The year-end vacation days are over, the holiday decorations have been taken down, and last year’s wall calendars have been replaced. We are now into the Narnia season (at least here in Cleveland), where it is always winter but never Christmas. The New Year has entered with a bang, and that means more than just inexplicable piles of dead birds. It also means there are lots of newsworthy developments to report. Here’s the latest:

 

FDIC Increases Number of Authorized Lawsuits: Earlier this week, the FDIC updated the Professional Liability Lawsuits page on its website to reflect that the number of lawsuits that it has authorized has been increased. The FDIC has now authorized lawsuits against 109 directors and officers of failed financial institutions, up from 82 as of the end of November 2010. The website also reports that the claims against these individuals represent claimed damages of $2.5 billion.

 

The web page includes a monthly table at the end, showing how the number of individuals against whom lawsuits are authorized has increased since the end of the third quarter. The page also reports that the FDIC has authorized four fidelity bond and attorney malpractice lawsuits.

 

The page reflects a number of interesting details regarding the FDIC’s approach to litigation and litigation history. Among other things, the page reports that the investigation preceding the decision whether or not to bring a lawsuit is usually completed "within 18 months," which explains in part why there have been relatively few FDIC lawsuits against directors and officers of failed banks so far (only two lawsuits against 15 individuals).

 

The page also includes some general information about the legal theories on which the FDIC can seek to recover, the applicable statute of limitations, and the FDIC’s prior history of D&O litigation during the S&L crisis.

 

Many thanks to the several loyal readers who sent me links to the New York Times Dealbook blog’s January 5, 2010 post about the updated FDIC web page.

 

2011’s First Filed Securities Suit Continues 2010 Trend: As far as I can tell, 2011’s first filed securities class action lawsuit is the lawsuit filed on January 3, 2011 in the Eastern District of New York against Tongxin International, Inc. and certain of its directors and officers. The plaintiffs’ lawyers corrected press release describing the suit can be found here and a copy of the complaint can be found here.

 

The lawsuit alleges that the defendants misled investors with respect to its financial reports. The plaintiffs allege that the company initially withheld its financial statements, and then was forced to withdraw previously reported results as unreliable. The company later sued its former CEO and CFO for wrongfully transferring the Company’s funds.

 

As I noted in my analysis of 2010 securities class action lawsuits, one of last year’s noteworthy securities suit filing trends was the significant number of lawsuits involving Chinese companies. From a practical perspective (if not strictly as a formal matter), the new Tongxin lawsuit appears to represent a continuation of that filing trend.

 

Tongxin itself is incorporated in the British Virgin Islands. However, it was formed as subsidiary of a special purpose acquisition company (SPAC) that was formed to acquire an automotive manufacturing company in China. In April 2008, the SPAC acquired Hunan Enterprise Co., Ltd, a Chinese automotive supplier, and the SPAC merged into Tongxin. Tonxin’s operating company, and the events referenced in the complaint, all are or took place in China.

 

The litigation trend of new securities lawsuits involving Chinese companies seems to have carried over into the New Year.

 

Record Number of FCPA Enforcement Actions in 2010: According to the Gibson Dunn law firm’s January 3, 2010 memorandum entitled "2010 Year-End Update" (here), 2010 was a record setting year for FCPA enforcement activity. The memo reports that both the SEC’s and DoJ’s 2010 enforcement actions – which were essentially double the prior year’s record levels – "dwarfed the tally from any prior year in the statute’s 33-year history."

 

According to data reflected in the memo, during 2010 there were 48 DoJ FCPA enforcement actions (compared to 26 in 2009) and 26 SEC FCPA enforcement actions (compared to 14 in 2009). The memo also reports that "nearly every FCPA enforcement action from the past 12 months can be traced to multi-defendant, if not industry-wide investigation that involved numerous companies or persons engaged in coordinate or parallel schemes."

 

FCPA-related settlements in 2010 also were at record setting levels. According to a January 5, 2010 post on The FCPA Blog (here), eight of the top ten FCPA settlements of all time were reached in 2010. As it happens, eight of the top ten FCPA settlements involve non-U.S. companies as well.

 

As I have observed numerous times on this blog, FCPA enforcement activity increasingly is accompanied by follow-on civil litigation, a phenomenon that the Gibson Dunn memo notes "saw a marked increase in activity amongst the plaintiffs’ bar." The memo goes on to observe that "hardly an FCPA investigation or resolution was announced during the past year that was not followed in swift succession by a press release from any number of plaintiffs’ firms from any number of plaintiffs’ law firms that have creased a cottage industry for private FCPA enforcement."

 

Despite the absence of a private right of action under the FCPA, plaintiffs continue to "shoehorn" FCPA-related claims under a wide variety of theories, including securities fraud, breach of fiduciary duties, torts and breach of contract. The law firm memo sets out a long list of various cases that plaintiffs have pursued or are pursuing on FCPA-related allegations.

 

As I previously detailed (refer here), FCPA-related claims represent a growing area of D&O exposure, with important D&O insurance coverage implications.

　

Are Bylaw Forum Selection Clauses Unenforceable?: Many corporate litigants prefer the friendly confines of the Delaware Court system. It is not just that many companies are organized in Delaware and its courts are viewed as business friendly, but also the judges who serve on the Court of Chancery are viewed as both highly skilled and as experienced on complex business litigation issues.

 

Earlier this year, in the Revlon Shareholders’ Litigation, the Delaware Court of Chancery suggested that corporations organized under Delaware law are "free" to adopt "charter provisions selecting an exclusive forum or inter-entity disputes." In the wake of this suggestion, many lawyers began to recommend that their client companies adopt charter provisions designating the Delaware Court of Chancery as the preferred forum.

 

However, on January 3, 2011, Northern District of California Judge Richard Seeborg held, in a case of first impression, that a forum selection clause in Oracle’s bylaws was not enforceable, at least in the absence of shareholder approval. Significantly, Judge Seeborg did not reach issues of Delaware law; his ruling of unenforceability was reached as a matter of federal common law. A copy of Judge Seeborg’s opinion can be found here.

 

As might be expected, plaintiffs’ lawyers have welcomed Judge Seeborg’s ruling – refer for example to David Bario’s January 5, 2011 Am Law Litigation Daily article, here, quoting the plaintiffs’ lawyers in the case as saying that

 

The insertion of these forum selection clauses in bylaws, rather than by amending a company’s charter with shareholder approval, has been increasing….I think this decision will help to pull the cover off the practice. It shows that passing a bylaw on normal company business is one thing, but when you’re going to pass a bylaw that limits shareholders’ rights, that’s something much different, and I think that’s at the core of the decision.

 

Others have been more critical of the decision. Rebecca Beyer’s January 5, 2010 Daily Journal article (here, registration required) about the decision quotes Stanford Law School Professor Joseph Grundfest as saying that "the distinction as to shareholders who hold shares prior to the bylaw amendment and after the bylaw amendment makes no sense….Every bylaw amendment has to bind all shareholders or it can’t work."

 

Grundfest said when people buy shares in a company they agree to allow directors to amend bylaws. "If shareholders don’t like the unilateral amendment, the shareholders can – by shareholder vote – overrule the board," he said. Grundfest also said that there likely will be further litigation on this issue, and that the issue could eventually make its way to the U.S. Supreme Court.

 

Time Out for A Couple of Technology Questions: What do you do when your Blackberry isn’t working? And why does the march of technological "progress" involve so many different kinds of fruit? (Special thanks to a loyal reader for a link to the video.)　

https://youtube.com/watch?v=kAG39jKi0lI%3Ffs%3D1%26hl%3Den_US

2010 was an eventful year in the world of D&O liability. Congress passed massive financial reform legislation, the Supreme Court issued landmark decisions in important cases and numerous claims emerged as the litigation landscape continued to evolve. With so much going on, it is a challenge to narrow the year’s events down to just the ten most significant developments.

 

With appropriate humility about the limitations of all year-end inventories, here is my list of the top ten D&O developments of 2010.

 

1. Securities Suits Pick Up in Year’s Second Half: As I detailed in my 2010 securities litigation overview (here), after a filing downturn in the year’s first half, the number of securities lawsuit filing picked up in the last six months of the year. Among other things, as the year progressed, filing activity shifted away from credit crisis-related cases and toward a broader range of other types of cases.

 

Although at least some of the litigation activity in the year’s second half was driven by limited or short term events (as was the case, for example, in the rash of cases filed against for-profit education companies and against Chinese domiciled companies), the shift away from credit crisis cases could suggest that the heightened pace of securities suit filings may continue as we head into 2010.

 

2. The Changing Mix of Corporate and Securities Lawsuits: As insurance information firm Advisen has well documented, the mix of corporate and securities lawsuits has been evolving over the past several years. The most important feature of this changing mix of cases has been the decreasing prevalence of class action securities lawsuits as a percentage of all corporate and securities cases.

 

As the percentage of class action securities lawsuits has declined, other types of lawsuits, particularly breach of fiduciary duty cases, have grown in relative frequency. Many of these breach of fiduciary duty cases are related to mergers and acquisitions activity. Indeed, as I noted in my year-end review of 2010 securities lawsuit filings, even many of the cases that are categorized as securities class action lawsuits involve merger objection cases.

 

　

It is important to keep this changing mix of cases in mind when considering the various year end reports on securities litigation activity. These reports will show that overall 2010 securities class action lawsuit filings are down compared to post-PSLRA averages. However, it would be mistake to conclude that the relatively reduced number of securities class action lawsuits means that claims activity in general is down. To the contrary, overall claims activity is actually up. The mere fact that securities class action lawsuits are down does not mean that fewer companies are being sued or that overall claims exposure has diminished, either for companies or insurers. Rather, what is happening is that the claims exposure is changing, away from securities class action lawsuits and toward other types of claims.

 

This shift away from traditional securities class action lawsuits as a percentage of all claims activity has important implications for the insurance marketplace. The shift toward higher frequency, lower severity type of claims could have a significant impact both on primary and excess carriers. Primary carriers may experience an increase in overall claims frequency, with consequences for their loss experience. Excess carriers, particularly higher excess carriers, may experience relatively fewer claims piercing their layers, possibly producing a positive impact on the excess carriers’ results.

 

　

3. Banks Fail, Lawsuits Loom: 157 banks failed during 2010, the largest annual number of bank failures since 1992. The total number of bank closures since January 1, 2008 is 322. In addition, in the FDIC’s most recent Quarterly Banking Profile (refer here), the FDIC identified 860 banks, or about one out of nine of all banks, as "problem institutions."

 

Given the magnitude of these problems in the banking industry, it is hardly surprising that litigation involving failed and troubled banks is increasingly significant. Indeed, 13 of the 177 securities class action lawsuits filed in 2010 involved failed or troubled banks. In addition, aggrieved investors in failed or troubled privately held banks also filed a variety of other lawsuits, primarily in state courts.

 

It may be anticipated that the FDIC will also actively pursue claims against failed banks’ former directors and officers. However, to date, the FDIC has instituted only two D&O claims as part of the current round of failed banks (refer here and here).

 

It appears that it will only be a matter of time before the FDIC launches further suits against former officials of failed banks. Widely circulated news reports have quoted FDIC officials as saying that the FDIC has authorized civil actions against more than 80 directors and officers of failed banks. In addition, the Wall Street Journal reported in November that the FDIC is conducting fifty criminal investigations against directors, officers and employees of failed banks.

 

While we may hope that the current round of bank failures may begin to wane as we head into 2011, it appears that the failed bank litigation may only just be getting started.

 

4. Credit Crisis Lawsuit Settlements: The Dog that Didn’t Bark This Year: The subprime and credit crisis-related litigation wave will be heading into its fifth year early in 2011. Since 2007, there have been over 230 subprime and credit crisis related securities lawsuits filed. Many of these cases continue to work their way through the system.

 

As some of these cases have survived the preliminary motions, they have moved toward settlement. There were several noteworthy credit crisis related securities class action lawsuit settlements during 2010, including Countrywide ($624 million, refer here), Schwab Yield Plus ($235 million , refer here), and New Century Financial ($124 million, refer here).

 

But while there have been a few noteworthy settlements of these cases this year, the more striking observation is how few of these cases have settled so far, particularly given how far along we are in the subprime and credit crisis litigation wave.

 

By my count, only 17 of the over 230 subprime and credit crisis-related securities class action lawsuit have settled, and only eight of these 17 settlements were announced in 2010. (My list of subprime and credit crisis-related lawsuit resolutions can be accessed here.)

 

NERA Economic Consulting stated in its year-end report on securities litigation that of the approximately 230 credit crisis securities suits, only 8% have settled, 29% have been dismissed, and 63% remain unresolved.

 

Of the 63% of unresolved cases, some of course will wind up being dismissed. But many more will settle, eventually. Given the now long duration of the credit crisis litigation wave, it can be anticipated that there may be many more settlements of these cases in 2011. The likelihood is that D&O insurers’ aggregate claims losses for these claims will mount, perhaps rapidly.

 

The question is whether the materialization of these losses will come as a surprise or has already been fully anticipated in the carriers’ prior years’ loss reserves. This answer to this question could have important implications for the D&O insurers’ 2011 calendar year results.

 

5. Megasettlements of Shareholders’ Derivative Lawsuits Surge: There was a time when the settlement of a shareholder derivative lawsuit involved the payment of little or no money, other than in connection with the payment of the plaintiffs’ attorneys’ fees. However, one of the more striking developments in recent years has been the emergence of jumbo settlements of shareholders derivative lawsuits, in which millions of dollars are paid to or on behalf of the company involved.

 

This emerging trend continued to develop in 2010, with at least two huge shareholder derivative lawsuit settlements: the $90 million AIG/Greenberg settlement (about which refer here) and the $75 million Pfizer settlement (refer here).

 

These 2010 settlements join a growing list of other jumbo derivative settlements in recent years, including the UnitedHealth Group settlement ($900 million, refer here); Oracle ($122 million, refer here); Broadcom ($118 million, refer here); and the first AIG derivative settlement (refer here).

 

The striking thing about these settlements is not only their size, but also the fact that in each case the company involved is solvent. The significance of this fact is that these settlements represent instances in which the companies’ D&O insurance potentially could have been called upon to fund an A Side loss outside of the insolvency context. These kinds of settlements provide concrete evidence of the value to policyholders of Side A insurance protection even outside of the insolvency context, and underscore the importance of added Side A protection in a well-designed D&O insurance program.

 

From the carriers’ perspective, these settlements suggest that Side A losses can mount outside of insolvency. Only the carriers themselves can answer the question whether or not they are actually pricing their Side A products for this loss exposure.

 

One final note about the Pfizer derivative lawsuit settlement concerns the unusual funding mechanism the settlement implemented. In many derivative lawsuit settlements the companies involved agree to institute corporate governance reforms. What was unusual about the Pfizer settlement is that the settlement agreement created a dedicated fund intended to finance the company’s agreed upon governance reforms. If the advance funding of corporate governance reforms were to become a standard feature of derivative lawsuit settlements, the cash cost of derivative settlements could increase substantially. This is a potential development worth watching closely.

 

6. Rare Securities Lawsuit Trials Result in Plaintiffs’ Verdicts: Very few securities class action lawsuits actually go trial. Most are settled or dismissed. But in 2010, two cases made it all the way through to jury verdicts. In January, the jurors in the Vivendi case entered a verdict on behalf of the plaintiffs against the company (about which refer here), and in November, the jurors entered a verdict for the plaintiffs in the BankAtlantic subprime-related securities suit (refer here).

 

In addition to these jury verdicts, in June 2010, the Ninth Circuit issued an opinion overturning the trial court’s post trial ruling in the Apollo Group case, a ruling that had set aside the jury’s $277.5 million jury verdict in that case. Refer here regarding the Ninth Circuit’s opinion in the Apollo Group case.

 

All three of these cases remain subject to further proceedings. The Vivendi case in particular is the subject of significant post-trial motions having to do with the composition of the plaintiffs’ class in the wake of the U.S. Supreme Court’s decision in the Morrison v. National Australia Bank case (about which refer to these prior guest blog posts, here and here. See also item 10, below).

 

The defendants in the Apollo Group case have filed a petition with the U.S. Supreme Court for a writ of certiorari (about which refer here). And the BankAtlantic case has now moved on to post-trial motions, and depending on the motions’ outcome, possible appeal.

 

But while the ultimate outcome of these cases remains to be determined, it is striking that all three of these cases not only involve rare trials, but all three resulted in jury verdicts for the plaintiffs. To be sure, there have also been recent securities lawsuit trials that have resulted in defense verdicts, as was the case for example in the JDS Uniphase trial (about which refer here).

 

According to information compiled by Adam Savett, the Director of Securities Class Actions at the Claims Compensation Bureau, there have now been ten securities class action lawsuit trial post-PSLRA and involving post-PSLRA facts. The scoreboard currently reads: Plaintiffs 6, Defendants 4. The scoreboard is of course subject to revision pending further proceedings. Nevertheless, the juries themselves seem to have been favoring the plaintiffs, a phenomenon that may make plaintiffs’ threats to push a case to trial represent a particularly threatening tactic.

 

7. Assessing Coverage for "Bump Up" Claims: As noted above, a significant and growing number of corporate and securities lawsuits arise out of merger and acquisition activity. Often, the goal of this litigation is to try to increase the transaction consideration. One recurring question is the availability of D&O insurance coverage for amounts paid in settlement of so-called "bump up" claims.

 

In October 2010, the First Circuit entered an opinion in coverage litigation involving Genzyme Corporation, discussing the question of the preclusive effect of a D&O policy’s "bump up" exclusion. The First Circuit overturned the lower court’s decision that had held that the company’s D&O insurance policy did not provide coverage for additional amounts paid to claimants who asserted they did not received adequate consideration in a share exchange.

 

Though the First Circuit reversed the lower court’s holding of noncoverage, the First Circuit did not invalidate the bump up exclusion and agreed that the exclusion precluded entity coverage for bump up amounts.

 

The First Circuit remanded the case to the lower court for further allocation proceedings (that is, because the First Circuit held that the bump up exclusion precluded coverage only under the policy’s entity coverage provision, further proceedings are required to determine whet portion if any of the underlying settlement is allocable to settlement of liabilities of persons insured under other insuring provisions of the policy).

 

Of critical importance is that the First Circuit found that exclusion is enforceable and is effective to preclude coverage according to its terms. The holding clearly will be relevant to questions of coverage in future cases involving settlements of "bump up" claims, at least where the implicated D&O insurance policies include bump up exclusions.

 

8. D&O Insurance Coverage for Informal SEC and Internal Investigations: Among the perennial D&O insurance issues are the questions of coverage for informal SEC investigations and for internal investigations. In either case, the question is whether or not there is a "claim" as required to trigger coverage under the policy.

 

In one of the year’s most noteworthy D&O insurance coverage decisions, Southern District of Florida Judge Kenneth Marra, applying Florida law in a summary judgment ruling in coverage litigation involving Office Depot, held there is no coverage under the company’s D&O insurance policies for either of these categories of expenses.

 

Though the holding in the Office Depot case is direct reflection both of the specific policy language involved and the facts presented, the decision nevertheless could be influential in future claims involving questions of coverage for informal SEC investigations and internal investigations. The Office Depot decision suggests that policy definitions of the terms "Securities Claim" and "Claim" are critical, particularly with respect to the definitional references to "investigations" and "proceedings." Refer here for a more detailed discussion of the case and the decision.

 

The Office Depot ruling is hardly the final word on these issues, but it clearly will loom large in future consideration of questions of coverage for these kinds of expenses. Insurers undoubtedly will seek to rely on the decision to try to preclude coverage for costs incurred in connection with informal SEC investigations and internal investigations.

 

On a related note, a separate court held in the MBIA coverage case that there is coverage under the D&O insurance policy at issue for special litigation committee expenses, as discussed here.　

 

9. Is a Whistle the Sound of the Future?: The massive Dodd Frank Wall Street Reform and Consumer Protection Act of 2010 enacted in July will affect virtually every aspect of our financial system, in ways that may only become clear over time. But among the Act’s innovations that seem likeliest to have a significant litigation impact are the Act’s new whistleblower provisions.

 

The whistleblower provisions include the creation of a new whistleblower bounty pursuant to which persons who first bring securities law violations to the attention of the SEC will receive between 10 percent and 20 percent of any recovery in excess of $1 million.

 

Give the magnitude of the fines paid in many recent SEC enforcement actions, particularly those involving Foreign Corrupt Practices Act violations (about which refer here), the prospective size of potential bounties is enormous. These bounty provisions seem likely to encourage a flood of whistleblower reports to the SEC. This could create an administrative nightmare for the SEC, and the agency is already struggling with funding limitations that may constrain its ability to implement the whistleblower requirements. On the other hand, the SEC, under pressure to rehabilitate its regulatory credentials after its failure to detect the Madoff scheme, will face significant pressure to pursue whistleblower claims.

 

Another 2010 development that seems likely to encourage an entirely different sort of whistleblower activity is the series of WikiLeaks disclosures. The extensive media attention give to the disclosures, as well as the suggestions of WikiLeaks founder Julian Assange that future disclosures will expose corporate misconduct, raise the possibility of that other self-appointed corporate scourges will launch similar guerilla campaigns involving the disclosure of internal corporate communications.

 

These two types of prospective whistleblower risks arguably represent an entirely new level of corporate exposure that could leave companies and their senior officials susceptible to claims of wrongdoing based on public or regulatory disclosures by persons inside the company with access to sensitive information. Indeed, companies and their senior officials could even be susceptible to claims for the alleged failure to implement and maintain sufficient controls to prevent embarrassing or harmful disclosures. Regardless, companies could face the prospect of significant risks involving person inside (or with access to) their own operations.

 

10. Foreign Companies, U.S. Courts: In June 2010, the U.S. Supreme Court issued its long-awaited decision in the Morrison v. National Australia Bank case, holding that Section 10(b) of the Securities Exchange Act of 1934 applies only to transactions taking place on the U.S. securities exchanges, or domestic transactions in other securities.

 

Among other things, the Morrison decision seems to represent the end of so-called "f-cubed" claims, involving foreign claimants who bought their shares in foreign companies on foreign exchanges.

 

Lower courts are now wrestling with Morrison’s implications, including, for example, the question of whether or not Morrison precludes claims under the U.S. securities laws against companies whose American Depositary Receipts trade on U.S. exchanges. (Surprisingly, at least one court has held that case has that effect, as discussed here.) Other courts have struggled to determine what falls within Morrison’s second prong relating to "domestic transactions in other securities." Clearly, there will be much further lower court activity as these kinds of issues are sorted out.

 

In the meantime, one consequence that seemed likely in the wake of Morrison is that there might be fewer (or at least only narrower) cases filed in U.S. courts involving non-U.S. companies. Contrary to expectations, however, there were quite a number of securities cases filed in U.S. courts involving foreign-domiciled companies in 2010, including many filed after the Supreme Court issued its Morrison opinion.

 

As reflected in my recent year-end analysis of 2010 securities lawsuit filings, there were 19 new securities class action lawsuits filed in 2010 involving foreign domiciled companies, representing 10.7% of all 2010 securities lawsuit filings. Of these 19 cases, 12 were filed after the Supreme Court issued its opinion in Morrison.

 

One possibly temporary factor driving many of these filings is the rash of new cases filed against Chinese- domiciled companies. There were ten new lawsuits against Chinese companies in 2010, eight of which were filed post-Morrison. It should be noted that the shares of many of these Chinese companies trade on U.S. exchanges and in fact many of the cases directly relate to the companies’ securities offerings in the U.S., facts which made these companies susceptible to securities lawsuits in this country even under Morrison.

 

The lower courts will continue to interpret and apply Morrison in the months ahead. In the meantime, it seems that lawsuits involving non-U.S. companies will continue to arise, at least where the companies’ shares trade on U.S. exchanges.

 

A Final Note: Readers of this blog post may also be interested in my September 2010 post entitled "What to Watch Now in the World of D&O," which can be found here.

　

Ten Top Ten Lists: Top ten surveys proliferated at year end, and so it seems like a list of ten top ten lists would be the appropriate accompaniment to The D&O Diary’s own top ten list:

The Year’s Top Ten Insurance Coverage Decisions

Top Ten YouTube Videos of 2010

Top Ten Annoying Things British Men Do While Abroad

Top Ten New Species (International Institute for Species Exploration)

Top Ten Goals from the 2010 World Cup

Top Ten TV Commercials of 2010

Top Ten Encyclopedia Britannica Queries 2010

Top Ten Must-Reads in the Law, 2010

Princeton Review Top College Ranking 2010-2011

Time Magazine’s Top Ten of Everything List

　

　

In the latest demonstration of just how far the U.S. Supreme Court’s holding in Morrison v. National Australia Bank may restrict Section 10(b) claims involving foreign companies, on December 30, 2010, Southern District of New York Judge Harold Baer held that U.S.-based hedge funds could not pursue the claims that Porsche and certain of its officers had misrepresented Porsche’s intent to take over Volkswagen, which the hedge funds claim put them in a "short squeeze" that cost them $2 billion.

 

A copy of Judge Baer’s December 30 ruling in the Porsche case can be found here.

 

Background

The plaintiff hedge funds had entered security based swap agreements that referenced the price of VW shares. The swaps did not trade on any exchanges. The swap agreements generated gains for plaintiffs as VW’s shares decline and produced losses as the price of VW shares rose.

 

The plaintiffs allege that all of the steps necessary to transact the swap agreements were carried out in the United States. The swap agreements contain choice of law and forum selection provisions that designate New York law and a New York forum.

 

In the lawsuits, the hedge fund plaintiffs allege that the defendants had caused a dramatic rise in VW stock prices by buying nearly all of the few freely-traded shares as part of a secret plan to take over the company. The plaintiffs allege that after months of denying that it sought to take over VW, Porsche on October 26, 2008 disclosed the extent of its accumulated holdings in VW stock, as a result of which the VW share price shot up, causing the plaintiffs losses on their share agreements.

 

The defendants moved to dismiss in reliance on Morrison, on the grounds that the transaction was not within the ambit of Section 10(b) of the Securities Exchange Act of 1934.

 

The December 30 Holding

Morrison had held that Section 10(b) applies only to "transactions in securities listed on domestic exchanges, and domestic transaction in other securities." Because the plaintiffs’ swap agreements do not trade on U.S. exchanges, the relevant inquiry, according to Judge Baer, is whether the swap agreements constitute "domestic transactions in other securities."

 

The plaintiffs argued that because they signed confirmations for securities-based swap agreements in New York, they engaged in "domestic transactions on other securities" within the scope of Section 10(b).

 

Judge Baer held that these arguments were "inconsistent" with the "Supreme Court’s intention" to "curtail the extraterritorial application of Section 10(b)." He added that if the argument were allowed, it "would extend extraterritorial application of the Exchange Act’s antifraud provisions to virtually any situation in which one party to a swap agreement is located in the United States."

 

Judge Baer found this situation to be indistinguishable from one in which a U.S.-based investor bought securities in a non-U.S. company on a foreign exchange, circumstances that other courts previously have held to be outside the ambit of Section 10(b) in the wake of Morrison.

 

Looking to what he described as the "economic reality" of the swap transaction, Judge Baer found that "Plaintiffs’ swaps were the function equivalent of trading the underlying shares on a German exchange," noting that "the swap agreements were transacted with undisclosed counterparties who may well have been located outside the United States," and that both the issuer and the perpetrator of the alleged fraud were also located outside the United States.

 

Judge Baer noted that he is "loathe to create a rule that would make foreign issuers with little relationship to the U.S. subject to suits here simply because a private party in this country entered a derivatives contract that references the foreign issuer’s stock. Such a holding would turn Morrison’s presumption against extraterritoriality on its head."

 

Discussion

Perhaps the most telling line in Judge Baer’s opinion is his statement that the U.S. Supreme Court’s intention in Morrison had been to "curtail the extraterritorial application of Section 10(b)," Clearly, that has been the lower courts’ approach, effectively "curtailing" the reach of Section 10(b) in a wide variety of circumstances.

　

With this presumption about Morrison’s intention as his starting point, Judge Baer seems very clear that the swap transaction at issue here did not satisfy the Morrison "domestic transaction" test. But while the mere U.S. location of one swap counterparty may not be sufficient to subject a foreign-domiciled issuer to U.S securities laws, Judge Baer’s analysis still does beg several questions left unanswered in his opinion, namely: if this transaction is not a U.S. "domestic transaction," of what jurisdiction is it a domestic transaction? If the transaction details here are not sufficient to constitute a "domestic transaction," what transaction details are sufficient?

 

It remains for other courts to work through these kinds of questions. In the meantime, Judge Baer’s analysis, if followed by other courts, could restrict other prospective plaintiffs’ ability to rely on Morrison’s second prong to try to bring Section 10(b) claims involving foreign companies. Judge Baer’s analysis, along with that of other courts, suggests that courts will take a narrow view of what constitutes a "domestic transaction in other securities."

 

Certainly, a court proceeding, as did Judge Baer, on the assumption that Morrison intended to "curtail the extraterritorial effect of Section 10(b)" arguably will be predisposed against finding that a transaction involving a foreign company’s securities not traded on U.S. exchanges is a "domestic transaction in other securities." Morrison’s second prong may not prove to be as valuable to plaintiffs as they initially thought it might.

 

Allison Frankel’s January 3, 2011 Am Law Litigation Daily article about the Porsche decision can be found here. The Sullivan & Cromwell firm, which argued the case on behalf of Porsche, has a detailed January 3, 2011 memorandum about the case here.

 

Special thanks to the several readers who provided me with copies of Judge Baer’s opinion.

 

Editorial Note: In my January 3, 2011 post, I mentioned that I would be publishing a list of the top ten D&O stories of 2010 today (January 4, 2011). However, because of the several time sensitive developments (including the above), I will postpone the publication of the top ten list until later in the week. Sorry for any confusion.　

　

　

The FDIC as receiver of the failed Haven Trust Bank may not intervene in a securities lawsuit brought by the aggrieved investors of the Bank’s holding company, according to Northern District of Georgia Judge Charles A. Pannell, Jr.’s December 29, 2010 order in the case. Judge Pannell’s ruling, a copy of which can be found here, could have important implications for other failed bank investor cases in which the FDIC has or may seek to intervene.

 

Background

Banking regulators closed Haven Trust, located in Duluth, Ga., on December 12, 2008. As detailed here, on December 31, 2009, investors who purchased shares in the bank’s holding company filed suit in the Northern District of Georgia alleging that the company’s former officials had misled investors in connection with the share offering, in violation of federal and state securities laws. The individual defendants had served as directors both of the holding company and of the operating bank.

 

On October 4, 2010, the FDIC as the failed bank’s receiver moved to intervene in the investor action. As detailed at greater length here, the FDIC alleged that the investor action was essentially just a "derivative lawsuit in disguise," and, under FIRREA, as receiver, the FDIC succeeded to all of the bank’s rights, including its rights to control actions brought on the company’s behalf.

 

The FDIC also asserted that it had an "interest" in the case sufficient to support intervention because of its interests in preserving the D&O insurance policy for potential recoveries in connection with future claims the FDIC as receiver might assert against the former directors and officers of the bank.

 

The December 29 Ruling

In his December 29 ruling, Judge Pannell rejected both of the bases on which the FDIC had sought to intervene.

 

First, Judge Pannell rejected the FDIC’s argument that the investors’ claims were essentially just derivative claims over which the FDIC had priority rights under FIREEA. Judge Pannell said

 

These claims are not derivative claims against the Bank but are instead direct claims against the defendants …. While the FDIC controls derivative claims against the Bank’s former officers, it does not control claims against the holding company’s officers …. In this case, the plaintiffs assert their claims not as stockholders of the failed Bank, but instead as shareholders of the holding company.

 

Second Judge Pannell rejected the FDIC’s argument that it was entitled to intervene because of its prospective interest in the Company’s D&O insurance policy. Judge Pannell found that the FDIC does not have a "legally protectable interest" because the FDIC "has no rights with respect to this insurance policy except as a potential claimant against certain of the policy’s insured parties," and the FDIC’s "potential future rights" are "insufficient to establish that the FDIC has an interest in this case that justifies intervention as of right."

 

Finally, Judge Pannell denied the FDIC’s request for "permissive intervention" because the FDIC’s intervention "would needlessly delay the current proceedings while the FDIC investigates to determine whether it has any legitimate claims against the defendants."

 

Discussion

As NERA Economic Consulting noted in its August 2010 study of failed bank litigation (here), private investor securities suits were "not a notable feature of the S&L crisis," because few of the institutions that failed during that era had conducted securities offerings. By contrast, private litigation against directors and officers of failed banks during the current wave have been "widespread." As a result, the FDIC is in a position of competing with investor claimants for dwindling D&O insurance policy proceeds, as the Haven Trust case demonstrates.

 

As I discussed in my prior post about the FDIC’s bid to intervene in the Haven Trust case, the claimants who may be competing with the FDIC for the D&O insurance policy proceeds include not only aggrieved investors, but in instances where the bank holding company is in bankruptcy, may also include the bankruptcy trustee.

 

In both of these kinds of cases, the claims against the individual defendants will be direct claims aimed against them in their capacities as directors and officers of the holding company. At least according to the logic of Judge Pannell’s decisions in the Haven Trust case, the FDIC’s rights as receiver may not be sufficient to allow the FDIC to control or otherwise take priority over these direct claims targeted at the holding company level.

 

The essential problem at the heart of all of these kinds of disputes is that the parties left aggrieved in the wake of a bank failure are set against one another in a scramble for the D&O insurance (or whatever might be left of it after defense expenses have eroded the limits). Meanwhile, the former directors and officers are put squarely in the crossfire, with heightened exposure to multiple conflicting claims. Whatever else might be the merits of Judge Pannell’s holding, the practical effect of his ruling is to exacerbate all of these forces.

 

From the FDIC’s perspective, Judge Pannell’s ruling, if followed by other courts, could put the FDIC in a quite a dilemma. On the one hand, the FDIC has been proceeding quite deliberately as part of its process of investigating bank failures and deciding whether to bring claims. (Indeed, even though 322 banks have failed since January 1, 2008, the FDIC has filed only two lawsuits against former directors and officers of failed banks).

 

On the other hand, however, if by proceeding deliberately the FDIC is to be disadvantaged in the scramble for D&O insurance policy proceeds, and if the FDIC is unable to intervene in and stay investor and trustee actions against former bank officials, it may find itself compelled to move more quickly to file suit, simply to try to preserve a part of the dwindling policy proceeds before the other claimants get there.

 

Whether or not the FDIC will now accelerate its investigative and litigious processes remains to be seen. But at a minimum, Judge Pannell’s ruling suggests that the FDIC does not have priority rights over the direct claims of bank holding company investors, which is a principle that could prove important in the numerous other failed bank-related proceedings.

 

Special thanks to the several loyal readers who sent me a copy of Judge Pannell’s ruling.

 

Editorial Note: In my January 3, 2011 post, I mentioned that I would be publishing a list of the top ten D&O stories of 2010 today (January 4, 2011). However, because of the several time sensitive developments (including the above), I will postpone the publication of the top ten list until later in the week. Sorry for any confusion.

　

2010 was a year of transition for securities class action lawsuit filings, as a number of trends that have been dominant in recent years diminished as the year progressed, while at the same time other trends emerged. Overall, the number of filings during the year was up slightly from last year, although below long term averages. But as noted below, the securities class action lawsuit filing levels are only part of what has been happening from an overall claims frequency standpoint.

 

Overall Numbers

By my count, there were 177 new securities class action lawsuit filings during 2010. (Please see my notes below regarding counting methodology.) The 2010 total is up from the 168 new securities suits in 2009, although below the 1997-2008 average of 197.

 

The 2010 filings were weighted toward the year’s second half, as there were only 74 new securities class action lawsuit filings the first six months of the year, compared with 103 during the last six months.

 

There were a number of different factors behind the relatively greater number of filing in second half of the year.

 

2010 Filing Trends

Perhaps the most significant factor behind these annual filing numbers is the diminishing numbers of subprime and credit crisis related cases during year.

 

The credit crisis cases had been a significant of all filings during the years 2008 (when there were 102 credit crisis-related lawsuit filings) and 2009 (62). By contrast during 2010, there were only 23 new credit crisis-related securities lawsuits, representing about 13% percent of the total. Of these 23 new credit crisis cases, only nine of these cases were filed in the year’s second half, and only one was filed after August 2010. Clearly, the credit crisis litigation wave is winding down.

 

Similarly, another important factor in recent years’ filings has been the phenomenon of belatedly filed cases. These cases, filed more than a year or more after the proposed class period cutoff date, had surged during 2009. The belated filings did continue in 2010, as there were 17 of these belated cases during the year. However, there were only three of these cases were filed in the year’s second half, and none were filed after September. Again, the phenomenon of belatedly filed class action seems to be winding down.

 

While these dominant trends from prior years diminished in the second half of 2010, a number of other trends emerged that largely explain the increase in filings during the last six months of the year.

 

First, a significant percentage of all 2010 filings were lawsuits related to mergers or acquisitions. These merger objection cases involve acquisitions, going private transactions or management buyouts, or allegations of proxy violations in connection with these kinds of corporate activities. There were 37 of these cases in 2010, representing more than one-fifth of all 2010 filings. 23 of these cases were filed in the year’s second half. These merger objection cases were a significant part of the increased number of filings in the year’s second half.

 

Second, there were several sector specific contagion events that resulted in a rash of cases against a number of companies in a specific category. As I have previously noted on this blog, these contagion events include an outbreak of lawsuits against for-profit education companies (as discussed here), and against companies domiciled in China (as discussed here).

 

By my count, 12 for-profit education companies were sued during 2010, all of them after August 1, 2010. These cases against for-profit education companies represent 6.7% of all new 2010 filings.

 

Similarly, there were 10 Chinese domiciled companied sued during 2010, eight of them in the year’s second half. These cases against Chinese companies represented 5.6% of all 2010 filings.

 

Together the cases against companies in these two categories were a significant factor in the increase in second half filings, as they represent nearly 20% of all filings in the year’s second half.

 

Another significant category of cases during the year are those involving failed and troubled banks. There were 13 cases filed against banking institutions during 2010, representing 7.3% of all 2010 filings.

 

One other 2010 filing trend worth noting is the securities class action lawsuit headline hit parade. In a sequence that was well-established this year, securities class action lawsuit filings followed almost immediately for companies suffering significant adverse publicity events. Companies hit with class action lawsuits this year as part of this pattern include Toyota, Massey Energy, Goldman Sachs, BP and even Lender Processing Services (a company caught up in the foreclosure process scandal). Indeed, it could be argued that the wave of suits against the for-profit education companies fit this same pattern.

 

Recurring Filing Trends

While some recent trends diminished during the year and other new trends emerged, there were some long-standing patterns that continued during the year. Among the most distinct of these continuing trends is that life sciences companies continued to attract plaintiffs’ lawyers’ attention as they have in past years (about which refer here).

 

During 2010, securities class action lawsuits were filed against 18 companies in the 283 Standard Industrial Classification (SIC) Code Group (Drugs), and against nine companies in the 384 SIC Code Group (Surgical, Medical and Dental Instruments). These 27 companies represent about 15% of all securities lawsuit filings during the year. By way of comparison, life sciences companies were sued in about 10% of all filings in 2009.

 

In addition, as has been the case for the last several years, financially-related companies also remained a prominent securities litigation target. There were 34 companies in the 6000 SIC Code series (Finance, Insurance and Real Estate) named in securities suits during the year. In addition, there were 18 other entities named as defendants to which no SIC code designation has been assigned. Most of these entities lacking SIC Codes are financially related. These two groups together represent a total of 52 of the 2010, or 29.3% of the total (compared with 37% during 2009).

 

But while there were concentrations in certain industry categories, the 2010 filings overall involved a surprisingly broad array of kinds of companies. Overall, the companies targeted in the 2010 represented 80 different SIC Code categories.

 

The 2010 filings were also generally geographically dispersed. The 2010 securities cases were filed in 47 different U.S. district courts. However, there were certain courts that saw high levels of new filings during the year. 35 of the cases ( nearly 20%) were filed in the S.D.N.Y., 19 (10.7%) were filed in the Northern District of California, and 19 (10.7%) were filed in the Central District of California. Together the cases filed in just these three courts represent more than 41% of all 2010 filings.

 

19 (or 10.7%) of the cases filed during 2010 involved companies domiciled outside the U.S. Surprisingly, 12 of these cases were first filed after the U.S. Supreme Court’s June 2010 decision in the Morrison v. National Australia Bank case, which narrowed the availability of U.S. courts for the claims of some claimants with claims against non-U.S. companies (about which refer here). As noted above, many of these cases against non-U.S. companies involved Chinese companies. There were cases filed against companies domiciled in eight other countries as well.

 

Looking Ahead

While it may be safe to say that the filings during 2010 represented some form of a transition, it is difficult to say what the year’s developments may portend as we head into 2011.

 

On the one hand, the upswing in cases in the year’s second half might be interpreted to suggest that 2011 will be an active year for new securities lawsuit filings.

 

On the other hand, the upswing in the second half was in many ways a reflection of outbreaks of litigation activity related to very specific and short term events, such as the scandal involving student lending in the for-profit education sector. Similarly, the uptick in cases filed against Chinese companies may signify nothing more than a reflection of the fact that an increased number of Chinese companies recently have sought U.S. listings. The litigation in the second half of the year from these kinds of events and activities may or may not continue to lead to litigation activity in 2011.

 

There are certain 2011 litigation trends that do seem relatively likely to continue in 2011. The merger related litigation activity show no signs of slowing down. Given the continuing surge of bank failures, it seems likely that we will continue to see new filings involved failed and troubled banks. And there doesn’t seem to be any reason to assume that the historically elevated levels of litigation activity involving life sciences companies will not continue into next year as well.

 

Some Observations About "Counting"

Although the process of counting lawsuits would seem like a relatively straightforward exercise, there are a number of issues that complicate the process and that can significantly affect the outcome. First and foremost you have to decide what "counts." For purposes of my analysis, I count each claim against a company raising the same allegations only once, regardless of the number of complaints that are filed. This counting method means that my lawsuit count will appear lower than that of other observers, like for example NERA Economic Consulting, which will count different complaints against the same company in different jurisdictions as separate lawsuits (at least until the complaints are consolidated).

 

Another issue is what kind of lawsuit to count. In general, I try to count class action lawsuit alleging violations of the federal securities laws. One particular category I have always struggled with are the merger objection lawsuits, which may be framed as class actions and may allege violations of the securities laws, but generally are based on allegations of that some aspect of a merger or acquisition is unfair to investors, by comparison to the more traditional stock-drop-disclosure-violation lawsuit.

 

In the past I have tended against including the merger objection lawsuits. I opted to include these lawsuits this year, in part because without including them my lawsuit count would diverge materially from other public reports about the 2010 filings. Indeed, if I had not included the merger objection lawsuits in my 2010, I would be reporting only about 140 new securities class action lawsuit filings this year. It is arguable that by including the merger objection lawsuits in my 2010 count, I have inflated the reported number of filings.

 

Another category of cases that I have included in my 2010 count but about which reasonable minds might differ are the cases involving private or other nonpublic entities. I have wrestled with this question every year, as the inclusion of these kinds of cases in the count arguably could have the effect of overstating the frequency risk to the companies that are most concerned about securities class action litigation activity levels, namely publicly traded companies.

 

A total of 17 of the 2010 filings involved private entities. The nature of these cases varies. But the inclusion of these kinds of cases arguably also overstates the securities class action litigation activity levels, at least as respects publicly traded companies.

 

The inclusion of the private company claims and the inclusion of the merger objection cases have a very material impact on the reported number of overall filings. Without these cases, the reported number of filings would have been substantially lower (that is, it would be 123 rather than 177). Again reasonable minds could dispute whether or not these categories of cases should be considered. Regardless, in considering the level of 2010 securities class action litigation activity, it is important to understand how these categories of cases are treated.

 

On a final note, the treatment of one other category of cases had the effect of deflating the reported number of filings. That is, by my count, there were five new cases filed involving ETF funds during 2010. Cases involving ETF funds were a significant part of 2009 securities class action litigation activity. However, in April 2010, Southern District of New York Judge John Koeltl entered an order consolidating all of the ETF lawsuits, including those filed in 2009 and 2010, into a single case (refer here). Accordingly, because the ETF cases are no longer separate suits, I have not counted the five new 2010 ETF lawsuit filings as separate cases for purposes of my 2010 lawsuit count.

 

A Final Note About Securities Class Action Frequency

As insurance information firm Advisen has well documented, the mix of corporate and securities lawsuits has been evolving over the past several years. The most important feature of this changing mix of cases has been the decreasing prevalence of class action securities lawsuits as a percentage of all corporate and securities cases.

 

According to Advisen, securities class action lawsuits represented less than 20 percent of all corporate and securities class action lawsuits during the first three quarters of 2010, which represents a significant decline from more traditional patterns in which securities class action lawsuits represented half or more of all corporate and securities lawsuits.

 

As the percentage of class action securities lawsuits has declined, other types of lawsuits, particularly breach of fiduciary duty cases, have grown in relative frequency. Many of these breach of fiduciary duty cases are related to mergers and acquisitions activity. Indeed, as I noted in my year-end review of 2010 securities lawsuit filings, even many of the cases that are categorized as securities class action lawsuits involve merger objection cases.

 

It is important to keep this changing mix of cases in mind when considering the various year end reports on securities litigation activity. These reports typically will show that overall 2010 securities class action lawsuit filings are down compared to post-PSLRA averages. However, it would be mistake to conclude that the relatively reduced number of securities class action lawsuits means that claims activity in general is down. To the contrary, overall claims activity is actually up. The mere fact that securities class action lawsuits are down does not mean that fewer companies are being sued or that overall claims exposure has diminished, either for companies or insurers. Rather, what is happening is that the claims exposure is changing, away from securities class action lawsuits and toward other types of claims.

 

Coming Attractions: Tomorrow I will be posting my list of the Top Ten D&O Stories of 2010. Those who have read this post closely will recognize at least two of the top stories on tomorrow’s list, as there is some overlap between today’s post and the first two items in tomorrow’s list. A certain amount of overlap was unavoidable, but rest assured that most of tomorrow’s post reflects additional and comprehensive observations about the events of 2010.

　　

On Wednesday December 29, 2010 at 1 p.m. EST I will be participating in a free webcast sponsored by Securities Docket, entitled "2010 Year in Review: Securities Enforcement, Litigation & Compliance."

 

The webcast panel, which will include Compliance Week editor Matt Kelly, Francine McKenna (re: The Auditors) , Mike Koehler (aka the "FCPA Professor"), Francis Pileggi (Delaware corporate law guru), Tracy Coenen (The Fraud Files), Lyle Roberts (The 10b-5 Daily) and Securities Docket’s Bruce Carton, will look back at 2010’s most significant events and trends in the areas of corporate compliance, auditor issues, the Foreign Corrupt Practices Act, Delaware corporate law, D&O insurance issues, white collar fraud issues, securities class actions and SEC enforcement.

 

For further information and to register, please visit the Securities Docket webinsar webpage, here.

 

New York Attorney General Andrew Cuomo’s December 21, 2010 filing of a civil fraud lawsuit against Ernst & Young in connection with the audit firm’s services to Lehman Brothers has captured headlines in business pages around the world. The complaint itself, which can be found here, raises some serious allegations. But the complaint also raises a number of interesting questions, as discussed below. The NYAG’s December 21, 2010 press release about the lawsuit can be found here.

 

The Complaint

The 32-page complaint alleges that between 2001 and September 2008, E&Y "facilitated" Lehman Brothers’ "massive accounting fraud." The complaint alleges that during that period E&Y earned over $150 million in compensation from Lehman, which allegedly was one of E&Y’s largest clients.

 

The complaint alleges that Lehman manipulated its balance sheet through quarter-end sales of billions of dollars of fixed-income securities to European banks, with the express understanding that the Lehman would repurchase the securities days later. Lehman’s use of these transactions, know as Repo 105 transactions, allowed Lehman to mask its balance sheet leverage. The scale of these transactions grew as Lehman’s financial condition deteriorated in 2007 and 2008.

 

The complaint alleges that E&Y was aware of Lehman’s use of these transactions, yet approved Lehman’s use of financial statements that did not disclose the existence of the transactions or their effect on Lehman’s balance sheet. These actions, the complaint alleges, "directly facilitated a major accounting fraud, and helped mislead the public."

 

The complaint alleges that these actions by E&Y violated New York’s Martin Act. The complaint seeks to compel E&Y to repay the fees it earned from Lehman as well as investor damages.

 

Discussion

There are a number of very interesting things about the NYAG’s complaint against E&Y.

 

The first is that the only defendant in the lawsuit is E&Y itself. There are no other individuals or entities names as defendants.

 

On the one hand, it is hardly a surprise that a governmental authority has decided to pursue a regulatory claim against E&Y, in light of the March 2010 report by the Lehman Brothers bankruptcy examiner Anton Valukas (about which refer here). In his report, Valukas had concluded "there are colorable claims" against E&Y for its "failure to question and challenge improper or inadequate disclosures." Given the bankruptcy examiner’s conclusions it seemed probable that there might eventually be some kind of regulatory action taken against E&Y.

 

On the other hand, the bankruptcy examiner’s report not only concluded that there are "colorable claims" against E&Y, but also concluded that there are "colorable claims" against the senior Lehman officials who "oversaw and certified the misleading financial statements," including Lehman’s CEO Richard Fuld and its CFOs, Christopher O’Meara, Erin Callan and Ian Lowitt. Moreover, the NYAG’s complaint expressly refers to other financial executives at Lehman who were involved in the company’s use of the Repo 105 transactions.

 

The NYAG’s complaint does not name any of these individuals as defendants. Indeed, one of the very curious aspects about the NYAG’s complaint is that it is virtually silent about the role or involvement of the most senior Lehman officials in the Repo 105 transaction; the individuals referred to by name in the complaint are by and large not the most senior executives.

 

And just as the complaint names no Lehman executives as defendants, the complaint also names no E&Y-related individuals as defendants. The sole defendant is E&Y itself, even though the individual E&Y audit partners responsible for Lehman’s audit and financial reporting are identified by name in the NYAG complaint. Yet it is the audit firm itself that is named as defendant, not the individuals.

 

The complaint’s firm-level focus is all the more interesting as allegations in the complaint do not seem to suggest that the decision to allow Lehman the accounting treatment it received was made at a firm-wide level or that anyone at E&Y other than the specific individual audit partners were aware of Lehman’s use and reporting of the Repo 105 transactions.

 

Setting aside the question of who been sued, there is also the question of the timing of the filing of this complaint. The complaint was filed by New York’s departing AG, Andrew Cuomo, who is just days away from taking up his duties as New York’s incoming Governor. Of course, it was his deputies and assistants who prepared and filed the complaint, but the timing of their actions means that this case will shortly become the responsibility of the incoming NYAG Eric Schneiderman.

 

Given that the incoming AG will be responsible for the case, it seems odd that he was not allowed control over its filing. On the other hand, under the heading of media relations, it may not be surprising that the outgoing AG wanted to make sure that everybody knew this complaint was filed on his watch.

 

Another question that combines these questions of targets and timing is the question of sequencing. The sequencing issue has two aspects – the first is why the NYAG has proceeded first against E&Y without at the same time or first going against any company officials. The second issue is the question of why the NYAG’s office is proceeding forward in advance of any action by the federal regulators.

 

The NYAG may be proceeding first against E&Y for tactical reasons, as a way to secure a settlement and/or the firm’s cooperation in connection with a later action against the corporate officials. Peter Lattman reported on December 20, 2010 on the Dealbook blog (here) that E&Y and the NYAG’s office have been in settlement negotiations. The complaint may simply represent negotiations in another form.

 

As for the NYAG’s moves ahead of the federal regulators, Lattman speculates that the action may in fact spur the SEC or the DoJ to act – which may or may not have been an intended consequence of the move.

 

But the most interesting question of all is – what will happen next? Will E&Y reach a settlement with the incoming NYAG? Will the NYAG file a separate action against senior Lehman officials? Will the SEC or the DoJ now take action, either against E&Y or former Lehman officials?

 

Whatever else might be said about the NYAG’s complaint, its very presence begs the question why there has yet been no federal regulatory action related to Lehman, a question further highlighted by the bankruptcy examiner’s report. My own view of the reason the federal regulators have not yet acted is that they know all too well that the Lehman collapse is the highest profile event related to the credit crisis.

 

Given that high profile, they know they can’t take any chance that their Lehman-related enforcement actions might fail. The unacceptable consequences (to the federal regulators) of a failed regulatory action are compelling them to build the most durable case they think they can construct before proceeding. I still think it is a question of when, nor if, the federal regulators will initiate their own Lehman-related enforcement actions.

 

Assuming for the sake of argument that the federal regulators will eventually launch their own Lehman action, it will be interesting to see if the federal action will target E&Y. Francine McKenna suggests on her Accounting Watchdog blog on the Forbes website (here), that when it comes to pursuing the accountants, the feds are all too happy to have the NYAG do the "dirty work."

 

For the record, I disagree with the media voices trying to suggest this is the "beginning of the end" of E&Y. This is not a criminal case of the kind that killed Arthur Anderson. This is a civil action. E&Y has taken a massive reputational hit and it likely will  have to pay substantial amounts to extricate itself from this case. But the firm’s continued existence is in no danger from this case.

 

Susan Beck has an interesting December 21, 2010 article on the Am Law Litigation Daily (here) about the defenses that E&Y has raised to similar allegations in investor litigation relating to the Lehman collapse.

　

"Year in Review" Webcast: On December 29, 2010 at 1 p.m. I will be participating in a free webcast sponsored by the Securities Docket, entitled "2010 Year in Review: Securities Enforcement, Litigation & Compliance."

　

The panel, which will include Compliance Week editor Matt Kelly, Francine McKenna (re: The Auditors) , Mike Koehler (aka the "FCPA Professor"), Francis Pileggi (Delaware corporate law guru), Tracy Coenen (The Fraud Files), Lyle Roberts (The 10b-5 Daily) and Securities Docket’s Bruce Carton, will look back at 2010′s most significant events and trends in the areas of corporate compliance, auditor issues, the Foreign Corrupt Practices Act, Delaware corporate law, D&O insurance issues, white collar fraud issues, securities class actions and SEC enforcement.

　

For further information and to register, please visit the Securities Docket webinsar webpage, here.

　

Season’s Greetings: Over the next few days, The D&O Diary will be taking a short holiday break. We will resume our normal publication schedule after the New Year. In the meantime, we would like to thank everyone for their support this past year and wish everyone a healthy and happy holiday season.

　

As our final holiday gesture, we would like to share this video (which has quickly gone viral) of the flash-mob-in-the-mall performance of The Hallelujah Chorus from Handel’s Messiah. Apparently the flash mob performance of this work has become quite the phenomenon this holiday season, to the point that a Sacramento choir’s December 20, 2010 attempt to stage its own flash mob scene resulted in a mall’s closure, as reported here.

　

Fortunately, the performance in this video reflects a more peaceful scene. Happy Holidays.

　

　

https://youtube.com/watch?v=SXh7JR9oKVE%3Ffs%3D1%26hl%3Den_US

Even after two years, the Madoff scandal continues to fascinate. Following close on the heels of last week’s news of Mark Madoff’s tragic suicide is the absolutely arresting news of Jeffry Picower’s estate’s $7.2 billion settlement with the U.S. government – to be specific, the precise amount of the settlement is $7,206,157,717, according to the Southern District of New York U.S. Attorney’s December 17, 2010 press release.

 

 

According to the press release, the settlement amount represents “all the profits Picower withdrew over the years.” Picower apparently first invested with Madoff in the late 70’s, and withdrew billions over time. After Madoff’s scheme was exposed “it became clear” that Picower had “profited at the expense of more recent [Madoff] investors.”

 

 

 

One aspect of the settlement, and apparently a critical condition on which Picower’s widow had insisted, is the provision that “neither Picower nor any of the related entities participating in the settlement had any involvement in, or knowledge of, Madoff’s fraud.”

 

 

 

This settlement will not leave Picower’s widow destitute. Most of this money had been intended for a philanthropic foundation, not for Picower’s heirs. According to the Washington Post (here), Picower’s widow will retain $200 million and his daughter will retain $25 million, the funds for all of which reportedly derived from sources other than Madoff-related profits.

 

 

 

Those readers who are curious to know exactly how a $7.2 billion civil forfeiture works will want to take a look at the U.S. Attorney’s December 17, 2010 forfeiture complaint. The complaint, which can be found here, is styled as an action by the United States against the “Defendant in rem” – specifically, “$7,206,157,717 on Deposit at J.P. Morgan Chase Bank, N.A..”

 

 

 

Among other interesting tidbits, the complaint reveals that, in order to generate those $7.2 billion in profits, the total amount that Picower had invested with Madoff’s investment advisory services was $617,456,578 – which by my calculation means that Picower’s investment with Madoff had supposedly generated lifetime returns of over 1,100%)

 

 

 

The estate’s December 17, 2010 stipulation of settlement with the government, which can be found here, represents in effect the estate’s agreement to forfeit the Defendant in rem to the government, to be effected, the stipulation recites, by the Clerk of Court’s issuance of “a warrant for the arrest of the Defendant in rem.”

 

 

 

Southern District of New York Judge Thomas Greisa approved the forfeiture case settlement. The settlement remains subject to the bankruptcy court’s approval.

 

 

 

This dual judicial approval is required because the settlement actually represents two different funds to be paid in settlement of two different matters. One fund, in the amount of $5 billion, is to be paid in settlement of the adversary proceeding the SIPC Trustee Irving Picard had filed against Picower in the bankruptcy court. The remaining $2.2 billion is actually in settlement of the civil forfeiture proceeding itself. Picard is to administer both funds for the benefit of the Madoff victims according to the detailed procedural specifications in the settlement stipulation.

 

 

 

 

The New York Times speculates that as a result of this and other recoveries, those who lost the amount of their principal investment by investing with Madoff may recover as much as 50 percent of their losses.

 

 

 

Special thanks to a loyal reader for providing the Picower settlement documents.

 

 

 

The Next Act of this Icelandic Saga Will Not be Staged in New York: Many readers may recall my May 2010 post about the events surrounding the failure of Iceland’s Glitnir Bank and the subsequent lawsuit filed in New York state court against the bank’s controlling shareholder and his wife, certain former bank directors and officers, and the Bank’s auditor.

 

 

 

At the time, I noted that “the obvious question about this case is what the heck is it doing in state court in New York?”

 

 

 

Apparently, the New York state court judge in charge of the case had exactly the same question. As reflected in Julie Triedman’s December 17, 2010 Am Law Litigation Daily article (here), on December 15, 2010, Judge Charles Ramos has thrown out the lawsuit on forum non conveniens grounds.

 

 

 

According to the article, among other issues with which Ramos was concerned was the practical problem associated with language translation. Judge Ramos seemed to accept the argument of counsel for one of the defendants, who had asked the Judge to “imagine the burden of trying to translate that all? We can’t even pronounce the names, much less translate this all.” (In that regard, I note that in typing my prior post about this case, I was unable to accurately reproduce the individual defendants’ names, as the requisite typographic symbols are simply unavailable.)

 

 

 

Judge Ramos also seemed annoyed by the very idea that this case could be added to his judicial burdens. The article reports that Judge Ramos said “you know something, we don’t need extra work. How many cases does the average judge in Iceland have in their inventory?…I’ve got 350.”

 

 

 

Demonstrating the true New Yorker’s perception of geography, Ramos added that “what I see unfolding is a case that is going to show me that the conspiracy was hatched in Iceland or Denmark or some place, but not necessarily New York.”

 

 

 

Ramos conditioned his dismissal on the defendants’ acceptance of jurisdiction in Icelandic courts. He advised the plaintiffs’ counsel to “get yourself a plane ticket.”

 

 

 

And Speaking of Failed Banks: Meanwhile, while everyone was distracted with other things, the FDIC quietly closed six more banks this past Friday night, bringing the 2010 YTD total to 157. There could be more bank failures yet to come this year, but given that next Friday is Christmas Eve and the following Friday is New Year’s Eve, the FDIC might be done closing banks, for this year at least.

 

 

 

Though the monthly totals fluctuated throughout the year from a monthly low of seven failed banks in February 2010 to a monthly high of 23 in April 2010, it definitely seems as if the bank closure pace slowed as the year progressed. There have been only 71 bank failures in the second half of 2010, compared with 86 in the first half. Moreover, after the FDIC closed 22 banks in July 2010, the agency closed only 49 banks over the following give months (an average of just under 10 banks a month).

 

 

 

The six bank closures this past Friday included three more bank in Georgia. There have been 51 bank failures total in Georgia since January 1, 2008, the highest total for any state during that period.

 

 

 

But the state with the highest number of bank closures in 2010 is Florida, which with one more bank closure this past Friday now has had 29 bank failures this year. (Georgia is second in 2010 bank failures with 21.) Florida also has the second highest number of bank failures since 2010, with 45.

 

 

 

Since January 1, 2010, there have now been a total of 322 bank failures. With 860 banks ranked as “problem institutions” in the agency’s most recent Quarterly Banking Profile, it seems likely that bank failure will likely continue as we head into 2010.

 

 

 

A Spectral Italian Vintner, Perhaps?: Novelist Jay McInerney’s wine column in this Saturday’s Wall Street Journal (here) contained this sentence: “When the elder brother died, he returned to Italy to run the family business.” In fairness, the surrounding context makes some sense out of this otherwise incomprehesible sentence. Nevertheless, The D&O Diary feels compelled to throw a flag on this sentence for unnecessary roughness in the use of the English language.

 

 

 

And Finally: If you have not yet had someone send you a link to the marvelous December 16, 2010  “Let it Dough!” illustrations on Christoph Niemann’s Abstract City blog on the New York Times website, give yourself a treat and take a few minutes to check them out here. (The “Hot Toddies” illustration alone justifies the time to visit the site.)

 

 

In its December 15, 2010 filing of Form 8-K (here), Ambac Financial Group announced that it had entered a memorandum of understanding to settle the subprime-related securities class action lawsuits pending against the company and certain of its directors and officers for a payment of $27.1 million, of which $24.6 million is to be paid by the company’s D&O insurers.

 

UPDATE: An informed source advises that in addition to the settlement on behalf of Ambac and its directors and officers, the plaintiffs in this case also entered a separate $5.9 million settlement with Ambac’s offering underwriters, bringing the total value of this settlement to $33 million.

 

The settlement is interesting in and of itself, but it is also interesting for the perspective it provides on the mountain of remaining unresolved subprime and credit crisis-related securities suits, as discussed below.

 

As discussed in greater detail here, in January 2008 Ambac and certain of its directors and officers were sued in a series of securities class action lawsuits filed in the Southern District of New York. These actions were later consolidated. The plaintiffs’ consolidated amended class action complaint can be found here. Further background regarding the case can be found here.

 

The plaintiffs’ allegations in the case largely related to the company’s provision of insurance coverage for collateralized debt obligations. The plaintiffs allege, among other things, that the defendants failed to disclose that the company lacked internal controls sufficient to ensure that the company’s standards for underwriting CDOs were adequate, and that the company had a far greater exposure to CDO-related losses and defaults than the company had previously disclosed.

 

In addition to the consolidated securities case, a separate securities suit was filed in December 2008 in the Southern District of New York against Ambac and certain of its directors and officers on behalf of invertors in the company’s Structured Repackaged Asset-Backed Trust Securities (STRATS), as reflected here. The STRATS lawsuit, which proceeded separately from the consolidated case, alleged that the defendants had issued false and misleading statements concerning Ambac’s financial results and operations.

 

On February 22, 2010, Southern District of New York Naomi Reice Buchwald granted in part and denied in part the defendants’ motion to dismiss in the consolidated securities case.

 

As I noted in a prior post discussing the dismissal motion ruling (here), Judge Buchwald’s decision was particularly noteworthy for her rejection of defendants’ attempts to argue that the company’s woes were not the result of fraud but rather were the result of the global financial meltdown; among other things, she stated that "the conduct that plaintiffs’ allege, if true, would make Ambac an active participant in the collapse of their own business, and of the financial markets in general, rather than merely a passive victim."

　

According to the company’s recent 8-K, the $27.1 million would resolve both the consolidated case and the STRATS lawsuit. As noted above, $24.6 million of the settlement is to be paid by the company’s D&O insurers, and the remaining $2.5 million is to be paid by Ambac. The settlement is subject to a number of conditions, including court approval.

 

This settlement is interesting because it would resolve one of the higher profile subprime cases, after a portion of the case survived a dismissal motion.

 

But the more interesting thing to me about this settlement is the fact that it has happened at all, or at least that it has happened now. My point is that even though about 230 subprime and credit crisis-related lawsuits have been filed since February 2007, very few of these cases have yet settled, even among the many cases that have survived motions to dismiss.

 

By my count, even taking the Ambac settlement into account, there still have been only 17 settlements of the subprime and credit crisis related securities class action lawsuits. (My list of the subprime and credit crisis-related securities lawsuit case resolutions can be accessed here.) To be sure, those settlements represent an aggregate amount of settlements of over $1.925 billion (although that impressive figure is largely a reflection of just four settlements – Countrywide, Merrill Lynch, Merrill Lynch Bond, and Schwab Yield Plus – which account for about $1.5 billion of the total.)

 

Regardless of the aggregate dollars involved in the 17 settlements to date, those settlements represent only a small part of the overall number of cases that have been filed. Moreover the subprime and credit crisis-related litigation wave will soon enter its fifth year, so you would start to think that more of these cases would be settled. Nevertheless, only eight subprime and credit crisis-related securities class action lawsuits have settled so far in 2010.

 

According to statistics the NERA Economic Consulting reported earlier this week in its 2010 study of securities class action lawsuits, of the 230 cases that NERA has identified as credit crisis-related, "only 8% have settled, 29% have been dismissed, and 63% remain unresolved."

 

Of course, a certain number of those 63% of all cases that are unresolved were filed fairly recently, and you wouldn’t expect those later filed cases to yet be near settlement. (NERA reported that there were 31 new credit crisis-related cases filed during 2010.) But many of these cases are now several years old.

 

These older unresolved cases, or at least those that survive dismissal motions, will eventually start moving toward settlement. (Relatively few will actually make it to trial, although the BankAtlantic credit crisis-related securities suit, in which the jury recently returned a plaintiffs’ verdict, is the rare case that did head to trial.)

 

I am going to go out on a limb here and predict that in 2011, there will be many more settlements of subprime and credit crisis-related securities cases than there were in 2010. We may soon get to the point that a settlement of the size of Ambac’s will no longer be particularly noteworthy. But we are not there yet.

 

As these cases move toward settlement, the insurers aggregate claim losses will begin to mount. In that regard it is worth noting that the average settlement of the 17 cases that have settled is over $110 million (although substantially lower if the four mega settlements noted above are disregarded). The implied losses that these 160-170 unresolved subprime cases represent is enormous – and that is not even taking defense costs into account.

 

Yes, not all of the settlement amounts will be paid by insurance. And yes, there will be a substantial number of those cases that will be dismissed. But many will eventually settle and much of the costs of settlement will be borne by the insurers.

 

To the extent that the carriers have adequately reserved for these losses, the settlements will not cause a ripple in the D&O insurance industry. But if the insurers are not adequately reserved for these losses, the resolution of these cases potentially could hit the industry as losses mount.

 

It would be interesting to conduct a survey amongst participants in the D&O insurance industry to find out whether people think that D&O insurers (a) are adequately reserved for these future losses; (b) think they are adequately reserved but will find out in the future they are not adequately reserved; or (c) are not adequately reserved.

 

A Couple of Interesting Law Firm Memos: A lot of law firm memos cross my desk every day, and not all of them are worth reading. But a couple of memos I recently reviewed were of particular interest.

 

First, in a December 9, 2010 memo entitled "Directors’ and Officers’ Liability: Shareholder Derivative Litigation Developments" (here), Joseph McLaughlin of the Simpson Thacher law firm summarized important recent judicial developments in federal and Delaware state court shareholder derivative litigation.

 

Second, in a December 6, 2010 memo entitled "The Board’s Expanded Role in an IPO" (here), David Westenberg of the WilmerHale law firm takes a brief look at the burdens and responsibilities of board of directors of companies that are going public.

 

In a prior post, I speculated how WikiLeaks-style disclosures might fuel claims against corporate officials, to the extent that the previously nonpublic information conflicted with public statements. The latest round of WikiLeaks disclosures includes revelations that provide a more specific example of this type of process at work.

 

The latest revelations are in the form September 2009 diplomatic cables from the U.S. Embassy in London, published in The Guardian on December 13, 2010. The cables can be found here. The cables summarize meetings held September 2-7, 2009 between two U.S. senators and three members of the House of Representatives and various Members of Parliament, U.K. government officials and leading banking executives.

 

The meetings largely involved the discussion of the causes and lessons of the global financial crisis.

 

Among the sessions summarized in the cables is a separate meeting between the three congressmen and RBS Chairman Philip Hampton. Hampton was appointed to the post by the U.K government in February 2009. In the meeting, Hampton commented on the involvement of RBS in the financial crisis.

 

The cables quote Hampton as having said that RBS "had made several enormous mistakes," the most significant of which were the bank’s "heavy exposure to the U.S. subprime market and the bank’s purchase of ABN Amro."

 

With respect to the ABN Amro purchase, Hampton commented that it had "occurred at the height of the market and without RBS doing proper due diligence prior to the purchase." Hampton commented that "the board of directors never questioned this purchase," which Hampton termed "a failure of their fiduciary responsibilities."

 

The timing of these revelations is awkward, to say the least, both for RBS and for the U.K. Financial Services Administration, coming as it does just days after the FSA announced that it had closed its RBS investigation and would take no further regulatory or enforcement actions.

 

In a December 2, 2010 statement (here), the FSA said it was closing its supervisory investigation of RBS, noting that while its investigations had revealed a number of "bad decisions" at the bank, the FSA had concluded that those "bad decisions" were "not the result of a lack of integrity by any individual." The FSA statement added that "we did not identify any instances of fraud or dishonest activity by RBS senior individuals or a failure of governance on the part of the Board."

 

A December 13, 2010 article in The Guardian (here) suggests that the latest WikiLeaks investigations could lead to "pressure" on the FSA to reopen the RBS probe. The Guardian article also attributes statements to attorneys that Hampton’s reported remarks "could be crucial for any shareholders trying to bring legal action for the losses they sustained on their shares." particularly with respect to losses shareholders sustained in connection with the company’s 12 billion pound share offering in March 2008.

 

Whether or to what extent these revelations will lead to new or augmented litigation involving RBS and its current and former directors and officers remains to be seen. But regardless of what might arise as a result of this specific disclosure, the event itself highlights the problems that companies may face as a result of WikiLeaks-type disclosures.

 

As I have previously noted, the WikiLeaks-type of disclosure of internal or confidential communications potentially could represent a new type of threat for corporate officials. There may be and likely will be WikiLeaks imitators willing to ambush companies and executives with undisclosed communications obtained in any number of ways, which could not only be embarrassing but could also subject them to claims.

 

"Structural Corruption": James Fallows has an interesting commentary in a December 10, 2010 post on his blog on the Atlantic Monthly website about the decision of former Office of Management and Budget director Peter Orzag to accept a senior position at Citibank, a financial institution that received substantial federal bailout support during the financial crisis.

 

Among other observations, Fallows notes the "structural corruption" Orzag’s move represents (drawing a distinction to "personal corruption) in that, which there may be nothing formally wrong with the move, it "says something bad about what is taken for granted in American public life.."

 

I think Fallows’ comments are worth contemplating. I am sure I am not the only one that found the depth of involvement of Wall Street insiders during the financial crisis more than a little disturbing. What Fallow describes as the structural corruption is the very thing that left so many Americans suspicious that the bailout was an inside job, meant to protect financial interest at the expense of American taxpayers. The certainty that Washington insiders can look forward to making millions on Wall Street merely reinforces this perception of corruption. And yet, as Fallows note, it is taken for granted.

 

Introduction to D&O Insurance: Many readers may be familiar with my series of posts on the Nuts and Bolts of D&O Insurance, which can be accessed by clicking on the link in the right hand column. Readers who are interested in the basics of D&O insurance may also want to read "Directors and Officers Insurance: An Overview" (here) by my friend David Gische of the Troutman Sanders law firm, and his colleague Meredith Werner. The article includes important historical background on the development of the insurance product.