I am pleased to reproduce below a guest post from my friend Maurice Pesso, who is a parner in the White & Williams law firm, and his colleagues Sarah Katz Downey. I welcome guest contributions from responsible commentators. This article first appeared as a White & Williams law firm memo. Please note that in an earlier post (here), I summarized a speech Judge Jed Rakoff gave last summer about the Bank of America case (mentioned below). Here is the guest post:

 

 

In a March 21, 2011 opinion by U.S. District Court Judge Jed Rakoff  in Securities and Exchange Commission v. Vitesse Semiconductor Corp., et al., Case No. 10cv9239 (S.D.N.Y. March 21, 2011) (the "Opinion"), Judge Rakoff, in approving the proposed consent judgments against Vitesse and two of its officers, questioned whether the SEC’s practice of allowing defendants to neither admit nor deny liability might render a proposed consent judgment “so unreasonable or contrary to the public interest as to warrant its disapproval.” Here are Judge Rakoff’s own words: “[h]ere an agency of the United States is saying, in effect, ‘although we claim that these defendants have done terrible things, they refuse to admit it and we do not propose to prove it, but will simply resort to gagging their right to deny it.’”

 

 

This is at least the second time that Judge Rakoff has publicly called into question the SEC’s settlement practices. In September 2009, Judge Rakoff initially refused to approve a $33 million settlement between the SEC and Bank of America relating to shareholder communications by Bank of America prior to its takeover of Merrill Lynch. Although Judge Rakoff subsequently approved the settlement on revised terms, he chastised the SEC for the initial settlement terms, stating that the settlement "does not comport with the most elementary notions of justice and morality, in that it proposes that the shareholders who were the victims of the Bank’s alleged misconduct now pay the penalty for that misconduct."

 

 

If Judge Rakoff’s reasoning gains traction in judicial or political quarters, the SEC may be placed in a position where it must refuse to enter into settlements with defendants unless the defendants admit liability. This would create a strong disincentive for defendants, and especially individual defendants, to settle with the SEC for at least two reasons: (1) if they admit liability, they will have limited future prospects as directors or officers of any registered company; and (2) the admission of liability will significantly raise the cost of resolving any related civil litigation, such as a securities class action.

 

In the wake of the Vitesse decision, D&O underwriters should be thinking about how the inability to settle SEC enforcement proceedings will affect the costs of defense for SEC enforcement proceedings and impact defense and settlement costs for related shareholder class actions and derivative litigation. On the one hand, if defendants cannot settle with the SEC without admitting liability, there likely will be fewer settlements and some defendants may decide to litigate until a final judgment — all resulting in increased costs of defense. On the otherhand, if a defendant chooses to litigate until a final judgment and a verdict is rendered against the defendant, the D&O insurer may be able to deny coverage in its entirety based on conduct exclusions in the D&O policy.

 

SEC v. Vitesse, et al.

 

On December 10, 2010, the SEC filed an enforcement proceeding against Vitesse Semiconductor Corporation and four Vitesse officers and directors. In its complaint, the SEC generally alleged that the defendants made numerous material misrepresentations in Vitesse’s SEC filings in an effort to conceal their fraudulent revenue recognition practices and stock options backdatings. Simultaneously with the filing of the complaint, the SEC filed proposed consent judgments against Vitesse and two of its officers, apparently anticipating that the court would simply approve the settlement as negotiated.

 

The consent judgments were presented to Judge Rakoff for court approval. According to the Opinion, the consent judgments lacked information explaining why they should be approved and how they met the requisite legal standards for court approval. In response to Judge Rakoff’s request for additional information, the SEC provided a December 21, 2010 letter brief. In addition, on December 22, 2010, a hearing was held before Judge Rakoff at which time the parties provided further information.

 

In the Opinion, Judge Rakoff acknowledged that, at first glance, the terms of the proposed consent judgments appeared inadequate based on the allegations of material misconduct by the defendants. However, despite the fact that the three defendants neither admitted nor denied liability, Judge Rakoff concluded that the terms of the settlement were “fair, reasonable, adequate, and in the public interest.” In finding that the terms of the proposed settlement were adequate, Judge Rakoff considered factors outside the terms of the settlement with the SEC, such as the fact that the two officers pled guilty to parallel criminal charges and that Vitesse had little money to pay based on its current troubled financial condition.

 

Despite having approved the settlement, Judge Rakoff raised concerns with the SEC’s longstanding practice of seeking court approval for settlements in which serious allegations of fraud are asserted against the defendants without requiring the defendants to expressly admit or deny the allegations.

 

As a practical matter, the SEC’s practice of settling with defendants who neither admit nor deny liability benefits both the SEC and the defendants. By entering into the consent judgments without admitting liability, the defendants are not collaterally estopped from asserting their innocence in parallel civil actions. Because the defendants do not have to admit liability, the SEC benefits because the defendants are more likely to enter into SEC settlements at an earlier time, and without requiring the SEC to devote substantial resources to taking enforcement actions to trial.

 

According to the Opinion, the SEC’s practice of entering into settlements where the defendants neither admit nor deny liability began decades ago and has developed through the years. Prior to 1972, after a court approved a settlement, the defendant would publicly deny his or her liability in connection with the SEC’s allegations. In response, in 1972, the SEC began to require all defendants who settled with the SEC without an admission of liability to refrain from publicly proclaiming their innocence. Nevertheless, SEC defendants still found ways in which to make it known that they never admitted liability — while being careful to refrain from denying liability at the same time.

 

In the Opinion, Judge Rakoff questioned whether the SEC’s practice of allowing defendants to neither admit nor deny liability might render a proposed consent judgment “so unreasonable or contrary to the public interest as to warrant its disapproval.” According to Judge Rakoff, the public suffers from the SEC’s practice of allowing the defendants to settle serious allegations without admitting liability, leaving the public with no way of knowing whether there was any truth behind the allegations.

 

D&O Coverage Implications

SEC settlements themselves are generally uninsurable under D&O policies because they are composed of either: (1) fines/penalties; (2) disgorgement; and/or (3) equitable relief. However, the costs associated with defending against SEC enforcement proceedings are generally covered under D&O policies.

 

As discussed, if Judge Rakoff’s reasoning is followed, the SEC may find itself pressured — or obligated — to enter into settlements only with defendants who will admit liability. If defendants cannot settle with SEC without admitting liability, there will be fewer settlements, and some defendants may decide to litigate until a final judgment — all resulting in increased costs of defense. In recent years, defense costs for even a single SEC defendant have run into the millions of dollars, and sometimes even more than $10 million. Because defense fees associated with SEC enforcement proceedings are generally covered under D&O policies, D&O insurers would feel the impact of increased defense costs in SEC actions.

 

At the same time, if a defendant chooses to litigate until a final judgment and a verdict is rendered against the defendant, the D&O insurer may be able to deny coverage for the defendant based on the conduct exclusions. In addition, the D&O insurer may be able to rely on the judgment to deny coverage for one or more D&O defendants in any related civil litigations. Depending upon the policy terms at issue, the D&O insurer may also be able to seek reimbursement of all of the defense costs that it previously advanced following an adverse verdict in an SEC trial.

 

The SEC’s reaction to Judge Rakoff’s criticism remains to be seen. Although intended to be an independent regulator, the SEC can be subjected to political pressure — especially from the U.S. Congress, which sets the SEC’s annual funding budget. It will be interesting to see if there is a slowdown in SEC settlements over the next few months and if other judges refuse to “rubber stamp” SEC settlements where the defendants neither admit nor deny liability. We will follow this issue and report any findings.

 

In a unanimous March 22, 2011 opinion by Justice Sonia Sotomayor, the U.S. Supreme Court rejected the argument of Matrixx Initiatives that adverse product reports must be "statistically significant" in order for a manufacturer to have an obligation to disclose the reports to investors. As a result of the Court’s decision, shareholders claims against the company for its alleged failure to disclose reports that its Zicam cold remedy caused loss of smell for some users will now be going forward. The Court’s opinion can be found here.

 

Background

Matrixx Initiatives manufactured an internasal cold remedy called Zicam. In April 2004, plaintiff shareholders filed a securities class action lawsuit against Matrixx and three of its directors and officers, alleging that the defendants were aware that numerous Zicam users experienced loss of the sense of smell. The complaint alleges that the defendants were aware of these problems because of calls to the company’s customer service line; because of academic research, which was communicated to the company; and because of product liability lawsuits that had been filed against the company.

　

The district court granted the defendants’ motion to dismiss, finding that the complaint failed to adequately allege that the alleged omissions were material, because the complaint did not allege that the number of customer complaints was "statistically significant."

　

As discussed at greater length here, on October 28, 2009, the Ninth Circuit reversed the district court, holding that the district court "erred in relying on the statistical significance standard" in concluding that the complaint did not meet the materiality requirement. The Ninth Circuit said that a court "cannot determine as a matter of law whether such links [between Zicam and loss of smell] was statistically significant, because statistical significance is a matter of fact." The defendants filed a petition for a writ of certiorari to the U.S. Supreme Court, and as discussed here, the Supreme Court granted the petition.

　

The Opinion

　

In their briefs before the U.S. Supreme Court, Matrixx urged the Court to adopt a "bright line" test that reports of adverse events with a pharmaceutical company’s produce cannot be material absent a sufficient number of reports to establish statistical significance. Matrixx argued that statistical significance is the only reasonable indicator of causation.

　

The Court declined to adopt the bright line test urged by Matrixx, reasoning that such a categorical rule would "artificially exclude evidence that would otherwise be considered significant to the trading decision of a reasonable investor."

　

The Court also rejected the notion that only statistical significance in the only reasonable indicator of causation, noting that medical professionals and the FDA regularly infer a causal event between a drug and adverse event. Justice Sotomayor wrote that "Given that medical professionals and regulators regularly act on the basis of evidence of causation that is not statistically significant, it stands to reason that in certain cases reasonable investors would as well."

　

This conclusion does not however mean that pharmaceutical companies have to disclose every adverse event. Rather, an adverse event is material and must be disclosed, the Court said citing its standing test for materiality, if it would "significantly alter the total mix of information." The "mere existence" of adverse reports "will not satisfy this standard." Rather, "something more is needed — but "something more" is "not limited to statistical significance." and "can from the source, context and context of the reports."

　

Justice Sotomayor reiterated, however, that absent a duty to speak, silence cannot be the basis of securities liability. Disclosure is only required when necessary to make previous statements not misleading; "Even with respect to information that a reasonable investor might consider material, companies can control what they have to disclose under these provisions by controlling what they say to the market."

　

Applying this total mix standard to this case, the Court concluded that the loss of smell reports of which the plaintiffs allege the defendants were aware, "the complaint alleges facts suggesting a significant risk to the commercial viability of Matrixx’s leading product." "This is not a case about a handful of anecdotal reports, as Matrixx suggests," Sotomayor wrote. She added the investors intend to prove that "Matrixx received information that plausibly indicated a reliable causal link between Zicam and anosmia," the medical term for a loss of smell.  At its most basic level, the Supreme Court’s decision in the Matrixx Initiatives case is essentially just a reaffirmation of its prior case authority dealing with the question of materiality. In particular the Court reiterated its prior statement of the standard for materiality in the   Basic, Inc. v. Levinson case and  TSC Industries v. Northway.  "companies can control what they have to disclose under these provisions by controlling what they say to the market "

　

The Court also found the plaintiffs’ allegations were sufficient to satisfy the requirements for pleading scienter. The Court noted that it has not yet determined whether recklessness along is sufficient to satisfy the scienter requirements, saving that question for another day.

　

Discussion 　  　

Viewed in that light, the decision may not be all that surprising. Just the same, there is something a little bit unexpected about this decision. The unanimous opinion represents a clean sweep for the plaintiffs, which given this Court’s track record arguably is an unexpected outcome. The Supreme Court has produced a number of decisions highly favorable to defendants in recent years, and while that has not been entirely uniform (there was the Merck decision last term for example), the Court has seemed to have a predisposition for the defense perspective.

　

By rejected the proposed "bright line" test , the Court has relieved plaintiffs of the burden of having to come up with sufficient facts to prove statistical significance. The lack of a bright line test may, however, represent something of a challenge for reporting companies going forward. Manufacturers receive "adverse event reports" in the form of customer complaints all the time. A bright line test would have clarified when the number of reports has reached a sufficient level that they must be disclosed. In the absence of such a clear standard, companies will face quite a struggle in trying to figure out what must be disclosed.

　

Once place companies may want to turn for guidance is the statement in Justice Sotomayor’s opinion that "companies can control what they disclosre under these provisions by controlling what they say tot he market."This statement suggests to me that the judicious use of precautionary disclosure may go a long way toward alleviating disclosure challenges.

　

Special thanks to my friends in the Securities Litigation group at Skadden Arps for alerting me to the Matrixx Initiative decision and for sending me a copy of their analysis of the decision (hewww.skadden.com/newsletters/Supreme_Court_Rejects_Bright_Line_Test_for_Materiality.htmlre)

I am pleased to reproduce below a guest post from my friend and colleague, David S. De Berry. Dave is an attorney and CEO of Concord Specialty Risk, a series of a Delaware limited liability companies owned by RSG Specialty Group, LLC. I want to emphasize that while Dave and I are now colleagues as a result of the common ownership of our two firms, I welcome guest post submissions from any responsible contributor. Dave’s topic is in an area not typically covered on this blog, but I still thought readers would find it of interest. Here is Dave’s post.

　

Companies could be facing a significant new exposure as a result of a new reporting requirement that goes into effect for tax returns that must be filed this year. The new reporting requirement expands beyond existing accounting requirements for tax uncertainty. The result is that tax liabilities not requiring a reserve for financial statement purposes may be directly disclosed to the IRS. This article discusses the new reporting requirements, the potential impact on securities litigation and the variety of insurance solutions available to address these issues.

 

The Requirement to "Confess & Rank"

The IRS now requires "large" corporations to "confess and rank" their uncertain tax positions when filing tax returns. Specifically, the IRS is now requiring corporations with (worldwide, gross) assets that exceed $100 million to provide the IRS with a "concise description" of all of their uncertain tax positions and to rank those positions by size of tax reserve, or by amount at issue (if not reserved), and to denote whether the position relates to transfer pricing. The information must be included in their 2010 U.S. income tax returns (generally filed on or before September 15, 2011 for calendar year taxpayers) under a new IRS form, Schedule UTP, which stands for "uncertain tax positions." The Schedule UTP form can be found here.

 

And the requirement to "confess and rank" to the IRS is slated to extend to all corporations as Schedule UTP phases in over the next five years. Corporations with total assets of $100 million or more must file Schedule UTP starting with 2010 tax years. Starting with 2012 tax years, the total asset threshold will be reduced to $50 million. Starting with 2014 tax years, it will be reduced to $10 million.　 The IRS stated that it will consider whether to extend the Schedule UTP reporting requirement to other taxpayers—such as pass-through entities or tax-exempt organizations—for 2011 or later tax years. The instructions for Schedule UTP can be found here.

 

The Dramatic Extension Beyond Current U.S. – GAAP

Companies reporting their financial statements in accordance with US-GAAP have recently had to follow a set of rules known as "FIN 48" when accounting for tax uncertainty. Essentially, FIN 48 requires that all tax positions be identified and evaluated in a two-step process: (1) the recognition step, which asks whether each tax position would more likely than not prevail under existing law – if not, then none of the tax benefits associated with the position are "recognized" (i.e., the entire amount at risk is charged or reserved and provisions for accruing interest and perhaps penalties must also be set forth in the financial statements); if the position is likely to prevail under existing precedent or authority, then the second (measurement) step is taken to determine how much of the tax benefits may be recognized for financial statement purposes and (2) the measurement step, which asks, as to each recognized position, how much of the position is more likely than not going to be allowed in a final resolution (via settlement or adjudication) with the taxing authority assuming the position were challenged and it would be settled on its own merits (no trading of positions for settlement purposes). The official publication of FIN 48 can be found here.

　

Schedule UTP is a dramatic divergence from the measurement step used in FIN 48 for accounting purposes. Under FIN 48, if a company believes (i.e., convinces its financial statement auditors) that it would never settle a tax position with the IRS and would more likely than not prevail in the adjudication of that position, no FIN 48 reserve is required. Under Schedule UTP, however, each such position must be disclosed and given a priority ranking as part of the corporate tax return filed with the IRS.

　

The Impact on Companies

The impact that Schedule UTP will have on securities class actions and derivative actions remains to be seen. The impact on corporate cash, balance sheets and income, however, is expected to be significant.For example, in a report by Credit Suisse dated May 18, 2007, entitled "Peeking Behind the Tax Curtain", Credit Suisse analyzed just 361 companies in the S&P 500 and found a total of $141 billion in unrecognized tax benefits for uncertain tax positions identified pursuant to FIN 48. A copy of an abstract of that repot can be found here.

 

To the extent that FIN 48 reserves relate to tax liabilities owed the IRS, Schedule UTP will almost certainly make the FIN 48 reserves a self-fulfilling prophecy. As discussed further below, however, there may be some relief for companies that posted large FIN 48 tax reserves of U.S. income tax liabilities. In cases where the tax position was not recognized, in part or in whole, because the company could not persuade its financial statement auditors with a tax opinion prior to the initial setting of FIN 48 reserves for the position, tax insurance may be available.

 

But regardless of the amount reserved for FIN 48 purposes, the amount not reserved but yet exposed by Schedule UTP will present a significant challenge to many companies. In certain instances, the discrepancy between tax liabilities reserved for FIN 48 purposes and tax liabilities disclosed to the IRS in Schedule UTP can be very significant. Many companies obtained tax opinions for certain tax positions and argued that they would never settle with (and would prevail over) the IRS to avoid FIN 48 reserves for those tax positions. As noted above, all such positions must now be disclosed in a concise narrative description and given a priority ranking as part of the corporate tax return.

 

When the discrepancy is material to the company’s financial condition and significant tax liabilities (and/or penalties) that were not reserved arise as a result of Schedule UTP, there may well be grounds for shareholder actions.

 

The Specter of Securities Class Actions & Derivative Suits

Absent rather extreme circumstances (e.g., Enron), it still seems fairly remote that an adverse, material, final determination of an uncertain tax position(s) not fully reserved in a company’s financial statements but reported on Schedule UTP could expose the company, its directors and officers and/or auditors to liability under securities laws or corporate law.

 

However, in instances in which the discrepancy between FIN 48 reserves and Schedule UTP exposure is both large (relative to liquidity) and protracted (not remedied over time by either increasing reserves or mitigating the tax risk, as discussed below), and/or if penalties are assessed, the plaintiff’s case becomes easier.

 

In Overton v. Todman & Co, 478 F.3d 479 (2d Cir. 2008), the Court vacated and remanded the trial court’s dismissal of a securities fraud claim against an accounting firm that purportedly failed to correct its certified opinion after learning that the company’s tax liability had not been correctly stated. (The appeal did not address the more difficult issue of loss causation because the trial judge had dismissed on the basis that the accounting firm had no "duty to speak.") The Court ruled:

 

Specifically, we hold that an accountant violates the "duty to correct" and becomes primarily liable under  Section  10(b) and Rule 10b-5 when it (1) makes a statement in its certified opinion that is false or misleading when made; (2) subsequently learns or was reckless in not learning that the earlier statement was false or misleading; (3) knows or should know that　potential investors are relying on the opinion and financial statements; yet (4) fails to take reasonable steps to correct or withdraw its opinion and/or the financial statements; and (5) all the other requirements for liability are satisfied [i.e., materiality, transaction causation, loss causation and damages]. { Id at pages 486-487.} 

 

A copy of the decision can be found here.

 

It would seem that the reasoning in Overton as to an auditor’s duty to correct and speak about an inaccurately disclosed tax liability should extend to corporate "speakers" when any corporate tax directors, CFO’s and the members of an Audit Committee discover a material discrepancy between FIN 48 reserves for U.S. income tax liabilities and Schedule UTP. For purposes of establishing liability under Section 10(b) of the Securities Exchange Act of 1934, a significant discrepancy followed by silence (and no action to mitigate loss or increase reserves) may well be viewed as the basis for establishing corporate scienter (particularly in jurisdictions that follow either a weak or semi-strong theory of corporate scienter) and/or scienter on the part of the CFO and members of the Audit Committee. And the "failure to take reasonable steps" language of Overton could well be applied to a derivative action taken against the Audit Committee that fails to correct or mitigate these discrepancies and subsequently incurs large legal and expert fees and/or penalties.

 

In fact, transparency regarding tax liabilities has taken center stage in recent corporate governance gatherings. On October 19, 2009, IRS Commissioner Doug Shulman addressed the 2009 National Association of Corporate Directors Governance Conference and urged that companies establish an open dialogue and regular meetings between their Audit Committees and Tax Directors and that directors are legally charged with oversight of their company’s compliance with tax laws. Commissioner Shulman made a number of detailed inquiries that should be undertaken by Audit Committees. The IRS’s suggested inquiries could one day serve as the checklist for proper corporate tax governance by many corporations and/or plaintiff’s counsel prosecuting a derivative action (particularly where penalties have been assessed). A copy of the Commissioner’s remarks can be found here.

　

Loss Mitigation Techniques

So how does a company protect itself from the risk that it failed to adequately reserve for tax liabilities? As noted above, the traditional approach of obtaining a tax opinion may no longer suffice. There are two major concerns: (1) the opinion will not prevent disclosure under Schedule UTP and (2) the opinion may not, in practice, protect the company against penalties, much less un-accrued taxes and interest.

 

A "covered" tax opinion that satisfies the standards of Treasury Circular 230 (31 CFR 10.35) is often touted as the company’s defense against penalties. In practice, however, not many corporate taxpayers want to waive their attorney-client privilege and provide the IRS with a tax opinion that (in order to be a covered opinion) develops all relevant legal theories and considers all relevant authorities, support and arguments, both favorable and not favorable for the taxpayer.

 

Accordingly, tax practitioners may wish to consider advising their clients to consider tax insurance for their material uncertain tax positions. In fact, some tax practitioners already include such advice as a standard provision in any tax opinion. (E.g., "Of course, our opinion is not binding on the IRS and there is a reasonable basis by which the IRS could successfully challenge the tax position. If greater economic certainty around the tax position is desired, tax insurance may be available.")

　

Moreover, tax return preparers may wish to consider comparing the FIN 48 reserves (and work papers) with the Schedule UTP before filing the tax return and would be well advised to inform their clients that tax insurance may be available for discrepancies, if any, and/or for tax positions that have not been fully recognized.

 

Tax Insurance Protection: In fact, tax insurance may be available via several alternative (but not mutually exclusive) approaches:

 

1. Transactional Tax Insurance covering a particular uncertain tax positions (or set of related tax positions) taken in particular tax year(s) against claims made during the policy period (often co-extensive with the statutory period in which assessments can be made).

 

2. Schedule UTP/FIN 48 Tax Insurance covering the shortfall in FIN 48 reserves for those selected uncertain tax positions set forth on Schedule UTP. The policy period will often be co-extensive with the statutory period in which assessments can be made with respect to the U.S. (federal) corporate income tax return. The difference between Schedule UTP/FIN 48 Tax Insurance and Transactional Tax Insurance is that the scope of uncertain tax positions is expected to be far broader in Schedule UTP/FIN 48 Tax Insurance, with higher limits. Subsequently policies would cover subsequent returns on a non-cumulative basis with respect to tax positions covered under multiple policies (i.e., the full amount of tax exposure may be insured but not more than the full amount will be insured).

　

3. FIN 48 Tax Insurance – An annual claims-made policy with a one-year policy period covering the adequacy of the FIN 48 reserves with respect to the tax positions covered under the policy. A claim is made when an audit makes inquiry about a covered tax position. Each year, a new set of covered tax positions are covered (subject to underwriting approval) as new tax positions are reported and/or as former tax positions are no longer subject to challenge.

 

Variations of the above prototypes may also be available. Tax insurance almost always allows the insured to select its tax counsel (subject to consent) and typically contains no more than a few exclusions. It is not, however, available for "reportable transactions."

 

Because tax insurance provides cash when needed to pay a tax bill, and because its purchase reflects a prudent risk management approach to the inherent complexities of tax planning, reporting and reserving, as Schedule UTP becomes a corporate requirement, so too may tax insurance. The alternative may well be a new wave of shareholder suits.　

　

Any list of the most important and influential Americans of the 20th century would have to include William Brennan, whose 34-year tenure as an associate justice of the U.S. Supreme Court coincided with –and in many ways both reflected and influenced – a period of extraordinary change both in American society and in its jurisprudence. Liberal icon and lightening rod for conservative rancor, Brennan was at the center of many of the Court’s highest profile decisions.

 

In an authorized biography entitled "Justice Brennan: Liberal Champion," journalist Stephen Wermeil and attorney Seth Stern provide a balanced and thorough overview of Brennan’s long and extraordinary life. Because Wemiel had the opportunity to interview Brennan before his death in 1997 and because the authors had access to Brennan’s personal notes and files, the book provides significant insight into the Supreme Court’s inner workings.

 

The book explores Brennan’s early life, including his childhood and his years at Harvard Law School, where he took classes with Felix Frankfurter (with whom Brennan would later serve on the U.S. Supreme Court – Frankfurter did not remember Brennan, who had not been a particularly brilliant law student). The book also examines Brennan’s early career as a labor lawyer in Newark and then as a state court judge in New Jersey.

 

But the bulk of the book is devoted to Brennan’s years on the Supreme Court. Brennan was nominated for the Court by Republican President Dwight Eisenhower, though Brennan was a lifelong Democrat. With an eye on the 1956 presidential election, Eisenhower wanted to nominate a youthful Catholic, preferably one with state judicial experience. Few candidates met all of these criteria, so Brennan found himself on the Supreme Court at age 50, with only seven years of state trial and appellate court judicial experience. (Eisenhower is reported to have later regretted the nomination.)

 

Brennan would quickly become a key ally and working partner of Chief Justice Earl Warren, together exercising an expansive vision of judicial authority. The authors refer to Brennan’s collaborative relationship with Warren as "one of the most enduring friendships important alliances in the history of the Supreme Court," resulting, among other things in an historic and surprisingly enduring expansion of civil rights.

 

Brennan arrived after the Court’s landmark Brown v. Board of Education decision declaring "separate but equal" to be "inherently unequal." However, he soon became an indispensible part of the working majority on the court that operated with the view that for too long the Court had, in the name of judicial restraint, abdicated its responsibility to protect civil liberties.

 

Brennan himself developed an activist, results-oriented approach, first manifest in cases dealing with segregation and racial inequality, but soon extended to a host of other areas, including criminal procedure, privacy, voting rights and obscenity. Brennan would be in the majority in a wide range of controversial opinions, including those involving abortion, school prayer, busing and affirmative action.

 

As a result of these decisions, the Court attracted fierce criticisms that it was acting in the role of Platonic Guardian and operating as a "roving commission" to do justice as they conceived it, in the process trammeling majoritarian institutions.

 

The activist judicial approach of Brennan and his liberal colleagues on the Court triggered a strong political backlash. Barry Goldwater’s 1964 presidential campaign, as well as Richard Nixon’s campaign in 1968, was in many ways built around criticisms of the Court and its liberal agenda. As the Court’s membership changed in the 70’s and 80’s due to the conservatives political successes, Brennan found himself dissenting more frequently and sometimes isolated – but still able to influence colleagues and, to a certain extent, to protect decisions of the Warren Court era.

 

Though the biography is generally favorable, the portrait that emerges is relatively balanced. Brennan appears as a conscientious and effective jurist who, as a result of the strength of his personal charm, principles and intellect became, as the authors claim "one of the most influential justices of the 20th century."

 

Brennan’s life story is well told in this detailed account, which not only examines his judicial career, but also his life off the court, including his marriage, his friendships, his religious life and even his finances. The book is filled with interesting insights and anecdotes, such as Brennan’s passionate opposition to the death penalty, and, on a more personal note, his marriage to his long-time secretary, Mary Fowler, just three months after the death of his first wife, Marjorie, to whom had had been married for nearly all of his adult life.

 

Along the way, the authors provide deep insight into how the Court works and how it has had such an extraordinary influence on so many aspects of American life and society.

 

Despite the many years of conservative majorities that followed Brennan’s tenure on the Court, a surprisingly large part of Brennan’s legacy remains intact. In areas such as civil rights, privacy, voting rights and criminal procedure, decisions that when first made were highly controversial remain the law of the land. It is perhaps fitting that in his confirmation hearing, David Souter, Brennan’s replacement on the Court, referred to Brennan as "one of the most fearlessly principled guardians the Constitution ever had."

 

I enjoyed reading this book and I have no hesitation recommending it. I will say that reading the book occasioned much thought and even concern as I reflected on Brennan’s brand of judicial activism. Though the Warren Court’s civil rights decisions were essential to removing deep racial injustices, the activist approach the Court employed led to other decisions about which it is difficult for me to feel quite as comfortable, even if just from an analytical point of view.

 

Moreover, an activist approach that finds rights and legal requirements without an explicit textual basis in the Constitution can be used for conservative as well as liberal purposes, as it might be argues subsequent courts have proven.

 

Reflecting on this afforded me a new appreciation for the merits of judicial restraint. In reading this book, I found it striking that after the first few years of the civil rights cases, Justices Hugo Black and John Marshal Harlan II, who had been important participants in many of the Warren Court’s early civil rights decisions, began pulling back and increasingly began refusing to follow the liberal majority. The book suggests the two justices (particularly Black) may have just been getting old. Perhaps I am getting old too, because I found myself appreciating their perspective.

　

It has been a long road — one that included among other things, an amicus brief filed at the U.S. Supreme Court in connection with Morrison v. National Australia Bank – but the defendants in the Infineon Technologies securities suit have managed to have the court dismiss the claims of company shareholders who purchased their securities outside the U.S. Northern District of California Judge James Ware’s March 17, 2011 order granting the defendants’ motion can be found here.

 

The plaintiffs first initiated their suit in September 2004, as detailed here. The plaintiffs allege that the company had participated in an illegal conspiracy to fix the prices of Dynamic Random Access Memory (DRAM) and then misrepresented the company’s financial condition as a result of the artificially inflated DRAM prices. Infineon’s American Depositary Shares and ordinary shares are listed on the NYSE, but during the class period 92% of its securities were traded on the Frankfort Stock Exchange.

 

Following the U.S. Supreme Court’s June 2010 decision in the Morrison case, the defendants moved to dismiss from the case the shareholders who purchased their Infineon shares outside of the U.S. In opposing the motion, the plaintiffs – citing Morrison’s holding that Section 10(b) of the ’34 Act applies only to "transactions in securities listed on domestic exchanges" and "domestic transactions in other securities" – argued that because Infineon’s ordinary shares are "listed on" the NYSE, Section 10(b) applies to all ordinary shares, even those purchased on the Frankfurt Stock Exchange.

 

Consistent with Southern District of New York Judge Deborah Batts’ January 2011 opinion in the RBS securities suit (about which refer here), Judge Ware had little trouble rejecting the plaintiffs’ "listed on" argument. Judge Ware stated that under Morrison "a securities transaction must occur on a domestic exchange to trigger application of Section 10(b) of the Exchange Act."

 

Judge Ware said that the plaintiffs’ "listed on" argument was "misplaced," noting that in the Morrison case itself, National Australia Bank had ADRs listed on the NYSE, but the plaintiffs in Morrison were unable to state a Section 10(b) claim because "that Section of the Exchange Act focuses only on securities transactions that take place in the United States."

 

Accordingly, Judge Ware granted the motion to dismiss with respect to "all claims asserted on behalf of individuals who purchased Infineon ordinary shares on the Frankfurt Stock Exchange."

 

Judge Ware’s opinion in the Infineon case joins a growing list of decisions in which federal district courts have dismissed from securities suits the shareholder claimants who purchased their shares of the defendant company’s stock outside of the U.S. What makes Judge Ware’s opinion noteworthy is that it is one of the first such opinions outside of the Southern District of New York. As far as I know, it is the first in the Northern District of California.

 

(Central District of California Judge Dale Fischer interpreted and applied Morrison for purposes of a July 2010 lead plaintiff ruling in the Toyota securities suit, but did not reach the question whether Morrison precluded the claims of shareholders who purchased their shares outside the U.S.)

 

It is increasingly clear that the district courts are applying Morrison broadly and are refusing to be persuaded to trim the decision’s effect or to reduce its impact on the claims of securityholders who purchased shares on foreign exchanges.

 

Plaintiffs seeking to circumvent Morrison may be forced to proceed by other means – as for example, are claimants whose federal securities suit against Porsche was dismissed based on Morrison. As reflected in their March 15, 2011 complaint (here), these plaintiffs are now attempting to assert state law claims of common law fraud and unjust enrichment against Porsche. The plaintiffs will face numerous obstacles as they attempt to chart an alternative course. But claimants barred by Morrison from asserting securities claims under the federal securities laws will continue to search for ways to try to assert their claims, both inside and outside the U.S.

 

Susan Beck’ March 19, 2011 Am Law Litigation Daily article about Judge Ware’s decision in the Infineon case can be found here.

 

Transatlantic Cable: Writing about the Infineon decision seems fitting as I am now in London for this week’s C5’s 20th Forum on D&O Liability Insurance. I will be speaking on Thursday March 24, 2011 on a panel with my friend Rick Bortnick of the Cozen O’Connor firm on the topic "The Latest U.S. Judicial Decisions." If you are attending the conference, I hope you will take the time to say hello, particularly if we have not previously met.

 

As recently as this past Monday, commentators were grumbling that the FDIC is moving too slowly in pursue claims against former directors and officers of failed banks. The FDIC has responded in dramatic fashion with a March 16, 2011 lawsuit filing in the Western District of Washington against three former Washington Mutual executives, as well as two of the executives’ wives.

 

According to news reports (here), the lawsuit seeks damages of as much as $900 million. The media stories also suggest that there is an agreement by WaMu’s outside directors to pay $125 million to settle claims by the FDIC is pending approval. A copy of the FDIC’s recent complaint against the WaMu executives and their wives can be found here.

 

WaMu’s September 2008 failure (about which refer here), represents by far the largest bank failure in U.S. history. The events surrounding its failure have already been the subject of extensive litigation, not the least of which is a pending securities class action lawsuit filed on behalf of WaMu’s shareholders, which, as noted here, survived a renewed motion to dismiss after the lead plaintiffs amended their complaint.

 

The FDIC filed its recent lawsuit in its capacity as WaMu’s receiver. The lawsuit names as defendants WaMu’s former CEO, Kerry Killinger, its former President and COO, Stephen Rotella, and its chief of home lending, David Schneider. In a rather unusual twist that shows just how aggressively the FDIC may be prepared to get in pursuing these claims, the complaint also names Killinger’s wife, Linda Killinger, and Rotella’s wife, Esther as explained below.

 

The complaint asserts claims against the three executives for Gross Negligence, Ordinary Negligence and Breach of Fiduciary Duty.

 

The complaint alleges that the three defendants caused the bank to take "extreme and historically unprecedented risks with WaMu’s held-for-investment loan portfolio." The three allegedly focused on short term gains, to the disregard of the bank’s long term safety and soundness. The executives, lead by Killinger, allegedly developed an executed a strategy to make billions of dollars of risky residential mortgages, increasing the risk profile of the bank’s held for investment mortgage portfolio.

 

The bank’s business strategy dictated a lending approach for which few lenders were turned away. The bank also layered multiple levels of risk with particularly risk loan products such as option ARM mortgages, the riskiness of which was further compounded by allowing stated income lending and other questionable lending practices.

 

The complaint alleges further that these executives continued to pursue their aggressive growth strategy even at a point when housing prices "were unsustainably high" and while relying upon an aging infrastructure that was inadequate to keep up with the enormous loan volume. The complaint alleges that the three executives knew the strategy was risky, knew the process weaknesses, and even knew there was a housing price bubble. Yet, the complaint alleges, the three executives marginalized the company’s risk management department.

 

As a result, when the bubble collapsed, the bank "was in an extremely vulnerable position" and, as a result of the three executives "gross mismanagement" the bank suffered losses of "billions of dollars."

 

The complaint also includes fraudulent conveyance claims against Killinger and his wife Linda, and against Rotella and his wife Esther.

 

The complaint alleges that in August 2008, Killinger and his wife transferred two residential properties to qualified personal residence trusts and appointed themselves as trustees. The complaint alleges that these transfers were made with the intent to hinder, delay or defraud Killinger’s future creditors.

 

The complaint contains similar allegations against Rotella and his wife with respect to an April 2008 residential real estate transfer and a September 2008 transfer from Rotella to his wife of $1 million.

 

In statements to the Wall Street Journal, here, Killinger and Rotella said the FDIC’s allegations are "baseless" and "lack credibility" and that the lawsuit is "unworthy of the government." I recommend that readers take a few minutes and read these two individuals’ statements. Whatever may be the merits of this and similar cases brought by the FDIC, it is very clear from these statements that there will be a personal price to pay for the individuals involved. The personal pain these men are feeling is palpable, and there will be more of this kind of pain for other former bank officials as more of these kinds of lawsuits are filed.

 

With the filing of this complaint, the FDIC has unmistakably demonstrated that it will pursue claims against former directors and officer of failed banks when it chooses to do so. Indeed, the claims against the two executives’ wives clearly show that the FDIC will proceed aggressively.

 

Given that WaMu represented the largest bank failure in U.S. history, it may come as no surprise that the FDIC is pursuing these kinds of claims. What has been surprising to some, and what occasioned the criticism I mentioned in my opening paragraph, is how deliberate the FDIC has been in choosing to pursue claims. WaMu failed nearly two and one half years ago. If the FDIC were to act with similar deliberation in pursing other claims, it could well be some time before we know for sure how extensive the FDIC’s litigation activity ultimately will be in pursing claims as part of the current bank failure.

 

It is, however, quite clear that the FDIC will be pursuing more of these types of claims. The FDIC recently updated the Professional Liability Lawsuits page on its website (here) to show that the FDIC’s board has approved lawsuits against 158 individual directors and officers of failed banks. Since the six lawsuits the FDIC has filed to date only amount to about 40 individual defendants in total, there are many more lawsuits to come, just based on the actions that have been approved so far.

 

One particularly interesting detail about the news surrounding the FDIC’s recent lawsuit is the report that WaMu’s outside directors have agreed to pay $125 million to settle claims. It is interesting that the outside directors agreed to pay this amount without the intervening step of a lawsuit against them. One question that immediately occurs to me is whether and to what extent this $125 million payment is to be funded by D&O insurance.

 

WaMu’s D&O insurance program was undoubtedly already under pressure due to the significant presence of other claims already pending against its former directors and officers. One possibility that occurs to me is that the bank may have carried a significant layer of Side A DIC protection, which may well have been triggered by the bank holding company’s bankruptcy. Because of the bankruptcy, all of the claims represent potential Side A losses, suggesting that the bank’s Excess Side A/DIC program could well have been called in to contribute. All these are details that those of us on the outside can only wonder about; however, comments from knowledgeable persons who are closer to the situation are always welcome.

 

Whatever may be the case, it is clear that D&O insurance may be playing a role of some kind in all of this. At least Stephen Rotella thinks so. In his statement to the Wall Street Journal to which I linked above, he speculated that the lawsuit itself "may be a way for the FDIC to collect a payout from insurers who provided officers and directors liability coverage for the time they worked at WaMu."

 

As noted, with this lawsuit, the total number of lawsuits the FDIC has filed as part of the current wave of failed bank litigation is now up to six. A list of the six lawsuits can be found here.

 

A March 17, 2011 Bloomberg article about the FDIC’s lawsuit can be found here. A March 17, 2011 Seattle Post-Intelligencer article about the suit can be found here.

　

I am pleased to be able to print below a guest post from my friend and industry colleagueDonna Ferrara. Donna is Senior Vice President and Managing Director, Management Liability Practice Group, at Arthur J. Gallagher & Co. As Donna indicates, this guest post is the result of an email exchange between Donna and myself following one of my recent blog posts about to a recent coverage decision. Because I recognized the depth of Donna’s feelings about the need for professionalism in the insurance claims process, I invited her to submit a guest post on the topic, which she has done and which I have set out below.

 

I want to emphasize that I welcome proposed guest posts from responsible commentators throughout the industry. I also encourage readers who have reactions to Donna’s guest post to please add their thoughts using the blog’s comment function. Here is Donna’s guest post:

　

After I posted a comment on Kevin’s blog, he asked if I would write about the need for professionalism in our business. The following is my opinion and does not reflect that of my employer or colleagues. In the interest of full disclosure, I currently work for a major insurance broker. In the past, I have represented both insurers and insureds, which provides, I believe, an unusual point of view.

 

First, this is not a sniveling request for a return to the days of elaborately false good manners and courtly lawyering, if there ever were such a time.

 

Rather, this is an unscientific discussion of how civil – or Rational – behavior is good business.

 

Navigating the arcane world of D&O insurance requires a fairly high level of expertise. One would hope that this would be matched by a high level of professionalism and respect, but that is not always the case.

 

Rationally, D&O disputes should not create feelings of betrayal and personal peril. Unlike criminal or civil rights cases, the ultimate issue is money. Yet often disputes are ratcheted to an emotional level more appropriate for armed combat.

 

Recently, I looked at cases in which D&O coverage disputes had been litigated to appeals courts, an expensive and unusual event. Most litigation settles long before there is anything to appeal. At Kevin’s request, I am not including the names or identifying information of the litigants. I have no knowledge of the cases reviewed, beyond what is publically available.

 

In each case, someone was pressing an argument which was, at best, difficult. For example, in one case, a carrier asserted that even if a court ordered a litigant to pay plaintiffs’ costs, that litigant was not "legally obligated to pay" those costs. In another, the insured argued that the policy provided coverage for investigations of the corporation, although the policy limited such coverage to individuals. In a third, the parties claimed that a provision which provided only defense coverage actually provided no coverage (in the carrier’s view) or full defense and indemnity (in the insured’s view).

 

Unsurprisingly, these arguments did not succeed. After the parties had expended substantial legal fees, appeals courts found, in effect, that the policies said what they said.

 

Why did the parties fight so hard to reach what should have been an obvious conclusion?

 

The reason may be found in the pleadings and motion practice.

 

In each case, there was a substantial amount of money at stake, but probably not a "bet the company" sum for either party. Still, the dockets reveal extensive and vitriolic communications between the parties and their respective counsel. Carriers complained that their advice had been ignored. Insureds claimed deception and bad faith. Both sides bickered over discovery. Sanctions were demanded. The exhibits to the pleadings included emails and letters demonstrating that animosity had been the tone of the parties’ relationship from the beginning.

 

In short, the litigants subscribed to the Tough theory of business and litigation.

 

Probably the parties felt that the sums involved justified their mutually Tough stance. Possibly, they felt that "It was the Principle" – although, again, the issue was really only money. In any case, being Tough virtually assured that they would end up in court, yet in none of these cases did one side succeed completely.

 

Rationally, the parties might have realized that courts are poor places to make difficult arguments. Courts are not equipped to make decisions based on business considerations. With few exceptions, judges were litigators in their past lives. They come from an adversarial background and are limited to deciding specific issues. They cannot make compromises or force settlements (at least not overtly). Every issue has to be reviewed. At the end of the process, there has to be a "winner" and a "loser" on every point, even if no one actually "wins" the entire case.

 

Moreover, most judges have more cases than they can handle. Aggressive tactics slow the docket, annoying judges and magistrates. True, Tough tactics mean more money for lawyers who bill on an hourly basis. Clients, however, resent high legal fees that are not accompanied by clear success (and even those that are).

 

I suspect that, at the end of the cases reviewed, no one felt victorious or vindicated.

 

In a Rational world, the parties in this litigation would have met before a claim had even been made. The contract would have been openly discussed. There would be a Rational presumption that good coverage costs more than poor coverage, that no insurer wants to accept unlimited risk and that the insured would want the policy to respond as its words – and advertising – indicated it would.

 

It is unlikely this discussion ever took place.

 

D&O insurance is sold in a market where price is often the primary, if not the sole, consideration and that price is set by competition, not by risk.

 

Underwriters, pressured to write business, tweak their forms, but price according to what other carriers charge. Because D&O claims are historically infrequent, but relatively severe, claims handlers do not have the chance to manage and pay many claims. Insureds demand the broadest possible coverage, for the lowest cost – a Bentley for the price of a bicycle. Brokers are in the middle, often an untenable situation. They must be seen as Tough, or risk losing the business.

 

Lawyers may exacerbate the situation: Often both client and lawyer perceive attorneys as the "hired gun". As a brash young attorney once said, "If my clients wanted to make nice, they would have called a florist." D&O is especially fertile ground for disputes: policy language varies and insurance is governed by the state law. Whatever position a party takes can find support somewhere.

 

The present economic climate increases the pressure on everyone: "bad" results can have bad personal consequences. Carriers’ personnel may be fired, lawyers dismissed and brokers replaced. Rationality may be perceived as weakness or lack of commitment.

 

Rather than suggest that the other side may have merit, parties feel compelled to press every point against equally committed adversaries.

 

In my own experience, there can and should be a Rational approach to D&O issues. While difficult and even counterintuitive, it is possible for insurers and insureds to listen to each other, discuss differences and come to appropriate business decisions. Everyone should know that their position had been heard. Lawyers can recognize that their clients might benefit more from compromise than scorched earth. Although we are bound to be advocates for our clients, we can and should be counselors as well.

 

This is just good business.

 

In the cases discussed, it is easy to imagine that the relationships among the litigants were damaged irreparably. The insureds were unlikely to ever purchase insurance from the carriers again, but the brokers and lawyers may have lost their clients as well.

 

I am not so naïve as to envision a world in which carriers and their insureds are "partners", in the sense that they will both benefit from the same outcome. While I passionately serve my clients, I know that insurance is a business of trading services for money. As with any business, rational, civil behavior can be mutually beneficial.　

　

In resolution of a securities case that at one time had actually been dismissed and that even after being revived was substantially narrowed based on the U.S. Supreme Court’s Morrison decision, the parties to the Credit Suisse subprime-related securities class action lawsuit have reached a settlement by which the company has agreed to pay the plaintiff class $70 million. A copy of the parties’ March 10, 2010 settlement agreement can be found here. The settlement is subject to court approval.

 

As reported in greater detail here, the plaintiffs filed their initial complaint in this action in April 2008. The plaintiffs alleged that the defendants had made material misrepresentations about the company’s asset valuation system, its internal controls (which allegedly allowed unauthorized placement of high risk mortgage-backed assets in client accounts), and its own exposure to losses related to subprime mortgages. Credit Suisse is domiciled in Switzerland. Its shares trade on several securities exchanges outside the U.S. and its ADRs trade on the NYSE.

 

In an October 5, 2009 order (here), Southern District of New York Judge Victor Marrero granted the defendants’ motion to dismiss, having concluded based on pre-Morrison standards that the court lacked subject matter jurisdiction over the claims of claimants who reside outside the U.S. and who had purchased their shares on foreign exchanges (so-called f-cubed claimants). The complaint had not identified the domicile of some other named plaintiffs, but Judge Marrero dismissed their claims as well.

 

Thereafter, the plaintiffs amended their complaint and the defendants renewed their motions to dismiss. As discussed here, on February 11, 2010, Judge Marrero held that the plaintiffs’ amended complaint was sufficient to overcome the initial defects and he allowed the case to go forward as to plaintiff shareholders who had purchased Credit Suisse ADRs on the NYSE and as to U.S.-based shareholders who had purchased Credit Suisse shares on the Swiss Stock Exchange. However, he also ruled that the court lacked jurisdiction over the claims of plaintiffs that resided outside the U.S. and that had purchased their shares outside the U.S.

 

In June 2010, the U.S. Supreme Court issued its opinion in Morrison v. National Australia Bank case. The defendants in the Credit Suisse case moved to dismiss the claims by Americans who bought their Credit Suisse shares on the Swiss exchange – that is, the so-called "f-squared" claims. In a July 27, 2010 opinion, Judge Marrero ruled that Morrison also precludes the f-squared claims. As discussed here, Judge Marrero was the first to hold that under Morrison applied to preclude f-squared as well as f-cubed claims.

 

The parties then initiated a mediation process that resulted in the settlement agreement filed with the court on March 10.

　

The settlement agreement has a number of interesting features. First, the settlement agreement specifies that following the settlement’s preliminary approval Credit Suisse "and/or its insurers" will cause the payment of the $70 million settlement fund to the escrow agent. The settlement agreement itself does not specify how much of the settlement ultimately is to be borne by Credit Suisse’s insurers. The use of the word "or" in the phrase "or its insurers" suggests that the insurers contribution could possibly be as much as the entire $70 million, but there is simply no way to tell for sure from the face of the settlement document. However, the clear suggestion is that at least some portion of the settlement is to be paid by Credit Suisse’s insurers.

　

Second, even though Judge Marrero dismissed out the Americans who bought their Credit Suisse shares on the Swiss exchange, the proposed settlement class consists not only of all purchasers who acquired Credit Suisse ADRs on the U.S. Exchange, but also "all U.S. Residents who purchased [Credit Suisse] securities on the Swiss Stock Exchange during the class period." Clearly, plaintiffs counsel was not prepared to concede – at least for settlement purposes – that Judge Marrero’s ruling on this issue was correct.

　

However, it appears that the Judge Marrero’s ruling dismissing out the f-squared claimants was taken into account in the settlement. The Americans who bought Credit Suisse shares on the Swiss exchange will enjoy only a limited recover compared to the ADR purchasers. 90% of the net settlement amount is to go to settlement class members who purchased ADRs on the NYSE, and 10% is to go to the U.S. shareholders who purchased common shares on the Swiss exchange. (ADR holders will receive $1.38 per share and the U.S. shareholders will or 13 cents a share..)

　

As Alison Frankel points out in her March 11, 2011 Am Law Litigation Daily article about the Credit Suisse settlement (here), the settlement split between the ADR holders and the U.S. common shareholders is similar to the settlement split in the recent $125 million Satyam settlement (about which refer here) in which the ADS holders were to receive $1.38 a share and common shareholders were to receive 6 cents a share.

　

Third, although the settlement agreement itself does not specify the amount of plaintiffs’ attorneys’ fees, the accompanying settlement papers discloses that the plaintiffs’ counsel intends to move the court and seek attorneys’ fees "not to exceed 27-1/2 percent of the settlement proceeds" plus $350,000 in expenses. If the plaintiffs’ counsel were to receive the full 27.5 percent amount, that would translate into a fee award of $19.25 million.

　

Beyond its specific features, the settlement is also interesting for what it represents. For starters, it is represents one of the few settlements so far of the more that 230 subprime and credit crisis-related securities class action lawsuits that accumulated during the period 2007 to 2010. By my count, the Credit Suisse settlement represents only the 19th settlement of a credit crisis securities suit overall and only the second such settlement so far in 2011.

　

As Cornerstone Research discussed in its recently released study of 2010 securities class action lawsuit settlements (refer here), the credit crisis cases have "settled at a slower rate than traditional cases." Though many of these cases have been dismissed, others have survived dismissal motions. (And some, like the Credit Suisse case itself, were initially dismissed but survived renewed dismissal motions.) As I have noted elsewhere there is a backlog of unresolved credit crisis lawsuits. Though these cases are in many instances still working their way through the system, more of these cases will be moving toward settlement in the months ahead.

 

The size of the Credit Suisse settlement is also noteworthy. The $70 million settlement amount makes the case the fifth largest credit crisis securities suit settlement so far. Many of the credit crisis lawsuit settlements have been large – the Cornerstone study shows that the average and median credit crisis settlements have run substantially higher than the average and median settlements of securities suits generally. The suggestion is that the aggregate costs of all of these settlements could represent a very substantial figure, a possibility that, among other things, could have important implications for the D&O insurance industry.

 

Break in the Action: The D&O Diary’s publication schedule will be intermittent for the next two weeks. The normal publication schedule will resume on March 28, 2011.　

　

On March 7, 2011, in the latest development in a long-running securities suit that is among the few securities class action lawsuits to go to trial and that had previously resulted in a $277.5 verdict in plaintiffs’ favor, the U.S. Supreme Court denied Apollo Group’s petition for writ of certiorari. As a result, the ruling of the Ninth Circuit reinstating the jury’s verdict will now stand. In addition, as a result of the decision to decline taking up the case, the interesting and arguably important issues the cert petition raised will now not be reviewed by the Supreme Court.

 

As detailed in greater length here, plaintiffs filed the suit after the company’s share price declined following the disclosure of a U.S. Department of Education report alleging that the company had violated DOE rules. On September 7, 2004, the company agreed to pay $9.8 million to settle the allegations. News of the settlement first became public on September 14, 2004, but the company’s share price did not actually decline until September 21, 2004, when a securities analyst issued a report expressing concern about the company’s possible exposure to future regulatory issues.

　

On January 16, 2008, a civil jury entered a verdict in favor of the plaintiff class on all counts, awarding damages of $277.5 million. Under the verdict, Apollo is responsible for 60 percent of the plaintiffs’ losses, former Apollo CEO Tony Nelson is responsible for 30 percent, and former CFO Kenda Gonzales is responsible for 10 percent. The jury verdict is discussed at greater length here.

　

As discussed in greater length here, on August 4, 2008, Judge James Teilborg of the United States District Court for the District of Arizona entered an order (here) granting the defendants’ motion for judgment as a matter of law, based on his finding that the trial testimony did not support the jury’s finding of loss causation. Judge Teilborg’s order vacated the judgment and entered judgment in defendants’ favor.

 

In its post-trial motion, Apollo argued that the evidence at trial was insufficient to support a finding that the analyst reports represented "corrective disclosure," because they did not contain any new fraud-revealing information. Judge Teilborg found that "the evidence at trial undercut all bases on which [the plaintiff] claimed the (analyst) reports were corrective."　

 

Accordingly, the court concluded that although the plaintiff "demonstrated that Apollo misled the markets in various ways concerning the DoE program review," the plaintiff "failed to prove that Apollo’s actions caused investors to suffer harm." The court therefore concluded that "Apollo is entitled to judgment as a matter of law."

 

In a June 23, 2010 opinion (here), a three-judge panel of the Ninth Circuit held that the district court "erred in granting Apollo judgment as a matter of law." The opinion states that "the jury could have reasonably found that the (analyst) reports following various newspaper articles were ‘corrective disclosures’ providing additional or more authoritative fraud-related information that deflated the stock price."

　

The Ninth Circuit further held that Apollo is not entitled to a new trial and that there is no basis for remittitur (reduction of the verdict). The Ninth Circuit reversed and remanded the case with "instructions that the district court enter judgment in accordance with the jury’s verdict." The company filed a petition for writ of certiorari to the U.S. Supreme Court.

　

The basis for the company’s cert petition was basically that if the efficient market hypothesis means anything, then the information about the DoE investigation was fully incorporated into the company’s share price when the news first hit the market on September 14. Either the market did not efficiently incorporate this information, in which case the market for the company’s stock is not efficient and the plaintiffs ought not to be able to rely on the fraud on the market theory to establish reliance, or the market is efficient and the company’s share price simply did not decline at the time of the corrective disclosure.

　

In a June 28, 2010 guest post on this blog (here), noted securities litigation defense attorney Tower Snow of the Howard Rice law firm articulated the inherent tension between these two positions as follows:

　

The courts can’t rely on the efficient market theory for purposes of creating a rebuttable presumption of reliance for purposes of class certification and then ignore its underpinnings for purposes of evaluating loss causation. Either one embraces the theory or one does not. If one embraces it, then once it is established that the prior disclosures revealed the truth about the allegedly misstated or omitted information, there is nothing left for the jury to decide. The later disclosure, by definition, cannot be corrective, as the market already had absorbed the information. Here, the "corrective" disclosure came out seven days after the information had been previously released. Seven days is an eternity in the financial markets.

　

As discussed in March 2011 memo from the Jones Day law firm discussing the U.S. Supreme Court’s cert denial in the Apollo Group case (here), the Circuits are split on the question of how soon after a corrective disclosure a stock price decline must occur in order for the loss causation requirement to be satisfied. At least two Circuits – the Second and the Third – have held that the claimant must show that the market immediately reacted. At least three Circuits – the Fifth, Sixth and Ninth – have head that the price decline may occur weeks or even months after the initial corrective disclosure.

　

In light of the Supreme Court’s refusal to take up the Apollo Group case, this split in the Circuits will remain unresolved. Moreover, the relatively plaintiff friendly standard articulated by the Ninth Circuit remains standing in that Circuit, where so many securities class action lawsuits are filed.

 

Finally, the Supreme Court’s cert denial means that the Ninth Circuit’s ruling in the Apollo Group case stands. The Ninth Circuit had remanded the case for "entry of judgment in accordance with the jury’s verdict." In other words, the Supreme Court’s cert denial means that the plaintiffs’ verdict in one of the very rare securities cases to go to trial will stand.

 

The Supreme Court’s cert denial was disclosed with little fanfare, as part of a long list of other rulings at the same time. Looking at the Apollo Group cert denial among the list of rulings might convey the impression that this is no big deal. But actually it is a little surprising. The U.S. Supreme Court has shown an active willingness to take up securities cases, having taken numerous cases up in each of the last few terms. And part of the willingness to take up these cases seemed to involve persistent hostility against securities suits in general. The opportunity to trim a plaintiffs’ victory and to resolve a circuit split certainly seemed to suggest the possibility that the Supreme Court might well grant the cert petition.

 

In any event, with the cert petition denial, the plaintiffs’ trial victory in this case appears as if it will stand. Even with the recent dramatic narrowing of the plaintiffs’ class in the Vivendi case, the plaintiffs overall are on a bit of a roll when it comes to securities lawsuit trials. The last three securities cases to go to trial (the Homestore case, refer here; the BankAtlantic case, refer here; and the Vivendi case, refer here) have all resulted in plaintiffs’ verdicts.

　

Trials in these cases are extremely rare, and these recent developments involve a very small percentage of all securities cases. Nevertheless, the plaintiffs’ bar undoubtedly will find this sequence of events, including the cert petition denial in the Apollo Group, to represent heartening developments.  Even with the cert denial in the Apollo Group case, however, there are still a couple of securities cases still pending before the court this term — the Matrixx Initiative case (refer here) and the Janus Capital Group case (refer here) — and it remains to be seen how plaintiffs will fare in those cases.　

　

　

Though the average dollar value of securities class action settlements approved in 2010 declined slightly compared to 2009, the median settlement amount reached record levels, according to Cornerstone Research’s annual 2010 Securities Class Action Settlement Study. Cornerstone’s March 10, 2010 press release about the study can be found here, and the study itself can be found here.

 

Largely as a result of the decline in the number of mega-settlements, the average securities class action lawsuit settlement approved in 2010 declined to $36.3 million, compared to S37.2 million in 2009. Both of these figures are well the 1996-2009 average settlement of $54.8 million. Even if the post-Reform Act settlement average is "normalized" by excluding the top-three settlements during that era, the 2010 average is still below the adjusted 1996-2009 average of $38.8. (All historical averages are adjusted for inflation.)

 

The median average class action lawsuit settlement approved in 2010 increased to $11.3 million from a 2009 median of $8.0 million. This 40% increase represents the largest single year increase in the median settlement in the last ten years.

 

The sizeable gap between the averages and medians is a reflection of the presence of a few significant larger settlements During the post-Reform Act era, more than half of the securities class actions have settled for less than $10 million, about 80% have settled for under $25 million.. Only 7 percent of cases have settled for more than $100 million. Thus, "while large settlements tend to receive substantial attention, they tend to occur infrequently."

 

The Cornerstone study reports the number of securities class action lawsuit settlements approved during 2010 is the lowest in ten years. The "more likely cause" for this decline is combination of the substantial drop in the number of new securities class action lawsuit settlements and the fact that the credit-crisis suits have taken longer to settle. The average time to settlement for cases settled in 2010 was 4.1 years, compared to 3.9 years for the cases settled in 2009.

 

Obviously, the most significant factor with respect to the overall size of securities suit settlements is the overall amount of investor losses (although the proportionate relationship between the size of the settlement and the size of investor losses decreases as the size of "plaintiff-style" damages increases.)

 

There are a number of other lawsuit features that present statistically significant differences in the size of the settlements. First, cases involving accounting allegations are resolved with larger settlements than cases without accounting allegations. For example, cases involving a restatement settled during the 1996-2010 period settled for 3.9% of "plaintiff-style" damages, but cases without a restatement settled for 3.1% of those amounts. In addition, filings that do not involve accounting allegations are more likely to be dismissed than filings with accounting allegations.

 

The report goes on to observe that the increased complexity of cases involving accounting allegations means these cases may take longer to resolve, which may be a factor contributing to the increased interval between the filing date and the settlement date observed over time.

 

Second, the presence of public pension plans as lead plaintiffs is associated with higher settlements as well. Though this observation could be explained by these investors choosing to participate in stronger cases, the study reports that even controlling for observable factors that affect settlement amounts, "the presence of a public pension plan as a lead plaintiff is still associated with a statistically significant increase in settlement size."

 

Other lawsuit features that are associated with statistically significant settlement amounts are the presence of Section 11 and/or Section 12(a)(2) claims; the presence of a remedy of a corresponding SEC action; and the presence of companion derivative claims. On the latter point, the report notes that class actions accompanied by derivative actions tend to be associated with other factors important to settlement amounts, such as accounting allegations, the presence of related SEC action and the involvement of public pension fund plaintiffs.

 

The credit crisis cases have settled more slowly than "traditional cases." There have also been relatively few settlements of these cases to date, as well. Of the credit crisis cases that have settled so far, they have tended to settle for larger amounts (median settlements of $31.3 million and average settlements of $103.1 million) but for lower percentage of estimated "plaintiff-style" damages (3.2% on average compared to 4.9% for all cases). My compilation of all credit-crisis settlements can be accessed here.

 

Some readers may note slight variations between the averages and median settlement figures reported in the Cornerstone report compared to those reported elsewhere. Thought there are differences, the figures are directionally consistent. The differences may be due to a combination of timing and methodology. The Cornerstone report designates the settlement year as the year in which the hearing to approve the settlement was held. Cases involving multiple settlements are reflected in the year of the most recent partial settlement (subject to certain additional considerations).

 

Though all of the report’s findings are interesting and important and the report is well worth reading at length and in full, for me the most significant finding is the report’s conclusion about the dramatic increase in the size of the median settlement. Averages can be driven by outliers, but medians are more reflective of the overall direction of settlements in general.

 

The rapid increase in the median settlement amount has important implications for corporate insurance buyers as well as for their insurers, particularly at a time when costs of defense are also escalating rapidly. For buyers, the rising median settlement amount clearly has important implications for purposes of limits selection and limits adequacy. I think the unmistakable conclusion is that the questions of limits adequacy may now involve larger levels of insurance than may have been the case in the past.

 

For insurers, and particularly those insurers who more typically are involved in the excess layers, the rising median may have important implications for likely loss experiences. The clear implication is that higher attaching excess layers are increasingly likely to be called upon to participate in case resolution, particularly in light of rising costs of defense. Losses are likelier to push up into higher layers.