On December 14, 2010, NERA Economic Consulting released its annual year-end study of securities class action lawsuit filings and settlements. The report, entitled "Trends 2010 Year-End Update," can be found here. Among other things, the NERA study reports that class action filings "picked up substantially" in the second half of 2010, and that median class action settlements reached an all-time high in 2010.

 

There are a couple of important considerations to be taken into account with respect to the NERA report. The first is that its analysis is with respect to filings and settlements through November 30, 2010. The report does incorporate a number of projections to account for the year’s final month.

 

In addition, the NERA report’s "counting" methodology, as reflected in footnote 3 of the study, may differ from the methodology used in other publicly available analyses of securities class action filings.

 

The NERA report states that "until cases are consolidated, we report multiple filings that potentially are related to the same allegations if complaints are filed in different circuits." And until cases are consolidated, "we report multiple filings if different cases are filed on behalf of investors in common stock and other securities." If the cases are ultimately consolidated, the data are adjusted. NERA’s methodology differs from that used by other observers (including The D&O Diary), and may result in a filing count that is higher than reported elsewhere.

 

The study does report a number of interesting findings, including the fact that class action filings accelerated in the second half of 2010. In fact, the study reports, the number of new class action filings in September (25) represents the highest monthly total of new "standard"  filings since August 2004.

 

According to the NERA report, there were a total of 219 filings in the year’s first eleven months. NERA projects a total of 239 filings by year end, which would represent an increase over the 220 filed in 2009 and would be "broadly consistent with the long-term average."

 

Though companies in the financial sector remain the most frequently targeted, the number of credit crisis-related lawsuits continues to decline. There were only 31 credit crisis related filings in 2010, compared to 57 in 2009 and 103 in 2008. More than half of the new lawsuits against companies in the financial sector in 2010 were unrelated to the credit crisis. About 40% of all 2010 cases named companies in the financial sector, which, while well below the peak of 72% in 2008, still remains above the 28% in 2005 and 2006, prior to the credit crisis.

 

Other sectors that also saw significant amounts of securities class action litigation included health technology firms, electronic technology and technology services sector. As I previously noted (here), there was also a sharp upturn in cases against companies in the for-profit education sector.

 

Despite the U.S. Supreme Court’s holding in Morrison v. National Australia Bank (about which refer here), the anticipated drop in cases against non-U.S. companies did not really materialize, largely do to the "spate of suits against Chinese-domiciled companies" (about which I recently commented here).

 

On the other hand, the number of belated filings of securities lawsuits declined in the second half of 2010. As I previously noted, there had been an upsurge in new case filings reflecting a substantial time lag between the date of filing and the proposed class period cutoff. The NERA study reports that for 2010 filings, the median time to file was only a month, compare to nearly six months for cases in the second half of 2009.

 

Among trends in factual allegations, the NERA study reports that filings of cases alleging breach of fiduciary duty more than doubled in 2010. Many of these cases were related to mergers or acquisitions.

 

With respect to case resolutions, the NERA study reports a number of interesting filings. Among other things, the study reports that the average settlement for cases settled in 2010, adjusted for outlier settlements, was $42 million, which is in line with 2009’s record high but well above the $30.4 million average for the period 2003 to 2010.

 

Even more significantly, the NERA study reports that in 2010, the median settlement jumped to $11.1 million, which not only represents an all-time high, but is more than a third higher than the 2009 median of $8.5 million. However, the report also notes that median investor losses for cases filed in 2010 were down substantially and more in line with pre-credit crisis cases. These more recently filed cases may push median settlements down in future years closer to the historical median.

 

Consistent with this last point, though average and median settlements are elevated, the settlements as a percentage of investor losses were consistent with similar ratios going back to 2002. The percentage in 2010 was 2.4%, well within the 2.2% to 3.1% range between 2002 and 2009.

 

One factor that may affect average and median settlements in the near term is the substantial overhang of unresolved subprime and credit crisis-related lawsuits. Even though several high-profile credit crisis cases have been resolved, many more remain pending. The NERA study reports that of the 230 credit crisis-related securities class action lawsuits, only about 8% have been settled, and another 29% have been dismissed, but fully 63% remain unresolved. These cases will continue to work their way through the system in the months ahead.

 

The NERA report is full of a wide variety of interesting information and insights, and is worth reading at length and in full. I hope to have my own study of the 2010 filings shortly after year end.

　

As reflected in detail below, noted D&O maven Dan Bailey of the Bailey & Cavalieri law firm has submitted the following guest blog post in response to an earlier guest post on this site. I would like to thank Dan for his willingness to have his comments published here. Dan’s guest blog post is as follows:

　

Kevin,I am responding to thearticle in your November 15, 2010 blog by John Iole at Jones Day regarding the "no broader than underlying" provision in virtually all excess D&O policy forms. I normally do not comment on articles which I think are misguided since conducting a public debate often elevates the visibility of the article and usually accomplishes little. However, in this instance it appears that John’s article has resulted in a number of brokers requesting the deletion of the "no broader than underlying" provision from excess D&O policies without fully appreciating the issues involved and the importance of that provision.

 

As summarized below, I think John’s article overstates the alleged concerns with such a provision and ignores the purpose and value of such a provision. Here is a brief summary of many of my concerns about the article.

 

     

  1. Purpose of Provision

    The primary purpose of this provision in excess policies is to avoid an excess insurer covering loss which is not covered under an underlying policy and thus to avoid the risk the excess policy would drop down in that situation. Excess policies typically state that liability attaches to the excess policy only if and when the underlying insurers and/or the Insureds pay loss which is covered under the underlying policies in an amount equal to the Underlying Limit.

     

    If the excess policy covers a loss not covered by the underlying policies, the Underlying Limit presumably would never be depleted by such loss since such loss is not covered by the underlying policies. In that event, a literal reading of the excess policy’s attachment provision would result in liability never attaching to the excess policy for such loss even though such loss is otherwise covered under the excess policy.

     

    That nonsensical result could cause a Court to conclude the excess insurer must pay the loss notwithstanding the fact that the Underlying Limit has not be exhausted as required by the attachment provision in the excess policy. In other words, there would be a risk that the excess policy would be forced to drop down and pay that loss at a much lower level within the insurance program than the excess insurer intended. Such a result would violate the intent of the parties and force the excess insurer to incur far greater loss exposure than was reflected by the excess insurer’s pricing and underwriting analysis.

    　

    Other purposes of this provision include (i) allowing the excess insurer (which is receiving substantially less premium that the underlying insurers) to rely on the underwriting analysis of underlying insurers (i.e. if an underlying insurer identifies and excludes an unacceptable risk, the excess insurer gets the benefit of that analysis), and (ii) providing assurance to the excess insurer 　that all of the underlying insurers will be actively involved in monitoring and adjusting any claim covered under the excess policy. Those purposes would obviously be lost if the provision is deleted from the excess policy.

     

    Therefore, this provision is important in order to preserve the integrity of the excess program structure and in order to avoid an excess insurer paying more losses than the excess insurer intended or contractually agreed to pay.

     

     

  2. Concerns with Provision

John’s article identifies several purported problems or concerns with this very standard provision, each of which are addressed below. It is important to note, though, that the article fails to even identify – much less address – the very important purposes and value of the provision from the excess insurers’ perspective. Plus, one should note that although this provision has been in virtually all excess D&O policy forms for decades, virtually no caselaw exists with respect to the meaning and applicability of this provision, thus indicating that in practice the provision does not create the controversies touted in the article.

 

     

  1. The article states that the provision allows the excess insurer to "pick and choose"　 among various underlying policy terms in defining the coverage afforded by the excess policy. That is simply incorrect. The provision is clear and absolute – if a loss is not covered under an underlying policy, that loss is not covered under the excess policy. There is no discretion involved, and the excess insurer cannot and need not "pick and choose" which provisions in the underlying policies the excess insurer does or does not want to adopt. The article cites to several examples of situations where this discretion could purportedly exist. However, those examples (e.g. different arbitration provisions in different underlying policies) are not valid examples since they deal with different procedural provisions in the underlying policies. The "no broader" provision only applies to the scope of coverage (i.e. is a loss covered or not) and does not apply to other procedural provisions, such as the notice, claims participation, cooperation, ADR, etc. provisions.

     

  2. The article states that this provision creates a "bewildering patchwork of coverage arguments". That is simply incorrect. Actually, the provision creates greater consistency within an insurance program by better aligning the scope of coverage among different policies within the program. By including this provision in all the excess policies, all of the excess polices will provide more consistent coverage throughout the program. It is only if the provision is deleted will the "bewildering patchwork of coverage arguments" be increased since there would be a higher likelihood that each policy within the program will have a different scope of coverage.

     

  3. The article states that the provision can create the risk that different insurers could apply inconsistent interpretations to the same term in an underlying policy. But that risk exists with or without this "no broader" provision. Even if the provision is deleted, the excess policies follow the terms of the Primary Policy and thus there is a risk the primary insurer may interpret a term of the Primary Policy differently than an excess insurer may interpret that provision.

     

  4. The article questions what does "broader coverage" mean for purposes of this provision. That is answered simply: is loss otherwise covered under the excess policy but not covered under the underlying policy?

     

  5. The article states that one cannot determine if coverage is broader until the loss is incurred. That is correct in many instances, but that dynamic is not due to the "no broader" provision. Under any policy, coverage typically cannot be determined until the loss is incurred, and deleting the "no broader" provision will not change that result.

　

In summary, the stated concerns regarding this provision are either not valid or not material, particularly when compared with the compelling purpose and value of this provision.The provision has survived the test of time over several decades without creating undue problems for Insureds while accomplishing some important benefits to excess insurers. Therefore, on balance I think the provision should be retained in excess policies.

 

*******

Once Again, I would like to thank Dan for his willingness to have his comments published here. The D&O Diary welcomes guest blog post submissions from responsible commentators. Please contact me if you think you might be interested in submitting a guest blog post.

 

An insurance broker’s settlement of claims for disgorgement of undisclosed contingent commissions does not represent covered loss under a combined lines professional liability insurance policy, according to a December 3, 2010 decision of the Illinois (Cook County) Circuit Court. A copy of the December 3 opinion can be found here.

 

Background

Aon Corporation was first sued in 1999 in a class action lawsuit brought on behalf of its customers who alleged the firm had acted improperly with respect to its receipt of certain contingent commissions from insurance carriers. This class action lawsuit came to be known as the Daniel action. Aon was also the subject of certain regulatory investigations from several states’ Attorneys General based on the same allegations.

 

As originally pled, the Daniel action sought damages as well as other relief. However, the Daniels action was amended multiple times. As ultimately pled, the Daniel action sought only a disgorgement into a constructive trust of the amounts allegedly improperly received.

 

On March 4, 2005, AON entered into a settlement with the Attorneys’ General in which it agreed to deposit $190 million into a fund to be paid to former clients of the firm. The agreement specified that the firm would not seek indemnification from its insurers for the funds paid in the settlement.

 

On March 9, 2005, AON entered a separate settlement in the Daniel action, in which the firm agreed to pay an additional $38 million. The Danies action was approved by the Court.

 

Aon sought indemnification from its insurers for the amounts paid in settlement of the Daniels case as well as defense expenses incurred in the Daniel case and the Attorneys General action.

 

Aon’s insurance program included a Combined Lines Policy which combined certain lines of professional liability insurance, including directors and officers liability insurance, errors and omissions insurance and other lines as well. The Combined Lines Policy insurance program consisted of a layer of primary insurance and multiple layers of excess insurance.

 

In August 2006, AON initiated an action in Illinois (Cook County) Circuit Court seeking a judicial declaration of coverage under the Combined Lines Policy for loss incurred in connection with the Daniels action and related matters. The parties filed cross motions seeking to establish whether or not the Danies settlement and the defense costs incurred in the Daniel and the Attorneys General actions represented covered loss under the Combined Lines Policy.

 

The December 3 Order

In arguing that there was no coverage under the Combined Lines Policy for the settlement and defense expenses, the carriers argued that "Loss" covered under the Policy does not include "disgorgement of an ‘ill-gotten’ gain, that is, money of property an insured allegedly had no right to receive in the first place." The insurers argued that the Daniel plaintiffs sought only a constructive trust, not individualized damages, making it clear "that they were seeking disgorgement as their only remedy." The carriers also argued that it would be against Illinois public policy to allow the firm to pay restitution or fund a constructive trust with insurance proceeds.

 

AON in turn argued that there were genuine issues of material fact whether or not the remedies the Daniel plaintiffs sought were restricted solely to restitution. AON argued further that even if the pleadings as amended sought only restitutionary relief, the original pleadings had sought damages, and therefore the firm was entitled to its costs of defending the original pleadings. AON also argued that there was a genuine issue of fact whether the Attorneys General actions sought only restitutionary relief.

 

In her December 3 opinion, Judge Kirie Kinnaird rejected AON’s arguments and held that the relief sought in the Daniel action was "restitutionary and not an insurable loss." Judge Kinnaird rejected the firm’s contention that it was entitled to the defense expenses incurred before the pleadings were amended to remove the damages allegations, since the ultimately operative complaint, and the one to which AON filed its motion to dismiss, sought only restitutionary relief.

 

Judge Kinnaird also rejected AON’s argument that because there had been no determination in the Daniel action that the contingent commissions were "ill-gotten," the commissions represented amounts the firm was entitled to receive, and therefore the Daniels settlement represented covered "Loss." Judge Kinnaird said:

 

Insurability does not depend on whether a claim has merit, but rather what the settled claim sought….This Court will not make a finding or determination of whether AON’s alleged actions in the Daniel litigation were "ill-gotten gains" or unlawful. The lawfulness of collecting contingent commissions was not at issue in the Daniel litigation and is not relevant here. It was the Daniel plaintiffs’ allegation that AON failed to disclose its eligibility to receive the contingent commissions and the retention thereof that gave rise to AON’s potential liability.

 

Finally, Judge Kinnaird held that the firm was not entitled to recover its expenses incurred in defending the Attorneys General actions because the matters were in the nature of disgorgement and restitution. Judge Kinnaird rejected AON’s argument that the way that the claims were characterized in the settlement documents altered this conclusion. Because the underlying claims were not covered, the expenses incurred in the defending the matters likewise were not covered.

 

Discussion

There is an extensive body of case law holding that D&O insurance does not cover disgorgement or amounts incurred that are restitutionary in nature. What makes this holding interesting is Judge Kinnaird’s express observation that the question of coverage for the amounts AON sought does not depend on whether or not the amounts themselves were "ill-gotten."

 

Rather, the Judge held, the question of coverage for the amounts sought depending solely on the fundamental nature of the relief sought. Because the relief sought in both the Daniel action and the Attorneys General action was fundamentally restitutionary in nature, there was no coverage under the policy at issue.

 

The part of Judge Kinnaird’s holding worth thinking about is the ruling with respect to defense expenses. I think most would accept that liability insurance can’t be used as a way for insured’s to finance their repayment of amounts that were not the insured’s in the first place. However, the determination of noncoverage for the amounts incurred in defending against wrongful acts may or may not be as obviously reasonable to many observers.

 

I would be interested in knowing readers’ thoughts on the defense expense question. I think there may be some difficult issues there to consider, especially with respect to individual defendants (particularly in the bankruptcy context).

 

Special thanks to a loyal reader for providing me with a copy of the AON decision.

　

SafeNet’s Excess Carrier’s Rescission Action to Go Forward: On December 7, 2010, Southern District of New York Judge Naomi Buchwald denied the motion to dismiss an action to determine whether or not there is coverage under SafeNet’s excess D&O insurance policy for the settlement of the company’s options backdating related securities class action lawsuit. A copy of the opinion can be found here.

 

The excess carrier’s action seeks to rescission. In her December 7 opinion, Judge Buchwald held that neither the underlying carrier nor individual directors and officers who had not been named as defendants in the rescission action were indispensible parties to the rescission action.

 

Judge Buchwald also rejected the argument that the rescission action was not yet ripe, because the primary policy had not yet been exhausted by payment. She held that the rescission action represented a ripe controversy notwithstanding the fact that the underlying limit had not been exhausted because the securities class action lawsuit settlement presented the "practical likelihood" that the excess limits would be called upon.

 

Semtech Options Backdating Securities Class Action Lawsuit Settles: On December 8, 2010, Semtech announced that it had settled what is one of the last remaining options backdating-related securities class action lawsuits. As reflected in Semtech’s December 8 press release, which can be found here, the case has settled for $20 million.

 

I have added the Semtech settlement to my running tally of options backdating related class action lawsuits, which can be accessed here.

 

According to data compiled by Adam Savett of the Claims Compensation Bureau, of the 39 options backdating related securities class action lawsuits, seven (or 18% were dismissed) and 31 have been settled or partially settled. The total value of all options backdating related securities class action lawsuit is $2.38 billion. The average settlement is $68.7 million, and the median settlement is $14 million. Savett’s data also reflects average and median insurer settlement contributions.

　

R-T Specialty, LLC Acquires Oakbridge Insurance Services, LLC

 

 

Acquisition Broadens RT’s Presence in the Executive and Professional Liability Segment   

 

Oakbridge is one of the nation’s leading specialty insurance intermediaries with extensive experience and exclusive focus on executive and professional liability exposures and insurance solutions. The company was organized in 2005 as the successor to Carpenter Moore Insurance Services’ Eastern U.S. operations. Oakbridge’s main office in Bloomfield, Connecticut is strategically located within a 15 mile radius of many of the underwriting facilities with whom the company transacts business. In addition, the company maintains offices in California, Minnesota, New Jersey and Ohio.

 

Tim Turner, President and CEO of RT Specialty, says of the acquisition, "At RT Specialty, our mission is to assemble the best and the brightest wholesale brokers in the country; brokers committed to providing our clients with the best resources available. The RT Specialty team, retail agents and brokers, and specialty insurance markets have long recognized Oakbridge’s reputation as an outstanding organization whose brokers are widely regarded as among the very best nationwide in the executive and professional liability arena. By combining our teams in these segments, we will solidify our position as the preeminent executive and professional liability wholesaler in the minds of retail brokerage firms, their clients, and the specialty markets that underwrite this insurance."

 

Jose Medina and Alex Jezerski, the Managing Members of OakBridge offer the following commentary. Jose Medina states: "For over 15 years, we have been steadily executing on a business model which depends on constant innovation, attracting and retaining the best people in the industry and staying true to our core mission of being the leading executive and professional liability wholesale intermediary in the country." Alex Jezerski adds: "RT Specialty has presented us with a once in career opportunity that will allow us to combine the expansive RT resources and existing talent pool with our unique business model, intellectual property and claims advocacy skills. The synergies between the two firms will be extraordinarily beneficial to our existing retailers and prospects, as we develop and expand the relationships that will continue to bring innovative products and solutions for our partners’ clients." 

 

About R-T Specialty, LLC

 

R-T Specialty, LLC is a subsidiary of Ryan Specialty Group, LLC specializing in wholesale brokerage, MGU/MGA underwriting facilities and other services to agents, brokers and carriers. In California: R-T Specialty Insurance Services, LLC License #OG97516 

 

About Oakbridge Insurance Services, LLC

OakBridge Insurance Services is one of the nation’s leading Executive and Professional Liability insurance intermediaries. The firm provides its services through co-brokerage alliances with strong, regional insurance brokers across the country.

#####

In the wake of Pfizer’s record-setting September 2009 $2.3 billion settlement of charges that it had engaged in off-label marketing of Bextra and other drugs, Pfizer investors filed shareholders derivative lawsuits against the company, as nominal defendant, and 19 of the company’s directors and officer, alleging that the defendants breached their fiduciary duties by failing to detect and prevent the illegal marketing.

 

The parties have now entered a $75 million settlement of the derivative lawuits. The settlement has several interesting features, particularly with respect to the insurance, which is funding the entire settlement amount. The settlement is subject to court approval.

 

Background

On September 2, 2009, the Department of Justice announced that Pfizer had agreed to pay a total $2.3 billion dollars in settlment of the off-label marketing allegations.. In its press release describing the settlement, the DoJ said that the settlement – which represented a criminal fine of $1.195 billion and a civil False Claims Act settlement of $1 billion, as well as certain additional civil forfeitures – represented the largest health care fraud settlement in the DoJ’s history.

 

Following the announcement of this settlement, investors filed a number of shareholder derivative lawsuits, which ultimately were consolidated in a single action in the Southern District of New York before Judge Jed Rakoff. Background regarding the derivative litigation can be found here. The plaintiffs’ consolidated amended complaint can be found here.

 

The Settlement

On December 2, 2010, the plaintiffs filed a motion for preliminary approval of the derivative litigation. The motion, to which the settlement stipulation is attached, can be found here (Hat tip to the Seeking Alpha blog for the settlement documents.).

 

In the settlement, Pfizer and the other defendants have agreed to set up a Regulatory and Compliance Committee to report to the company’s board and to take appropriate steps to prevent future drug marketing violations. Among other things the committee will review compensation policy and practices to ensure they are consistent with the compliance objectives.

 

One of the things that makes this settlement unusual is the way the committee’s activities are to be funded. As part of the settlement, a pool of funds – to be financed entirely by insurance – will be used to pay for the committee’s activities for five years.

 

Under the settlement stipulation, four of the company’s D&O insurers "shall pay a total of $75 million into an escrow account under the control of Pfizer." After payment of fees and expenses, the remaining escrow funds "shall be subject to the exclusive control of the Regulatory Committee for funding activities of the Regulatory Committee for its initial five years." If the committee spends more than the funds available, Pfizer will make up the difference. If the committee spends less that the remaining funds, unspent amounts are to be returned to the insurers. (The four insurers involved are listed on page 9 of the settlement stipulation.)

 

A further provision of the settlement stipulation specifies that settlement contribution by the fourth of the four insurers is subject to arbitration. Pfizer may have to pay the insurer up to $20 million depending on the outcome of the arbitration.

 

An exhibit to the settlement stipulation specifies that the plaintiffs’ lawyers will seek attorneys’ fees of $22 million plus costs of $1.9 million. The amount of the plaintiffs’ fees awarded is to come out of and thereby reduce the $75 million. If plaintiffs are awarded the full amount of fees and costs sought, the net funds remaining of the original $75 million would be $51.1 million.

 

At least one news report suggests that the company’s entry into this derivative settlement, together with the earlier DoJ settlement, may have hastened or even directly led to the abrupt departure of Pfizer CEO Jeff Kindler.

　

Discussion

A frequent component of derivative lawsuit settlements is the company’s agreement to adopt certain governance reforms or to implement certain corporate therapeutics. So from that perspective, Pfizer’s agreement as part of this settlement to set up a compliance committee to ensure good behavior is not unusual.

 

One of the things that is unusual about this arrangement is that, among other things, there is a specific pot of money that is to be set aside to fund the compliance reforms to which the company has agreed as part of a derivative settlement.

 

And what is even more unusual, and arguably unprecedented, is that the funds to be set aside for these activities are to be provided for exclusively by the company’s D&O insurers.

 

I am sure the D&O insurers’ contribution toward this settlement was the subject of extensive negotiation. I can certainly imagine the carriers taking the position that the cost of the company’s compliance or governance activities represents corporate overhead expenses and as such is not covered loss under the company’s D&O liability insurance. I expect these kinds of questions had to be sorted out in the course of the negotiation of this settlement. (The fact that one of the four D&O insurer’s contribution toward the settlement is subject to arbitration suggests further that these questions were not fully sorted out as part of the settlement negotiations.)

 

On the other hand, the idea behind the settlement may be that the individual defendants nominally agreed to pay for the remedial measures, and the insurers are simply paying on the individuals’ behalf. From that perspective, the prospect of the D&O insurers undertaking to pay those amounts on the individuals’ behalf may make the arrangement more consistent with the D&O insurance policy’s basic proposition.

 

But while this latter analysis may make the insurers’ contribution explainable in insurance terms, the fact that the insurers are basically paying for corporate governance reforms arguably represents something of a novel development and may represent a noteworthy precedent going forward.

 

Another noteworthy aspect of this settlement of this settlement is its sheer size. The $75 million dollar value of the settlement makes it one of the largest shareholders derivative settlements of which I am aware, exceeded only by a very small handful of other derivative settlements, including the UnitedHealth Group settlement ($900 million, refer here ); Oracle ($122 million, refer here), Broadcom ($118 million, refer here), AIG ($115 million, refer here), and the AIG/Greenberg settlement ($90 million, refer here).

 

There was a time when a significant cash payment was not a part of shareholders’ derivative lawsuit settlements. However, as this growing list of jumbo settlements underscores, derivative suit settlements involving a large cash component are becoming increasingly common – which , among other things, has important implications for D&O insurers and their policyholders.

 

Along those lines, one thing the Pfizer settlement has in common with these other jumbo derivative settlements is that each of these settlements involves solvent entities. The relevance to me from the fact that Pfizer is solvent derives from the added fact that this settlement almost certainly represented a payment of the Side A of the company’s insurance program – indeed, the identity of the insurers involved strongly suggests that this settlement represents a Side A insurance loss.

 

If as I assume to be the case this settlement represents a Side A insurance loss, this settlement represents yet another case in which insurers have been called upon to fund a substantial Side A loss outside of the insolvency context. (Please see my discussion of the Broadcom settlement, here, for a more detailed review of the significant of the Side A loss payment outside of the insolvency context.)

 

These kinds of settlements provide concrete evidence of the value to policyholders of significant amounts of Side A insurance even outside of the insolvency context.

 

These settlements also underscore the fact that even Excess Side A insurers are exposed to potential losses – even outside of the insolvency context – and that this exposure seems to be increasing over time. Only the insurers themselves can answer the question of whether or not they are actually pricing their products for the risk of Side A losses outside the insolvency context.　

 

Among 2010 securities class action lawsuit filing trends are two phenomena that emerged in the second-half of the year – the flurry of lawsuits filed against for-profit education companies and the proliferation of suits involving companies domiciled in China. These two filing trends converged in a single case filed last week against a Chinese for-profit education company.

 

According to their December 2, 2010 press release (here), plaintiffs’ lawyers have filed a securities class action lawsuit against China Education Alliance, Inc. and certain of its directors and officers. The complaint, which was filed in the Central District of California, can be found here.

　

According to the complaint, the company provides educational resources and training through its Internet websites and training facilities in China. The complaint seeks to hold the defendants liable for misrepresenting the company’s financial performance. According to the press release, the complaint alleges that

 

contrary to the Company’s annual reports filed with the SEC for fiscal 2008, which reported $24.9 million of revenue, an annual report for the Company’s main operating subsidiary filed with the Chinese authorities reported less than a million of revenue for 2008. This discrepancy, along with other accounting inconsistencies, and contradictions about the Company’s online education and training center operating segments, has raised red flags of fraud. When this adverse information was released to the market on November 29, 2010 the price of China Education Alliance stock fell substantially damaging investors.

 

In my prior post discussing the recent outbreak of securities suits targeting Chinese companies, I noted that a recurring theme in the suits is the allegation that the companies had reported different financial information to Chinese authorities than they reported in their SEC filings. The new complaint against China Education Authority echoes this recurring allegation.

 

The complaint also cites sources reporting that the company’s Internet sites are not functional and its training centers appear to be inactive, suggesting that the company may not even be an operating business as claimed in its U.S. public filings. (These allegations, which make for rather interesting reading, are detailed in paragraph 37 of the complaint.)

 

In any event, the plaintiffs’ firm that filed the suit against China Education Alliance apparently has concluded that suing Chinese companies is a growth business. In addition to the new suit against China Education Alliance, the same firm also filed a separate lawsuit in the Southern District of New York last week against Mecox Lane Limited, a Chinese company that just completed its U.S. debut in an IPO on Nasdaq in October 2010.

 

According to the plaintiffs’ firm’s December 4, 2010 press release (here), the online apparel company’s share price declined significantly on November 29, 2010 when the company disclosed that "contrary to the company’s registration statement filed with the SEC, the company’s gross margins had been adversely impacted by increased costs and expenses, which made it impossible for Mecox to achieve the results defendants projected at the time of the IPO."

 

The extent to which the plaintiffs’ firm that filed these suits perceived an opportunity in suing Chinese companies is underscored in firm’s press release about the new Mecox Lane lawsuit. Among other things the press release cites about the firm, it also states that the firm "has substantial experience litigating matters involving companies based in the People’s Republic of China."

 

In any event, of the roughly 162 new securities class action lawsuits filed so far this year, nine of them (or about 5.5%) have involved Chinese companies. Seven of these nine have been filed just since September 17, 2010.

 

Ten of the 162 YTD 2010 securities suits (or about 6%) have involved for-profit education companies. All of those suits have been filed since mid-August.

 

The plaintiffs’ firm that filed these suits may well be on to something, as all signs suggest that problems involving Chinese companies may continue to emerge. According to a December 3, 2010 Audit Integrity memo (here, registration required), "many U.S.-listed Chinese companies have little to no intrinsic value."

 

The Audit Integrity memo adds that "many of these companies have relied on the ‘China’ brand in order to go public," but "the vast majority of these companies are thinly capitalized and are in lines of business that are neither unique nor innovative." Many of the Chinese company stocks "may prove to be valueless" and in many cases the companies "appear to be manipulating their financial results."

 

Even though the U.S. Supreme Court’s June 2010 decision in the Morrison case may restrict the scope of suits that may be filed against foreign domiciled companies in certain respects, foreign companies may still be sued under U.S. securities laws in connection with securities transactions taking place in the U.S.

 

Since many Chinese companies have pursued U.S. listings in recent years, these companies are susceptible to securities suits in the U.S., at least as to investors who purchased their shares on U.S. exchanges. The Audit Integrity analysis suggests that many more Chinese companies could well find themselves as U.S. securities suit targets, in addition to the nine companies that have been sued so far this year.

 

Message From the Fringe: Our San Francisco correspondent filed this report via text message Friday evening: "There’s a wookie in the BART station."

 

Accompanying the various print media stories this past week about the latest judicial developments involving jailed former Tyco CEO Dennis Kozlowski was the iconic photo of Kozlowski draping his arms over the shoulders of a couple of beauties at his wife’s infamous $2 million birthday bash on Sardinia.

 

There’s something about this photo that captures the ego-centric excessive essence of the era of corporate scandals. Maybe it’s the look of self-impressed arrogance on Koslowski’s face. It certainly is no surprise that the pictures and videos from the birthday party were a featured part of Kozlowski’s criminal trial.

 

The reproduction of the picture in connection with last week’s story highlights the fact that if you happen to have your arms around a couple of babes at a $2 million birthday bash on Sardinia paid for by persons to whom you owe a fiduciary duty, it is a really bad idea to allow pictures. (In fairness, at his criminal trial Kozlowski argued that the company paid only half of the cost of the event, which ostensibly also had some business-related purposes.)

 

The universality of this "no pictures" principle suggested to me that it might be worthwhile to assemble in one place all of the lessons that may be derived from the various corporate scandals over the years.

 

First, there is what I will call the Fabulous Fab Rule, which is that it is a really bad idea to write emails so provocative that they wind up reproduced above the fold on the front page of the Wall Street Journal.

 

Second, there’s the the Gen Re Executives Rule, which is that it is a good idea, if you discussing by telephone a transaction to recharacterize a public company’s reported financial results, to remember that all telephone calls at your Irish trading desk are recorded.

 

Third, there is the Smartest Guys in the Room Rule, which is that if an analyst is asking a probing question that targets sensitive issues (like the fact that Enron released its financial results without a cash flow statement or a balance sheet), it is a bad idea allowing yourself to be recorded referring to the analyst as an "asshole." (Actually, Skilling’s statement was "Well, thank you very much, we appreciate that …asshole.")

 

There undoubtedly are many other similar rules in the same vein that might be added to this list, and I encourage readers that have additional thought along these lines to add them to the list using this blog’s comment feature.

 

The Faithless Servant: The news stories this past week about Kozlowski related to the December 1, 2010 order by Southern District of New York Judge Thomas Griesa in the lawsuit Tyco filed against Kozlowski about the approximately $100 million of compensation that Kozlowski claims the company owes him under certain deferred compensation agreements. Tyco contended that the agreements were fraudulently induced or that the benefits were otherwise forfeit under New York’s "faithless service doctrine."

 

Based on the jury findings in the criminal trial, Judge Griesa concluded that under the faithless servant doctrine, Kozlowski must forfeit compensation and benefits earned during his period of disloyalty. Judge Griesa also concluded that various agreements entered during the period of Kozlowski’s disloyalty were fraudulently induced.

 

However, Judge Griesa also held that Kozlowski was entitled to trial on the question of his entitlement to benefits earned prior to the time at which the jury determined his disloyalty began. He also concluded that Tyco was not entitled to summary judgement on the company’s claim for contribution for legal expense incurred in defending lawsuits arising from Kozlowski’s breach of fiduciary duty.

 

The December 3, 2010 Wall Street Journal article about Judge Griesa’s ruling can be found here.

 

O.K., We Missed the Bridge Implosion, But You Don’t Get to See an Angry Troll Everyday: This video has quickly gone viral. From the WGN Morning News, here’s live local television in all of its glory:

　

https://youtube.com/watch?v=y9HiJVBA0CE%3Ffs%3D1%26hl%3Den_US

Though it quickly recovered, Bank of America’s share price declined earlier this week on speculation that the company is the bank whose internal documents WikiLeaks intends to post on the Internet at some future date. According to news reports, the WikiLeaks  founder Julian Assange has asserted that he has five gigabytes of Bank of America documents, which translates to roughly 600,000 pages of information. Assange has asserted that the documents to be disclosed contain highly damaging information.

 

Assange is a master of bombastic overstatement (as well as a world champion self-promoter). But let’s assume for the sake of discussion the documents are as revealing as Assange has tried to suggest and also assume that the documents do relate to Bank of America.

 

The WikiLeaks disclosure of internal company information potentially could have a couple of immediate litigation related impacts. First, to the extent relevant, the documents could affect the vast of amount of litigation that is pending against Bank of America as a result of the company’s takeover of Merrill Lynch or relating to other business activity before and during the financial crisis. It is entirely possible the revelations could aid the plaintiffs in these various cases.

 

On the other hand, and to the extent the documents relate to events or activities about which there has previously been no prior company disclosure, the WikiLeaks disclosure potentially could lead to entirely new litigation unrelated to existing cases. Were that to occur, the lawyers for the prospective plaintiffs’ complaint drafting would be substantially aided by the disclosures of internal company documents.

 

The potential revelation of internal company documents that were never intended for public consumption could also lead to a wide variety of other types of claims. If the company were to be harmed in some way by the ultimate revelation – say, for example, by a stock price drop or by reputational damage – shareholders might well file claims against senior company officials for failing to implement controls to prevent this kind of disclosure or for misrepresenting the quality of controls that were in place.

 

Depending on the type of information revealed, there could be other types of claimants. For example, customers, vendors or competitors about whom damaging information is revealed could well file suits seeks damages for the company’s failure to prevent the revelations.

 

It is one thing to consider these possibilities exclusively within the context of the threatened disclosure of Bank of America documents. It is something else entirely to consider the possibility that the threat of this type of guerilla disclosure of internal corporate documents represents a new and serious exposure for all companies. After all, what Assange is now threatening to do to Bank of America could be repeated against other companies by other zealots who somehow get access to internal communications.

 

At a minimum, it seems likely that companies and their senior executives may be mobilized to undertake vigorous new efforts to prevent future information leaks of this type. The problem for everyone is that, in the U.S. at least, we have proven to have a peculiar talent for overreacting to the most recent security breach. Due to this phenomenon, the unsuccessful efforts of the shoe and underwear bombers have managed to make air travel excruciatingly unpleasant. Corporate (over)reaction to the threatened WikiLeaks disclosure could lead to the imposition of information security constraints that could make daily life for corporate technology users extremely inconvenient and unpleasant.

 

But beyond the potential operational effects, the threat of this type of information disclosure event could also represent a new category of corporate executive exposure. Shareholders and others may expect company officials to prevent this type of disclosure from happening and may hold the officials accountable if information disclosures occur. Finally, persons whose interests are harmed by disclosures of internal company information could seek to hold the company and its senior executives liable of harm that might arise from this type of disclosure.

 

It is of course entirely likely that none of these things will ever come to pass. But even if the threatened WikiLeaks disclosure never happens or represents something less than threatened, these risks are still out there lurking in the realm of possibilities.

 

Put these issues down as one more damned category of things to worry about.

　

　

　

Settlement is the critical goal in every claim that cannot be resolved otherwise. It terminates the open dispute, it provides the parties with finality, and, perhaps, most importantly, it provides the parties with repose. After a settlement is final, everyone is free to get on with their lives.

 

Notwithstanding these fundamental settlement values, are there times when a D&O insurer may nevertheless seek to recoup from its own insured the amount the insurer previously paid in settlement of a third-party claim? A November 22, 2010 Eastern District of Virginia decision, applying Kansas law, in a case involving Sprint Nextel Corporation, addressed this issue. The court held that an excess D&O insurer could not, two years after a settlement was final and based upon post-settlement case law developments, recoup from its insured the amount the insurer paid toward settlement.

 

Background

In February 2004, Sprint Nextel’s board voted to recombine the company’s two separate tracking stocks, leaving a single surviving equity interest. The holders of shares to be retired received, in exchange for their shares, additionally issued shares of the surviving share class.

 

In March 2004, investors who had held shares of the retired class of stock filed class action lawsuits alleging that the company’s board breached its fiduciary duty by implementing a conversion ratio that undervalued the retired shares.

 

Sprint Nextel provided notice of claim to its D&O insurers. At the time of the shareholder claims, Sprint Nextel carried a total of $100 million in D&O insurance, which was written over a $25 million self-insured retention. The first three layers of the D&O insurance program consisted of three layers of $15 million each, arranged between a primary layer of $15 million, and two excess layers of $15 million.

 

In 2007, as a result of mediation, the parties to the shareholder litigation agreed to a $57.5 million settlement. The settlement was to be funded by Sprint Nextel’s payment of the $10 million remaining under the deductible, as well as full $15 million contributions from the primary, first excess and second excess carriers. The fourth level excess carrier contributed the remaining balance.

 

The second level excess carrier agreed to pay its limit but sought in its letter of consent to "reserve its rights to deny coverage and seek repayment."

 

The carriers ultimately funded their respective contributions toward the settlement. On December 12, 2007, the court entered final judgment in the shareholder litigation. The second level excess carrier closed its claim file.

　

However, in December 2009, after the District of Massachusetts issued its opinion, in the Genzyme case, the second level excess carrier filed a complaint against Sprint Nextel in the Eastern District of Virginia against its insured, seeking to recover the $15 million it had paid in the 2007 settlement.

 

As I discussed in a prior post, here, the district court held in the Genzyme case that under Massachusetts law Genzyme’s D&O insurance did not cover amounts Genzyme paid to settle the claims of individuals who asserted they had received inadequate consideration in an exchange for their tracking shares of an internal Genzyme division.

 

The second level excess carrier and Sprint Nextel filed cross-motions for summary judgment.

 

The November 22, 2010 Decision

In seeking to recover its settlement payment, the second level excess carrier argued that the settlement did not represent covered loss under the policy because it represented a delayed payment of a preexisting obligation (in that the company had preserved the Board’s right to decide to recombine the two separate classes of tracking stock into a single class). The second level excess carrier also argued that the settlement represented a mere redistribution of assets among different classes of Sprint shareholders.

 

In making these arguments, the second level excess carrier relied on the Massachusetts District Court’s September 28, 2009 opinion in the Genzyme case. As I as discussed at length here, the district court’s opinion in Genzyme was overturned by the First Circuit on October 13, 2010.

 

In rejecting the second level excess carrier’s argument that the settlement merely represented a preexisting obligation, Judge Claude Hilton wrote that "it is no understatement to say that one of the principal reasons for D&O insurance is to cover D&Os when they are alleged to have breached such preexisting obligations. The mere existence of generalized obligations to follow the law and honor one’s fiduciary duty does not render uninsurable a lawsuit alleging that corporate directors failed to do so."

 

Judge Hilton also rejected the second level excess carrier’s further argument that there is a general public policy against insuring this type of settlement. Judge Hilton also noted that the second level excess carrier only decided to file its recoupment action after the Massachusetts District Court entered its opinion in Genzyme, which the second level excess insurer characterized as "a case of first impression" – which contention, even if true, is inconsistent with the notion that there is a clear and pervasive public policy against payment of these types of settlements.

 

To the contrary, Judge Hilton found, Kansas public policy "favors enforcement of D&O insurance policies" and the second level excess carrier had not identified any grounds that would justify restitution or recoupment of the settlement payment.

 

Judge Hilton specifically noted that though the D&O policy allows the reinsurer to seek repayment of defense costs if the costs were not covered, "there is no basis under the policies for an insurer to make a settlement advance and later to seek its return."

 

Judge Hilton said that he would not allow the second level excess carrier "to retroactively amend its policy by trying to infer a recoupment right or attempt to circumvent the policy’s terms by invoking restitution." Although the carrier may have made its payment "grudgingly," there "can be no question that the payment was made voluntarily." Judge Hilton also found there was no excuse for the second level excess carrier’s delay in brining its action.

 

Discussion

I can certainly see the argument that amount paid in the underlying settlement represents nothing more that a payment by or on behalf of the company to make up for the inadequate consideration the company allegedly paid to the holders of the retired shares in the share recombination.

 

But in the end, I don’t think that Judge Hilton’s grant of summary judgment in favor of Sprint Nextel necessarily depended on the merits of the second level excess carrier’s arguments about the nature of the settlement amount or even on the fortuity that the Genzyme decision was reversed after the second level excess carrier filed this action.

 

I think the summary judgment ruling is best understood as a reflection of the second level excess carrier’s timing. It might have been one thing if the second level excess carrier had asserted its position and resisted its settlement obligation while the underlying claim was still pending. The simple fact is that the second level excess carrier did not bring its recoupment action until two years after the settlement of the underlying claim was final.

 

Moreover, as Judge Hilton noted, the grounds on which the second level excess carrier sought to recover the amounts it had paid in settlement was not "fraud, duress or mistake of fact," which might justify setting a prior settlement aside and requiring a restoration of funds. Rather, the second level excess carrier’s bid to recoup funds was based solely on a district court opinion entered two years after the underlying claim was finally settled.

 

If carriers were able to seek the return of settlement payments years after the fact based on nothing more than post-settlement case decisions, the case resolution process could be seriously compromised. Settlements could become nothing more than a contingent arrangement, a state of affairs which frankly is in no one’s interest.

 

Whatever else might be said about second level excess carrier’s decision to pursue this belated action, one can only hope that the outcome of this case and the impression it makes might deter other carriers from seeking to recoup settlement payments long after the fact, at least in the absence of fraud or other similar factor.

 

Our beat here at The D&O Diary is basically restricted the world of directors’ and officers’ liability. So, regrettably, we don’t often have the occasion to write about college football. But a story making the rounds on the Internet manages to connect Colonial Bank (the third largest bank to fail during the current bank failure wave) and the evolving pay-to-play scandal surrounding Auburn University quarterback and Heisman candidate Cam Newton. So we felt empowered to write a post about it.

 

From the moment the Montgomery, Alabama bank closed in August 2009, observers have been asking what the bank failure might mean for Auburn football. As noted at the time on Time Magazine’s Curious Capitalist blog (here), Colonial’s founder, CEO and Chairman, Bobby Louder was also "the dominant force at Auburn University since George Wallace appointed him to [Auburn’s] board of trustees in 1983." ESPN.com called Louder "The Most Powerful Booster in College Football."

 

Many readers undoubtedly are aware that the news wires have been buzzing recently with stories about how Cam Newton’s father allegedly demanded payment from Mississippi State in order for Cam Newton to play there coming out of junior college. Since Newton did not wind up attending Mississippi State, but does play for Auburn, many have questioned whether or not there may have been similar payment demands at Auburn.

 

The lines of the Colonial Bank and the Cam Newton stories have started to cross, at least on the Internet. At least according to stories making the rounds online, the government authority’s investigation of circumstances surrounding the collapse of Colonial Bank has led to the discovery of information suggesting the possibility of payments made in order for Newton to play at Auburn.

 

I have linked in the next paragraph to a site that contains an exhaustive summary of the various details of this story that are available on the Internet. I would like to emphasize that in linking to this site, I am in no way indicating that I necessarily think any of the information on the site is true. The web site’s host himself indicates that he has not verified any of the information. The newsworthiness of these unproven allegations consists of the fact that these allegations are being raised, in that they suggest how far reaching the investigation into a bank’s failure potentially may spread. (Besides, as I noted at the outset, they involve college football, which is another reason I am writing about them here)

 

With all disclaimers duly noted, the site, which can be found here, makes for some awfully interested reading and I would suggest making some time to read all the way through the page. The page is assembled rather awkwardly and you will have to scroll down multiple times. Special thanks to a loyal reader for forwarding me the link to the site.

 

While we cannot now know what among the various things asserted on this site are factual, I would have to say that it would hardly come as a surprise that there might be some sort of a governmental investigation in connection with the collapse of Colonial Bank. Colonial Bank had assets of $25 billion, making its closure the third largest failure in the current wave of failed banks. Its failure caused a $2.8 billion loss to the FDIC insurance fund. Given the numbers involved, an investigation seems probable.

 

In addition, one of the former directors of Colonial, Milton McGregor, also a prominent casino owner and a prominent Auburn football booster, was recently arrested in Alabama in connection with a vote buying scandal that followed FBI wiretaps. The inflammatory question is whether or not the wiretaps divulged anything about payments to Cam Newton. There are news articles denying that the wire taps revealed anything about Cam Newton. However, it does seem clear that for whatever reason the FBI is involved in investigating the Cam Newton allegations.

 

A couple of observations, one D&O related and one not. On the D&O side, the information on the linked site (even if ultimately unproven) potentially could implicate at least two D&O insurance policies, the policy for Colonial and the policy of the Auburn University Board of Trustees. (Please note that I am not expressing an opinion here whether or not anything on the Internet constitutes a claim under any policy or even constitutes circumstances that might give rise to a claim)

 

Because of the significant overlap in membership between the two boards, there are at least a couple of complicated insurance questions. One has to do with the capacity in which the various individuals were acting in connection with the various misconduct alleged, as the capacities seemed to have overlapped in many important ways.

 

The other insurance problem is, well, an other insurance problem. The "other insurance" clause in each of the policies could lead to some roundabout analysis between the two policies.

 

I will reserve for another day (and perhaps another blog site entirely) my views about the insanity of a system in which college football players, who risk potentially crippling injuries and whose athletic displays produce billions of dollars of economic activity, are deprived of any financial benefit for their efforts. This grotesque system inevitably leads to scandals like the current one involving Cam Newton.

 

And Now From Our Vietnam Bureau: Under the heading of things we did not really expect to find ourselves writing about, we also note that Bloomberg news reports (here) that regulators in Vietnam have brought there first securities enforcement action, accusing a pharmaceutical company official of stock price manipulation. Apparently regulators and market participants around the world recognize the need to maintain marketplace integrity.