date tallies is that during March 2010, the FDIC took control of 19 banks, compared to only three in March 2011. In addition, the first Friday in April 2011 also passed without any additional bank failures.

 

The 26 bank failures through the end of March would if annualized project to about 104 bank failures by year end 2001, which would be the lowest annual number of bank failures since 2008 (when there were 25). But if the bank failure pace that prevailed in March 2011 were to continue, the number of bank failures by year end could be well below that projected number.

 

One of the signs that will be interesting to watch is the number of problem institutions reported when the FDIC releases its next Quarterly Banking Profile for the quarter ended March 31, 2011. The Profile is due to be issued sometime later in May. The number of problem institutions has been increasing every quarter for several years now, although the rate of increase has slowed. In its last profile, the FDIC stated that 2010 was a “turnaround” year for the banking industry. If last year truly was a turnaround year, the reported number of problem institutions should finally start to decline — which, if it were to happen, would tend to support the probability that the slower rate of bank failures could well continue as the year progresses.

 

With the 23 bank failures so far this year, the total number of bank failures since January 1, 2008 stands at 348. Even with this significant number of failed institutions and the amount of time that has passed since the beginning of the current bank failure wave, the FDIC has so far filed lawsuits against the directors and officers of only six failed banks. (Refer here to access a list of the FDIC lawsuits.)

 

On its website, the FDIC reports that as of March 15, 2011, it has authorized lawsuits against a total of 158 individuals. However, the six FDIC lawsuits so far collectively include only about  43 individual defendants, which suggest that there are a number of additional lawsuits being readied and likely to be filed in the near future. In addition, the number of individuals against whom lawsuits have been authorized has grown over recent months to its current level of 158, and since banks have continued to fail in the interim, it seems likely that the authorized number will continue to grow, which would imply an even greater number of lawsuits yet to come.

 

The number of lawsuits that ultimately will be filed remains to be seen. But while that part of the story unfolds, it is noteworthy that for the first time in quite a while, the story appears to be that the number of bank failures is declining. And that sure seems like a good thing to me.

 

Over the last few days, there have been a series of rulings in high-profile lawsuits arising out of the subprime meltdown and credit crisis. As discussed below, just in the past week there were dismissal motion rulings in cases involving Freddie Mac, Wachovia/Wells Fargo, and AIG. Though some or all of the claims in these cases were dismissed in whole or in part, the plaintiffs have managed to live at least for another day (if only just barely in the Freddie Mac case). At the same time,  in the AIG ERISA case, the case largely survived the dismissal motion.

 

Freddie Mac: On March 30, 2011, Southern District of New York Judge John Keenan granted without prejudice the defendants’ motion to dismiss in the Federal Home Loan Mortgage Corp. (Freddie Mac) subprime-related securities class action lawsuit. A copy of the March 30 order can be found here.

 

Freddie Mac is of course one of the government sponsored entities that was at the center of the residential mortgage crisis in 2008. On September 7, 2008, it was placed in the hands of a conservator. In August 2008, shortly before the company entered conservatorship, the company’s public shareholders filed a securities class action lawsuit against the company and certain of its directors and officers, as discussed in greater detail here.

 

The plaintiffs alleged that in various public statements the defendants had made three types of misrepresentations or omissions: (1) about the company’s exposure to “non-prime mortgage loans”; (2) about its capital adequacy; and (3) about the strength of its due diligence and quality control mechanisms. The defendants moved to dismiss.

 

In finding that the alleged misrepresentations about the company’s exposure to subprime mortgages were insufficient, Judge Keenan found that “the Amended Complaint does not explain why Freddie Mac’s disclosures in its November 2007 Financial Reports … were insufficient to convey the truth that Freddie Mac was dealing in non-conforming mortgages to the public.” He added that “Plaintiffs present no theory at all about why Freddie Mac’s disclosures would not be understood by the reasonable investor and thus part of the ‘total mix’ of information that determined its share price.”  

 

Judge Keenan also found that the alleged misrepresentations regarding the company’s capital adequacy were also insufficient. He observed that “in a volatile economic, political and regulatory environment like the one that existed in the summer and early fall of 2008, with even Freddie Mac’s primary regulator being replaced, Plaintiffs must show more to plausibly claim that Freddie Mac’s statements were made without any basis in fact. “ However, he concluded that “Plaintiff has not adequately pleaded sufficient facts giving rise to a strong inference that Freddie Mac’s statements about its capital adequacy or its hope that it would continue to function were made with intent to defraud or without factual basis.”

 

With respect to the alleged misrepresentations regarding the company’s internal controls and processes, Judge Keenan found that “there are simply no facts in the Amended Complaint from which one could reasonably infer a causal link between Freddie Mac’s statements about its underwriting standards and internal controls and any loss suffered by purchasers of its equity securities during the Class Period.” He added that “considering that the price of Freddie Mac’s stock was clearly linked to the ‘marketwide phenomenon’ of the housing price collapse, there is decreased probability that Plaintiffs’ losses were caused by fraud.”

 

Judge Keenan granted the motions to dismiss without prejudice and allowed the plaintiffs’ 60 days in which to file a Second Amended Complaint.

 

An April 1, 2011 Bloomberg article about Judge Keenan’s decision in the Freddie Mac case can be found here.

 

Wachovia/Wells Fargo: On March 31, 2011, Southern District of New York Judge Richard Sullivan issued his rulings on the motions to dismiss in the consolidated securities litigation that had been filed on behalf former equity shareholders and bondholders of Wachovia Corporation. In a lengthy and detailed opinion (here), Judge Sullivan granted the defendants’ motions to dismiss the equity securities litigation, but he denied the motion to dismiss the bondholders’ action, other than with respect to certain bond offerings in which the plaintiffs had not actually purchased any securities.

 

As Judge Sullivan wrote in summarizing the various plaintiffs’ allegations, “all claims arise from the financial disintegration Wachovia experienced between its 2006 purchase of Golden West Financial Corporation and its 2008 merger with Wells Fargo & Company.” In essence, the complaint is based on the difficulties Wachovia experienced as a result of the Golden West “Pick-A-Pay” mortgage portfolio. Further background regarding the equity securities litigation can be found here and background regarding the bondholders’ litigation can be found here.

 

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

 

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

 

However, Judge Sullivan denied the defendants’ motions to dismiss the bondholders’ ’33 Act claims (other than with respect to the offerings in which the plaintiffs had not purchased shares, with respect to which the motion was granted). In concluding that the bondholders’ allegations were sufficient when the equity securities plaintiffs’ allegations were not, Judge Sullivan found that the bondholder plaintiffs had adequately alleged misrepresentation in the relevant offering documents with respect to loan to value rations maintained in the mortgage portfolio and with respect to the alleged manipulation of the appraisal process to produce inflated appraisal values.

 

On the strength of these alleged misrepresentations in the offering documents, Judge Sullivan also denied defendant KPMG’s motion to dismiss the bondholders’ 33 Act claims.

 

Susan Beck’s April 1, 2011 Am Law Litigation Daily detailed article about Judge Sullivan’s ruling can be found here.

 

AIG ERISA Action: In a March 31, 2011 order (here) in the AIG subprime-related ERISA action, Southern District of New York Judge Laura Taylor Swain, denied the defendants’ motion to dismiss, other than with respect to plan organized on behalf of Puerto Rico employees with respect to which the motion was granted on the ground that because none of the name plaintiffs participated in that plan, they lacked standing to pursue those claims.

 

The plaintiffs are participants or beneficiaries in I two AIG plans, the AIG Incentive Savings Plan and the American General Agents’ & Managers’ Thrift Plan between June 15, 2007 and the present. Each plan offered participants a menu of investment options, one of which was the AIG Stock Fund, which invested in AIG stock.

 

The plaintiffs alleged that the defendant plan fiduciaries breached the duty of prudence by continuing to offer the AIG Stock Fund as an investment option, even when they knew or should have known that AIG stock was no longer a suitable and appropriate investment. The plaintiffs further alleged that the defendants failed to disclose to fellow fiduciaries nonpublic information that was need to protect the interests of the Plans. The plaintiffs also alleged that the defendant fiduciaries failed to monitor the investments and failed to provide complete and accurate information regarding AIG’s mismanagement and improper business practices.

 

Judge Swain rejected all of the grounds on which the defendants’ sought to dismiss the allegations asserted on behalf of participants and beneficiaries of the AIG Incentive Saving Plan and the American Genera Agents’ and Managers’ Thrift Plan. Judge Swain held that Plaintiffs had sufficiently alleged that had there been an investigation triggered by  the “warning signs” regarding problems in AIG’s Financial Products Unit, “it would have demonstrated that AIG stock had become an imprudent investment.”

 

Judge Swain also found that the Plaintiffs “have adequately alleged that Defendants failed to disclose the true extent of the risk facing AIG as a result of its financial decisions and the decline of the residential housing market, and that Defendants affirmatively misrepresented the strength and extent of the processes AIG had in place to mitigate this risk.”

 

Finally, she found that the plaintiffs “have sufficiently alleged that AIG and the director defendants were aware of the increasingly risky financial position maintained by AIG, material weaknesses in AIG’s financial health and the potential impending erosion of the value of AIG’s stock.”

 

An April 1, 2011 Bloomberg article about Judge Swain’s rulings can be found here.

 

I have in any event added these  rulings to my running tally of subprime-related lawsuit dismissal motion rulings, which can be found here.

 

Discussion

It has been quite a while since the subprime and credit crisis litigation wave first started in early 2007. Yet many of the cases are still working their way through the system. The cases discussed above involve some of the highest profile participants in many of the events surrounding the credit crisis. One thing that is striking, at least about the Freddie Mac and the Wachovia cases, is the extent to which the courts seemed influenced by the comprehensiveness of the credit crisis. It seems that in the context of a global economic crisis – particularly one that caught so many by surprise – the courts continue to be skeptical of fraud claims, absent concrete support for the allegations.

 

These rulings suggest that the barrier to overcome the initial judicial skepticism may be substantial. Indeed, the plaintiffs in the Wachovia case failed to overcome the court’s concerns despite having assembled 50 confidential witnesses, and despite the fact that the aggregate market cap drop on which the equity shareholders was approximately $109 billion.

 

On the other hand, the hurdle the plaintiffs must overcome is not insurmountable. The Wachovia bondholders’ Section 11 claims are going  forward. And even the plaintiffs in the Freddie Mac case will have at least another chance to replead to try to overcome the initial pleading hurdles.

 

Judge Swain’s ruling in the AIG ERISA case seemed more receptive. But it is worth keeping in mind that ERISA plaintiffs do not face the same heightened pleading standards that securities lawsuit plaintiffs face under the PSLRA. Perhaps even more significantly, the ERISA plaintiffs do not have to plead scienter.

 

In any event, all three of these cases will be worth watching as they continue to work their way through the system.

 

Special thanks to the loyal readers who provided me with copies of these rulings.

 

In my year-end securities litigation survey, I noted that while a number of new trends emerged during 2010, one securities lawsuit filing trend had remained constant during the year – that is, life sciences companies remained a favored securities class action lawsuit target. The heightened exposure that life sciences companies face is fully detailed in a March 2011 memo from David Kotler and Kathleen O”Connor  of the Dechert law firm entitled “Survey of Securities Fraud Class Actions Brought Against Life Sciences Companies.” A copy of the memo can be found here.

 

According to the memo, 29 different life sciences companies and their directors and officers were the subject of class action securities lawsuit filings in 2010, representing about 16.5% of all2010 securities lawsuit filings. Both the absolute filing numbers and the relative percentages of all filings are up from recent years. The 29 life sciences securities suits were up substantially from the 19 filed in 2009 (representing 10% of all securities suits that year) and from the 23% filed in 2008 (representing 10% of all securities suits).

 

It is worth noting that the count of 29 suits involving life sciences companies  does not include lawsuits involving allegations relating to mergers and acquisitions. If the merger objections suits were included, at least seven more suits would be added to the count.

 

The 2010 life sciences securities suits as a group do reflect certain distinctive characteristics. First, the 2010 lawsuits were more heavily weighted towards life sciences companies with larger market capitalizations. 28% of the 2010 lawsuits were brought against life sciences companies with market capitalizations over $10 billion, by contrast to only 5% in 2009.

 

The 2010 life sciences securities suits  also involved a significant number of lawsuits based not on such industry specific issues as FDA approvals or safety recalls. Consistent with the patterns of securities suit filings against life sciences companies in recent years, more than half of the filings involved allegations of financial improprieties, such as misstated or misleading financial reports or accounting mistakes or mismanagement.

 

To be sure, many of the 2010 did involve more industry specific allegations such as prospects or timing of FDA approval (9 of the 29 2010 lawsuits); allegations involving product efficacy (8); product safety (7); marketing practices (4); and manufacturing processes (2). Another five involved insider trading allegations.

 

The memo’s authors have been tracking the life sciences cases since 2007, and while the filings from those earlier years have not yet fully developed, there is some growing evidence to suggest that though life sciences companies may be sued more frequently than other cases, the cases may be dismissed more frequently than are cases in the larger universe of securities class action lawsuits.

 

The authors note that the SEC and the DoJ have made a priority of Foreign Corrupt Practices Act (FCPA) enforcement regarding life sciences companies and in at least one case (involving SciClone Pharmaceuticals), the FCPA enforcement has resulted in a follow-on securities class action lawsuit.

 

The authors also include a discussion of the U.S. Supreme Court’s recent decision in the Matrixx Initiatives case (about which refer here). They note that “by rejecting statistical significance as setting a minimal threshold for disclosure, Matrixx will require life sciences companies to assess … disclosures and investor impact more holistically, and on a case by case basis.” The authors also note that “life sciences companies are now faced with heavily fact-specific questions of where to draw the disclosure line in the absence of a bright-line standard.”

 

The authors conclude with a number of practical suggestions for life sciences companies to take to minimize the risk of, and impact from, securities fraud class actions.

 

Share the Road: The April 2, 2011 Wall Street Journal carried a rant entitled “Dear Urban Cyclists: Go Play in the Traffic” (here), written by alleged humorist P.J. O’Rourke. O’Rourke apparently is incensed by what he perceives as the increasing preference of traffic planners for urban bicycle lanes. His essay contains a lot of statements like “ bike lanes violate fundamental principles of democracy.” Some might say that Mr. O’Rourke’s comments want proportionality.

 

My own perspective on urban cycling took a completely unexpected turn during a recent visit to London. Owing to historically unprecedented weather conditions – it was sunny and pleasant six straight days in a row while I was there – I had occasion to try out the new Barclays Bicycle Hire arrangement. The way this arrangement works is that you pay a fee for bicycle access (one pound for a single day, five pounds for a week), and then you pay a one pound an hour usage fee. (There are other arrangements for longer term users.) The best part of the arrangement is that once you have paid the access fee, you can pick up or drop off a bike at any of the numerous bike racks around the city.

 

What this means is that you can rent a bike and tool around the city without having to cycle all the way back to the place where you first rented it. You can also drop the bike off at a rack if you just want to stop and get a snack or go in a store. The first day I tried the system, I picked up a bike in Green Park and cycled all the way around Hyde Park; dropped the bike off and took the tube to Trafalgar Square  and then biked down Whitehall, past Parliament, across Lambeth Bridge to Lambeth Park; then I dropped the bike off in Vauxhall and took the tube to Regent’s Park, picked up another bike at the tennis courts there and cycled around the Park.

 

The second time I tried it, I ran a relay of bicycles all across the west end into Kensington, Notting Hill and Bayswater, stopping and starting for meals and shopping, all the while traveling through and exploring parts of the city I have never seen before.

 

According to Wikipedia (here) , there are over 5,000 bicycles and 317 docking stations available in central London. The docking stations were first installed in London in July 2010, but the heavy, three-speed bicycles themselves are already ubiquitous (particularly on kind of bright, sunshiny days I enjoyed there last week).

 

There are downsides. Among other things, the rental does not include a helmet. In addition, the left hand lane rule of the road that prevails in London led to intermittent tense moments for me, particularly with respect to other cyclists whose behavior was not always predictable. Also, it takes a certain kind of courage to try to ride a bike through, say, Piccadilly Circus.

 

All of those concerns notwithstanding, I have to say that I found this bicycle hire scheme absolutely marvelous. One of the docking stations is located just outside the hotel I favor when I visit London, and now that I am comfortable with the scheme, I intend to take advantage of the arrangement on future visits. It is a convenient and enjoyable way to get around the city.

 

As for Mr. O’Rourke and his dyspeptic vision of urban bicycling, I can only surmise that he had not given the new London bicycle hire arrangement a chance. I think a cruise around Hyde Park on a sunny afternoon would do him a world of good, and might entirely alter his views about urban bicycling and democracy.