For the second time, a court has given investors leave to proceed and also certified a plaintiff class in a secondary market misrepresentations claim under the revised Ontario Securities Act. In an order dated March 1, 2011, Ontario Superior Court Justice Wolfram Tausendfreund granted leave to investors to proceed against Arctic Glacier Income Fund, its trustees and related entities and executives. A copy of Justice Tausendfreund’s order can be found here.

 

As discussed at length here, effective in 2005, Ontario revised its securities laws (in legislative provisions now generally referred to as Bill 198) potentially making it easier for disappointed investors to bring actions for civil liability against directors and officers of public companies for alleged secondary market misrepresentations.

 

Section 138.8 (1) of the revised Ontario Securities Act specifies, however, that a liability action cannot be commenced "without leave of court granted upon motion with notice to each defendant." The court is to grant leave only "where it is satisfied" that the action "is being brought in good faith" and there is a "reasonable　possibility" the plaintiff will prevail at trial.

 

In a "landmark" December 2009 ruling, discussed here, Ontario Superior Court Justice Katherine van Rensberg granted plaintiffs in the Imax securities class action lawsuit leave to proceed with their claims. Justice van Rensberg also granted the plaintiffs’ motion to certify a global class in that case. In a February 2011 order (discussed here), another Superior Court Justice denied the defendants’ motion for leave to appeal Justice van Rensberg’s rulings.

 

The March 1 ruling involved an action brought by investors who had purchased shares of the Arctic Glacier Income Fund. The Income Fund is an unincorporated mutual fund trust that is a reporting issuer in ten Canadian provinces. Interests in the Income Fund trade on the Toronto stock exchange. The Income Fund’s sole assets are shares of Arctic Glacier Inc., a corporation organized under Alberta law. The company and its wholly owned subsidiary, Arctic Glacier International, provide packaged ice to consumers in Canada and the United States.

 

In March 2008, the Income Fund announced that it had become aware of an U.S. Department of Justice antitrust investigation involving the packaged ice industry. In 2009, Arctic International pleaded guilty to a criminal, anticompetitive conspiracy in the U.S. In the plea agreement, Arctic International agreed to pay a US$9 million fine and admitted that it had participated in a conspiracy to suppress competition in the packaged ice business in Michigan between 2001 and 2007. Following the announcement of the investigation, Income Fund’s unit price declined. The plaintiffs initiated an action alleging that they had been misled in connection with the company’s alleged legal and regulatory compliance programs.

 

As required under the revised Ontario Securities Laws, the plaintiffs moved for leave to proceed. In order to determine whether or not the plaintiffs had met the statutory requirement in order to obtain leave – that is, that "there is a reasonable possibility that the action will be resolved at trial in favor of the plaintiff" – Justice Tausendfreund followed the analysis of Justice van Rensberg in the Imax case with respect to the requirements to meet this standard. After noting that he saw no reason to depart from her analysis, Justice Tausendfreund said that "the applicable standard is more than a mere possibility of success, but is a lower standard than a probability."

 

Justice Tausendfreund concluded that the plaintiffs had met this "leave test" under Section 138.8 and granted them leave to pursue statutory claims for misrepresentation in the secondary market. He also granted the plaintiffs’ motion to certify a class of all investors who had purchased the Income Fund units during the class period, declining the defendants’ request to narrow the class.

 

The significance of Justice Tausendfreund’s ruling is that now a second set of plaintiffs has been granted leave to proceed with a claim for secondary market misrepresentations under the revised Ontario Securities Laws. In addition, Justice Tausendfreund, like Justice van Rensberg in the Imax case, found that the showing required to satisfy the "leave test" is relatively low.

 

It would is possible to overgeneralize from just these two cases, but at least so far that the plaintiffs have been relatively successful in overcoming the initial procedural hurdles in pursing secondary market misrepresentation claims under the revised Ontario Securities Act.

 

In addition, the plaintiffs have also succeeded in having a broad class certified as well. The certification of a global class in the Imax case may be of greater significance, given that Imax shared traded on both the Toronto and New York stock exchanges, whereas the Arctic Glacial Income Fund shares traded only on the Toronto exchange. But nevertheless, the relatively low initial threshold for leave and the courts’ willingness to certify broad classes are positive developments for the plaintiffs in these cases, and may make the remedies available under the revised Ontario Securities Act more attractive to other claimants.

 

An interesting and detailed March 8, 2011 analysis of the Arctic Glacier decision by the Osler, Hoskin & Harcourt law firm can be found here. The law firm memo raises a number of interesting questions about the decision, particularly with respect to the class certificaiton ruling. A March 4, 2011 Globe and Mail article about the recent ruling can be found here.

 

We Are All One: In her fascinating article in the March 7, 2011 issue of The New Yorker entitled "The View from the Stands" (here) about soccer in Turkey, Elif Batuman reported the following comments of one fan of the Beşiktaş team about the team and its followers (who are known as Çarşi):

 

He characterized Beşiktaş as the team of the unexpected, the team of underdogs, and talked about Çarşi’s slogans, which are unveiled on giant banners during matches. “We are all Black,” proclaimed one banner, after rival fans had made references to the race of the French-Senegalese Beşiktaş star Pascal Nouma. When [competitior] Fenerbahçe disparaged a Beşiktaş manager whose father had been a janitor, there were banners saying “We Are All Janitors.” And when an international committee of astronomers removed Pluto from the list of planets Çarşi took up the cause: “We Are All Pluto.”

 

 

Among the questions that followed in the wake of the U.S. Supreme Court’s Morrison v. National Australia Bank decision has been whether and to what extent plaintiffs’ lawyers will resort to courts outside the U.S. to pursue securities claims on behalf of investors who purchased the defendant company’s shares outside the U.S. The action recently filed in the Netherlands on behalf of non-U.S. investors in Fortis presents shows that plaintiffs’ lawyers will be pursuing these claims.

 

A recent announcement involving prior Dutch settlements underscores that efforts to obtain recoveries outside the U.S. on behalf of non-U.S. investors have actually been underway for some time. The settlements show how parallel (or at least sequential) proceedings can resolve the claims of both U.S. and non-U.S. investors, respectively. These procedures, which have been used before in the same way, may afford a means by which all investors – including even non-U.S. investors – potentially may obtain recoveries, notwithstanding the constraints of Morrison.

 

On March 3, 2011, the Stichting Converium Securities Compensation Foundation issued a Hearing Announcement in connection with the settlements totaling $58.4 million on behalf of investors who purchased shares of Converium Holding AG between January 7, and September 2, 2004 and who did not purchase their shares on a U.S. exchange and who were not residents of the U.S. at the time they purchased their shares. The hearing, to be held on October 3, 2011 in the Amsterdam Court of Appeals, will determine whether or not the settlements will be held binding.

 

The Non-U.S. investor proceedings in the Netherlands follow the settlement of related proceedings the U.S. As discussed at length here, Converium investors first filed a securities class action in the Southern District of New York in October 2004. The plaintiffs alleged Converium and certain of its officers and directors, as well its corporate parent, Zurich Financial Services, had made misleading statements about Converium’s financial condition, including the adequacy of its loss reserves for its North American business during the class period. (Converium had spun out of Zurich in a 2001 IPO.)

 

In 2007, while the U.S. case was pending, SCOR Holding (Switzerland) acquired the voting rights of Converium pursuant to a tender offer.

 

In rulings dated March 6 and March 19, 2008 (refer here and here, respectively) Judge Denise Cote, applying pre-Morrison standards for determining the reach of the U.S. Securities laws, certified a class consisting of all persons who purchased Converium American Depositary Shares on the NYSE, and all U.S residents who purchased their Converium Shares on a non-U.S. exchange. Excluded from the class were investors who had purchased their shares on any non-U.S. exchange who were not U.S. residents at the time of their purchased.

 

The U.S. action ultimately settled for a total of $84.6 million, consisting of $75 million from SCOR and $9.6 million from Zurich. The Southern District of New York approved this settlement and entered final judgment on December 22, 2008.

 

As detailed here, in July 2010, two groups acting on behalf of the non-U.S. Converium investors entered settlement agreements with Scor and Zurich. The total amount of the two settlements is $58.4 million, of which $40 million is to come from SCOR and $18.4 million is to come from Zurich. The SCOR settlement agreement can be found here and the Zurich settlement agreement can be found here. The two groups acting on the investors’ behalf were Stichting Converium Securities Compensation Foundation, Dutch foundation formed for the purpose of seeking recoveries on behalf of the Non-U.S. Converium investors. Dutch investors in particular were represented by Vereniging VEB NCVB.

 

Pursuant to the Dutch Collective Settlement of Mass Damages Claims Act (known as WCAM), enacted in 2005, the parties then petitioned the Amsterdam Court of Appeals for approval of the settlement. An English translation of the parties’ petition, as amended, can be found here. The Act basically allows parties to seek court approval for collective settlement of mass actions entered for the benefit of class members who do not opt out.

 

On November 12, 2010, the Amsterdam Court of Appeals entered a provisional judgment acknowledging its right to recognize the settlements and scheduling a hearing for interested parties to appear and present their arguments with respect to the petition. Interestingly, the November 12 order specifically references the U.S. Supreme Court’s Morrison decision and the impact the decision has on the ability of Non-U.S. investors to pursue securities claims in U.S. courts. The hearing to determine whether the settlement agreements will be binding will take place on October 3, 2011.

 

These settlements represent the latest occasion when the new Dutch procedures have been used to reach settlements on behalf of non-U.S. investors in connection with securities claims that were also the subject of U.S. securities class action lawsuit claims and settlements.

 

The first and highest profile of these prior settlements was the $381 million settlement on behalf of non-U.S. Royal Dutch Shell investors. As discussed here, in May 2009, the Amsterdam Court of Appeals approved the settlement and authorized payment to Non-U.S. investors. The Dutch settlement followed an earlier settlement of a parallel U.S. securities class action lawsuit settlement on behalf of U.S. investors and arising out of the same factual allegations.

 

The Royal Dutch and the Converium settlements illustrate possible means by which, even in the wake of Morrison, non-U.S. investors can obtain recoveries for their investment losses. As plaintiffs’ attorneys cast about for alternatives for non-U.S. investors to pursue in the wake of Morrison, the use of settlements under the Dutch procedures may provide a possible remedy.

 

However, as Luke Green noted in a recent detailed post on the Risk Metrics Group Insights blog (here), there are a number of limitations on the usefulness of this Dutch procedure for investors seeking recoveries. First, only court authorized representatives can pursue claims on behalf of investors, and representatives cannot seek damages. Rather, the Dutch courts can only certify the class and approve out of court settlements. Green also notes that absent a chance in EU regulations, the class representative may have difficulty enforcing the settlement outside the Netherlands. A detailed discussion of the potential conflict between the Dutch Act and the laws of other jurisdictions can be found here.

 

In the circumstances where there is no prior U.S.-based settlement or U.S. action to provide both leverage and a path to settlement, the non-U.S. investors will have to try another approach – as was the case for the Fortis investors who recently filed an action in the Netherlands in which they seek to assert claims on behalf of investors who affirmatively joined the action. Of course, it remains to be seen how successful that approach will be.

 

In the meantime, it seems probable that investors will continue in the wake of Morrison to explore jurisdictional alternatives, in the Netherlands and elsewhere. As I recently noted (here), Canada could represent yet another alternative, at least to the extent the recent Ontario court certification of a global class in the Imax securities class action proves to represent the potential reach and applicability of the Ontario securities laws. Developments in yet other jurisdictions could present additional possibilities.

 

In any event, it is probably worth noting that post-Morrison, the class certified in the U.S. action would not have included the U.S. residents who purchased their Converium shares outside the U.S. Following Morrison, several district courts have ruled (e.g., refer here) that the claims of these so-called "f-squared" investors are outside the ambit of the U.S. securities laws. These investors would essentially be in the same boat with the non-U.S. investors who purchased their shares outside the U.S.

　

Is the SEC Targeting Outside Directors?: A March 3, 2011 memo from the Haynes and Boone law firm entitled "SEC Enforcement: Spolighting Outside Directors" (here) takes a look at a recent SEC enforcement action that specifically targeted outside directors for their allegedly failure to fulfill their responsibilities as Board member at a company that engaged in fraudulent misconduct.

 

The memo suggests that although the specific case involved "egregious" misconduct, the SEC’s actions signal "a new willingness to prosecute those directors who disregard or neglect their duties." The memo suggests a number of lessons from the case, including in particular that outside directors must respond to "red flags."

 

Another Sarbanes-Oxley Clawback Action: In a separate March 3, 2011 action (here), the SEC also entered a negotiated settlement with the former CEO of Beazer Homes, in which the CEO agreed to reimburse the company $6.4 million in cash and also various company securities the CEO had received as part of his incentive bonus compensation during 2006. The SEC alleged that the company had filed fraudulent financial statements during the period for which the CEO had been awarded the bonus compensation.

 

The SEC had asserted its right to compel the return (or to "clawback") the bonus compensation under Section 304 of the Sarbanes Oxley Act. Under Section 304, it is not necessary for the individual target to have participated or even to have been aware of the conduct resulting in the company’s misstatement. The Beazer Homes CEO neither admitted nor denied the SEC allegations.

 

This is not the first time the SEC has used Section 304 to clawback compensation. As noted here, the SEC has previously sought to clawback compensation from the CEO of CSK Auto. The SEC also previously entered a clawback settlement with the CEO of Diebold (refer here).

 

As I noted in a prior post (here), these kinds of clawback actions present a host of complex D&O coverage issues. In any event, we are likelier to see more clawback actions in the future, in light of the expanded clawback requirements in the Dodd-Frank Act.

 

Academy Awards Retrospective: In the academy awards ceremony last week, The King’s Speech carried away a host of trophies. And perhaps appropriately so. It is an entertaining movie with excellent acting. And as I noted in an earlier post when I saw it, the movie made excellent use of music.

 

But I agree with Joe Queenan’s February 20, 2011 column in the Wall Street Journal. For all of its finery and as good as it is, The King’s Speech is a formulaic movie. As at least one Internet reviewer before me has observed, it is The Karate Kid with a British accent and better costumes. Take nothing away from Colin Firth, who was excellent, but were it not for our general enchantment with British royalty, this movie would not likely have swept the statuettes.

 

For my money, True Grit was the best movie of the year. If you saw the movie, you will recall the dreamlike sequence after Rooster Cogburn rescues Mattie and races through the night on horseback to try to get her medical attention. An absolute stunning visual sequence that was all the more remarkable because you didn’t notice it until you thought about it later.

 

Not only that, but Haille Steinfeld deserved the Oscar for best supporting actress. Anyone who can portray a 14 year old hung upside down in a cave filled with a decaying corpse and poisonous snakes and manage to convey simultaneously both terror and a sense of self-control has to win the award. And if you really want to appreciate how fantastic Haille Steinfeld was as the most recent version of Mattie, you should see how Kim Darby in the same role in the older version absolutely killed the movie. (I ask you, how could anyone play Mattie as a whiny simp?)

 

I am sure that like me many viewers enjoyed the unusual characters, odd but amusing dialog and unexpected plot of True Grit. The recent version of the movie more faithfully reproduced the feel of the novel on which the movie was based. Charles Portis wrote book. I know this because Portis wrote another book which I would argue is one of the funniest books out there.

 

Ten years after he wrote True Grit, Portis published The Dog of the South, which is the story Ray Midge’s headlong plunge from Little Rock into Mexico and then Belize. Midge is chasing his friend, Dupree, who ran off with Midge’s wife and took his car. And Midge wants his car back. It would be hard to quickly summarize Midge’s meandering quest and the oddball assortment of characters he encounters. The book is full of curious observations and busted bicycle wheel conversations that somehow make sense and are always funny (albeit often incorrect politically). Here’s a short excerpt to give a flavor of the book:

 

In South Texas I saw three interesting things. The first was a tiny girl, maybe ten years old, driving a 1965 Cadillac. She wasn’t going very fast, because I passed her, but still she was cruising right along, with her head tilted back and her mouth open and her little hands gripping the wheel

 

Then I saw an old man walking up the median strip pulling a wooden cross behind him. It was mounted on something like a golf cart with two-spoked wheels. I slowed down to read the hand-lettered sign on his chest. "Jacksonville Fla or Bust."

 

I had never been to Jacksonville but I knew it was the home of the Gator Bowl and I had heard it was a boom town, taking in an entire county or some such thing. It seemed like an odd destination for a religious pilgrim. Penance maybe for some terrible sin, or some bargain he had worked out with God, or maybe just a crazed hiker. I waved and called out to him, wishing him luck, but he was intent on his marching and had no time for idle greetings. His step was brisk and I was convinced he wouldn’t bust.

 

The third interesting thing was a convoy of stake-bed trucks all piled high with loose watermelons and cantaloupes. I was amazed. I couldn’t believe that the bottom ones weren’t being crushed under all that weight, exploding and spraying hazardous melon juice onto the highway. One of nature’s tricks with curved surfaces. Topology! I had never made it that far in my mathematics and engineering studies, and I knew now that I never would, just as I knew that I would never be a navy pilot or a Treasury agent. I made a B in Statics but I was failing in Dynamics when I withdrew from the field. The course I liked best was one called Strength of Materials. Everybody else hated it because of all the tables we had to memorize but I loved it. I had once tried to explain to Dupree how things fell apart from being pulled and compressed and twisted and bent and sheared but he wouldn’t listen. Whenever that kind of thing came up, he would always say – boast, the way those people do – that he had no head for figures and couldn’t do things with his hands, slyly suggesting the presence of finer qualities.　

　

In the fifth FDIC lawsuit against former directors and officers of failed banks as part of the current bank wave, on March 1, 2011, the FDIC as receiver for the failed Corn Belt Bank and Trust Company filed suit in the Central District of Illinois federal court against four former officer and directors of the bank, seeking to recover losses of at least $10.4 million.. A copy of the FDIC’s latest complaint can be found here.

 

According to the Complaint, examiners began criticizing the bank’s lending practices as early as 2003. The Complaint alleged that between 2003 and 2008 the bank "failed to address recurring criticisms by examiners regarding imprudent lending practices," and April 2, 2007, the bank entered a memorandum of understanding (MOU) with examiners. In November 2008, after the bank failed to comply with the MOU, the FDIC issued a cease and desist order. The bank ultimately failed on February 13, 2009.

 

The lawsuit itself is failed against the four members of the bank’s loan committee. These four individuals include the bank’s CEO, its chief lending officer and two outside directors. The complaint alleges that the four defendants "failed to adequately inform themselves of the relevant risks and acted recklessly in approving one or more of five high-risk commercial loans."

 

The five loans, all of which were made between 2005 and 2007 and all of which related to the long-haul trucking business, allegedly were "improperly underwritten and extended 100 percent financing to out of state, start-up businesses, and were primarily secured by rapidly depreciating semi-tractors." The complaint further alleges that the CEO and Chief Loan officer unilaterally funded the fifth of the five loans after the loan committee tabled its approval, and they failed to unsure that the loans were properly administered.

 

The complaint alleges that the defendants’ alleged conduct was "particularly egregious" because they approved one or more of the five loans "after Bank examiners repeatedly warned the Bank that it suffered from weak loan administration, and that it was facing risks posed by out of area lending, high loan-to-value ("LTV") loans, and excessive exposure to loan concentrations within its loan portfolio." All five of the loans at issue allegedly shared these characteristics.

 

The complaint alleges gross negligence under FIRREA and negligence under Illinois law against the four individuals for approving the loans. The complaint also specifically alleges gross negligence under FIRREA and negligence under Illinois law against the former CEO and the former chief lending officer in connection with the approval of the fifth of the five loans. Finally, the complaint alleges gross negligence under FIRREA and negligence under Illinois law against the former CEO and former chief lending officer for failing to properly administer the loans and for failing to protect the bank’s security interest in the collateral.

 

The FDIC’s complaint against the four former Corn Belt officials is just the fifth complaint filed so far as part of the current bank wave, and first since the FDIC filed two complaint’s the same day in January 2011. It is the second of the five to be filed against officials of a failed bank that had been based in Illinois. The complaint is interesting because it not only names the two bank officers as defendants, but it also names two outside directors who had served on the bank’s loan committee, as well.

 

Like the four prior lawsuits the FDIC filed as part of the current wave of bank failures, this lawsuit was filed over a year after the institution itself failed. Although the FDIC’s motivations can only be inferred, it appears that what may have provoked this suit is what the FDIC attempted to describe as the defendant’s "particularly egregious" conduct of having approved these particularly loans in the fact of examiners’ warning about loans sharing the characteristics of the five loans at issue.

 

In the Professional Liability Litigation page on the FDIC’s website (here), the FDIC has said, as of its last update, that it has approved lawsuits against a total of 130 individuals. The four previous lawsuits that had been filed named a total of 35 individuals as defendants. With the addition of the four individuals named as defendants on the Corn Belt lawsuit, a total of 39 individuals have now been named as defendants, suggesting that lawsuits to be filed against 91 additional individuals remain pending. Of court, the total number of individuals against who lawsuits have been authorized is likely to continue to grow as well.

 

My table of the lawsuits the FDIC has filed against former directors and officers of failed banks as part of the current failed bank wave can be accessed here.

 

Special thanks to a loyal reader for alerting me to the Corn Belt lawsuit.

　

　

A frequent component of derivative litigation resolution is an award to the plaintiffs of the fees and expenses the plaintiffs incurred in pursuing the suit. A contentious, recurring question is whether D&O insurance covers fee awards to derivative litigation plaintiffs. This issue received a through going over in a February 17, 2011 opinion from a five judge panel of the New York Supreme Court, Appellate Division.

 

In the opinion (here), a three-judge majority held, over the dissent of two judges, that a $8.8 million derivative plaintiffs’ fee award was covered under Loral Space & Communications D&O insurance policy, but all five judges held unanimously that the D&O policy did not cover the separate $10.7 million awarded for plaintiffs’ fees in a related action seeking damages for breach of fiduciary duty.

 

Background

The coverage suit arises out of litigation filed after Loral agreed to enter a financing transaction with MHR Fund Management. In the transaction, MHR agreed to provide Loral $300 million in exchange for convertible preferred stock Loral was to issue to MHR.

 

Two lawsuits ensure. First, a BlackRock fund filed a shareholders’ derivative action seeking to rescind the deal. Second, Highland Crusader Offshore Partners filed a damages action. Both actions alleged Loral had breached its fiduciary duty because the value to MHR of the proposed deal allegedly far exceeded $300 million.

 

The cases were consolidated. Following a trial, the Delaware Chancery Court concluded that the transaction was unfair to Loral, and reformed the deal terms so that MHR would receive nonvoting common stock rather than convertible preferred stock. The court awarded no damages and made no findings of fault.

 

Concluding that the plaintiffs’ actions had produced a substantial benefit for Loral, and applying the corporate benefit doctrine, the Court entered a fee award to BlackRock of $8.8 million and entered a fee award to Highland of $10.7 million. Loral paid these amounts and then sought coverage under its D&O insurance policy for the payments.

 

Loral’s D&O insurer denied coverage and commenced an action seeking a judicial declaration that their policy did not cover the plaintiffs’ attorneys’ fee awards. The trial court denied the insurer’s motion for summary judgment and granted summary judgment in Loral’s favor. The insurers appealed.

 

The February 18 Order

On appeal, the insurers argued that the Highland fee award was not covered because the Highland action for damages was not a "securities claim" and therefore there was no coverage under the policy for any amount related to that action. The insurers argued that the BlackRock fee award was not covered because the BlackRock litigation produced a benefit for Loral and therefore the fee award did not represent covered "Loss since it was a cost the company incurred as part of procuring the benefit.

 

The five-judge panel unanimously agreed that there was no coverage for the $10.7 million Highland fee award, because the Highland damages action was neither a derivative suit nor did it allege violation of any securities law, and therefore it did not represent a securities claim as was required to bring the claim within the Policy’s coverage.

 

The panel split badly on the question whether or not the fee award in the BlackRock derivative action was covered under the D&O policy. The three-judge majority concluded that it was. Its reasoning turned it part on the policy’s definition of "Loss," which provides that "Loss" includes "damages, judgments, settlements or other amounts (including punitive or exemplary damages where insurable by law) and Defense Expenses in excess of the Retention that the Insured is legally obligated to pay."

 

The majority rejected the insurers’ argument that because the derivative suit produced a benefit for Loral, Loral had not suffered a "Loss." The majority perceived this argument as essentially a suggestion that the fee award should be offset against the nonmonetary benefit Loral received as a result of the restructured transaction. The majority found that while Loral received a benefit in that it no longer suffered the detriment that would have followed from the transaction as originally structured "it does not follow that Loral actually made a tangible profit."

 

The attorneys’ fee award, the majority found, "constitutes damages" and representing "other amounts" that Loral has become "legally obligated to pay" and therefore comes within the Policy’s definition of "Loss." The majority also noted that the Policy expressly covers derivative lawsuits and that "to declare that Loral has no coverage for derivative plaintiffs’ attorneys’ fees would deprive Loral of the coverage for derivative lawsuits that it paid for and expected to receive."

 

The dissent objected to the majority’s conclusion about the derivative fee award. First, the dissent argued that the "legally obligated to pay" language in the definition of Loss followed and referred to "the Retention," not to "other amounts."

 

The dissent also argued that in order for the derivative fee award to be covered, it would have to represent "an actual loss, not an expense or the cost of doing business." The dissent reasoned that in this case, Loral "did not sustain a loss but rather benefitted from the judgment."

 

A fee award a derivative suit, the dissent observed, represents "the equitable entitlement of the successful derivative plaintiff to recover the expenses of his/her attorneys’ fees from all the shareholders of the corporation on whose behalf the suit was brought." The dissent observed that "if not spreading the cost of attorneys’ fees sounds in unjust enrichment, the obvious corollary is that shifting the cost to shareholders as a group cannot be characterized as a loss."

 

Discussion

The insurers in this case did not come away empty, as the appellate court unanimously agreed that because there was no coverage under the policy for the Highland damages claim, the $10.7 million Highland fee award was not covered under the Policy.

 

This holding was not preordained as at least one court has recently held that a fee award can represents damage for which there can be coverage under a D&O policy even if there is no coverage under the policy for the underlying litigation. In a February 9, 2010 ruling (here), the District of Minnesota held that a derivative lawsuit fee award represented "damages" and could be covered under a D&O insurance policy even where the underlying claim itself was not covered under the policy.

 

With respect to the question of coverage for the BlackRock derivative fee award, the insurers did manage to persuade two of three judges that because of the nature of the outcome of the underlying case and the nature of the derivative fee award, the award did not represent a loss to Loral and therefore is not covered under the policy.

 

The narrowness of split between the majority and the dissent on this issue suggests that this dispute is far from resolved. Even just in this case, there seems a substantial likelihood for further appellate proceedings in the New York Court of Appeals. And in general, given the close split, the underlying issue is likely to continue to be debated in other cases.

 

The carriers assert their position on these issues with conviction. Policyholders find the insurers’ rationale on this issue obscure and unpersuasive (those are among the milder adjectives, actually) – although obviously the insurers were able to persuade two judges of the appellate court of their position, so clearly there is something to their position on this issue.

 

The danger for all involved is that this issue will continue to come up over and over again. A colleague in the industry suggested to me in a note about the Loral case that eventually this issue may have to be addressed in the policy, along the lines of the way the industry developed a policy solution to the contentious issue that Section 11 settlements were not covered under the Policy. The way the industry addressed that issue is that it became standard to include in public company D&O policies language stating that the insurer would not take the position that a settlement of a ’33 Act case was not covered under the Policy. Perhaps, the colleague suggested, the industry will adopt a similar approach on this derivative lawsuit fee award issue.

 

I am interested in readers’ thoughts on these issues. I hope readers will add their observations to this post, using the blog’s comment feature.

 

Many thanks to the several readers who sent me a copy of the Loral decision.

 

I am Word Power: In a column in the February 28, 2011 issue of The New Yorker entitled "Who Am I" (here), Demetri Martin wrote "I am bravery. I am courage. I am valor. I am daring. I am holding a thesaurus."

 

Securities lawsuits rarely go to trial, but on February 24, 2011, just three months after the last securities suit trial concluded, a Central District of California rendered a verdict on behalf of plaintiffs against the sole trial defendant, the former CEO of the defunct Homestore company. The jury found that the defendant, Stuart H. Wolff, had violated the federal securities laws in connection with a series of statements the company made in 2001.

 

A copy of the jury verdict form can be found here. The court’s trial minutes for jury verdict can be found here. The February 25, 2011 press release about the verdict from the lead plaintiff, the California State Teachers’ Retirement System (CalSTRS), can be found here.

 

As detailed further here, investors first filed a securities class action lawsuit against the company and certain of its directors and officers in December 2001. CalSTRS was named as lead plaintiff in March 2002. Subsequent amended complaints named additional defendants, including the company’s auditor and certain other outside companies and entities.

 

Essentially, the plaintiffs alleged that the company had engaged in a scheme to create a circular flow of money through a series of roundtrip financial transactions whereby money flowed from Homestore to outside firms and then back to Homestore. Through these transactions, the company allegedly was able to represent itself as a successful and growing company. The company was later forced to restate more than $120 million in revenue.

 

During the course of the long and complicated procedural history of this case, a number of the defendants were dismissed out of the case, while other defendants, including the company itself, certain individual defendants, and the company’s outside auditor, entered into a series of settlements with the plaintiffs. On January 25, 2011, a civil jury trial commenced against the sole remaining defendant in the case – Stuart H. Wolff, the company’s former Chairman and CEO.

 

The jury returned its verdict on February 24, 2011. The Special Jury Verdict Form is very detailed and somewhat challenging to interpret. Basically, it appears that of the 22 allegedly misleading company statements on which the plaintiffs relied, the jury concluded ten were materially misleading. Of these, the jury found that Wolff was involved in the preparation of five of the statements, and that his involvement in those statements was knowing or reckless.

 

The jury also found with respect to four additional knowing or reckless misrepresentations that Wolff was responsible for the person making the statement, and therefore with respect to those four statements Wolff was subject to control person liability.

 

With respect to the question of damages, the jury found that a number of other company officials as well as Wolff were responsible, but in each case Wolff’s responsibility was 50% or greater. The jury also calculated the per share price inflation that resulted from each misrepresentation for which Wolff was responsible, in several cases calculating the inflation four places to the right of the decimal.

 

In its press release, CalSTRS said only that "the exact amount of damages is being calculated."

 

In some respects, the outcome of this jury trial may come as no surprise. In April 2010, Wolff was sentenced to four and a half years in prison after pleading guilty to conspiracy to commit securities fraud in connection with the company’s allegedly deceptive financial reporting. Wolff is incarcerated in the federal penitentiary in Lompoc, California, although he was transferred to facilities in Los Angles for the recent civil trial.

 

In addition, in December 2010, Wolff reached an $11.9 million agreement with the SEC, settling allegations that he had inflated the company’s reported revenues. As part of that settlement, Wolff did not admit to the SEC’s securities fraud allegations.

 

In light of these prior developments, the recent jury verdict may not be that surprising. But what is surprising is that the case went all the way to a jury trial at all. Trials in securities class action lawsuits are exceedingly rare, although there have been a rash of jury verdicts in recent months.

 

According to data compiled by Adam Savett, the Director of Securities Class Actions at the Claims Compensation Bureau, prior to the recent verdict against Wolff in the Homestore case, there had been a total of ten securities class action lawsuits filed after the 1996 enactment of the Private Securities Litigation Reform Act and involving post-PSLRA conduct that have gone to all the way through to jury verdict. In other words, the verdict against Wolff is just the eleventh verdict in a post-PSLRA securities class action lawsuit.

　

With the plaintiffs’ verdict against Wolff in the Homestore case, the securities class action jury verdict scoreboard (taking into account post-verdict proceedings and reflecting only the current status of post-verdict proceedings) is as follows: Plaintiffs 7, Defendants 4. (The scoreboard is subject to revision pending the outcome of additional proceedings in several of the cases.)

 

These numbers convey how rare securities lawsuit trials are. It is worth noting that the verdict in the Homestore case is the third in just thirteen months, coming as it does just three months after the verdict in the BankAtlantic case (about which refer here) and thirteen months after the verdict in the Vivendi case (refer here). My friends in the plaintiffs’ bar will undoubtedly be quick to point out that all three of these cases resulted in verdicts for the plaintiffs as well.

　

The histories of prior securities cases that have gone to trial show that verdicts in these cases are subject to extensive post-trial procedures. Indeed, just last week the Court in the Vivendi case entered an order substantially narrowing the scope (and value) of the plaintiffs’ verdict in that case. In all likelihood, there will be further developments in the Homestore case, particularly given the case’s long procedural history.

 

In addition to the prospect for post-trial procedural developments, the parties to the Homestore case also face a rather daunting challenge of trying to interpret and calculate the effect of the jury’s findings on damages. The combination the jury’s findings about Wolff’s proportionate level of responsibility and of its findings about the respective levels of per-share price inflation will require, in order to arrive at a precise dollar figure for damages, mathematical calculations approaching in terms of complexity the formulae used for calculating planetary motions.

 

.　

 

On February 26, 2011, Berkshire Hathaway issued Chairman Warren Buffett’s much-anticipated annual letter to the company’s shareholders (here). Although aficionados of Buffett’s letters will not be disappointed, this year’s letter is largely focused on Berkshire’s performance and has fewer excursions into larger topics than in past years. (Full disclosure: I own BRK.B shares, although not as many as I wish I did.)

 

Overview

Perhaps even more than in prior years, the 2010 letter sets out a detailed analysis of Berkshire’s long-term performance, opening with a detailed review of Berkshire’s history compared to that of the S&P 500. (Interestingly enough, Berkshire failed to outperform the S&P 500 for the last two years in a row, the first time in Berkshire’s history that has happened.) Buffett then moved on to a review of Berkshire’s performance during 2010. Although Buffett addresses Berkshire’s investment performance, his devotes greater space to detailing the annual performance of Berkshire’s operating companies.

 

Because Berkshire often is perceived essentially as an insurance holding company, he takes considerable pains to highlight the relative performance of Berkshire’s noninsurance businesses, particularly Burlington Northern Santa Fe, for which Berkshire paid about $27 billion last February in the company’s largest ever acquisition. Buffett called the railroad’s performance "the highlight of 2010" and commented that it is working out "even better" than expected. The railroad generated operating earnings of $4.5 billion and net earnings of $2.5 billion.

 

With respect to the company’s insurance businesses, Buffett returns to several themes that will be familiar to those who have followed his letters over the years.

 

First, he emphasizes how elusive underwriting profitability has been for many insurers. Though Berkshire’s insurance businesses have, Buffett emphasizes, produced "an underwriting profit for eight consecutive years" and an underwriting gain of $17 billion during that period, underwriting profitability "is not an outcome to be expected of the P/C industry as a whole." (He compares, by way of example, Berkshire’s $17 billion of underwriting profit over the last 8 years to State Farm’s more than $20 billion underwriting loss during the same period.)

 

As a result, "the industry’s overall return on tangible equity has for many decades fallen far short of the average return realized by American industry, a sorry performance almost certain to continue."

 

The reason for the industry’s poor performance, Buffett comments, is that too many insurers forget one of the critical insurance disciplines, which is "the willingness to walk away if the appropriate premium can’t be obtained." The reasons for this recurring failure are that "the urgings of Wall Street, pressures from the agency force and brokers, or simply a refusal by a testosterone-driven CEO to accept shrinking volumes has led too many insurers to write business at inadequate prices."

 

Because so much of Buffett’s letter is a celebration of the company’s many success stories, it stands out when Buffett acknowledges a rare defeat. In this letter, Buffett acknowledges that from the perspective of its financial results, NetJets has been a "failure," and is Berkshire’s "only major business problem." Buffett does not acknowledge the many prior letters in which he had previously praised the company and its prior management. However, he does assert that under its new management, the company is turning around.

 

This Year’s Homily

Buffett’s letter would not be representative of type without an essay on broader topics. Though there is less of that in this year’s letter, Buffett still does manage to work in some commentary on the topic of "leverage," selecting as the text for his homily a letter his grandfather Earnest send to Buffett’s Uncle Fred in 1939.

 

Buffett notes that while debt usually can be refinanced, it sometimes happens that "maturities must actually be met by payment," for which "only cash will do the job." Credit, Buffett reflects, is "like oxygen" – that is, "when either is abundant, its presence goes unnoticed. When either is missing, that’s all that is noticed."

 

The lesson of all this for Berkshire is illustrated in Earnest’s letter to Uncle Fred, in which Earnest gave Fred and his wife $1,000 to hold as a safety reserve. (Earnest’s letter, reproduced at page 23 of the shareholder’s letter, is interesting in many ways, not least because of the immense wealth that Earnest’s grandson went on to accumulate later on.)

 

Taking the necessity for a "reserve" as an operating imperative, Buffett explains that Berkshire will always hold at least $10 billion in cash and customarily keep at least $20 billion at hand so that the company can "withstand unprecedented insurance losses" and can "quickly seize acquisition or investment opportunities, even during times of financial turmoil."

 

By conserving cash and avoiding leverage, as well as by retaining and reinvesting earnings, Berkshire has grown its net worth from $48 million to $157 billion in four decades. Though being so cautious about leverage has penalized the company’s returns, it "lets us sleep at night." And perhaps more importantly, "during the episodes of financial chaos that occasionally erupt in our economy, we will be equipped both financially and emotionally to play offense while other scramble for survival." Indeed it was this very circumstance that "allowed us to invest $15.6 billion in 25 days of panic following the Lehman bankruptcy in 2008."

 

Those Telling Asides

Readers familiar with Buffett’s past letters will know that among his letters’ most rewarding features are his occasional asides, where he pauses to make humorous or aphoristic observation. There are fewer purely humorous asides in this year’s letter, but there are the usual share of aphorisms and anecdotes, as noted below.

 

First, Buffett is long on America’s prospects. Though conceding that Berkshire’s businesses will expand abroad, "an overwhelming part of their future investments will be at home," explaining that "money will always flow toward opportunity, and there is an abundance of that in America." He adds that the country’s "human potential" is "far from exhausted," observing that "the American system for unleashing that potential – a system that has worked wonders for over two centuries despite frequent interruptions for recessions and even a Civil War – remains alive and effective." Buffett note that "as in 1776, 1861, 1932 and 194, America’s best days, according to Buffett, "lie ahead."

 

Second, in emphasizing the level of Berkshire’s directors’ stewardship commitment, Buffett stresses that "we do not provide them directors and officers liability insurance, a given at almost every other large public company. If they mess up with your money, they will lose their money as well." (Though Buffett highlights this approach to D&O insurance as a corporate strength, don’t expect this practice to catch on widely. No other company can offer an indemnification commitment as substantial as Berkshire’s. Nor could any insurer make an insurance commitment as financially substantial as Berkshire’s indemnification undertaking. Buffett’s views on D&O insurance reflect a unique set of circumstances.)

 

Third, with respect to our country’s shared goal of home ownership, Buffett observes that "all things considered, the third best investment I ever made was the purchase of my home, though I would have made far more money had I rented and used the purchase money to buy stocks." (His two best investments were, he says, "wedding rings.") But the American dream can become "a nightmare if the buyer’s eyes are bigger than his wallet and if a lender – often protected by a government guarantee – facilitates his fancy." Our goal should not be to put families in the house of their dreams, "but rather to put them in a house they can afford."

 

Fourth, Buffett argues that net income is a "meaningless" number for Berkshire, because it is so susceptible to the timing of Berkshire’s realization of investment gains or losses. Buffett expresses "deep disgust" for the "game playing" some managers use to manipulate net income, "a practice that was rampant throughout corporate America in the 1990s and still persists, though it occurs less frequently and less blatantly than it used to."

 

Buffett urges Berkshire shareholders to "ignore our net income figure, suggesting that "operating earnings, despite having some shortcomings, are in general a reasonable guide as to how our businesses are doing."

 

Finally, Buffett takes on the Black-Scholes valuation method, arguing that it "produces wildly inappropriate values when applied to long-dated options." Its appeal of course is that the method "produces a precise number." But that precision is illusory, as it suggests values that are more appropriately estimated can be pinpointed with accuracy.

 

Buffett concludes that the practice of teaching Black-Scholes as "revealed truth" needs reexamination, particularly since "you can be highly successful as an investor without having the slightest ability to value an option." What you need to know is "how to value a business."

 

Discussion

Buffett’s latest annual letter sounds many familiar themes. Indeed many of this year’s points of emphasis have appeared (in some cases, many times) in prior letters. I doubt there is a single Berkshire shareholder unfamiliar with the stories of Buffett’s initial investments in GEICO and the Berkshire Hathaway textile firm, which Buffett recounts again in this year’s letter. At times, the 2010 letter reads like a collection of Buffett classics.

 

Of course, what makes him Buffett is the extent to which he has across the years honored his conservative investment principles, as a result of which it is entirely appropriate that Buffett has once again rehearsed the lessons of his lifetime of investing.

 

But the annual letter is so anticipated because of the insights Buffett has expressed over the years about the economy, about the financial marketplace, and even about life. On that score, this year’s letter is a little disappointing. His criticism of the Black-Scholes method, for example, is modest compared, for example to his attack in his 2002 letter on derivative securities as "weapons of financial mass destruction" or his withering criticism in his 2006 letter of "the 2-and-20 crowd" of hedge fund managers.

 

One problem Buffett now has is that his company is getting so huge and diverse. Just summarizing the past year’s results of Berkshire’s increasingly numerous operating businesses is a much more space-consuming task than just a few years ago. (I was stuck by the number of apparently sizeable companies Buffett mentions in his letter that I have never even heard of, even though I have been a Berkshire shareholder for years and have followed the company closely. There are even more Berkshire companies, also quite sizeable, that Buffett never mentions.)

 

Indeed, one of the striking aspects of Buffett’s letter is the extent to which Berkshire’s various businesses have become integral components of American commerce. It is not just the diversity of companies Berkshire encompasses, it is the significance of the companies to the entire economy – for example, BNSF moves more freight than any other railroad, and Mid-America is the largest electrical supplier in three states.

 

In the end, Buffett can perhaps be excused if he comes off as a little repetitive. He has not only made himself and Berkshire’s shareholders wealthy, but he has also built an extraordinary company that survived the economic crisis, profited from the downturn, and emerged stronger than ever. His track record, underscored in the table in his letter comparing Berkshire’s and the S&P 500’s performance over five year intervals since the mid-60s, is striking.

 

If Buffett’s latest letter lacks the entertainment value of some prior letters, for Berkshire shareholders the letter more than makes up for that with the level of the company’s performance. Berkshire’s 2010 earnings of $13 billion were up 61% from the year before. At year end, the company had $38 billion in cash. Its businesses are generating about $1 billion a month in cash.

 

Yet Buffett, in typical fashion, emphasized that given the company’s size, it is unlikely to reproduce prior results. "The bountiful years, we want to emphasize, will never return. The huge sums of capital we currently manage eliminate any chance of exceptional performance."

 

Buffett’s confidence in the future of America is reassuring. But the reference to the future inevitably leads to consideration of Berkshire’s own future, in light of Buffett’s age (80). Without acknowledging the issue directly, Buffett addresses the concern both in his lengthy discussion of the managers of various Berkshire businesses – particularly David Sokol, who is engineering the NetJets turnaround while managing Mid-American – and in his discussion of the thought process behind the selection of Todd Combs as an investment manager for Berkshire.

 

Berkshire, Buffett seems to be suggesting, will remain in good hands. Berkshire’s shareholders can hope that for the company as well as for our country, the future is bright.

 

Water Works In his interesting essay "How Skyscrapers Can Save the City" in the March 2011 issue of The Atlantic (here), Edward Glaeser observes that "One curse of the developing world is that governments take on too much and fail at their main responsibilities. A country that cannot provide clean water for its citizens should not be in the business of regulating film dialogue." It is also true that most governments that successfully provide clean water to all of their citizens don’t try to regulate film dialog. The provision of clean water could be the ultimate test of governmental efficacy as well as the key to political freedom.　

　

Though 2010 was a "turnaround" year for banks, the number of problem institutions continued to increase  during the year, according to the FDIC’s Quarterly Banking Profile for the fourth quarter of 2010. A copy of the FDIC’s February 23, 2011 press release about the report can be found here, and the Quarterly Banking Profile itself can be found here.

 

The FDIC defines a problem institution as one the agency has rated as a 4 or 5 on a 1 to 5 scale of ascending regulatory concern. Problems institutions are those with financial, managerial or operational weaknesses that threaten their continued viability. The FDIC does not publish the names of the institutions that it defines as problem institutions.

 

Of the 7,667 institutions that were federally insured as of December 31, 2010, the FDIC rated 884 as problem institutions, or about 11.5% — or one out of nine — of all banks in the country. These problems banks represented $390 billion in assets. These year end 2010 figures compare with the 702 banks rated as problem institutions at the end of 2009, representing $402 billion in assets.

 

The year-end 2010 tally of problem banks is not only up from the end of 2009, it is also up from the end of the third quarter of 2010. There were 860 problem institutions as of September 30, 2010, representing $379 billion in assets.

 

Though the number of problem institutions has continued to increase, the rate of increase has slowed. The FDIC noted in its press release that the rate of increases in the number of problem institutions has declined in each of the last four quarters.

 

The number of problem institutions as of the end of 2010 is the largest number of problem institutions since March 31, 1993, when there were 928.

 

The number of problems institutions has continued to grow even as the number of bank failures has continued to mount, which has the effect of reducing the number of institutions rated as problems. The 157 bank failures in 2010 were the highest number of bank failures since 1992 (when 181 banks failed.) Though the FDIC stated in its press release that it expects 2010 to be the high water mark of the current bank failure wave, 22 additional banks have failed already in 2011, putting this year’s bank closure pace ahead of last year’s.

 

Overall, however, the news in the Quarterly Banking Profile was relatively good. The FDIC characterized 2010 as a "turnaround" year, one in which the banking industry reported four consecutive quarters of positive income. The industry’s fourth quarter aggregate profit of $21.7 billion represented a $23.5 billion increase from the industry’s $1.8 billion loss in the year prior quarter. Almost two thirds of reporting institutions reported improvements in quarterly net income from a year ago. Much of the improvement in earnings is attributable to reductions in provisions for loan losses.

 

The DealBook blog’s summary of the FDIC’s report can be found here.

 

More Investors Opting Out?: Luke Green has an interesing February 23, 2011 post on his Risk Metrics Insights blog (here) about the number of large institutional investors that have opted out of the $624 million Countrwide securities class action settlement. As many as 33 large investors have opted out of the settlement, which has resulted in changes to the class action settlement, including the reduction of the settlement amount to $601.5 million. Many of the opt outs apparently have initiated separate litigation, as well. Green notes that there are a host of arguments against and in favor of opting out, but he nevetheless asks whether the willingness of large investors to opt out possibly represents a larger trend.

 

D&O Case Law Survey: The policyholder side coverage law firm Lowenstein & Sandler has published a "Review of 2010 Case Law on D&O Insurance Coverage," which can be found here. The memo provides brief reviews of critical D&O insurance coverage decisions from the past year.

 

 

In the long-awaited rulings on the post-trial motions in the Vivendi securities case, Judge Richard Holwell has entered a February 22, 2011 order materially narrowing the plaintiff class based on the U.S. Supreme Court’s holding in Morrison v. National Australia Bank. A copy of Judge Holwell’s opinion, in which he eliminated ordinary shareholders from the class and further narrowed the class to only certain investors who purchased the company’s ADRs, can be found here.

　

The bulk of Judge Holwell’s 124-page opinion is taken up with the parties’ other post-trial motions, particularly Vivendi’s motion to set aside the verdict in whole or in part. Judge Holwell largely denied the motions. However, he declined to enter judgment for the plaintiffs, holding that Vivendi had the right to attempt to attempt to refute the presumption of reliance on an individual basis.

　

Background

Vivendi is one of the very rare securities class action cases to have gone to trial, and (as far as I know) the only case to have gone to trial involving so-called "f-cubed" claimants – that is, foreign domiciled shareholders of foreign companies who bought their shares on a foreign exchange. As discussed here, on January 29, 2010, following a four-month trial, a federal jury found that with respect to the 57 allegedly misleading statements at issue, Vivendi had violated Section 10(b). However the jury concluded that Vivendi CEO Jean-Marie Messier and CFO Guillame Hannezo had not violated Section 10(b).

　

The parties filed post-trial motions, and after the U.S. Supreme Court entered its opinion in Morrison v National Australia Bank, the parties submitted supplemental briefs.

　

With respect to the Morrison-related issues, it is important to note that during the relevant time period, Vivendi’s ordinary shares had traded only on the Paris Bourse. The company’s American Depositary Receipts (ADRs) were listed and traded on the NYSE. In its revised May 2007 order (here), the district court had certified a class in the Vivendi case consisting of Vivendi shareholders located in the U.S., France, England and the Netherlands.

　

The February 22, 2011 Opinion

In his February 22 opinion, Judge Holwell rejected the plaintiffs’ argument that because Vivendi ADRs were "listed" on the NYSE, the entire class of underlying shares (and not just the specific shares backing the ADRs) were "registered" with the SEC and therefore within the ambit of Section 10(b) (an argument on which the plaintiffs had elaborated in an earlier post on this blog, here).

　

Judge Holwell worked through the plaintiffs’ "listing" argument, an analysis that because somewhat abstruse as he labored with the complex factual questions whether or not the ordinary shares underlying the ADRs had somehow become "untethered" from the ADRs (perhaps through share redemptions or otherwise). Judge Holwell conceded that plaintiffs’ arguments did give him "pause," but ultimately he concluded that the argument "cannot carry the freight that plaintiffs ask it to bear."

　

Ultimately, Judge Holwell pushed past the complexity, and even stepped over the question whether Justice Scalia made a mistake in the way he used the word "listing" in the Morrison opinion. Judge Holwell finally dismissed the "listing" argument as "contrary to the spirit" of Morrison’s holding, citing with approval earlier district court opinions in the RBS case (refer here) and in the Alstom case (refer here), among others.

　

Judge Holwell also rejected the plaintiffs’ argument that Section 10(b)’s ambit extended to U.S. domiciled investors who purchased ordinary Vivendi shares outside the U.S (so-called "f-squared" claimants). In doing so, Judge Holwell, by his own account, joined other courts in "rejecting the argument that a domestic transaction occurs whenever the purchaser or seller resides in the United States." He observed that "there can be little doubt" that the phrase "domestic transaction" was "intended to be with relevance to the location of the transaction, not to the location of the purchaser."

　

On the basis of these Morrison-related rulings, Judge Holwell amended the class certification to exclude all purchasers of ordinary shares. As amended, the class certification includes persons in the U.S, France, England and the Netherlands who purchased or otherwise acquired Vivendi ADRs during the class period.

　

The (lengthy) balance of the opinion addresses the parties’ other post-trial motions, which Judge Holwell largely denied, except as to one of the 57 statements at issue, on which he granted Vivendi’s motion to set aside. Of particular interest, among Judge Holwell’s post trial motions is his conclusion that there want nothing fundamentally inconsistent about the jury’s finding of liability against Vivendi while at the same time finding no liability against the two individual defendants.

　

Finally, Judge Holwell denied plaintiffs’ motion for entry of judgment, holding that Vivendi was entitled to try to rebut the presumption of reliance as to individual investors.

　

Discussion

Given the prior district court rulings entered in the wake of Morrison, there is arguably nothing all that surprising about Judge Holwell’s Morrison-related rulings. To be sure, our friends in the plaintiffs’ bar had strong feelings about the "listed" argument, but at least one other judge had already rejected the argument, making Judge Holwell’s ruling that much less novel or noteworthy.

　

One issue that Judge Holwell did not address, because the parties apparently jointly conceded it, was the question whether or not the ADR transactions themselves did not did not come within the ambit of Section 10(b). At least one court has held, in light of Morrison, that ADR transactions are not "domestic transactions" within the meaning of Morrison. The Vivendi plaintiffs can at least be glad that they did not have the ADR transactions taken out of the class as well – there wouldn’t have been anything left.

　

But even with the ADR transactions (or at least some of them – see the discussion below) kept in the class, the class damages look materially smaller than they did when the verdict was first entered. At the time, the plaintiffs’ lawyers were quoted as saying that the aggregate class damages might be as much as $9.3 billion. In David Bario’s February 22, 2011 Am Law Litigation Daily article about Judge Holwell’s rulings (here), he quoted Vivendi’s counsel as saying that the effect of Judge Holwell’s rulings is to reduce the plaintiffs damages by 90%. (Of course, the 10% remaining still arguably represents a pretty big number – just not $9.3 billion.)

　

Though Judge Holwell substantially trimmed the class definition, the remaining class still has some rough edges as a result of the court’s prior class certification rulings. The complex process by which the court defined the class based on its determination that investors in certain countries might or might not enforce a securities law related judgment of a U.S. court is still a part of the revised class definition. Thus ADR investors in the U.S., France, England and the Netherlands are in the class, but not ADR investors in other countries (for example, Germany or Austria) are not . Though this particular issue does look different post Morrison, it is still a fundamental problem in the case left over from an earlier stage that is still out there as a potential source of further challenges, perhaps on appeal.

　

Judge Holwell’s final note about Vivendi’s right to rebut the presumption of reliance as to individual investors certainly poses some interesting procedural issues. It is not entirely clear how these issues are to be sorted out, although the possibility of individual trials certainly seems to be implied in Judge Holwell’s February 22 order. The possibility for further procedural wrangling seems high.

　

Special thanks to a loyal reader for sending along a copy of Judge Holwell’s ruling.

　

　

　

　

Great news – the survey is back. After year’s interruption, Towers Watson has resumed its annual D&O Liability Survey. The report for the 2010 survey (a copy of which can be found here) is full of valuable information about D&O insurance policyholders’ limits selection, program structure, and claims experiences, among many other things. The entire industry should celebrate the return of this venerable and highly valued survey report. Towers Watson’s February 22, 2011 press release about the survey report can be found here. Full disclosure: I was consulted in connection with the survey questionaire and results.

 

Preliminary Notes

The survey report contains numerous valuable insights, as discussed in detail below. However, a number of preliminary observations are in order, as these observations may aid in understanding the results.

 

First, the characteristics of the survey respondents provide important context for some of the report’s findings. In particular, the pool of 496 respondents to the 2010 survey was weighted toward large institutions and entities. Excluding nonprofit respondents, the survey respondents’ average revenues were $3.7 billion, and nearly two- thirds of all respondents had revenues over $1 billion.

 

The respondents’ average asset size is $4.6 billion, with about 70% of all respondents reported assets of over $1 billion. Even just the private company respondents include a significant number of very larger organizations. Thus, about 44% of the private company respondents reported assets of $1 billion or more.

 

The pool of public company respondents was also weighted toward large publicly traded companies. The average market capitalization of the public company respondents is $4.6 billion, with about 71% of public company respondents reporting market caps of $1 billion or over. Nearly a third of all public company respondents have market caps over $5 billion. 23% of all public company respondents have market capitalizations over $10 billion.

 

Second, the pool of respondents to this year’s survey is relatively smaller than prior years’. As the report itself notes, because "the sample size is smaller this year," the data are "less statistically reliable." (As I note below, everyone in the industry has a stake in trying to increase the size of the sample in future surveys, in order to try to address this concern.)

 

Third, the difference in the number of organizations represented in the survey response pools may be only one way that the two sets of survey respondents differ. The pool of respondents may well differ in other ways too, such as by industry or by size. Given the differences between the respondent pools, there is a possibility that apparent differences between the reported survey results may reflect only the change in the composition of the pool, rather than changes in the underlying behaviors. In other words, comparisons between different years’ survey results should be viewed cautiously.

 

The Survey Findings

1. The survey found that, excluding nonprofits, 53% of all respondents have international operations. Of the companies with international operations, 47% reported that they purchased local policies in foreign jurisdictions. (The 2008 survey found that only 2% of respondents purchased local policies in foreign jurisdictions.)

 

2. The average limits purchased among all private company respondents was $34 million. However, the average limit purchased by private companies with assets of less than $250 million was $7 million.

 

3. The average limit purchased among all public companies was $118.3 million. However, the average limits for public companies with market caps of less than $250 million were $26.1 million. The average limits for companies with market caps between $250 million and $499 million is $42.4 million, and the average limits for companies with market caps between $500 million and $999 million is $57.2 million.

 

4. 21% of survey respondents said they had increased their D&O limits at the last renewal. The survey report speculates that this could reflect a reaction "to the fact that D&O liability exposures are arguably at an all time high," but also acknowledges that at a time of generally declining prices, it "may also be likely that purchasers are reallocating a portion of their savings to buy additional limits."

 

5. The survey notes that 35% of nonprofit respondents and 22% of private company respondents were unsure of how their D&O insurance program is structures, about which the report notes that "brokers and other management liability consultants need to spend more time educating their nonprofit and private company clients about their insurance coverage."

 

6. 9% of all survey respondents reported that they purchase D&O insurance that covers only outside or independent directors. (The 2008 survey found that only 0.3% of all respondents purchased D&O insurance that covers only outside or independent directors.)

 

7. 75% of public company survey respondents reported that their company purchases Excess Side A insurance or Side A/DIC insurance, which the survey report notes is a "significantly higher" percentage than noted in the 2008 survey. 83% of companies with market caps over $10 billion purchased Excess Side A or Side A/DIC insurance, but only 50% of companies with market caps under $250 million purchased Excess Side A or Side A/DIC insurance.

 

8. The average amount of Excess Side A insurance purchased by public companies is $47.5 million, but only $14.5 million for companies with market caps of under $250 million, and $20 million for companies with market caps between $500 million and $999 million.

 

9. 35% of private organizations reported buying Excess Side A insurance, but only 20% of private companies with assets of under $250 million. The average amount of Excess Side A insurance purchased by private company respondents is $18.8 million, but only $6.2 million among private companies with assets under $250 million.

 

10. 31% of all respondents reported having a D&O claim in the last 10 years (up from only 17% in the prior survey report). Asset size had a direct bearing on the likelihood of a claim.

 

11. The most frequent type of claims for nonprofit respondents and private company respondents was employment related claims. Among public company respondents, the most frequent type of claim is the shareholder or investor suit.

 

Discussion

This year’s report is full of interesting and useful information that will be valuable to insurance buyers and their advisors. Though I have summarized the report above, the report is replete with additional interesting detail, and the report merits reading at length and in full.

 

Many of the observations noted in the report may reflect in part the weighting of the respondent pool toward larger organizations. Thus, for example, the report’s observations about the following phenomena may reflect the number of larger entities in the survey pool: the relatively higher prevalence of entities purchasing local policies in foreign jurisdictions; the larger number of entities purchasing insurance solely for the protection of outside or independent directors; the increased prevalence of Excess Side A insurance or Side A/DIC insurance; and the reported increase in the number of claims experienced.

 

Indeed, the survey report itself notes with respect to each of these categories that prevalence of these phenomena increased as the size of the responding entity increased. Accordingly, the use made of the report’s observations of each of these items should take into account the survey respondent pool’s relative weighting toward larger institutions. Some of the observations may or may not retain their validity when compared to the universe of all firms or entities, or perhaps even when compared to a range of smaller firms and entities.

 

All of that said, with respect to many of the items measured in the survey, the survey report may be the only publicly available source of information. Particularly with respect to the many items measured in the report for which there is no publicly available alternative source, the survey reports provides indispensible insight

 

It is this aspect of the survey which ultimately makes it invaluable – that is, there is no other place where D&O industry professionals and their clients and customers can go to get the kind of information in this report. For that reason, the report’s return after a one year interruption is, as I noted at the outset, a cause for celebration.

 

Because just about everyone in the industry refers to this survey and because the entire industry benefits from the availability of the information in the survey, everyone in the industry has an equal stake in making the survey as broad and valid as possible. All of us have a stake in trying to make sure that future surveys reflect a broad cross-section of all firms and entities, and that as many respondents as possible complete the survey.

 

Now that the survey is back again, we can all look forward to the survey’s continuation in future years. We should all plan on trying to encourage maximum participation in future surveys as well.

 

Many thanks to Larry Racioppo of Towers Watson for providing me with a copy of the survey report..

 

Auction Rate Securities Litigation Grinds On: The mess left behind when the market for auction rate securities froze in February 2008 still has not been cleaned up. But the mess did beget at least one tangible byproduct – a mountain of litigation that continues to grind its way through the system. And though many of these cases, like the MRU Holdings case described below, have failed to survive initial dismissal motions, there have been a a very few, like the Akamai case described below, that have managed to overcome the initial pleading hurdles.

 

As discussed at length here, the MRU Holdings case arguably was somewhat distinct amount the auction rate securities cases. Unlike most cases, it did not involve purchasers of the auction rate securities themselves alleging to have been misled by their broker dealers (or by their mutual fund). The case did not even involve shareholders’ claims that they had been misled about the extent of a company’s exposure to its own auction rate securities investments. Rather, the plaintiffs in the MRU Holdings case were investors in a company that originated student loans and securitized the loans by putting them into pools for securitization. The investors claim to have been misled about the company’s dependence on the artificially favorable auction rate securities marketplace as a way to generate capital and free up income.

 

Though the MRU Holdings case represented a variant on the usual auction rate securities litigation, the case itself did not fare better than many of the other auction rate securities litigation cases.

 

In a February 17, 2011 order (here), Southern District of New York Judge Richard Berman granted the defendants’ motions to dismiss in the MRU Holdings case. Among other things, Judge Berman concluded that the company’s disclosure documents fully disclosed the company’s vulnerability due to its resort to the ARS marketplace. The disclosures, he found, "appear to have been based upon an appraisal of MRU’s financial position during an economically difficult timeframe and when read in their entirety not only bespeak caution but shout it from the rooftops." (citations omitted) Judge Berman also concluded that the plaintiffs had failed to plead scienter adequately as well.

 

By interesting contrast, in a February 15, 2011 order (here), District of Massachusetts Judge Joseph Tauro denied the defendants’ motions to dismiss in the individual action that Akamai Technologies filed against Deutsche Bank. Akamai claimed that it had been misled in connection with the company’s purchase of $217 million of ARS. Judge Tauro had little trouble concluding that Akamai’s allegations satisfied the pleading requirements. Significantly, Judge Tauro concluded that Akamai did not need to plead scienter since the PSLRA’s heightened pleading standard for scienter is inapplicable to a claim to Akamai’s control person liability claim.

 

I have added these cases to my running tally of credit crisis-related litigation dismissal motion rulings, which can be accessed here.

　

In Memoriam: It is with sadness that I note here the passing of Judge Richard L. Williams of the United States District Court for the Eastern District of Virginia. It was my privilege and honor to have clerked for Judge Williams many years ago, when I was just out of law school and he had only recently gone on the federal bench. My year clerking for him was one of the best years of my life. Following my clerkship, Judge Williams remained a mentor and a friend, for me as he was for so many others. He was an avid outdoorsman, an unequalled story-teller, a good judge and a good man. He taught me so much about how life should be lived. Judge, we will miss you.

 

The February 21, 2011 obituary for Judge Williams from the Richmond Times-Dispatch can be found here.

　　

In a settlement that has a number of interesting features, Satyam Computer Services, an Indian technology outsourcing company, has agreed to pay $125 million to settle the consolidated securities class action litigation pending against the company in Southern District of New York.

 

The only settling defendant is the company itself, which is now known as Mahindra Satyam. The settlement does not resolve claims against the individual defendants, including certain of the company’s former directors and officers, or against PricewaterhouseCoopers-related entities.

 

The settlement is subject to court approval, as well as other regulatory and governmental approval. A copy of February 16, 2011 settlement stipulation can be found here.

 

Background

Satyam was quickly dubbed the "Indian Enron" when it was revealed in January 2009 – in a stunning letter of confession from the company’s founder and Chairman — that more than $1 billion of revenue that the company had reported over several years was fictitious. Investors immediately filed multiple securities class action lawsuits in the Southern District of New York.

 

The plaintiffs’ consolidated amended complaint alleges that in addition to fabricating revenues senior company officials siphoned off vast sums from the company to entities owned or controlled by the Chairman and members of his family. The defendants include ten former directors and officers of the company; certain entities affiliated with the company’s chairman and individuals associated with those companies; and certain PwC-related entities.The defendants filed motions to dismiss.

 

The Satyam Settlement

In the settlement stipulation, Satyam has agreed to pay $125 million into a settlement fund. The company, which is apparently funding the settlement entirely out of its own resources, is the only settling defendant. The claims against all of the other defendants remain pending.

 

In addition to the $125 million, Satyam also agreed to pay the settlement class 25% of any recovery the company may obtain against the PwC entities, in the event the company in its sole discretion decides to pursue a claim against the PwC entities.

 

There amount of plaintiffs’ attorneys’ fees specified or agreed to in the stipulation, however the settlement papers reflect that plaintiffs’ counsel intends to seek a fee award of 17% of the settlement fund, as well as out of pocket expenses not to exceed $2.5 million.

 

Lead counsel also intends to seek court approval to establish out of the settlement fund a $1 million litigation fund "to help pay for future litigation costs incurred during the continued litigation of the Action against the Non-Settling Defendants."

 

Discussion

There are a number of interesting things about this settlement, the first being its size. Even though it is only a partial settlement, the $125 million settlement amount would be tied for 69th on the list of the all-time largest securities class action settlements.

 

Another very interesting feature of the settlement is that it resolves only the claims against the company – leaving all of the company’s former directors and offices in the lawsuit. These individuals include not only the company’s former Chairman and founder and his family members who were at the center of the scandal, but also the various outside individuals who were serving on the company’s board while the alleged fraud was going on. The suggestion seems to be that the current company management is prepared to leave all of the former board members hanging out there on their own.

 

The fact that the company apparently is also funding this settlement out of its own resources is also interesting. Shortly after the scandal broke, there were press reports that the company carried $75 million of D&O insurance. Of course, these press reports may have been mistaken. Or perhaps the insurance was unavailable to the company, either because the insurance did not include entity coverage or because the carriers are asserting coverage defenses. The possible availability of insurance raises the question whether the coverage is available for the individuals’ defense or any future settlements (assuming it has not already been depleted or exhausted by prior defense fees).

 

Another interesting component of the settlement is the composition of the settlement class to which the parties stipulated as part of the settlement. The class includes not only investors who bought the company’s American Depositary Shares on the NYSE, but also U.S. residents who bought ordinary company shares on Indian stock exchanges.

 

The interesting question is whether, in light of the U.S. Supreme Court’s holding in Morrison v. National Australia Bank, the U.S.-based investors who purchased their shares on the Indian exchange actually have claims they can assert under U.S. securities laws. (Indeed, the settlement stipulation expressly notes that the defendants had supplemented their pending motions to dismiss, seeking in reliance on Morrison to dismiss the claim of the U.S. residents who purchased their shares on the Indian exchanges.)

 

Several U.S. district courts (refer for example here and here) have already ruled that Morrison precludes Section 10(b) claims of so-called "f-squared claimants" – that is, U.S. residents who bought share of non-U.S. companies outside of the U.S. Nevertheless, the proposed settlement class includes these f-squared claimants. In other words, the proposed settlement class includes claimants who may or may not have the ability to assert claims under Section 10(b) in light of Morrison. Indeed, as the remaining defendants might even succeed in having those claimants’ claims dismissed as the case goes forward.

 

However, in recognition of the hurdles that these investors face, the settlement agreement provides that the U.S. investors who bought their shares on the Indian exchange will not receive the same proportion of compensation as the ADS investors.

 

As Alison Frankel notes in her February 17, 2011 Am Law Litigation Daily article about the settlement (here), common share holders will take a 90 percent discount on their potential recovery, by comparison to the ADS investors. The agreement states that this discount is "in recognition of additional legal hurdles facing U.S. residents who purchased Satyam ordinary shares on markets outside the United States in seeking to recover under federal securities laws." The estimated average recovery would be $1.36 per ADS and 6 cents per ordinary share.

 

But though the proposed class definition arguably includes a class of claimants broader than Morrison might prescribe, the proposed class does not include non-U.S. residents who purchased their Satyam shares on the Indian exchanges. These investors’ claims apparently are not resolved or even addressed by this settlement.

 

Another interesting feature of this settlement is the extent to which it seemingly encourages further litigation against the Non-Settling parties. The settlement not only includes the company’s agreement to pay the settlement class 25% of any recovery the company may obtain from the PwC entities, but it also includes a $1 million war chest for the claimants to use in order to continue their claims against the other defendants. This settlement might be good news for Satyam and for the settlement class, but it seems like bad news for the remaining defendants and for the PwC entities.

 

In other words, the company may be settling, but this case is far from over.

 

Bankruptcy and D&O Insurance: On March 2, 2011 at from 1:00 pm EST to 2:30 EST, the Torts and Insurance Practice Section of the American Bar Association will be sponsoring a teleconference on the topic of "D&O Insurance in the Context of Bankruptcy." The teleconference will feature a number of distinguished speakers, including my good friend Perry Granof. Information about the teleconference can be found here.