Although the world of electoral politics may seem distant from the directors’ and officers’ liability arena, there was one development in Tuesday’s elections that potentially could affect the D&O claims environment, and it happened right here in The D&O Diary’s home state of Ohio. It has not drawn much national attention, but Ohio’s activist Attorney General Richard Cordray (pictured) lost his reelection bid to his Republican challenger, former U.S. Senator Michael DeWine.

 

Regular readers of this blog know that during his time in office, Cordray has been both highly active and highly visible in leading securities class action lawsuits on behalf of the Ohio public pension funds. Cordray was prominently involved in the recently announced $725 million AIG securities class action lawsuit settlement (about which refer here). Cordray put himself forward in connection with the $400 million Marsh contingent commission securities class action lawsuit (about which refer here).

 

In addition, in November 2009, Cordray led the way on behalf of the Ohio pension funds in filing a securities class action lawsuit against the rating agencies, in which he accused the rating agencies of "wreaking havoc on U.S. financial markets by providing unjustified and inflated ratings of mortgage-backed securities in exchanged for lucrative fees from securities issuers." The rating agency lawsuit is discussed here.

 

Cordray’s office has also sought lead plaintiff status in the securities class action lawsuit filed against BP, as discussed in his July 21, 2010 press release.

 

While Cordray was Ohio Attorney General, his office regularly issued reports on the status of the various securities class action lawsuits his offices was leading. The reports were titled "Holding Wall Street Accountable." The most recent report, dated August 31, 2010, can be found here. His office’s webpage detailing the various securities class action lawsuits in which Cordray was involved can be found here

 

In Tuesday’s election, the Republicans made a clean sweep of the Ohio statewide offices, but the Attorney General contest was by far the closest of any of state level race and. Cordray lost to challenger Mike DeWine by a narrow margin.

 

It remains to be seen whether or not DeWine will try to take up his predecessor’s mantle of "Holding Wall Street Accountable." DeWine’s campaign advertisements emphasized his background as a former prosecutor, and (in light of various scandals in Cuyahoga County), his promises to pursue corruption, an approach that potentally could lend itself to a scourge of Wall Street kind of approach.

 

However, one of the key planks of DeWine’s campaign platform was his commitment to "creating jobs through a business-friendly environment." Given DeWine’s overall conservative background and his commitment to maintaining a "business-friendly environment," I suspect the securities class action litigation agenda will be deemphasized once DeWine takes office.

 

To be sure, even if (as seems likely) DeWine steps back from his predecessor’s securities class action leadership role, others elsewhere might step forward. But the absence of an aggressive attorney general whose agenda includes using securities class action litigation as a policy and political tool could impact the frequency and magnitude of future securities litigation, at least to a certain extent.

 

Reuters reporter Dan Levine’s November 4, 2010 article (here) also speculates that Cordray’s defeat, along with the losses of numerous other activist attorneys general nationally, could help speed resolution of the current foreclosure mess, as well, as the defeated candidates seek to advance measures before they leave office. Among other things, Levine describes Cordray as one of the "spiritual leaders" among the activist AG’s who were agitating on the foreclosure issues.

 

Some Data About Follow-On FCPA Lawsuits: I have written frequently on this blog about the possibility of follow-on civil litigation brought by investors against companies that have been the target of an FCPA enforcement action. A November 1, 2010 Reuters article by Brian Grow entitled "Bribery Investigations Spark Shareholder Suits" (here) provides some quantification for this observation.

 

The article reports that according to Westlaw data, since the beginning of 2010 alone, plaintiffs’ lawyers have filed 24 shareholder suits against companies that have disclosed FCPA investigations. (The cases are a mix of class actions and derivative suits). The past average has been about eight such suits a year. The article also reports that though some cases have been dismissed, plaintiffs generally have been successful in these cases. Of the 37 cases in the preceding four years, 26 resulted in settlements.

 

The November 2010 issue of Metropolitan Corporate Counsel published (here) a roundtable discussion entitled "Compliance and Litigation Issues As Foreign Corrupt Practices Act Enforcement is on the Rise." The article includes a discussion of some of the challenges involved with FCPA compliance issues.

 

I will be participating in a panel at the upcoming PLUS International Conference in San Antonio. The panel, which is entitled "Foreign Corrupt Practices Act: Unexpected Liabilities for D&O Insurers, will be moderated by my friend Joe Monteleone, and is scheduled as the first session on Thursday, November 11, 2010. More information about the Conference and the FCPA panel can be found here.

 

The Nuts and Bolts of D&O: I hope readers have noticed that I have added a reference in the right hand column of this blog to my multipart series on the nuts and bolts of D&O. The reference, which can be found right below the "Subscribe" dialog box,  includes a link to the series index.

　

In a resolution of one of the longest running subprime-related securities class action lawsuits, the parties to the Toll Brothers subprime securities suit have agreed to settle the case for $25 million. The parties’ stipulation of settlement filed on October 28, 2010 can be found here.

 

The Toll Brothers case was among the first of the subprime-related securities suits when it was first filed in April 2007. As reflected in greater detail here, the plaintiffs allege that between December 9, 2004 and November 8, 2005, the defendants made several misrepresentations relating to the company’s "ability to open new active selling communities at the rate necessary to support its financial projections, traffic in its existing communities, demand for Toll Brothers homes, and the ability to continue its historically strong earnings growth." The Amended Complaint further alleges that despite "adverse developments" the company raised its earning projections, which allegedly inflated the company’s share price, facilitating the defendants’ sale of 14 million of company shares for proceeds of over $617 million.

　

The Amended Complaint also alleges that "within days" of the completion of the insider sales, defendants "shocked investors" in a series of disclosures between August and November 2005 revealing that traffic and sales were declining, as a result of which the company’s share price declined 43% from its class period high.

 

As reflected in greater detail here, in August 2008, the district court denied the defendants’ motion to dismiss. After extensive additional procedural wrangling that included a trip to the Third Circuit, the parties agreed to settle the case during mediation.

 

　

A November 2, Reuters article discussing the settlement can be found here.

 

The interesting thing to me about this development is the simple fact that this case has settled. For whatever reason, there have been very few settlements of the subprime-related securities class action lawsuits, even though we are now will into the fourth year of the subprime litigation wave.

 

By my count, there have still only been 16 settlements of subprime and credit crisis related securities class action lawsuits, even though there have been over 220 subprime related securities class action lawsuits filed since the beginning of the subprime litigation wave in early 2007 and even though scores of cases have survived the initial dismissal motion. I would be very curious to know if any readers out there have any suggestions on why so few of these cases have settled.

 

It is probably worth noting that even though there have been only sixteen settlements of subprime and credit crisis-related securities class action lawsuits, those sixteen settlements total over $1.85 billion dollars (including the $624 million settlement in the Countrywide case).

 

It is also interesting to note that, because the Toll Brothers lawsuit was filed in early 2007, after the beginning of the subprime litigation wave, the lawsuit is counted among the subprime related cases, the class period for the case goes from December 9, 2004 and November 8, 2005 and relates to events and circumstances that allegedly took place well before the subprime meltdown really gained momentum. The lawsuit’s relation back to the earlier time period is reminder that the later problems were in many ways foreshadowed by earlier events.

 

In any event, I have added the Toll Brothers settlement to my running tally of subprime and credit crisis-related settlements and other case resolutions, which can be found here.

 

The Subprime and Credit Crisis-Related Cases Are Still Coming In: While the earliest cases are now finally being resolved, there are still subprime and credit crisis-related cases being filed. The latest case is the lawsuit filed on November 3, 2010 in the Northern District of Florida against The St. Joe Company and certain of its directors and officers.

According to the plaintiffs’ lawyers November 3 press release, the Complaint (a copy of which can be found here) alleges that the defendants failed to disclose that:

 

(1) as the Florida real estate market was in decline, St. Joe was failing to take adequate and required impairments and accounting write-downs on many of its Florida based property developments; (2) as a result, St. Joe’s financial statements materially overvalued the Company’s Florida based property developments; (3) the Company’s financial statements were not prepared in accordance with Generally Accepted Accounting Principles; (4) the Company lacked adequate internal and financial controls; and (5) as a result of the foregoing, the Company’s financial statements were materially false and misleading at all relevant times.

 

The lawsuit follows on the heels of an October 13, 2010 report critical of the company written by hedge fund manager David Einhorn, the President of Greenlight Capital. Einhorn is perhaps best known for his very public bet against Lehman Brothers prior to the firm’s collapse. Einhorn’s report about St. Joe was the subject of a November 3, 2010 Wall Street Journal article (here).

 

My list of all 222 subprime and credit crisis related lawsuits that have been filed since February 2007 can be found here.

 

The Nuts and Bolts of D&O Insurance: I hope all readers have noticed that I have added a reference (with a hyperlink) in the right hand side bar to a single-page index for my multipart series on D&O insurance. Tell a friend.

 

If the lawsuit filed on Monday is any indication, the long-anticipated FDIC litigation against failed banks may have arrived. On November 1, 2010, the FDIC filed a lawsuit in the Northern District of Illinois against eleven former directors and officers of Heritage Community Bank, a lending institution in Glenwood, Illinois that failed in February 2009. A copy of the FDIC’s complaint can be found here.

 

Because 304 banks have failed since January 1, 2008, there has been widespread speculation that the FDIC might pursue claims against the former directors and officers of the failed institutions. Until now, the FDIC has filed just one lawsuit against former executives of a failed bank, involving former officers of IndyMac bank (about which refer here). More recently, there had been reports that the FDIC’s board had authorized numerous lawsuits to proceed – and now the lawsuits apparently have begun.

 

The Heritage Community Bank lawsuit, filed by the FDIC in its capacity as the bank’s receiver, seeks to "recover losses of at least $20 million" that the FDIC alleges the bank suffered because the defendants "failed to properly manage and supervise Heritage and its commercial real estate lending program." The complaint alleges claims of negligence, gross negligence and breach of fiduciary duty.

 

Essentially, the complaint alleges that the defendants made imprudent or improper commercial loans while "making millions of dollars of dividend payments to Heritage’s holding company and paying generous incentive awards to senior management." The complaint also alleges that by December 2006, the defendants knew the bank was in trouble, but instead of curtailing lending, the defendants "tried to mask the Bank’s mounting problems" by lending troubled borrowers more to pay down earlier loans.

 

The defendants in the case include not only the bank’s CEO, CFO and various lending officers, but also five outside directors.

 

The defendants are alleged to have extended or approved commercial real estate without appropriate expertise, processes or supervision, allowing loans in excess of prudent loan to value rations. The bank allegedly also lacked appropriate loan monitoring processes. The bank allegedly failed to post appropriate loan loss reserves, and even inappropriately recognized income as subsequent loans were used to pay off interest on prior loans.

 

The inappropriately recognized income allowed the allegedly improper holding company dividends and incentive compensation payments. (The allegedly improper incentive compensation payments in 2007 totaled $825,000.) The FDIC alleges that the total amounts of the improper dividends and inventive compensation payments were over $11 million.

 

Counsel for the defendants issued a press release on the defendants’ behalf that stated among other things:

 

The FDIC has now filed a lawsuit against the Bank’s former officers and directors for failing to foresee the recent unprecedented collapse in real estate values. The FDIC’s action is both regrettable and wrong. With the advantage of 20-20 hindsight, the FDIC blames the former officers and directors of a small community bank for not anticipating the same market forces that also caught central bankers, national banks, economists, major Wall Street firms, and the regulators themselves by surprise.

 

From my perspective, this case seems like an unexpected place for the FDIC to have started. The allegedly improper compensation seems relatively modest and there are otherwise no allegations of self-dealing or other egregious conduct. Similarly, there are no allegations that the bank operated in violation of any regulatory orders or consents.

 

Even taking the FDIC’s complaint on its own terms, it looks as if this bank (like so many others) got caught up in the real estate bubble and then failed to recognize the collapse until it was too late. In the aftermath, it seems easy to say the bank should have been more prudent than it was. The bank has a lot of company in that regard, starting with the Federal Reserve and going from there.

 

I will say this (in quotation of a comment from one of my readers) this complaint is a hell of a lot more compact than the 300-page behemoth the FDIC filed in the Indy Mac case.

 

It is perhaps not much of a surprise that this suit involves an Illinois failed bank. There have been 38 bank failures in Illinois since January 1, 2008, the third highest number of any state, behind only Georgia (46) and Floriday (43).

 

Earlier news reports had suggested that the FDIC had authorized lawsuits against as many as 50 former directors and officers of failed banks, but news reports concerning the new Heritage Community Bank lawsuit report that the FDIC has now authorized lawsuits against "more than 70" former directors and officers. Reliable sources tell me that the FDIC has also filed a lawsuit against the former directors and officers of a specific failed bank in a Western state although I have been unable to independently verify that.

 

But in any event, it appears the FDIC failed bank D&O litigation has now begun. It seems probable that may more lawsuits will follow. Stay tuned.

 

Special thanks to John M. George, Jr. of the Katten & Temple law firm for providing copies of the complaint and of the defense counsel press release. George’s firm is of counsel in connection with the defense of one of the indidivudal defendants.

 

Among the many innovations introduced in the massive Dodd-Frank Wall Street Reform and Consumer Protection Act enacted this past July are the new whistleblower provisions, designed to encourage employees and others to report securities law violations to the SEC. The bounty award provided for in the whistleblower provisions seem likely to encourage fraud reporting, but many observers are voicing concerns about these provisions. And as noted below, there may be other concerns above and beyond those generally noted, particularly with respect to potential D&O insurance coverage issues.

 

Section 922 of the Dodd Frank Act specifies that a person who provides "original information" to the SEC of fraud within the company that leads to an enforcement penalty of $1 million or more may be entitled to collect between 10 and 30 percent of the penalties of $1 million or more. The provision also provides substantial retaliation protections for whistleblowers.

 

An article in the November 1, 2010 Wall Street Journal article (here) notes a number of concerns about the new whistleblower provisions, the first and foremost of which is that the bounty provisions provide incentives for prospective whistleblowers to race to the SEC in order to be the first to report violations, which in turn encourages prospective whistleblowers to bypass internal fraud detection mechanisms mandated by the Sarbanes Oxley act. Bruce Carton previously discussed many of these same concerns on his Securities Docket blog, here.

 

There is little doubt that the bounty provisions are likely to encourage fraud reporting. As I have noted elsewhere, penalty awards, for example, have skyrocketed in recent years, with many recent awards in the hundreds of million dollars. Whistleblowers potential rewards are enormous.

 

To put this into perspective, and as noted in the Journal article, the whistleblower whose tip resulted in the recently announced $750 million settlement between GlaxoSmithKline and the Justice Department stands to get an award of $96 million, under similar whistleblower provisions in the False Claims Act.

 

In recognition of the likelihood of substantial whistleblower awards, the SEC has already established a fund of approximately $452 million to fund the payments to whistleblowers, according to the SEC’s Annual Report to Congress on the Whistleblower Program, which was released last week. (The congressional report was mandated by the Dodd Frank Act.)

 

Under these circumstances, it seems highly likely that whistleblower actions will proliferate, and so the concerns noted in the Journal article and elsewhere seem warranted. In addition to the items noted elsewhere, there are a couple of other issues arising from the new whistleblower provisions that are worth considering as well.

 

The first is that the threat of legal proceedings from the whistleblower action is not limited just to the possible SEC enforcement action. A related and accompanying threat is the possibility of a follow-on civil litigation, brought on behalf of the target company’s investors, in which the plaintiffs will claim that the company’s senior managers failed to take appropriate steps to ensure that proper controls were in place, or that investors were misled by the company’s statement about the company’s controls.

　

These kinds of follow-on civil actions have been a frequent accompaniment of FCPA enforcement actions, as I have often noted on this blog. It seems probable that as whistleblower actions mount in response to the Dodd-Frank Act provisions, that there will be a parallel increase in civil actions following on after the whistleblower enforcement action.

 

The fines and penalties associated with a whistleblower enforcement action would likely not be covered under a D&O insurance policy, although the fees incurred in defending against the action potentially could be covered, at least as to individual defendants.

 

The follow-on civil actions would likely be covered under the typical D&O insurance policy, subject to all of the applicable policy terms and conditions. However, one potential D&O insurance coverage issue that might arise concerning the follow-on civil actions has to do with the possibility that the individual whistleblower could be an insured person under the D&O policy. This might arise, for example, if the whistleblower is also an officer of the company. The risk is that either the enforcement action or the follow on civil proceeding might run afoul of the insured v. insured exclusion typically found in most D&O insurance policies.

 

Following the enactment of the Sarbanes Oxley whistleblower provisions a few years ago, many D&O insurance policies were amended to ensure that a claim related to a Sarbanes-Oxley whistleblower action would not run afoul of the insured v. insured exclusion. Many of these amendments were written sufficiently broadly that the coverage carve back for whistleblower claims would preserve coverage not only for Sarbanes-Oxley whistleblower claims, but would also preserve coverage under other types of whistleblower claims. Many of these amendments were written sufficiently broadly that they would likely preserve coverage for Dodd-Frank whistleblower claims as well.

 

However, not all of the whistleblower carve back amendments are equally broad, which may raise the question about the potential applicability of the insured v. insured exclusion to Dodd Frank whistleblower claims, whether with respect to the initial enforcement action or even the possible follow-on civil action. Given the high likelihood of future Dodd Frank whistleblower claims, the review of the applicable D&O insurance policy language, seems like a critical next step.

 

In any event, the range of possibilities seems to include the likelihood of an increase both in enforcement actions and follow-on civil lawsuits, which has important implications far beyond the narrow provisions of the policy’s exclusionary provisions.

 

More Securities Suits Against For-Profit Educational Companies: One of the most distinctive securities class action lawsuit filing trends in the second half of 2010 has been the sudden arrival of a multitude of securities suits against for-profit education companies. As I noted in an earlier post, these suits follow a congressional investigation in to the companies’ practices involving student loans.

 

In recent days, plaintiffs have added two more companies to the growing list of for-profit education companies that have been hit with securities lawsuits. First, on October 28, 2010, plaintiffs’ lawyers initiated a securities suit against The Washington Post Company and certain of its directors and offices, in connection with the companies Kaplan, Inc. education subsidiary. Second, on November 1, 2010, plaintiffs’ lawyers initiated a securities suit against DeVry, Inc. another for-profit education company.

 

These two latest suits brings the number of securities suits filed against for-profit education companies so far this year to nine, which represents about 6% of the approximately 145 securities lawsuit filed this year.

 

Though the Washington Post Company is obviously a media company, it actually carries the 8200 SIC Code (Educational Services), reflecting the relative importance of the Kaplan Inc. subsidiary’s revenues to the company’s overall financial picture.

　

In our era, the burgeoning BRIC countries represent the developing economies forcing their way onto the global stage and arguably even threatening to dominate the financial arena in the decades ahead. It is hard to remember now, but in the late 19th century, the developing economy that was pushing its way into the global financial stage was that of the United States.

 

The captivating story of how our country became a global economic powerhouse is entertainingly told in H.W. Brands’ fascinating new book, "American Colossus: The Triumph of Capitalism 1865-1900." Brands portrays the transformation as part of a struggle between the principles of democracy and the exigencies of capitalism.

 

In Brands’ account, though the forces of democracy predominated in the early nineteenth century, in the late nineteenth century, the animal spirits of capitalism emerged triumphant. While the country was transformed, the results included some rather unsavory side-effects, many of which suggest some rather sober reflections on our present circumstances.

 

The picture of the United States in the late 19th century, as the country emerged from a devastating civil war and struggled to overcome challenges imposed by immense geographic distances, is one of stark contrasts, between the seemingly unlimited opportunities available and the astonishing excesses perpetrated in pursuit of those opportunities.

 

If the country’s transformation produced unprecedented economic expansion and vast wealth, it also entailed  environmental devastation, rampant corruption, labor exploitation, a deliberate policy of ethnic cleansing targeting a vulnerable indigenous population, and a destructive cycle of boom and bust.

 

The story of the United States transformation into a global powerhouse involves some familiar details, such as the almost incredible accumulation of immense wealth by Rockefeller, Carnegie, Vanderbilt and others. But in Brands’ account, the transformation also involves a host of other important but sometimes overlooked developments and processes, such as the conversion of the vast central plains from untamed grasslands full of roaming buffalo herds into industrial cattle ranches and monoculture farms encompassing wheat fields of previously unimaginable size and scale.

 

As the American economy was transformed it also was forced to adapt to or perhaps even invent the processes and practices required by modern capitalist economies. Among other things, the development of a transcontinental rail system was a project of such enormous size that it simply outstripped the existing accounting and management tools and controls, a situation that almost inevitably led to waste and corruption. The unexpected part is not that the waste and corruption took place but that the railroad nevertheless was completed, opening the country’s virtually unexplored interior both to settlement and development.

 

The country’s growth into a global powerhouse involved more than just an increased exploitation of geographic and material assets. It also meant the adaptation to new requirements and the elimination of old structures.

 

For example, the transformation of the South’s failed slavery economy to a functioning labor economy was an evolution required for the Southern states to advance. Though the transformation was only partially completed during the nineteenth century, the region’s movement from a feudal slave economy based on compulsion and exploitation to a capitalist labor economy built on supply and demand was an indispensible part of the country’s overall conversion into a modern economy.

 

Perhaps the most compelling aspect of Brands’ book is the way the earlier era suggestively prefigures our own. As events associated with the development of industrial scale agriculture demonstrate, the world was "flat" long before Tom Friedman declared it to be so:

 

Even in the best years, the Red River farmers were at the mercy of occurrences half a world away. Price tickets in managers’ offices recorded fluctuations in the grain markets in Minneapolis and Duluth and Buffalo, which in turn responded to developments in the world market. "A rainfall in India or a hot wind in South America is felt upon the Dakota farm in a few hours. The nerves of trade thrill around the globe, and the wages of the harvester in the Red River Valley are fixed by conditions in the fields of Russia , or in Argentina, or in India. The distance between the fields has been lost. The world’s wheat crop might as well lie in one great field, for the scattered acres are wired together in the markets, and those markets are brought to the farmer’s door."

 

In our own time, we struggle to understand the weaknesses and systemic failures that allowed the recent global financial crisis to occur. We might do better to understand that these kinds of weaknesses have been around for a long time; indeed many of the same questions we are now asking ourselves were being asked following the periodic crises and busts that occurred with devastating regularity during the late nineteenth century.

 

For example, in the aftermath of the Jay Gould’s and James Fisk’s audacious attempt to corner the gold market, then-Congressman (and future President) James Garfield wrote that "however strongly we may condemn the conspirators themselves, we cannot lose sight of those causes which lie behind the actors and spring from our financial condition. The conspiracy and its baneful consequences must be set down as one of the items in the great bill of costs which the nation is paying for the support of its present financial machinery."

 

Brands’ book is full of fascinating anecdote and telling detail. He ranges across a multitude of topics and issues, including immigration, politics, racial integration, technological innovation and change, as well as all of the attendant social and economic consequences involved. If the book has one fault, it is perhaps in its very range. Brands’ framework sweeps so broadly that at times he leave the impression of simply moving from topic heading to topic heading, with less connective tissue than many readers might desire.

 

Despite the overall celebratory tone of his book – it is, after all, subtitled as "The Triumph of Capitalism" — Brands also seems ambivalent about capitalism itself. At different times (and occasionally, at the same time) he is exhilarated by the irresistible force of unbridled capitalism or appalled by its exploitative and corrupt excesses. Perhaps in the end however, that is the moral of his book, that capitalism encompasses both, and that what is required most is a watchful and wary eye.

 

Time Marches On: During Back-to-School Night this fall, I asked my son’s high school U.S. history teacher where the semester break would fall chronologically in the curriculum. When the teacher said they aimed to get through the nineteenth century by the semester break, I expressed surprise, noting that when I studied U.S. history, the Civil War had been dividing point. The teacher eyed me carefully and then commented that there is quite a bit more U.S. history to be studied now than there was when I was in school. (I did not tell my son later that I think his history teacher is a wiseass.)

 　

　

In a series of posts, I have been exploring the “nuts and bolts” of D&O insurance. In this post, the seventh in the series, I examine the perennial questions of limits selection and program structure – that is, how much insurance is enough, and how should the insurance be structured? As explained below, these two questions are inextricably linked.

Limits Selection

One of the most challenging questions for anyone that advises D&O insurance buyers is the question of what is the right amount of insurance. The question inevitably involves a mixture of art and science, particularly because the analysis is affected by basic considerations of cost and risk tolerance. While there are certain objective benchmarks that can help to inform the process, the benchmarks must be considered in conjunction with relevant considerations that should also influence the analysis.

The question of D&O insurance limits selection is, of course, different depending on whether the buyer is a publicly traded company or is privately held. The difference in analysis between the two is not just in the total quantity of insurance purchased but also in how the limits selection question is analyzed. I discuss the question of limits selection for public and privately held companies separately below.

For publicly traded companies, there are some basic benchmark reference points and some additional considerations that every insurance buyer should asses.

Publicly traded companies will first want to approach questions surrounding limits selection from the perspective of basic limits adequacy, taking into account the company’s likely securities class action litigation settlement exposure. The securities suit settlement exposure is the appropriate starting place because for most companies in most circumstances, a securities suit represents the company’s largest management liability exposure. The company should be provided with information sufficient to allow it to assess the range and distribution of settlements for companies of its size and other characteristics.

A second benchmark publicly traded companies may want to consider are peer purchasing patterns – that is, how much D&O insurance do other companies like ours buy? Some buyers find this information reassuring, although care should always be taken to make sure that peculiar purchasing patterns, which sometimes can be industry-wide, do not inappropriately drive an important decision like limits adequacy.

In addition to these basic, relatively objective guidelines like settlement trends and peer purchasing patterns, there are additional considerations that should also be taken into account.

The first is that information about securities class action settlements, discussed above, does not take into account defense expense. Defense costs must be considered, because under most D&O insurance policies, defense costs erode the limits of liability. Every dollar of defense cost means one less dollar available for settlements or judgments. For a company to be sure that it has adequate limits of liability both to defend and to settle serious claims, appropriate consideration must be given to likely defense expenses as well as to settlement amounts. Along those lines, it is critical to note that both settlements and defense expenses have been escalating in recent years, much faster than the rate of economic inflation.

The other consideration that should be taken into account is that the most important value of D&O insurance is the protection it affords individual insureds in the event of a catastrophic claim. When things go seriously wrong, the D&O insurance may be the individuals’ last line of defense.

When these catastrophic type events occur, the company and the individual directors and officers may find themselves battling multiple legal proceedings simultaneously. In addition, the interests of the various defendants in the various proceedings may conflict dramatically, particularly when ousted former management is faulted for the company’s woes. Often when this occurs, each defendant will retain separate counsel. Under these circumstances, defense expenses can mount astonishingly quickly, causing the rapid depletion or even the complete exhaustion of the available insurance (for more about which, refer here).

The possibility of a catastrophic claim that could consume available limits underscores the importance of careful consideration of limits selection issues. Simply put, what other cases might have settled for in the past or how much insurance other companies buy may provide little guidance for the question of how much insurance a particular company might need in the future, particularly since the settlement and purchasing pattern data tend to be backward looking and incorporate historical patterns that may not be relevant to future requirements.

On the other hand, the difficulty of using a catastrophic claim scenario is that it may quickly lead to the rather unhelpful conclusion that no amount of insurance is enough to address the top end exposures. At some point, the analysis must shift from the quantity of insurance to the structure of the insurance, a question I address further below.

With respect to private companies, the issues are different, primarily because privately held companies do not typically face class action securities litigation risks. However, merely because private companies have no class action securities litigation exposure does not mean that private companies and their directors and officers do not face serious liability risks. I have in fact seen numerous private company D&O claims that have settled for millions of dollars. For that reason, an appropriate awareness of the possibilities should also inform private company D&O limits selection issues.

For private companies, the objective reference standards are peer purchasing patterns by company asset size. These peer data have the same benefits and limitations as they do for public companies, but many buyers find this data useful and reassuring in the insurance acquisition process.

The limits of liability for private company D&O insurance is, like public company D&O insurance, in most instances subject to erosion by defense expenses. so many of the same considerations concerning defense expenses should also be taken into account for questions of private company D&O limits selection.

One added consideration particular to private company D&O insurance is that the entity coverage available under a private company policy is quite a bit broader in the private company policy than is the entity coverage in a public company policy. (The public company policy is limited to securities claims; the private company policy is not so limited.)

The broader entity coverage available in the private company policy creates the possibility that the limits of liability could be eroded by the defense expenses and settlements of the entity, potentially leaving the individuals with less (or no) insurance remaining to defend themselves or settle claims. The broader entity coverage in the entity policy could influence some buyers to increase the D&O insurance limits of liability, as one way to protect against erosion or exhaustion of the limits by entity claims.

Program Structure

In light of the escalating average claims severity and of the catastrophic potential for defense expense to deplete policy limits, it may be necessary to reconsider commonplace concepts of limits adequacy. Increased limits alone, however, may not solve all of the problems.

Part of the solution has to be program structure. Clearly, one of the factors that can contribute to limits depletion or exhaustion is that so many different people are accessing the insurance, particularly when there are multiple simultaneous claims. One way that well-advised corporate officials can ensure they are not left without insurance to protect them as individuals is through supplemental D&O insurance structures dedicated solely to their own protection.

These supplemental structures might take any one of a number of different forms, including for example, excess Side A coverage for a specified group of individuals, or even through an individual D&O insurance policy (so-called IDL coverage). While there are a variety of ways this supplemental insurance might be structured, the possibility of catastrophic claims underscores the importance of addressing these issues as part of the insurance acquisition process.

The point of these supplemental insurance structures is to ensure that no matter what happens, the individuals (or some subset of them, for example, the non-officer directors) will have a pot of money with their name on it, as reassurance that the individuals will not be left with unresolved claims but no insurance remaining with which to defend themselves. For more about structuring D&O insurance to protect non-officer directors, refer here.

Moreover these alternative structures often have broader coverage than the “traditional” D&O insurance; for example, they often contain fewer exclusions. They also provide so-called “drop down” protection when they provide first dollar coverage, in the event, for example, that the underlying traditional D&O insurers have become insolvent or seek to rescind coverage. In addition, because these alternative insurance structures protect only specified individuals, the insurance cannot be siphoned off for the payment of entity claims or the claims of other individuals who are not insured under the structure.

The complexity of these limits selection and program structure issues underscore how indispensible it is that insurance buyers enlist knowledgeable and experienced advisors in their D&O insurance acquisition process. In particular, it is important that buyers ensure not only that their advisors have access to the data described above that is relevant to the limits selection process but also have the ability to explain the limitations of the data as we well as the additional considerations that should be taken into account. In addition the insurance advisor should be able to guide the company through the process of selecting the right insurance structure to ensure that the company and its directors and officers are adequately protected even in the event of a catastrophic claim.

Readers who would like to read the prior posts in this series about the nuts and bolts of D&O insurance should refer here:

Executive Protection: Indemnification and D&O Insurance – The Basics

Executive Protection: D&O Insurance – The Insuring Agreement

Executive Protection: D&O Insurance—The Policyholder’s Obligations

D&O Insurance: Executive Protection – The Policy Application

Executive Protection: Private Company D&O Insurance

Executive Protection: D&O Insurance Policy Exclusions

The LexisNexis Top 25 Business Law Blogs of 2010, as selected by the members of the LexisNexis business law communities, have been announced, and I am pleased and honored to discover that The D&O Diary is among this year’s designees. The LexisNexis announcement, including the list of the 2010 Top 25 Business Law blogs, can be found here.

 

I am particularly happy to find my blog among the honorees because the list includes so many blogs that I follow and bloggers whose work I respect. I encourage everyone not only to take a look at the list, but also to visit the other sites, particularly those with which you might be unfamiliar.

 

Readers may note in the LexisNexis announcement that though the Top 25 blogs have been chosen, the voting is not yet finished. The voting for the Top Business Law Blog of 2010 will continue and the winner will be announced on November 5, 2010. I encourage all readers who are also members of a LexisNexis business law community to cast a vote for their favorite business law blog. I would be honored and humbled if anyone should choose to cast a vote for The D&O Diary.

 

Interested readers who are not familiar with the site may also want to take a look at the LexisNexis Corporate & Securities Law Community, which can be found here. The community site contains a wealth of resources, including links to blog posts and articles, case law and commentary, and podcasts.

 

My thanks to the members of the LexisNexis business law communities for voting for my site as a Top 25 Business Law Blog, and my congratulations to all of the honorees.

 

Among the many cases filed as part of the subprime litigation wave are the numerous cases filed on behalf of holders of mortgage-backed securities against the firms that issued the securities. In many of these cases, the plaintiffs have not alleged that they have failed to receive payments due under the securities, but rather they have alleged that their investments have declined in value or are now riskier than when purchased.

 

As these cases accumulated in 2008 and 2009, observers questioned whether these investors’ claimed harms represented injuries cognizable under the federal securities laws, as I discussed in an earlier post.

 

In an October 14, 2010 decision (here), Southern District of New York Judge Miriam Goldman Cedarbaum held in a case filed on behalf of holders of certain asset-backed certificates issued by Goldman Sachs-related entities that, where the holders had not alleged that they had failed to receive payments due under the certificates, they had failed to allege injuries cognizable under the federal securities laws.

 

The investors had purchased the asset-backed certificates in 2007 offerings. The certificates entitled the holders to monthly distributions of interest, principal or both. The offering documents for the certificates warned investors that the offering underwriters "cannot assure you that a secondary market" for the securities will exist, and "consequently, you may not be able to sell your certificates readily or at prices that will enable you to realize your desired yield."

 

In its amended complaint, the plaintiff did not allege that it had failed to receive the monthly distributions. The harm the plaintiff claimed is that a hypothetical sale in the secondary market at the time of the suit "would have netted, at most, between 35 and 45 cents on the dollar." The plaintiff also claimed that it is exposed to "much more risk than the Offering Documents represented with respect to both the timing and absolute cash flow to be received."

 

In her October 14 ruling, Judge Cedarbaum noted that at a prior hearing she had previously denied the defendants’ motion to dismiss the plaintiffs’ claims based on Section 12 (a) (2) of the ’33 Act. However, she granted the defendants’ motion to dismiss plaintiffs’ Section 11 claims, holding that the plaintiffs alleged injuries were insufficient to state a claim.

 

In rejecting the sufficiency of plaintiff’s argument that that their certificates would have a diminished value in a hypothetical sale, Judge Cedarbaum noted that "the Certificates were issued with the express warning that they might be resalable." She concluded that because the plaintiff "made an investment that it knew might not be liquid, it may not allege injury based upon the hypothetical price of the Certificates on a secondary market at the time of the suit." She noted further that the complaint failed to allege that a secondary market for the certificates "actually exists" and also failed to allege "any facts regarding the actual market price" for the certificates at the time of the suit.

 

Judge Cedarbaum also rejected the sufficiency of the plaintiff’s allegations about the increased risk of diminished cash flow in the future, not that "Section 11 does not permit recovery for increased risk." She said that "to allege an injury cognizable under Section 11," the plaintiff must "allege the actual failure to receive payments due under the Certificates," adding that though the plaintiff has "had three opportunities to amend its complaint, it has never made the allegation."

 

Discussion

As far as I am aware, Judge Cederbaum’s ruling is the first in which mortgage-backed investors’ Section 11 claims have been dismissed for lack of cognizable injury based on a failure to allege that payments due under the securities had been terminated or interrupted. There were quite a few of these mortgage-backed securities lawsuits filed during 2008 and 2009, and Judge Cedarbaum’s decision potentially could be quite significant in these other cases, at least where the investors have not alleged that payments due under the instruments have failed.

 

One aspect of this decision is the presence in these instruments’ offering documents of precautionary language warning about the potential unavailability of a secondary market for the instruments. Investors in instruments with offering documents that lacked this precautionary language may still be able to try to argue establish a cognizable injury based on the diminished resale value of the securities. However, those other claimants would also have to be able to allege that there actually is a secondary market for their securities and will have to allege what the resale price would be in order to allege injury sufficiently.

 

In any event, Judge Cedarbaum’s ruling potentially could be sufficient in many of the other securities suits that mortgage-backed asset investors filed in 2008 and 2009.

 

Special thanks to Doug Henkin of the Milbank Tweed law firm for providing a copy of Judge Cedarbaum’s opinion. Doug is the co-author of a paper I cited in my earlier post raising the question of whether mortgage-backed asset investors would be able to satisfy the requirements under Section 11 to allege a cognizable injury. An updated version of the paper can be found here.

 

I have in any event added Judge Cedarbaum’s ruling to my running tally of subprime and credit crisis related dismissal motion rulings, which can be found here.

 

A Securities Litigator’s Guide to D&O Insurance: Readers of this blog may be interested to know about two articles written by Jack Cinquegrana and John R. Barankiak Jr. of the Choate Hall law firm. The articles, which can be found here, are entitled "A Securities Litigator’s Guide to D&O Insurance," provide a brief overview of D&O insurance basics and also discusses issues that frequently arise concerning payment of defense costs and settlements. The articles are relatively short but contain some interesting observations and comments.

 

Sorry: My blog hosting service experienced a variety of service outages and problems on Monday. Readers may have experienced delays in receiving email notifications and difficulty in accessing the most recently added content. I am assured the problems have been addressed. I apologize for the inconveniences yesterday.

　

　

　

　

As has now become a familiar routine, this past Friday night the FDIC took control of several more commercial banks. The seven additional banks seized on Friday bring the year to date total number of failed banks to 139, and the total since January 1, 2008 to 304. At the same time, lawsuits involving failed and troubled banks are also accumulating, and on Friday, investors filed two more banking-related securities class action lawsuits. And as noted below, the jury trial in another banking related-securities class action lawsuit continues to go forward in federal court in Florida.

 

Recent Banking-Related Securities Suits

The first of the new lawsuits was filed on October 22, 2010 in the Northern District of Illinois against PrivateBancorp and certain of its directors and officers. As reflected in the plaintiffs’ lawyers’ October 22 press release (here), the Complaint alleges material misrepresentations in connection with the company’s June 4, 2008 and May 11, 2009 securities offerings. The complaint (which can be found here) alleges that the company’s share price fell over 37% in October 2009 after it announced that it held nearly $400 million in nonperforming loans.

 

The other recently filed banking-related suit was filed on October 22, 2010 in the Northern District of Iowa against Meta Financial Group and certain of its directors and offices. According to their October 22, 2010 press release (here), the Complaint (which can be found here) relates to the company’s October 12, 2010 announcement that the Office of Thrift Supervision was investigating the company in connection with its iAdvance credit origination program. The complaint alleges that the company’s shares declined over 40% on the news.

 

Statistical Review of Recent Banking-Related Litigation

Securities class action activity involving commercial banks represents a significant part of 2010 securities class action lawsuit filings. By my count, there have been at least ten securities class action lawsuits so far this year involving banking institutions, representing about seven percent of the approximately 143 securities suits filed year to date.

 

As noted in NERA’s August 2010 report on failed bank litigation, investor lawsuits involving failed and troubled banks have been a significant accompaniment of the current round of banking problems. According to the NERA report, private investor litigation "was not a notable feature of the S&L crisis litigation," but this time around "private litigation against D&Os has been widespread."

 

Among other statistics, the NERA report notes that of the 240 securities class action lawsuits filed against financial sector firms in 2008 and 2009, there were 45 against depositary firms. The report further notes that of the 20 largest failed banks prior to 2010, 13 involved publicly traded institutions, and eight were involved in securities class action litigation through the end of 2009.

 

Updated Overview of Bank Failures

Meanwhile the number of failed banks continues to mount. The 139 banks closed in 2010 through October 22 is nearly equal to the 140 banks closed in all of 2009. The seven banks closed this past Friday night includes two more failed banks in Georgia and Florida, respectively, as well as one more in Illinois. There three states – Georgia, Florida and Illinois – are the states with the highest numbers of failed banks, both this year and since January 1, 2008.

 

So far this year, Florida has the highest number of failed banks, with 27, followed by Georgia (16), Illinois (16) and California (10). These four states alone have combined for 69 bank failures this year, or just under 50% of all 2010 bank failures.

 

Though 39 states and Puerto Rico have each had at least on bank failure since January 1, 2010, the bank failures have predominately been concentrated in just a handful of states, again led by the same four states – with Georgia leading the way with 46 failed banks, followed by Florida (43), Illinois (38) and California (32). These four states together have had 159 bank failures, or about 52% of all failed banks since January 1, 2008. Other states with high numbers of failed banks during that period include Minnesota (14), Washington (13), Missouri (11) and Nevada (10).

 

The 2010 bank failures have largely been concentrated among smaller banks. 116 of the 139 bank failures, or about 83%, have involved institutions with less than $1 billion in assets. 32 (or about 29%) of the 2010 bank failures have involved banks with less than $100 million in assets. Of course, given that there are many more smaller banking institutions in the U.S. than there are larger banks, it may be unsurprising that there are so many bank closures involving smaller banks.

 

Discussion

While the bank closure statistics are striking, it is worth noting that the lawsuits described above, as well as much of the banking-related securities litigation, involves banks that remain in operation. In other words, the current level of banking-related securities litigation represents more than just the direct fallout from the high level of bank failures. Rather the litigation reflects the pressures and stresses more widely distributed throughout the entire U.S. banking industry in the wake of the credit crisis.

 

Even though we are well past the depths of the financial crisis (at least temporally), many banks remain under pressure, as reflected in the FDIC’s most recent quarterly banking profile (about which refer here). In many instances, this pressure has, among other things, led to litigation.

 

So while we continue to wait and see the extent to which the FDIC will, as a result of the current round of bank failures, become an active claimant against former directors and officers of failed bank, investors have pressed ahead with their own claims. Many of these investor claims have come in the form of securities class action lawsuits, the targets of which include a range of banking-related defendants, beyond just the failed institutions. The most recent filings suggest that we may continue to see more commercial banking-related securities litigation in the months ahead.

　

Meanwhile, BankAtlantic Securities Trial Continues: Among the banking-related securities cases filed in recent years is the securities class action lawsuit filed against BankAtlantic Bancorp and certain of its directors and officers, which recently became one of the very rare securities class action lawsuits to actually go to trial (about which refer here). The jury trial in the case is going forward in federal court in Miami, and as reflected in the October 22, 2010 post in the Southern Florida Business Journal Blog (here), the trial has among other things involved the plaintiffs’ introduction of inflammatory internal emails highly critical of the bank’s lending practices and processes.

 

According to informed sources, the plaintiffs are likely to conclude the presentation of their case some time during the upcoming week, and it will then be the defendants’ turn to present evidence and to introduce testimony.

 

Plaintiffs in the case are represented by Matthew Mustokoff and Andrew Zivitz of the Barroway Topaz firm and Mark Arisohn of Labaton Sucharow. The defendants are represented by Eugene Stearns of the Stearns Weaver Miller law firm.

 

Anatomy of a Failure: Those readers wondering how in the world we got into this current banking mess may want to take a look at the article entitled "Death of a Small Town Bank" in November 1, 2010 issue of Time Magazine (link currently unavailable) The article tells the story of Community Bank & Trust (CBT) of Cornelia, Georgia, which the FDIC closed on January 29, 2010.

 

Though CBT is just one of the 139 banks that have failed this year, its tale encompasses so many of the problems underlying the current crisis. All of the usual details are present, as a small town institution got caught up in the speculative fever caused by rapidly escalating real estate prices, compounded by administrative and procedural shortcomings (and possibly worse) that led to faulty and some improper loans. The sudden collapse of prices that accompanied the financial crisis left lenders unable to repay and the bank saddled with a portfolio of bad loans that ultimately caused the bank’s failure and left the town with a challenging future. The article makes for interesting, if sobering, reading.

 

For Those Looking for Something to Feel Good About: Those readers who have had just about enough of depressing stories about failed banks may want to take a look at the cover article from the October 24, 2010 issue of The New York Times Magazine entitled "The D.I.Y. Foreign-Aid Revolution." The article reports the stories of several individuals who have made it their personal responsibility to try to make the world a better place, and who actually have each found a way to actually do things that can make a difference. A really inspirational article about some really interesting and impressive people.

 

The astonishing pace of legislative and judicial changes – just over the last few months alone – underscores how rapidly the liability exposures in the directors and officers arena can be transformed. In the latest issue of InSights (here), I take a look at the current hot topics in the world of directors’ and officers’ liability. There is much to discuss in the world of D&O, with further changes just over the horizon. The year ahead could be very interesting and eventful. The latest InSights article reviews what to watch now in the world of D&O.

 

The Latest Bulletin From Our San Francisco Bureau:  Our SF correspondent filed this report before last night’s game (names removed to protect privacy, swear words modified to conform with the family-oriented approach of this blog):

 

So living with a wacko Giants fan is actually really fun right now. Yesterday {name removed} and her mom and godmother went kayaking outside the stadium and it sounds like SO MUCH FUN. I have added it to my to-do list of things while I live in the Bay.

 

Anyway, aside from kayaking (and drinking, and eating, and singing while kayaking) Giants fans wear these ugly fake beards to mimic the "rally beards" that the pitchers have (well, all the pitchers except Lincecum). And they have t-shirts that say "Fear the Beard." I have seem some television footage of very small children and very blonde women in beards. Very strange.

 

Also, just to prove that Tim Lincecum really could never play on any team except the Giants or the A’s, everyone knows he smokes pot like it’s his job, and the fans wear shirts that say "Let Timmy Smoke." I very much doubt that would be the public reaction ANNNYwhere else. Also he doesn’t cover his mouth when he swears, so "F*ck Yeah" t-shirts are also very popular.

 

Unfortunately, I’m still not overly interested in the BASEBALL…just the funny things that San Franciscans do while they WATCH baseball.