The storm has passed and the sun is shining down on chilly Times Square for the second day of the PLUS D&O Symposium. For those at the conference and for those stranded at home by the weather, I wanted to pass along a couple of links as an accompaniment for today’s conference panels.

 

First, I wanted to pass along a link to a podcast posted yesterday on the webpage for the LexisNexis Corporate and Securities Law Community. The podcast, in which I discuss trends in corporate and securities litigation during 2010, can be found here. The podcast content provides a complement to the discussion during yesterday’s first panel at the conference.

 

Second, for those of you who have not seen it already, I wanted to make sure to pass along a link to the February 2011 Advisen report entitled "Merger Objection Lawsuits: A Threat to Primary D&O Insurers?" The report, which can be found here, provides useful statistical detail and additional commentary regarding the growing levels of M&A related litigation. Full disclosure: I provided commentary for the Advisen report.

 

To those at the conference, enjoy the rest of the day. Please say hello if we have not yet had a chance to meet yet.

 

By the way, I took the picture of Times Square accompanying this post this morniing using my camera phone. "I want to wake up/ in a city/ that doesn’t sleep…"

 

So your flight was cancelled and you weren’t able to make it to New York for the PLUS D&O Symposium? Have no fear, my flight managed to get through and I made it to the conference, and so I am able to report here on the first day’s proceedings.

 

It may be cold consolation for those of you who didn’t make it, but you should know that you are not alone. There were quite a few empty seats in this morning’s sessions, and even a couple of speakers were unable to make it. Fortunately, the conference organizers were able to locate some able substitutes, and the show is going forward.

 

The day’s opening session was, as is customary, devoted to current corporate and securities litigation trends. The session was chaired by Bruce Angiolillo of the Simpson Thacher law firm, who substituted into the role at the last minute. The other panelists included leading members of both the plaintiffs and defense bar, as well as Columbia Law Professor John Coffee.

 

There were a number of recurring themes during the opening session, one of the most interesting of which was the recurring suggestion that the nature of securities class action litigation has been changing. For example, Professor Coffee noted that the source of the wrongdoing has changed; whereas in the past, the typical securities case would involve allegations of financial fraud, now there are many more cases involving alleged product defects or operational deficiencies than there are cases alleging financial fraud or restatements. Plaintiffs’ attorney Michael Dowd of the Robbins Geller firm, while acknowledging that filings of new financial fraud cases may have declined more recently, stated that he "has faith" that the financial fraud cases "will be back."

 

Other panelists echoed this suggestion that securities cases are changing, although they invoked different points of reference. Bill Grauer of the Cooley law firm noted that cases are becoming "much more complex" and "much more fragmented," particularly as one set of circumstances can and often does give rise to a multitude of separate regulatory and litigated proceedings.

 

In focusing on the past year’s most significant developments, the panel extensively discussed the U.S. Supreme Court’s decisions in the Morrison case (about which refer here) and in the Merck case. With respect to the Morrison case, among the topics discussed were the as yet unanswered questions that will have to be resolved in the wake of Supreme Court’s decision.

 

For example, Professor Coffee noted that questions remain on the question whether Morrison will apply to liability claims under Section 11 of the ’33 Act as well as to the Section 10(b) type claims that were involved in the Morrison case itself (at least one court has said that Morrison does extend to the ’33 Act, refer here). He also noted that the applicability of Morrison to tender offer litigation also remains to be answered. Finally, he noted that we are all waiting to find out what impact, if any, the Morrison opinion will have on the jury verdict entered in the Vivendi case (about which refer here).

 

Jay Eisenhofer of the Grant & Eisenhofer firm also noted some additional questions that remain in the wake of Morrison, including whether or not Morrison will preclude claims of persons who purchased American Depositary Receipts in the U.S (at least one court has held that at least with respect to ADRs purchased over the counter, as opposed to on an exchange, Morrison does preclude the applicability of Section 10(b)). He also noted that it will remain to be seen whether plaintiffs who bought their shares outside the U.S. can pursue claims under the law of the non-U.S. company’s home country, and whether or not plaintiffs can and will attempt to pursue claims under the common law.

 

The panel also extensively discussed the U.S. Supreme Court’s decision in the Merck case (about which refer here). Several panelists noted the difficulty defendants will now have, in the wake of Merck, showing that the plaintiffs had access to information sufficient to trigger the running of the statute of limitations, the result of which may be to keep cases alive much longer. Professor Coffee asserted that while the Merck decision may not be as important as the Morrison decision, it will "have an impact," and Dowd agreed that Merck will "have an impact on the quantity and quality of cases."

 

The panel also discussed the rising levels of merger and acquisition related litigation. As a preliminary matter, Eisenhofer expressed some skepticism whether there really is an increase in the level of M&A activity, suggesting that the apparent increase may simply be a refection of the fact that these types of suits may not have been fully "captured" in litigation statistics in the past, and that M&A litigation generally will "rise and fall" with the level of economic activity.

 

One attribute of the M&A related litigation that is arising is that it is often characterized by multiple proceedings in separate jurisdictions, a development that created logistical and cost issues for all concerned, which represents another manifestation of corporate and securities litigation. Several panelists suggested that one reason that these cases may be "migrating" away from Delaware is that the Court of Chancery has proved to be skeptical of many of these cases and therefore unwilling to award plaintiffs significant attorneys fees, particularly where the ostensible benefit to the defendant company as a result of the litigation is slight.

 

The panel discussed the question of whether or not companies can use forum selection clauses in their by laws to try to designate in advance to forum in which litigation involving the Board must go forward. The problem is that at least one court (in the Oracle case, about which refer here, scroll down) has found that a by-law forum selection clause is not enforceable.

 

The panel debated whether or not the whistleblower provisions of the Dodd-Frank Act will be significant. While some panelists expressed the view that the whistleblower provisions could have a significant impact on securities litigation, others were less sure. Professor Coffee noted that at least in the short run, the SEC’s budget constraints and the unwillingness of Congress to fund many activities mandated in Dodd-Frank may constrain the significance of whistleblowing at least for now.

 

As far as what may lie ahead in 2011, the panel discussed at length the cases now pending on the U.S. Supreme Court’s docket, particularly the Halliburton case, which will examine the question of whether or not the loss causation issue must be determined at the class certification stage. Eisenhofer expressed the view that the Halliburton case is "the big case of the Supreme Court term."

 

Professor Coffee stated that he believed, consistent with the holding in the Seventh Circuit and with the amicus brief filed by the Solicitor General, that far from loss causation being an issue that must be determined at the class action certification stage, as the Fifth Circuit has held, the issue of loss causation is a "common issue" that does not have to be proven at the class certification stage because it is not related to the Rule 23 predominance requirement.

 

Dowd, the plaintiffs’ attorney, noted that one consequence of this these efforts to drive issues that appropriately should be dealt with later in the case into a point earlier in the case is that defense expenses accrue much more quickly and much earlier in the case, sometimes creating impediments to later settlement because defense fees have substantially exhausted the available insurance.

 

Angiolillo had an interesting comment on what may be interfering with case settlement. He suggested that over the last ten years or so, it has become increasingly common for company’s D&O insurance to be structured into a tower of as many as twelve layers of insurance, and that as defense fees and prospective settlement amounts move progressively through the towers, points of resistance emerge that interfere with settlement efforts. Angiolillo suggested that the process participants "need to do a better job getting everyone on the same page" because this "structural issue …inhibits settlements."

 

And For Those Who Want More: Those home-bound due to weather and therefore unable to attend this conference and want more about what is going on with respect to directors and officers liability and insurance issues can refer to the several recent blog posts I have added on that very topic, including The Top Ten D&O Stories of 2010 (here), What to Watch Now in the World of D&O (here), A Closer Look at the 2010 Securities Class Action Filings (here), and The Latest Status on the Subprime and Credit Crisis-Related Securities Litigation (here).

 

The number of outstanding securities class action lawsuits in Canada reached an all-time high during 2010 according to a January 31, 2011 report by NERA Economic Consulting entitled "Trends in Canadian Securities Class Actions: 2010 Update." The report can be found here. The report includes an appendix in which securities lawsuit trends in several other countries are summarized, including Australia, Japan, and Italy, as well as the United States.

 

According to the report, there were eight new securities class action lawsuits filed in Canada during 2010. The number of 2010 filings is one fewer than the nine new cases filed in 2009, and two fewer than the record ten filings in 2008. Allowing for the settlements in six cases during the year in which defendants agreed to pay a total of CAN$80 mm, there are now 28 active Canadian securities class action lawsuits.

 

A total of 25 lawsuits have now been filed under Bill 198, the relatively new secondary liability provisions of the Ontario securities laws. Of the nine Bill 198 cases that have settled, the average settlement is CAN$10.7 mm, with four cases settling for more than $10 million and three settling for less than CAN$3 million.

 

Interestingly, one of the 2010 filings involved a company – Canadian Solar – whose shares do not trade on a Canadian exchange (its shared trade on NASDAQ. This is the second Canadian securities suit involving a company whose share do not trade on a Canadian exchange (the first being the 2008 lawsuit involving AIG).

 

The report notes that it has become relatively common in recent years for Canadian companies to be subject to securities lawsuit in the United States. Between 1996 and 2010, Canadian-domiciled companies have been named as defendants in securities class action lawsuits in the U.S. Of these, 17 cases also had parallel class action lawsuits in Canada.

 

The report notes that the number of future filings in the US against Canadian companies may decline in future years owing to the U.S. Supreme Court’s holding in Morrison v. National Australia Bank. Indeed, Morrison could have an impact on at least some of the cases pending in the U.S. against Canadian companies. The report notes that the Morrison case comes at a time when Canada and even other countries may be expanding the reach of their collective action mechanisms. It is entirely possible that there may be an increase of lawsuits in Canada involving companies whose shares do not trade in Canada, particularly in light of the fact that at least one Canadian court has been willing to certify a global class of claimants.

 

The average settlement amount of the 37 U.S. cases involving Canadian companies that have settled is US$71.5 mm, but this average is skewed by two large settlements involving Nortel. The median of these settlements is US$6 mm. For the 14 US cases against Canadian companies that have settled since 2007 (i.e., after the Nortel settlements), the average settlement is U.S $20.5 mm and the median settlement is uS$6.2 mm.

 

This Week at the PLUS D&O Symposium: Weather permitting, this week I will be attending the 2011 PLUS D&O Symposium in New York City. I know that many readers of this blog will also be there. I hope that if you see me at the Symposium that you will take a minute to say hello, particularly if we have not previously met. I look forward to seeing everyone there, or at least everyone who can make it through the storm. Safe travels to all, good luck to all of us with the weather.

　

According to Popular, Inc.’s January 27, 2011 press release (here), the Puerto Rican bank holding company has reached an agreement in principle to settle the subprime related securities lawsuit pending against the company, as well as in the related ERISA lawsuit. The securities suit has settled for $37.5 million, and the ERISA suit has settled for $8.2 million. The settlement is subject to court approval.

　

The plaintiffs’ complaint focused on the company’s accounting for a deferred tax asset. In the three years preceding the beginning of the class period (which went from January 24, 2009 to February 2009), the company had recorded tax loss carry forwards that totaled over $1 billion, largely as a result of the company’s U.S. subprime and other lending operations. The benefit of these deferred tax assets could only be realized if the company experienced sufficient U.S.-based gains within 20 years.

　

To offset the possibility the company might not fully realize the value of the deferred tax assets, accounting rules require reporting companies to take a valuation allowance, but the company recorded no material valuation allowance of this asset until late 2008. The company ultimately recorded an allowance for the full value of the asset. Following the announcement of this action, the company’s share price fell substantially.

　

The plaintiffs allege that the increasing, multiyear U.S.-based operating losses prevented it from anticipating sufficient taxable income to realize the full value of the deferred tax asset prior to the expiration of the 20-year period, yet failed to take a valuation reserve because doing so would have lowered the bank’s risk-based capital ratio below regulatory requirements. The financial picture the company’s treatment of the asset portrayed allowed the company to raise over $300 million in a May 2008 offering.

 

As discussed here, on August 2, 2010, District of Puerto Rico Judge Gustavo Gelpi granted in part and denied in part the defendants’ motion to dismiss.

 

According to the company’s press release, "management expects" that approximately $30 million of the $37.5 million securities class action settlement and all of the $8.2 million ERISA settlement will be funded by insurance. The parties expect to submit a joint motion for preliminary approval of the settlements within 45 days.

 

The press release also notes that the company has not yet reached settlement of the separate but related derivative lawsuit. As discussed here, on August 11, 2010, District of Puerto Rico Judge Jay Garcia-Gregory denied in part and granted in part the defendants’ motion to dismiss the derivative lawsuit.

 

Finally, the press release states that the company is aware of a separate lawsuit filed by individual claimants on January 18, 2011 but that the company has not yet been served.

 

The Popular securities lawsuit settlement is the first of subprime-related securities class action lawsuit settlement of the year. As I noted here, and as Cornerstone Research also noted in it recently released year-end securities litigation, the subprime-related securities suits have been taking longer to resolve than have securities cases generally.

 

Indeed, even though more than 220 securities class action lawsuits were filed between 2007 and 2010 as part of the subprime and credit crisis-related securities litigation wave, only 18 of the cases have settled so far, including the Popular settlement. My guess is that though the Popular settlement is first one this year, there will be many more before year end.

 

The Popular case is also the first subprime-related securities settlement involving a commercial bank. During the subprime-related litigation wave, a host of troubled and failed banks have been sued. A number of those cases have been dismissed, but others, like the Popular case have not been dismissed. Unlike many of the banks involved in these lawsuits, Popular’s banking operations remain functional, so the resolution of this case may have relatively little to say about the cases involving failed banks.

 

I have in any event added both settlements to my running tally of subprime and credit crisis-related case resolutions, which can be accessed here.

 

The Financial Crisis Inquiry Commission Report: On January 27, 2011, the Financial Crisis Inquiry Commission released its report, concluding that the 2008 Financial Crisis was an avoidable disaster caused by both private and public sector failings, including corporate mismanagement and excessive risk-taking on Wall Street and widespread failures in government regulation designed to preserve the safety and soundness of our financial system.

 

The report itself can be found here, and the report’s conclusion, as well as the two dissents filed on behalf of a total of four commissioners, can be found here

 

The Commission was established as part of the Fraud Enforcement and Recovery Act passed by Congress and signed by the President in May 2009. The Commission’s purpose was to "examine the causes, domestic and global, of the current financial and economic crisis in the United States."

 

I must confess that due to the fact that the report weights in at 633 pages, I have not yet had a chance to read the entire report. I will say, based on the parts I have read so far, that whomever is responsible for the authorial voice in the report has definite literary pretensions.

　

Thus, for example, in alluding to the report’s conclusion that the Federal Reserve had failed to adequately supervise subprime mortgage lending, the report rhetorically asks "What else could one expect on a highway where there were neither speed limits nor neatly painted lines?" And of the financial institutions’ recklessly willingness to take on risk, the report says "Like Icarus, they never feared flying ever closer to the sun." And in describing the sheer extent of blameworthiness, the report says "To paraphrase Shakespeare, the fault lies not in the stars, but in us."

 

Maybe the prose is not too high-falutin for a governmental Commission report, but the problem with the use of that kind of language is that it runs the risk of coming off like the work of, say, an over-wrought blogger. (Not that there are any of those around here.)

 

The Commission itself was intended to be bipartisan, but it would be difficult to try to characterize the report as bipartisan, owing to the fact that the only four Republicans on the Commission dissented from the report. The Commission’s inability to reach a consensus, at a minimum, dilutes the report’s persuasiveness, as it now appears more like an expression or a mere point of view, rather than a set of definitive findings.

 

While I intend to try to read the entire report at some point, I have to say that I find it odd that we are being given this report only now, half a year after Congress enacted its massive financial reform legislation. Am I the only one that thinks that the sequencing might have been improved if the reform legislation were only taken up after the Commission issued its report?

 

The one thing I think everyone should know is that the Commission’s website has a separate Resources page, here, that is stuffed with all sorts of useful and interesting graphics, reports, and fact sheets, as well as a glossary of terms and even a searchable document archive. A note on the webpage advises that the Commission will soon be adding to the page an interactive timeline, audio files, interview notes, as well as other materials gathered in the course of the investigation. The graphics library alone is well worth the time to visit the site.

　

In recent days, I have published a series of posts with analysis of and commentary on recent trends in securities class action litigation. As part of this continuing series of posts, I thought it would be useful to include commentary from the plaintiffs’ perspective. With that in mind, I reached out to Max Berger at the Bernstein Litowitz Berger & Grossman firm, and Max graciously agreed to participate in an interview for this blog in the form of a Q&A exchange.

 

By way of background, Bernstein Litowitz is one of the country’s leading plaintiffs’ class action law firms. Max is a partner in the firm and is also head of the firm’s litigation practice. He prosecutes class and individual actions on behalf of the firm’s clients. He and his firm have been involved in some of the highest profile securities class action lawsuits in recent years. Max has indicated with an asterisk in the text of his answers below some of the cases in which his firm has been involved. My questions to Max appear in italics, and his answers appear as indented text (Please note that Max’s portion of the content also includes the indented text following his final answer.)

 

Q.: What do you think were the most important securities litigation trends or developments in 2010?

 

A.: There are several trends we have seen throughout 2010 that are really continuations of developments from prior years. Central among those, from our perspective representing institutional investors as plaintiffs in these cases, is that the challenges investors face in successfully prosecuting federal securities claims continue to grow. On virtually every element of our clients’ claims, including scienter, loss causation, class certification and standing, we have seen the hurdles increase as a result of court decisions adverse to investors. One notable exception is the statute of limitations, an issue where the Supreme Court provided a favorable ruling this year in Merck.* Of course, that ruling was influenced by the heightened requirements for pleading scienter in a securities fraud action that make it virtually impossible for an investor to assert a claim of fraud until there is clear evidence of fraudulent intent.

 

While the obstacles to bringing and prosecuting securities cases have dramatically increased, we have seen the scope of the wrongdoing become exponentially larger. Investors have obtained several large recoveries, even as restatements by public companies have declined. Subprime litigation – by which I refer to the full panoply of cases tied to high-risk lending, mortgage securitization and sales of mortgage-backed securities in the last five or six years – remains front and center. The scope and egregiousness of a number of those cases has prompted significant private institutions that have not previously engaged in securities litigation to file claims, and it will be interesting to see whether the involvement of such institutions in these types of cases is a trend that continues. The recent warnings from the FDIC about the financial condition of many midsized banks, coupled with the initiation of securities class actions against several regional banks at the end of 2010, suggests that investors have not yet learned the full truth about the reckless lending and loan management practices of the banks in which they have invested.

 

Finally, toward the end of 2010, we began to see a resurgence of merger and acquisition activity. For investors in public companies, that trend underscores a need to increase vigilance over the terms of these transactions to ensure that shareholders’ interests are being protected. Indeed, there has been an increase in transactional litigation, and we do expect that trend to increase along with the number of significant deals projected in 2011.

 

Q.: What impact do you think the Dodd-Frank whistleblower provisions will have on private securities litigation? Are there other aspects of the Dodd-Frank Act that you think will have an important impact on securities litigation?

 

A.: In our experience, the whistleblower provisions of Dodd-Frank have not yet had a significant impact on private litigation. As in cases outside the securities arena, there are very high hurdles faced by whistleblowers when they decide to take on a former employer. They risk becoming pariahs in self-protecting industries and often imperil their current employment and future employment prospects. Nonetheless, other significant recoveries that whistleblowers have helped obtain – such as in the recent GlaxoSmithKline case, in which a whistleblower who helped the government recover billions of dollars, stands to recover nearly $100 million for herself – may incentivize whistleblowers to take advantage of the protections afforded by Dodd-Frank. In light of the important role that whistleblowers can play in PSLRA litigation, where plaintiffs need to satisfy exacting pleading requirements without access to formal discovery, these provisions of Dodd-Frank certainly have the potential to be very significant if they lead to more witnesses coming forward and providing the kind of information that plaintiffs need to plead sustainable securities fraud claims.

 

The Dodd-Frank whistleblower provisions, of course, mark a return to the steps taken in the wake of the last round of major corporate scandals at the start of the last decade. Those cases led to Sarbanes-Oxley which included its own whistleblower provisions – provisions which, in our experience, did little to encourage whistleblowers to come forward or to discourage corporate misconduct. We hope that Dodd-Frank will prove more effective, though we are still awaiting significant clarification and rule-making on many of its central provisions.

 

Q.: I have heard you say that you think the settlement in the Pfizer derivative suit represents an important development and may serve as a model for future settlements in derivative cases. What is it about the settlement that you think is important?

 

A.: The resolution in Pfizer is unique in many respects. That case involved allegations of systemic and widespread violations of the drug marketing laws that were not being controlled by Pfizer’s board and senior executives, who also rewarded employees that engaged in these practices with bonuses and allowed retaliation against employees who were trying to stop them. These unlawful marketing activities were responsible for Pfizer paying the largest fine in United States history. Our derivative suit accused the board and officers of breaching their fiduciary duties to Pfizer shareholders. Our challenge was not to just return dollars to Pfizer from these individuals because it would have hardly affected their corporate behavior. We wanted to effect long-lasting institutional change at Pfizer to prevent this conduct from occurring in the future.

 

In crafting the settlement, our objective was to implement a true prophylactic protection for Pfizer shareholders going forward – something with teeth that would prevent the recurrence of conduct that, as we alleged, certain defendants engaged in repeatedly. We also wanted to provide a template for other companies engaged in similar behavior.

 

To achieve that result, we worked with a renowned corporate governance expert – Professor Jeffrey N. Gordon from Columbia Law School – to address our core allegations and concerns. 　The settlement requires the defendants to create a new regulatory board committee with a broad mandate to oversee Pfizer’s drug marketing practices for at least five years.　 Significantly, this committee will have the power to order its own studies and investigations, and can retain independent experts.　 To carry out this mandate, the new committee has access to its own funding – under the terms of the settlement, the defendants’ insurance carriers agreed to pay $75 million into a fund that will be exclusively used to pay for the committee’s work and attorneys’ fees awarded by the court.　 The agreement to provide that funding is one of the most remarkable aspects of this settlement, and it is one that we view as a critical element, if the committee is to be both independent and effective. The settlement also requires the board’s compensation committee to review Pfizer’s compensation policies for employees and consultants with the new regulatory committee to make sure those policies are consistent with compliance requirements, and to discuss possible clawbacks from employees who directly supervise illegal practices in the future.　 The settlement also requires the creation of an ombudsman program to give Pfizer employees a way to alert the company about potential illegal practices and improper pressure from supervisors without fear of retaliation. Incidentally, the fact that we included this ombudsman provision may say something about our view of the whistleblower protections provided by Dodd-Frank, discussed above. Finally, the Committee is to be chaired by an independent director and regular reports of the Committee’s work are required to be made to the full board and the shareholders. The Committee and its structure have been embraced by two former SEC Chairs, Harvey Pitt and Richard Breeden.

 

While Pfizer is not the first case in which the defendants agreed to implement corporate governance reforms as a component of a settlement, we feel that the mechanisms provided for in this settlement will make it the most effective reform of corporate governance achieved through shareholder derivative litigation, paralleling the reforms implemented at Texaco in the wake of the landmark employee discrimination action against that company.*

 

Q.: Many of the subprime and credit crisis-related securities cases are now working their way through the system. Some have been dismissed while others have survived the preliminary motions. Are there any generalizations that can be drawn from the rulings in these cases so far? Can you make any generalizations about the settlements so far in these cases?

 

A.: Our perspective is that, as the courts and the public have become more sophisticated about the subprime mortgage collapse and the ensuing financial crisis, there is increasing recognition of the fact that the bursting of the housing bubble and the economic meltdown were not the result of some unpredictable tsunami. Rather, many of the companies that have been the subject of securities actions contributed to the bubble and subsequent collapse. For example, Judge Buchwald’s recent decision sustaining fraud claims against Ambac and its officers described the defendants’ claims that they were simply the victims of the financial collapse—an argument that has been made repeatedly and which we have seen in a number of our cases—as being "premised on a convenient confusion of cause and effect." According to Judge Buchwald, in that case, if the plaintiffs’ allegations were true, "Ambac [was] an active participant in the collapse of their own business, and of the financial markets in general, rather than merely a passive victim."*

 

Similarly, while some observers responded to the collapse of Lehman Brothers as an unforeseeable result of a credit crisis driven by the housing market, the report of the bankruptcy examiner has made clear that Lehman and its auditor violated basic accounting rules to manipulate Lehman’s balance sheet.* In the subprime and related litigations where plaintiffs are able to marshal these kinds of facts demonstrating that the financial crisis, rather than some force of nature, was in many ways the result of widespread misconduct by corporations and individuals, courts are receptive to investors’ claims that are based on that misconduct. Accordingly, we are seeing fewer dismissals in what we consider to be meritorious cases as well as larger recoveries in many of these cases. The fact that Bank of America agreed to pay almost $3 billion to Fannie Mae and Freddie Mac is a good recent example. Even though some have questioned the amount of that settlement, it does show that these claims have teeth.

 

The only generalization one can really make about the subprime and credit-crisis related securities actions is that they are no different from other securities actions: generally, we are seeing cases dismissed where the plaintiffs cannot muster the evidence required to meet the heightened requirements of pleading scienter or where loss causation cannot be established, while most well-pleaded cases are moving forward and often resulting in significant recoveries as in New Century* (particularly given that, like New Century, many of the issuers at the heart of the subprime fiasco are now bankrupt). That said, as with other securities litigation, we have seen some dismissals of cases that we consider meritorious, but those situations do not appear unique to the subprime arena.

　

Q.: What impact has the U.S. Supreme Court’s opinion in Morrison v. National Australia Bank had on securities litigation? How has it changed your firm’s approach to cases involving foreign domiciled companies? Is your firm considering alternative approaches on behalf of foreign claimants, such as pursuing claims in courts outside the U.S.?

 

A.: There is no question that Morrison has had, and will continue to have, a significant impact on investors and on the function of the capital markets more broadly. Through that decision, the Supreme Court has largely denied investors—including U.S. investors who purchase securities abroad—the protections of the federal securities laws, regardless of the extent to which foreign companies engaged in misconduct within the United States. There are a number of what we consider to be very significant cases, where the claims of fraud have real merit, in which U.S. investors may be left with no practical recourse. We will need to see how investors, plaintiffs’ counsel and the courts respond in the coming years, and whether Congress, in turn, takes steps to correct this narrowing of the federal securities laws.

 

Many of the institutions we represent are considering different avenues to protect themselves. In the Toyota securities litigation,* for example, the Maryland State Retirement and Pension System as Lead Plaintiff has asserted claims under Japanese law on behalf of investors who purchased Toyota shares on the Tokyo exchange, in addition to the Exchange Act claims asserted on behalf of purchasers of Toyota securities on the New York exchange. It is also possible that Morrison will lead to an increase in foreign litigation, as well as individual domestic actions brought under state law, which was not impacted by the Supreme Court’s ruling in Morrison. The recent Fortis filing in the Netherlands certainly indicates that U.S. and foreign investors are open to considering litigation outside of the U.S., but whether investors will find the same protections in foreign litigation that they have found here remains to be seen. Many significant cases that are subject to Morrison are still working their way through the District Courts and we will see what other strategies investors pursue in response to Morrison as those courts, and the appellate courts, render guidance interpreting the Supreme Court’s decision.

 

Q.: If you were a D&O underwriter, what would you be interested in knowing about a company that you were underwriting? What do you think the most important risk indicators would be?

 

A.: My focus would be on the company’s leadership and the corporate governance structure that is in place. Are the directors independent and are critical board committees comprised of independent directors? Most importantly, are a majority of the directors on the compensation, compliance and audit committees independent? It is critical that directors have relevant industry experience. While service on other corporate boards may bring relevant experience, I would also be wary of directors who are concurrently serving on multiple boards. Finally, with regard to management, I would examine the compensation structure. Is executive compensation tied to performance? If so, are the metrics being used objective or subject to manipulation? And significantly, are executives being rewarded for achieving long-term objectives rather than short-term goals? As we have seen repeatedly, incentivizing executives to achieve near-term benchmarks for growth or performance can create a motivation to manipulate results to achieve compensation goals, whereas long-term incentives can bring the interests of management in line with the objectives of the company’s shareholders.

 

Q.: There have been a lot of changes in the environment surrounding securities litigation in recent years, all the way from important court decisions to changes in the plaintiffs’ bar. What do you think the most important changes have been and why?

 

A.: The principal changes we have seen over the past 15 years have been the legislative and judicial actions to raise imposing hurdles to prosecuting securities cases, particularly as class actions. Those hurdles have dramatically raised the bar for effective prosecution and private enforcement. As a result, these cases have become much more expensive and problematic. I am not the first to observe that in many securities cases, the evidence that must be marshaled in order to survive a motion to dismiss is more than what you would need to get some other cases past summary judgment, and that requires a significant investment of time and resources in cases that may not be sustained. This, in turn, has resulted in a culling of the herd of law firms prosecuting these cases. In many ways, I feel we have also seen the plaintiffs’ bar rise to meet these challenges and the level of practice among the plaintiffs’ firms is far more sophisticated than it was before the PSLRA. Frankly, firms unable to rise to meet these challenges cannot succeed under the regime that has been implemented since 1995.

 

Whether as a result of that increased sophistication, the heightened hurdles to advancing beyond the pleading stage, the nature and scope of the cases we are seeing or some combination of those elements, we are certainly seeing higher recoveries in the cases that are being prosecuted. And not only higher absolute recoveries, but a better percentage of investor losses being recovered in the cases that we consider meritorious. In WorldCom, for example, bond purchasers received $0.65 on the dollar; in Cendant, the recovery was $0.60 on the dollar; in Refco, about $0.50 on the dollar.*

 

Finally, private enforcement of the securities laws is now more important than ever because regulatory recoveries have been wholly inadequate to compensate investors victimized by fraud.

 

Q.: What do you think are the most important trends or developments to watch as we head into 2011?

 

In the coming year, the U.S. Supreme Court—which has in the recent past exhibited an unusual interest in securities fraud actions—will be considering several cases that have the potential to reshape a significant area of our practice. Several commentators have noted that business interests have found a receptive ear on the Roberts’ Court, and have been quite assertive in gaining that audience. Two cases the Court recently agreed to hear regarding the standards for class certification under Rule 23 of the Federal Rules of Civil Procedure—Wal-Mart v. Dukes, which examines the standards for class certification in an employment discrimination action, and Erica P. John Fund v. Halliburton, whichlooks at whether and to what extent investors will be required to demonstrate loss causation at the class certification stage—exemplify such an effort. I believe the decisions in these cases have the potential to profoundly impact the ability of not only investors—but also workers, consumers, patients and employees—to hold corporate wrongdoers accountable in court.

 

The Supreme Court also recently heard arguments addressing the appropriate standards for measuring materiality of information that executives are required to disclose to investors in Matrixx Initiatives v. Siracusano—a question that has ramifications not only for the pharmaceutical and biotechnology industries, which have been the subject of a number of significant decisions in recent years, but potentially for virtually every securities fraud action. The court is also considering another case in which the liability of "behind-the-scenes" defendants—by which I mean third parties that are alleged to have a role in carrying out a fraud, even though the allegedly false and misleading statements cannot be readily attributed to them. Specifically, in Janus Capital Group v. First Derivative Traders,the Court is consideringwhether claims under Section 10(b) can be asserted against a subsidiary mutual fund advisor entity that is alleged to have orchestrated the fraud, even though its parent mutual fund actually made the false and misleading statements. While I believe the circumstances of this case may be unique to the mutual fund industry, the Court certainly has the opportunity to set forth a broad rule of law even if it could narrowly decide the question under the specific facts before it.

 

Another important development for investors to focus on during the coming year will be the ongoing implementation of the Dodd-Frank financial reform legislation. In one recent report, Securities and Exchange Commission officials complained that the agency lacked the proper funding to undertake the significant new responsibilities it was assigned under Dodd-Frank, and had in fact shifted resources used to fund ordinary expenditures—such as the hiring of expert witnesses—to other programs in order to meet its new obligations under the legislation. The perception of how successful the SEC is in fulfilling its mission under Dodd-Frank will likely impact how Congress and the courts view the role of private enforcement of the securities laws, as well as the extent to which investors have been given the proper legal tools to hold wrongdoers accountable.

　***********

Finally, in all honesty, anyone interested in securities litigation trends and developments should read your blog, which is always objective, incisive and very intelligently written. Congratulations, Kevin, and thank you for keeping us all so well informed!

　_________________

*In the interests of full disclosure, I note that Bernstein Litowitz Berger & Grossmann LLP serves or has served as lead or co-lead counsel in a number of the above-referenced cases, including Merck, Pfizer, Texaco, Ambac, Lehman Brothers, New Century, Toyota, WorldCom, Cendant and Refco.

 

Many thanks to Max for his willingness to participate in this exchange.

Every year, the Stanford Law School Securities Class Action Clearinghouse, in conjunction with Cornerstone Research, releases its annual overview of securities class action lawsuit flings. As I noted in a post last week, this year’s version introduced a number of innovations and reflected a host in interesting observations. (The full 2010 Stanford/Cornerstone report can be found here.)

 

 

Because the securities class action litigation environment clearly is going through a significant transition, I thought it would be worthwhile to check in with the Stanford Law Professor Joseph Grundfest, who oversees the Stanford website. Professor Grundfest was gracious enough to agree to participate in an interview for this site. The interview, in the form of a Q&A, is reproduced below. My questions appear in italics, followed by Professor Grundfest’s responses.

 

 

Q. What do you think were the most important securities class action litigation trends during 2010?

 

 

            A: The dramatic increase in merger related federal class securities fraud litigation. These cases were traditionally filed only in state court, but the decline in traditional securities fraud litigation appears to have generated a demand in the securities fraud plaintiff bar to find new cases to fill the litigation pipeline. Also, plaintiffs may discover that it is easier to control this litigation if they can bring cognizable federal claims, even if those claims are quite weak.

 

 

Q. What do you think were the most important judicial trends concerning securities litigation in 2010?

 

 

            A: The implications of the Supreme Court’s Morrison decision continues to reverberate in the lower courts, and many observers are surprised by the vigor with which the lower courts are dismissing actions related to foreign market activity. Morrison is not being interpreted narrowly.

 

 

Q. What impact do you think that the Dodd Frank Act will have on securities litigation? Do you think the Dodd Frank whistleblower provisions will lead to significantly increased SEC enforcement activity? Are there other provisions of the Act that you think are particularly important from a litigation or enforcement activity standpoint?

 

 

            A: Dodd-Frank’s bounty provisions are the joker in the deck here. If the presence of the bounty causes a material increase in SEC enforcement actions, it is reasonable to expect an increase in parallel private actions. After all, that’s the way the market works now: if the SEC files a claim that plaintiffs haven’t yet pursued, it’s only a short matter of time before a very similar private complaint is on file in federal court. There’s no reason that the market won’t work that way in response to SEC actions instituted in response to whistleblower information.

 

 

Q. You are in regular contact with directors at some the leading companies in the country. What are directors most concerned about these days? Are there particular liability exposures that you think directors are worried about?

 

 

            A: Thoughtful, honest directors are most concerned with the implications of Dodd-Frank’s bounty provisions. In an ideal world, these directors would want all employees with information about potential violations to report those concerns to the appropriate authorities within the company, including the audit committee, so that prompt remedial activity (including potential self-reporting to the SEC) could take place as quickly as possible. Now, however, these directors find themselves in competition with the SEC which stands ready to offer significant financial rewards for the provision of information that might otherwise go to compliance authorities within the corporation. Honest directors, standing ready to remedy all violations brought to their attention, will now be frozen out of the information market because they simply can’t compete with the significant bounties available under Dodd Frank.

 

Q. You have been systematically observing securities class action litigation now for many years. What do you think are the most important securities class action trends and developments in recent years, and why?

 

 

            A: It’s a business. The business responds to the forces of supply and demand, and reacts to exogenous shocks in the form of financial crises and revelations of backdating. If you analyze the securities litigation process from a purely economic perspective, otherwise mysterious behavior becomes far more transparent.

 

 

Q. Several years ago you suggested that there had been a “permanent shift” to lower securities class action litigation activity levels. I wonder what you think of that suggestion now with the benefit of the passage of time and of the opportunity to review intervening events.

 

 

            A: To formally test this hypothesis, we still need several more years’ worth of data. With that caveat firmly in mind, I would like to suggest that this years’ data are consistent with that observation. The “core rate” of litigation, i.e., the number of companies named as defendants in traditional securities fraud actions, is well below the pre-Sarbanes Oxley level, once we net out the merger disclosure cases that inflate this year’s census. This observation suggests that fewer issuers are engaged in the sorts of conduct that would have stimulated litigation prior to Sarbanes Oxley. To be sure, plaintiff counsel can point to a variety of legal developments that arguably raise the bar for plaintiff recovery, but the cases likely precluded either reflect attempts to expand the scope of liability beyond the contours set by the Supreme Court, or involve weaker, more remote claims. The strong cases alleging clear frauds are, in my view, being prosecuted as strongly as ever.

 

 

Q. Are there pending cases or ongoing issues that you are watching that you think will be particularly important in the months ahead?

 

 

            A: There are three securities cases pending before the Supreme Court this term and any or all of them could lead to decisions that would have significant implications for the securities fraud litigation market. Also, the Supreme Court has a busy class action procedure docket, and decisions in those non-securities cases could have profound implications for the prosecution of class action securities fraud litigation.

 

 

Q. Do you have any predictions about 2011 securities litigation activity, as far as anticipated levels or trends?

 

 

            A: I would expect the core rate to remain constant, and from there I would expect a bump up as even more merger disclosure litigation finds its way to federal court and a bump down as Morrison reduces the incidence of claims targeting foreign trading activity. Farther down the road, I would not preclude an increase in litigation activity attributable to whistleblower “tag along” cases that will be filed shortly after the Commission announces litigation or settlements arising from Dodd Frank bounty hunter disclosures.

 

 

Q. If you were to be called upon to serve as a D&O insurance underwriter, what are the most important things you would want to consider when reviewing a particular company, and why?

 

 

            A: I would only insure issuers who promise not to file any claims :)

 

 

I would like to thank Professor Grundfest for his willingness to participate in this dialog. I know there are many D&O insurance underwriters who earnestly wish they could implement his proposed D&O insurance underwriting philosophy.

In a gigantic 398-page opinion dated January 19, 2011, Southern District of New York Judge Robert Sweet has denied the defendants’ motion to dismiss in the securities class action lawsuit filed in connection with the collapse of Bear Stearns. He did however grant defendants’ motions to dismiss the related shareholders’ derivative lawsuit and ERISA class action lawsuits. A copy of Judge Sweet’s January 19 opinion can be found here.

 

Background

 

As detailed here and here, investors first filed a securities class action lawsuit against Bear Stearns and certain of its directors and officers in March 2008 in the wake of the company’s collapse and sale to JP Morgan. As amended the plaintiffs’ complaint also names the company’s outside auditor, Deloitte & Touche, LLP, as a defendant.

 

 

In their massive consolidated amended complaint (here) , the securities class action plaintiffs allege that in a series of statements during the class period, the defendants made material misrepresentations or omissions with regard to the company’s exposure to subprime mortgages; with respect to the performance of and valuations in connectionwith one of its hedge funds; with respect to the company’s liquidity; with respect to the company’s risk management and valuation practices. The company is alleged to have inflated its reported financial results and financial condition, among other things due to use of inappropriate models to value the company’s subprime-mortgage related assets. Deloitte is alleged to have knowingly and recklessly offered materially misleading opinions about the company’s accuracy.

 

 

A separate shareholders’ derivative action was also filed, as was an ERISA class action lawsuit, which were consolidated with the securities class action lawsuit. The defendants in the various actions moved to dismiss.

 

 

The January 19 Opinion

 

In a detailed analysis dozens of pages in length, Judge Sweet rejected the defendants’ contention that the plaintiffs’ allegations of materially misleading statements were insufficient.

Judge Sweet also held that the plaintiffs adequately pled scienter. While he concluded that the individual defendants’ trading in their shares of company stock were not sufficient to establish motive and opportunity to violate the securities laws, he nevertheless found that plaintiffs allegations were sufficient to establish a strong inference of conscious misbehavior and recklessness. 

 

 

In concluding that the plaintiffs had adequately alleged scienter, Judge Sweet noted, among other things, that

 

 

the Securities Complaint has alleged that the Bear Stearns Defendants willfully or recklessly disregarded warnings from the SEC regarding Bear Stearns’ risk and valuation models which allegedly were designed to give falsely optimistic accounts of the Company’s risk and finances during the Class Period. The Securities Complaint also alleges that the Bear Stearns Defendants improperly delaying taking the hedge fund collateral, thus intentionally or recklessly avoiding the revelation of losses and the consequent negative effect. These allegations are sufficient to create a strong inference of scienter.

 

 

Judge Sweet expressly rejected the defendants’ allegation that the plaintiffs’ allegations represented mere fraud-by-hindsight, noting that “the adverse consequences of Bear Stearns’ disclosures relating to its exposure to declines in the housing market, and the adverse impact of those circumstances on the Company’s business going forward, are alleged to have been entirely foreseeable to Defendants at all relevant times.”

 

 

In rejecting the fraud-by-hindsight contention, Judge Sweet also cited with approval from the February 2010 dismissal motion ruling in the Ambac subprime securities lawsuit, in which Judge Naomi Reice Buchwald had noted that the conduct alleged, if true “make the defendants an active participant in the collapse of their own business, and of the financial markets in general, rather than a mere passive victim.” Judge Sweet added that “the same logic applies here, where Defendants’ alleged misconduct was integral to the decline of Bear Stearns, and the financial markets with it.”

 

 

Judge Sweet also held that the plaintiffs had adequately alleged loss causation, stating that:

 

 

The Company’s failure to maintain effective internal controls, its substantially lax risk management standards, and its failure to report is 2006-2007 financial statements in accordance with GAAP not only were material. but also triggered foreseeable and grave consequences for the Company. The financial reporting that was presented in violation of GAAP conveyed the impression that the Company was more profitable, better capitalized, and would have better access to liquidity than was actually the case. The price of Bear Stearns’ securities during the Class Period was affected by those omissions and allegedly false statements and was inflated artificially as a result thereof. Thus, the precipitous declines in value of the securities purchased by the Class were a direct, foreseeable, and proximate result of the corrective disclosures of the truth with respect to Defendants’ allegedly false and misleading statements.

 

 

Judge Sweet also rejected Deloitte’s motion to dismiss, holding that the securities complaint adequately alleged the firm’s recklessness, “if not actual knowledge, based on its awareness of red flags and its duty to investigate.” Judge Sweet held that the plaintiffs had adequately alleged scienter as to Deloitte, observing that “the facts underlying the alleged accounting violations with respect to the valuation models and fair value measurements, the hedge funds and the inference from the events of the collapse establish the failure to consider the red flags and constitute adequate allegation of reckless disregard sufficient to establish scienter.”

 

 

While Judge Sweet entirely denied the securities class action defendants’ motion to dismiss, he granted the defendants’ motions to dismiss the consolidated shareholders’ derivative suit. The derivative suit was essentially a “double derivative” suit brought on behalf of shareholders of JP Morgan, alleging misconduct on the part of various Bear Stearns defendants. Judge Sweet agreed with the defendants’ contention that the plaintiff lacked standing to assert the double derivative allegations because the plaintiff no longer holds Bear Stearns shares and does not sufficiently allege harm to JP Morgan. Judge Sweet also found that the plaintiff had not adequately alleged demand futility. He also concluded that certain of the plaintiff’s claims were barred by the doctrines of res judicata and collateral estoppel.

 

 

Finally, Judge Sweet granted the motion to dismiss the ERISA class action complaint, holding that the plaintiffs’ allegations were not sufficient to overcome the applicable presumption of prudence and failed to establish improper conflicts of interest.

 

 

Discussion

 

In a recent post I noted that whatever may be the overall track record for plaintiffs in the securities lawsuits arising out of the subprime meltdown and credit crisis, the plaintiffs are showing a consistent record of success in this highest profile cases. The Bear Stearns case my be one of the highest profile cases of all, because, as Judge Sweet noted at the outset of his opinion, the Bear Stearns collapse “was an early and major event in the turmoil that has affected the financial markets and the national and world economies.”

 

 

Not only is the outcome of the dismissal motions in the Bear Stearns case entirely consistent with the prior outcomes in other high profile cases, but Judge Sweet’s rulings were made in reliance on the opinions in many of those other cases, including in particular AIG (refer here) and Fannie Mae (refer here).

 

 

One prior ruling on which Judge Sweet particularly relied is Judge Naomi Reice Buchwald’s dismissal motion denial in the Ambac Financial case, about which I previously commented here. I noted the significance at the time of Judge Buchwald’s holding that the general financial collapse is no defense to securities fraud if the defendants allegedly caused their own and the financial system’s collapse. I continue to believe this analysis may be influential in other pending cases, as it was here in the Bear Stearns case.

 

In any event, the Bear Stearns case joins the growing list of high-profile subprime meltdown and credit crisis cases in which the dismissal motions have been denied, including Citigroup (refer here), AIG (here), Countrywide (here), Fannie Mae (here), Washington Mutual (here), New Century Financial (here), Sallie Mae (here) and Bank of America (here).

 

It is entirely possible that JP Morgan anticipated the possibiltiy of this development at the time it acquired Bear Stearns; according to press reports at the time, in connection with the acquisition, JP Morgan set aside $6 billion to cover anticipated litigation costs (among other things). 

 

I have in any event added the Bear Stearns decision to my running tally of subprime and credit crisis-related lawsuit dismissal motion rulings, which can be accessed here. (Note that I have separately tallied Judge Sweet’s rulings on the securities class action, derivative and ERISA lawsuits.)

 

 

David Bario’s January 24, 2011 Am Law Litigation Daily article about the Bear Stearns opinion can be found here.

 

As a result of the First Circuit’s January 20, 2011 opinion, the plaintiffs in the Nomura Asset Acceptance Corporation mortgage-backed securities lawsuit have managed to revive a slender portion of their case, albeit on a rather precarious basis. The First Circuit otherwise affirmed the lower court’s dismissal of the remainder of their case.

 

The First Circuit’s opinion could be influential in other mortgage-backed securities suits, particularly on questions surrounding the standing of claimants to assert claims based on offerings in which they did not purchase securities.

 

The First Circuit’s January 20 opinion can be found here.

 

Background

As discussed here, purchasers of mortgage pass-through certificates filed this action in March 2008 against Nomura Asset Acceptance Corporation, certain of its directors and officers, the eight mortgage trusts that had issued the certificates, and the offering underwriters who had supported the 2005 and 2006 public offerings of the certificates.

 

On September 30, 2009, District of Massachusetts Judge Richard G.Stearns granted the defendants’ motions to dismiss, as discussed here. Judge Stearns held that the plaintiffs lacked standing to assert claims in connection with the six out of the eight offerings in which the named plaintiffs had not purchased certificates. Judge Stearns found that the plaintiffs had not adequately pled claims with respect to the two remaining offerings.

　

With respect to the plaintiffs’ allegations concerning the mortgage originators’ underwriting standards, Judge Stearns found that the offering documents contain a "fusillade of cautionary statements" that "abound with warnings about the potential perils." Judge Stearns noted that plaintiffs’ contention that they were not "on notice" of those perils "begs credulity."

 

The plaintiffs appealed.

 

The January 20 Opinion

In a January 20 opinion written by Judge Michael Boudin for a three judge panel, the First Circuit affirmed Judge Stearns’ dismissal except with respect to the plaintiffs’ allegations concerning the mortgage originators’ underwriting practices.

 

With respect to the standing issue, the plaintiffs had argued that the class action vehicle affords a proper basis for representative plaintiffs to assert claims for a broad class of claimants, and that the eight mortgage-backed offerings were sufficiently linked by the common shelf registrations statement on which the certificate issuer relied.

　

In rejecting these assertions and concluding that the named plaintiffs lacked standing in the six offerings in which they themselves had not purchased securities, the First Circuit stated:

 

In our case, as in others involving mortgage-backed securities, the necessary identify of issues and alignment of incentives is not present so far as the claims involve sales of certificates in the six trusts. Each trust is backed by loans from a different mix of banks; no named plaintiff has a significant interest in establishing wrongdoing by the particular group of banks that financed a trsut from which the named plaintiffs made no purchases. Thus, the claims related to the six trusts from which the named plaintiffs never purchased securities were properly dismissed, as were the six trusts and defendants connected to nly those six trusts.

 

The First Circuit also noted that "the named plaintiffs have no stake in establishing liability as to misconduct involving the sales of those certificates."

 

The First Circuit then turned to the sufficiency of plaintiffs’ allegations of securities law violations. The First Circuit had little trouble affirming the district court’s dismissal with respect to the plaintiffs’ allegations concerning mortgage appraiser practices and concerning the offering documents statement of the rating agencies ratings.

 

However, the First Circuit reached a different conclusion with respect to the plaintiffs allegations that, contrary to representations in the offering documents, the originators of the mortgages underlying the certificates "routinely violated" lending guidelines and instead simply approved as many loans as possible.

 

The First Circuit acknowledged the district court’s conclusion that the offering documents contained warnings about the mortgage originators’ practices, but disagreed with the district court’s conclusion that these warnings precluded a possible finding of liability. (The First Circuit omitted to mention that the district court had found that the offering documents contain a "fusillade of cautionary statements" and that it "begs credulity" that the plaintiffs were not put on notice of these concerns.)

 

The First Circuit, by contrast to the district court found that "plaintiffs’ allegations of wholesale abandonment may not be proved, but – if accepted at this stage – it is enough to defeat dismissal." The First Circuit found that "the specific allegations" as to the mortgage originator’s practices "offer enough basis to warrant some initial discovery aimed at these precise allegations."

 

Having granted the plaintiffs a revival of at least one category of their claims, the First Circuit made it clear that the revived claims may have only a precarious lease on life. The First Circuit added with respect to these claims that the district court is "free to limit discovery stringently and to revisit the adequacy of the allegations thereafter and even before possible motions summary judgment."

　

Discussion

A recurring question in many of these mortgage-backed securities suits had been the question whether or not a named plaintiff that bought securities in one offering initiated pursuant to a shelf registration statement can assert claims based on other offering based on the same shelf registration, even if the named plaintiffs bought no securities in the other offerings.

 

In general, the district courts have been holding that the plaintiffs lack standing at least as to the offerings in which they did not purchase securities, but the question has continued to arise.

 

As the first Court of Appeals ruling on this question as part of the current wave of subprime-related litigation, the First Circuit’s conclusion on the standing issues is likely to be highly influential even outside of the First Circuit, and indeed could just about put an end to the issue.

 

The First Circuit’s reversal with respect to the plaintiffs’ allegations concerning the mortgage originators’ underwriting practices is interesting, if for no reason than the rather stark difference in perceptions of the plaintiffs’ allegations at the district court level and at the appellate court level. Whereas, the district court found that the suggestion that investors were not put on notice of the alleged practices "begs credulity," the appellate court, while providing relatively little explanation for its different conclusion, found that the allegations at least merited some discovery.

 

Perhaps the one way that the First Circuit’s differing conclusion may be understood is by reference to many other district court opinions in mortgage-backed securities cases in which the courts have concluded that allegations that the mortgage originators "systematically disregarded" stated underwriting guidelines are sufficient to state a claim. The First Circuit did not refer to these other court’s conclusion, but its holding shares a common thread with these other courts’ decisions.

 

And so the plaintiffs in this case have (just) managed to live for another day – at least as to two of the eight offerings, and at least one of the three categories of alleged misrepresentations. Whether this new lease on life in the end will be sufficient for the plaintiffs remains to be seen. The First Circuit issued an engraved invitation for the district court on remand to afford the plaintiffs only the most circumscribed discovery and also to revisit the adequacy of the plaintiffs’ claims – "even before summary judgment," whatever that may have been meant to suggest.

 

I have in any event modified my running tally of the subprime and credit crisis lawsuit dismissal motions to reflect the First Circuit’s limited reversal of the district court’s dismissal in this case. The dismissal motion register can be accessed here.

 

The First Circuit’s reversal, however limited, does at least serves as a reminder that it may be dangerous to jump to too many conclusions about how plaintiffs are faring in the subprime and credit crisis related cases. There are still many more cases to be heard, and, as this case shows, there is always the possibility that further proceedings may alter or even undo prior results.

 

It is probably worth noting that the First Circuit’s opinion in the Nomura case represents the forth appellate ruling so far as part of the litigation wave arising out of the subprime meltdown and credit crisis-related litigation wave. As discussed in my recent status update on the credit crisis litigation, appellate courts have affirmed the dismissals of at least three subprime securities suits: NovaStar Financial (here), Centerline (here) and Impac Mortgage (here). The Nomura case represents the first appellate decision that did not result in a complete affirmance of the lower court’s ruling of dismissal.

 

Special thanks to a loyal reader for providing me with a copy of the First Circuit’s opinion in the Nomura case.

 

Law Firm Memo Round-Up: From this week’s mailbag, here is a brief register of several law firm memos. First, a January 11, 2011 memo from the Vinson & Elkins law firm presents a brief update of the current state of play regarding ERISA stock drop cases. Second, the 2011 Edition of "Corporate Governance and Securities law: A Public Company Handbook" from the Curtis, Mallet-Prevost, Colt & Mosle law firm can be found here. Finally, the Shearman & Sterling law firm’s January 2011 memo entitled "FCPA Digest: Recent Trends and Patterns in the Enforcement of the Foreign Corrupt Practices Act" can be found here.

 

As Israel is to Louisiana, Nigeria is to Alabama: And Yemen is to Vermont, at least according to an absolutely fascinating map published this past week in The Economist magazine that matches each U.S. state with a country whose GDP most closely resembles that particular state’s GDP. Ohio’s economy is comparable, for example to Belgium’s, while New York’s is equivalent to that of Australia, and Virginia’s is comparable to Poland. Even the District of Columbia is the equivalent of Kuwait.

 

The comparisons are interesting, but the larger message is that every single U.S. state has an economy as big as that of some countries, so collectively the United States economy is huge.

.

The map also affords interesting comparisons by population.. If you click on the blue "Population" box, the map displays the country whose population size is equivalent to each state – Oklahoma is comparable to Congo-Brazzaville, Virginia is equivalent to Burundi, Idaho is equivalent to Guinea-Bissau, Wyoming is equivalent to the Solomon Islands, Colorado is equivalent to Eritrea, and so on.Absolutely fascinating.

　

A Moviegoer’s Comment: This past Saturday night after a viewing of the film "The King’s Speech," the audience in the east side Cleveland movie theater where my wife and I were watching the film broke into applause. Now, I enjoyed the film and I appreciated the actors’ fine performances. But exactly to whom or to what was the audience showing its appreciation? Am I the only one that finds applauding for a movie a little odd?

 

Admittedly, it is unusual for me to have seen this movie, or any movie, in a theater. Our viewing of "The King’s Speech" marked the first time that my wife and I had gone to the movies, just the two of us, since we saw "The Madness of King George" about sixteen years ago. Without intending, we seem to have limited our range of moviegoing exclusively to films portraying British monarchs named George that have disabilities constraining their abilities to fulfill their kingly duties. This is, shall we say, a rather limited genre. .

 

I don’t know if there is such an Oscar, but if there were an award for best adaptation of classical music for dramatic effect, "The King’s Speech" would be a clear winner. The film’s use of the first portion of the Second Movement from Beethoven’s Seventh Symphony during the dramatic moment that Colin Firth as King George VI finally delivered his "speech" was brilliant. The movie ends with an excerpt from Beethoven’s Emperor Concerto, which is a nice touch, as well.

 

In appreciation for the movie’s use of music, here is video with an interesting graphic depiction of the Second Movement from Beethoven’s 7th.　

　

https://youtube.com/watch?v=4uOxOgm5jQ4

As a result of a spike in second half filings, the number of new securities class action lawsuits increased slightly in 2010 compared to the year before, although the 2010 filing levels remained below historical averages, according to the annual study released jointly by Cornerstone Research and the Stanford Law School Securities Class Action Clearinghouse. This year’s version of the study, entitled "Securities Class Action Filings: 2010 Year in Review," introduces some innovations that provide some interesting perspectives on securities class action lawsuit filings.

 

The study can be found here, and the joint January 20, 2011 press release about the study can be found here.

 

According to the study, there were 176 securities class action lawsuit filings in 2010, up 4.8% from 2009, but 9.7% below the 1997-2009 average number of filings (195). The increased number of filings in 2010 was largely due to the increased filing activity in the second half of the year, when 104 new securities suits were filed (compared to only 72 in the first half).

 

A significant factor in the increased number of 2010 filings was the number of lawsuits related to merger and acquisition transactions. According to the report, there were 40 filings with allegations related to M&A transactions, which represents a 471 percen increase from the seven M&A-related filings in 2009.

 

This increase in M&A-related litigation cannot be explained simply as reflection of increased M&A activity, since M&A activity increased only 20 percent in 2010. The increase, the report suggests "may be largely a result of changes in plaintiff law firm behavior rather than changes in underlying market forces." The press release quotes Stanford Law Professor Joseph Grundfest as saying that "plaintiffs lawyers are scrambling for new business as traditional fraud cases seem to be on the decline," adding that "there is little reason to believe that this trend will reverse or slow down."

 

The report also notes a number of trends that have previously been noted elsewhere, including the decreasing number of credit crisis-related lawsuits during the year, and the spate of lawsuits involving for-profit education companies and also involving Chinese companies.

 

With regard to the surge in lawsuits involving Chinese companies, the press release quotes Professor Grundfest as saying that this litigation is arising as "some Chinese issuers struggle to conform to Western market norms, adding that at the same time others might engage in outright fraud." The report itself adds the observation that most of the Chinese companies sued in 2010 were only recently listed on major U.S. exchanges; eight out of the 12 Chinese companies sued were listed during 2009 or 2010, while the remaining three issuers were listed toward the end of 2006, 2007 and 2008. On average these companies were sued within 1.4 years of their listing dates.

 

The report includes a status update for the credit crisis related filings. The report confirms an observation I had previously noted, which is that the credit crisis cases seem to be reaching the settlement stage more slowly than compared to securities cases generally. The report states that credit crisis filings "have significantly lower settlement rates compared to non-credit-crisis filings," largely as a result of the cases pending in the Second Circuit. The report shows a 9.8 percent settlement rate for credit-crisis filings compared to 24.1 percent for non-credit crisis filings. However, the dismissal rates for credit crisis-related filings "do not appear to be different from non-credit-crisis-filings."

 

A new feature added to this year’s report is an analysis of the litigation exposure following initial public offerings. The report analyzed the likelihood that a company would be sued in the eleven year period after its IPO, and compared that likelihood to the possibility that a company in the S&P 500 would be sued during that same eleven year period.

 

The report found that the exposure to securities class actions is the highest during the first few years after an IPO, although the exposure diminishes over time as the companies mature. The analysis showed that there is more than a 10 percent chance that firms would be hit with a securities suit within three years of an IPO, with the highest risk in the second year after an IPO, when they faced a 4.1 percent chance of being sued.

 

Interestingly enough, at least with respect to IPO companies that survived for eleven years, the possibility of those companies being sued during that eleven year period is actually lower than for the S&P 500 companies during that period. The S&P companies had a 49.9 percent chance of a suit during that period, compared to only 28.7 percent for the IPO companies. The report speculates that this lower risk over the longer period may be explained by the fact that the IPO companies tend to be much smaller than S&P 500 companies, and therefore represent less attractive targets for the plaintiffs’ lawyers.

 

One particularly interesting aspect of the report’s IPO review is its analysis of the survivability of IPO companies. The report shows that only 39.4% of IPO companies survived for the full eleven year study period (compared to 65.1% of S&O 500 companies).Indeed, more than 35 percent of companies failed to survive four years after their IPO (compared to less than 15% of the S&P 500 that failed to survive the first four years of the study period).

 

The report’s industry analysis shows that as filings against financial companies declined due to the diminution of the credit crisis litigation wave, filings against companies in the health care sector spiked.

 

The report also notes that as the number of M&A related cases has increased, the phenomenon noted in recent years of belated filings (in which the filing date came well after the stock price decline that precipitated the suit) has largely abated.

 

Overall, the report contains a number of interesting observations and findings, and the report warrants reading at length and in full.

 

Two final notes: First, the lawsuit count reflected in the Cornerstone report may differ from other published figures, as the Cornerstone report counts multiple filings against the same defendants as a single filing (compared to other commentators that may count separate complaints separately until they have formally been consolidated).

 

Second, while securities class action lawsuit filings may have been down in 2010 compared to historical averages, the overall level of corporate and securities litigation during the year was actually up – indeed, at "record" levels" – at least according to Advisen’s recently issue report about 2010 litigation activity, about which refer here.

 

My own analysis of the 2010 securities class action lawsuit filings can be found here.

 

Though securities class action lawsuit filings were below historical averages, overall corporate and securities litigation reached "record" levels during 2010, according to a report from the insurance information firm, Advisen. The report, which was released on January 19, 2011 and is entitled "2010 a Record Year for Securities Litigation," 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 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, 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 Analysis

According to the latest Advisen report, there were a total of 1196 corporate and securities lawsuits field in 2010, which is slightly above the 1171 corporate and securities lawsuits filed in 2009, and represents a "record."

 

According to the report, there were 193 securities class action lawsuits filed in 2010, down from 233 in 2009 (Advisen’s securities class action lawsuit counts may differ from those of other published sources because the Advisen count, unlike those of other sources, include state court securities class action lawsuits as well as federal court lawsuits). The 193 securities class action lawsuits is 2010 is well below the 2004-2009 average of 227. The Advisen report attributes the relative decline to "a sharp drop in credit crisis suits."

 

The proportion of all securities class action lawsuits as a percentage of all corporate and securities lawsuits has been, according to the report, "steadily trending downward." Thus, prior to 2006, securities class action lawsuits represented as much as one third of all corporate and securities lawsuits. However, in 2010, securities class action lawsuits represented only 16 percent of all corporate securities lawsuits, and only 14 percent during the fourth quarter of the year.

 

Two growing categories of corporate and securities litigation are breach of fiduciary duty lawsuits and shareholders derivative lawsuits.

 

Breach of fiduciary duty lawsuits have grown rapidly as a category of all corporate and securities litigation. As recently as 2004, fiduciary duty suits represent only 8 percent of all corporate and securities lawsuits, whereas they represented about a third of all corporate and securities suits in 2010, and 40 percent in the fourth quarter of 2010. Many of the breach of fiduciary duty cases filed in 2010 are related to merger and acquisition transactions.

 

Similarly, derivative lawsuits filings increased to 129 in 2010, up from 93 in 2009. In 2011, the derivative lawsuits represented 11 percent of all corporate and securities lawsuit filings.

 

Financial firms remained the most frequently sued companies in 2010, although filings against financial firms were down relative to prior years. Overall, 30 percent of the corporate and securities lawsuits in 2010 were filed against financial firms, compared to 40 percent in 2008 and 2009. The remaining 2010 lawsuits were more widely dispersed than in recent years.

 

The report notes that the average settlement value of all corporate and securities lawsuits in 2010 was $37 million, compared to $29 million. In considering this information it is critically important to consider that this figure aggregates regulatory and enforcement settlements with private lawsuit settlements. In that regard it is important to note that the report states that average securities class action settlement in 2010 was $32 million, the average breach of fiduciary duty settlement was $17 million, and the average derivative settlement was $11 million. In each case the private lawsuit settlements averages are substantially influenced by outlier settlements.

 

The Advisen report also notes that securities litigation has been "on the rise" in recent years outside of the U.S. The report notes that there were 36 "securities suits" in courts outside the U.S., which is ‘in line" with 2006-2008 totals.

　

Discussion

The data point to which most discussions default in trying to gauge the level of corporate and securities litigation activity is the level of securities class action lawsuit filings. Indeed, a number of commentators (including this blog) release annual studies of securities class action lawsuit filing levels, which typically trigger discussions about whether or not lawsuits are up or down.

 

The Advisen study makes it clear that if the discussion is focused solely on securities class action litigation activity, then there may be a misleading impression about the level of overall corporate and securities litigation.

 

The fact is that securities class action litigation is an increasingly smaller part of all corporate and securities litigation. So even though the number of securities class action lawsuits filed in 2010 was down relative to recent annual averages, the overall level of corporate and securities litigation was up in 2010 – in fact, according to the Advisen report, it was at "record" levels.

 

There are probably a few caveats that need to be supplied with these overall observations about filing levels. First, some readers may object to the conflation of regulatory and enforcement actions with private civil lawsuits. One obvious concern is that the conclusion that corporate and securities litigation overall is reaching "record" levels may simply be a reflection of the fact that regulatory authorities have ramped up their enforcement activities – indeed, there is no doubt that that is at least part of what is going on.

 

Along those lines, I think it is fair observation that the Advisen analysis would be improved if the regulatory and enforcement actions were separated out from the overall analysis. In that regard, it is particularly unfortunate that the "securities fraud" category is both confusingly named and also incorporates both regulatory actions and securities lawsuits not brought as securities class action lawsuits, eliminating any chance that a reader might try to filter out the regulatory and enforcement activity from the private litigation activity.

 

Another concern is that even if securities class action lawsuit filing levels are down relative to historical norms and as a percentage of all corporate and securities lawsuits, securities class action lawsuits remain the most significant source of severity risk – at least in terms of private civil litigation, as distinct from regulatory and enforcement actions.

 

However, from the perspective of the likelihood of litigation, and in particular from the perspective of the claims experience of D&O insurance carriers most active in the primary layer, the increasing incidence of other types of corporate and securities litigation is a very significant development. An analysis focused solely on securities class action litigation would miss the significance of the increase claim frequency coming from these other kinds of claims, and the resulting claim exposure for companies and for the D&O insurers.

 

My own analysis of the 2010 securities class action lawsuit filings can be found here.　 

 

2010  Securities Litigation Overview Webinar: On Friday January 21, 2011, at 11:00 am EST, I will be participating in a free webinar on the topic "Year End 2010 Securities Litigation Overview," sponsored by Advisen, to discuss 2010 securities litigation trends and developments.. Other panelists participating in the webinar include David Bradford of Advisen, Kevin Mattesich of the Kaufman Dolowich law firm and Gerald Silk of the Bernstein Litowitz firm. Further information about the webinar, including registration instructions, can be found here.