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.

 

The foreclosure paperwork and processing mess has been unfolding on the front pages of the nation’s news papers for several weeks now. While the situation has created a lot of uncertainty, the one thing that seemed probable was that litigation would follow. But while the likelihood for lawsuits seemed high, it did not necessarily follow that there would be D&O claims arising out of the mess.However, at least one D&O claim has now arisen out of the foreclosure muddle.

 

According to their November 23, 2010 press release (here), plaintiffs’ lawyers have filed a securities class action lawsuit in the Middle District of Florida against Lender Processing Services, Inc. and certain of its directors and officers. The complaint, which can be found here, alleges that the defendants failed to disclose that

 

(i) that the Company had engaged in improper and deceptive business practices; (ii) that the Company’s subsidiary Docx had been falsifying documents through the use of robo signers; (iii) that the Company had engaged in improper fee sharing arrangements with foreclosure attorneys and/or law firms, including, but not limited to, undisclosed contractual arrangements for impermissible legal fee splitting, which are camouflaged as various types of fees; (iv) as a result of the Company’s deceptive business practices, the Company reported misleading financial results; and (v) further, as a result of the foregoing, at all relevant times, the Company’s financial outlook lacked a reasonable basis.

 

On October 4, 2010, after the company released a statement responding to what it described as "mischaracterization of its services," the company’s share price declined.

 

It remains to be seen whether or not there will be further securities suits growing out of the foreclosure mess (although I have to say the possibility of additional lawsuits growing out of this situation seems likely.)

 

The one thing that has definitely become clear is that the plaintiffs’ securities bar is riding in the wake of the business headlines. Toyota has a problem with sudden acceleration? Wham, in comes the securities class action lawsuit. Massey Energy has a coal mining catastrophe? Pow, in comes the securities lawsuit. BP suffers a massive oil spill? The next thing that follows is a securities class action claim. The same goes for the disclosures of possible student loan fraud at for-profit education companies, as basically every company in the industry has now been hit was a suit. I am sure if the plaintiffs’ lawyers could figure out how to file a securities suit against the North Koreans for launching missles against South Korea on Monday, the would do that too.

 

It has pretty much gotten to the point that the way to determine who will be sued next is simply to read the newspapers. And by that indicator, we can probably expect to see more securities suits arising out of the foreclosure mess.

 

While the condition of commercial banks continues to improve overall, the number of "problems institutions" also continues to grow, in both absolute and percentage terms, according to the FDIC’s latest report on the banking industry. The FDIC’s Quarterly Banking Profile, dated November 23, 2010 and reporting figures through September 30, 2010, showed that the FDIC now rates 860 banks as problem institutions, up 829 at the end of the second quarter.

 

The increased numbers of problem banks stands in contrast to the overall tenor of the report. Tthe FDIC said that during the thing quarter the banking industry was characterized by "resilient revenues and improving asset quality." Year over year earnings improved for the fifth consecutive quarter. Indeed almost two out of three institutions reported higher net income than a year earlier.

 

Other signs are also positive. Quarterly provisions for loan losses were at the lowest quarterly amount since the fourth quarter of 2008, net charge-offs were lower than both the previous quarter and the year-earlier quarter, and industry assets continued to improve.

 

However, within this good news, some evidence of continuing difficulties also emerged. One in five banks continues to be unprofitable. The 860 institutions reported as problem institutions represent more than 11 percent of all 7,780 insured institutions. In other words, the FDIC ranks about one our of nine of all banks in the country as problem institutions.

 

(The FDIC considers a bank a "problem institution" if it is ranked as either a "4" or a "5" on the agency’s 1 to 5 scale of supervisory concern. Problem institutions are "those institutions with financial, operational, or managerial weaknesses that threaten their continued financial viability." The FDIC does not publish the names of the banks it considers to be problem institutions.)

　

The 860 problem institutions at the end of the third quarter represent an increase of 308 problem institutions during the twelve months since September 30, 2009, or about 56%. This increase is all the more noteworthy given that 172 banks closed during that period and so fell off of the problem list.

　

The number of problem institutions at the end of the third quarter is the largest number of problem institutions since March 31, 1993, when there were 928.

 

One positive note is that while the number of problem institutions continues to increase, the aggregate assets represented by these problem institutions declined in the third quarter, to $379.2 billion, from $403.2 at the end of the second quarter. This is the second quarter in a row that the assets of problem banks have declined. The fact that aggregate assets are declining even as the total number of problem banks is increasing suggests that many of the newly added problem banks are smaller institutions.

 

A total of 314 banks have failed since January 1, 2008, with 149 during 2010 alone (so far). Yet the number of problem institutions continues to grow, which suggests that there could be more, possibly many more, bank failures yet to come. Although there had been some hope that the number of bank failures might have peaked and would now begin to taper off, the FDIC’s latest report suggests that we could continue to see bank closures well into 2011 and possible beyond.

 

In the meantime, as I recently noted, the FDIC reportedly is gearing up to pursue both civil and criminal proceedings against former directors and officers of the failed banks, while at the same time investors have also been pursuing their own separate claims. It seems highly probable that these claim-related activities will escalate in the months ahead.

 

A November 23, 2010 New York Times article about the FDIC’s report can be found here.

　

The lead article in the November 17, 2010 Wall Street Journal reported that the FDIC is conducting 50 criminal investigations of directors, officers and employees of failed banks. Given that (as of November 19, 2010) 314 banks have failed since January 1, 2008, this report suggests that the FDIC is investigating possible criminal charges in connection with a pretty hefty percentage of the bank failures — about 16%, if each of the 50 investigations relates to a separate bank.

　

These reports of as many as 50 criminal investigations are all the more striking because up to this point, the FDIC has not conspicuously pursued criminal charges. The most prominent criminal charges filed as part of the current wave of bank failures related to the May 2010 indictment of two former officials from Integrity Bank in Alpharetta, Georgia. Integrity Bank failed in August 2008, which was fairly early in the current failed bank wave. Many more banks have failed since then, and so the FDIC may just now be completing its investigations of many of the later bank failures.

 

In the meantime, banks are continuing to fail. Just this last Friday night, the FDIC closed three more banks, bringing the 2010 YTD total number of bank failures to 149. (The Journal article does note that FDIC officials "expect the failure wave to peak this year.")

 

Obviously, the FDIC has not even had an opportunity to investigate the most recent bank failures, which suggests that the figure of investigations could grow.

 

The Journal article quotes one FDIC official, speaking of possible civil actions to be brought against former officials of failed banks, "these numbers will continue to grow as time goes on." (The Journal article repeats the information, now widely circulated, that the FDIC has authorized civil actions against more than 80 directors and officers of failed banks.) The Journal article also reports that it takes up to 18 months for the FDIC to determine whether to bring an action, meaning that "the surge in scrutiny is likely to continue for years."

 

One particularly noteworthy step the FDIC has taken as it readies itself to pursue actions in connection with the failed banks is that it has begun to try to recover documents from outside law firms that were advising the directors and officers of failed institutions before they were closed.

 

As detailed in a November 20, 2010 Bloomberg story (here) the FDIC has sued one law firm and threatened to sue another in order to recover documents bank executives gave the lawyers before the institutions failed.

 

A copy of the November 9, 2010 complaint filed against the Bryan Cave law firm can be found here; a copy of the November 10, 2010 consent order attempting to resolve the matter can be found here. A November 12, 2010 Am Law Daily article about the dispute can be found here. .

 

In the dispute involving the second law firm, the law firm itself initiated an action, in the form of a November 17, 2010 declaratory judgment action. The law firm had received a letter from the FDIC demanding the immediate return of the documents their clients had supplied them.

 

It may be, as suggested in the Journal article, that the wave of bank failures will peak this year. But the FDIC’s recent actions seem to be preliminary to an onslaught of litigation activity (both civil and criminal) and suggest that the FDIC claims-related activities have only just begun but will be accelerating for some time to come.

 

Special thanks to a loyal reader for copies of the pleadings in the FDIC’s law firm related litigation.

　

Meanwhile, Investors Pursue Securities Suits Against Banks: While the FDIC’s moves toward litigation involving failed banks has been a long time coming, investors in failed and troubled banks have much more assertive. As I have previously observed, a noteworthy feature of the current round of bank failures has been the significant numbers of investor suits involving failed and troubled banks.

 

The numbers of investor related suits involving failed or troubled banks continues to mount. Just in the last week, investors filed two more securities class action lawsuits involving failed banks.

 

First, as reflected in their November 18, 2010 press release (here), plaintiffs’ lawyers have initiated a securities class action lawsuit in the District of Delaware against Wilmington Trust Corporation and certain of its directors and officers. A copy of the complaint can be found here.

 

Second, in a separate November 18, 2010 press release (here), another plaintiffs’ firm announced that they had filed a securities class action lawsuit in the Eastern District of Tennessee against Green Bankshares and certain of its directors and officers. A copy of the complaint can be found here.

 

With the addition of these two latest lawsuits, as many as thirteen of the approximately 154 new securities class action lawsuit filed during 2010 have involved commercial banks, or roughly 8.5% of all 2010 securities class action lawsuits. The banking related securities suit activity has been one of the most significant factors in 2010 securities filing activity (not even taking into account the claims that have arisen involving banking companies that were not publicly traded).

 

Perhaps the only other group of companies that has been so specifically targeted in lawsuits this year is the for-profit education sector, which has been hit with nine separate securities class action lawsuits this year, or about 6 percent of all 2010 securities suits.

 

Schwab YieldPlus Settlement Back On?: As I reported in an earlier post, the Charles Schwab Corporation had announced its decision to withdraw from the $235 Schwab YieldPlus Fund subprime-related securities class action settlement, due to a dispute about whether or not the settlement stipulation released the California state law claims of non-California class members.

 

However, according to November 18, 2010 news reports (here), the parties to the YieldPlus case have reached a revised settlement The revised settlement is intended to make it clear that all of the claims of the class are released, including the California state law claims of non-California residents.

 

A copy of the parties’ November 17, 2010 amendment to their settlement stipulation, reflecting the revised understanding, can be found here. A copy of the parties’ joint motion regarding the revised settlement stipulation can be found here. The parties’ amended settlement stipulation is subject to the approval of Northern District of California Judge William Alsup.

 

QE II: Here at The D&O Diary we have followed with interest the debate about the Federal Reserve’s latest round of "quantitative easing." Because we feel unqualified to comment on the Fed’s actions, we express no views of our own here about the wisdom of the Fed’s approach.

 

Others have not been as restrained.

 

In that vein, a video critical of the Fed’s actions has been making the rounds and I have attached it below. I want to stress that this video does not necessarily reflect my views, and I am linking to it here only because I think it is pretty amusing and because it has been a while since I have had occasion to link to a video on this site. Special thanks to a loyal reader for the link to the video. 

https://youtube.com/watch?v=PTUY16CkS-k%3Ffs%3D1%26hl%3Den_US

Directors and officers can expect their company’s D&O insurance policy to provide them with a claim defense, but only for claims against them for actions made while they are acting in an "insured capacity." The question is whether the determination of the capacity in which the individual was acting depends on the claimant’s allegations, or does it depend on the individual’s actions, regardless of what may be alleged?

 

An October 20, 2010 unpublished Ninth Circuit opinion (here) held that "an insured would reasonably expect coverage for actions taken in the capacity of director or officer of an insured company, whether or not that capacity was alleged by the third-party plaintiff."

 

Frederick Goerner was CEO of TransDimension, and was insured under the company’s D&O insurance policy, which provided coverage for claims against insured persons for "any actual or alleged error" committed by an insured individual "in [his] capacity as such".

 

In litigation to determine whether the company’s D&O insurer had an obligation to provide a defense to Goerner for claims that had been asserted against him, the district court had held that the because the underlying complaint did not specifically allege that Goerner had been acting in his capacity as TransDimension CEO, but rather asserted that he action on behalf of two other industries in the same industry, coverage under the policy was not triggered. Goerner appealed.

 

On appeal, the carrier argued that because the underlying complaint did not specifically allege that the claimant’s losses resulted from action Goerner took in his capacity as TransDimension’s CEO, there was no coverage.

 

A three-judge panel of the Ninth Circuit held that, because the carrier’s position, if valid, would preclude coverage even for actions in his insured capacity if the claimant failed to allege in the complaint that the actions were in an insured capacity, the carrier’s position "defeats the purpose of the insurance coverage."

 

The Ninth Circuit said that the guiding consideration is whether "the insured would reasonably expect a defense by the insurer," and that the specific question here is whether the actions at issue in the complaint "could have been taken by Goerner in his capacity as CEO of TransDimension."

 

Finding that Goerner had shown that TransDimension had business dealings "with all of the individuals and companies at issue in the underlying complaint" and that TransDimension’s board "authorized and paid for Goerner’s travels to meet with those two companies in Asia," the Ninth Circuit concluded that Goerner had presented facts that "give rise to the possibility of coverage" and that the carrier therefore was obligated to provide Goerner with a defense.

 

Discussion

Questions of insured capacity are not infrequent in litigation involved senior corporate officials, particularly where the individuals involved wear multiple hats. A not uncommon question, for example, is whether an individual, who is affiliated with a private equity firm and who is serving on the board of the PE firm’s portfolio company, was acting in a capacity for which the individual is insured under the portfolio company’s policy.

 

The Ninth Circuit’s decision in this case clarifies that the allegations in the complaint alone are not conclusive of the issue. Rather, courts should look at what is reasonable to expect under the circumstances given the nature of the misconduct alleged against an individual defendant.

 

The Ninth Circuit’s ruling ensures that an insured person’s rights under a D&O policy are not subject to the vagaries involved with a third-party plaintiffs’ pleading peculiarities. Basically, insured persons ought to be able to count on their insurance to respond in the kinds of situations for which the insurance was intended to respond. The problem of course is that at the outset of a claim, often all there is to go on is the complaint. Answering the capacity question at the outset may require parties to be flexible and keep an open mind, in order to avoid protracted disputes of the kind involved here.

 

It is worth noting that the Ninth Circuit’s opinion in this case was designation "not for publication." Nevertheless the opinion may still be cited. Under Federal Rule of Civil Procedure 32.1, circuit courts may no longer prohibit the citation to opinions designated, inter alia, "not for publication."

 

A November 17, 2010 memo from the McGuire Woods law firm discussing this case can be found here.

 

The recurring issue of insured capacity is one of the basic coverage issues that can complicate claims handling. Readers interested in getting a handle on the basics of D&O insurance coverage may want to refer to my multipart-series on the nuts and bolts of D&O insurance, which can be accessed here.

 

D&O Liability Insurance Conference: On November 30 and December 1, 2010, I will be co-chairing with my friend Michael Early of the Chicago Underwriting Group the American Conference Institute’s 16th Annual Summit on D&O Liability in New York. The D&O Diary is a media partner for this event. The conference brochure can be found here. I hope readers who will be attending the event will make a point of greeting me at the conference, particularly if we have not previously met.

　

In the first securities class action jury verdict to arise out the credit crisis, on Thursday November 18, 2010, the jury in the BankAtlantic securities lawsuit in federal court in Miami returned a verdict in the plaintiffs’ favor, finding seven of the statements at issue to have been false, and awarding damages of $2.41 per share. According to sources, this damage measure translates to total damages of as much as $42 million.

 

The case went to the jury last week after more than four weeks of trial, testimony from 13 fact witnesses and one expert witness. The verdict form the jury was required to complete ran to some 53 pages. At the outset of the trial, the lead defense counsel had characterized the claim as a "completely made-up, frivolous claim."

 

In their completed verdict form, the jury found the company and two of the five individual defendants to be liable for seven of the 19 statements at issue. The two defendants held liable are the company’s CEO, James Lavan, and its CFO, Valerie Toalson. All of the statements for which the defendants were found liable had been made in 2007. The completed jury verdict form can be found here.

 

As reflected here, the plaintiffs’ complaint had alleged that the defendants had made misleading statements about the bank’s loan portfolio from October 2006 through October 2007 and had "materially understated reserves for real estate loan losses on its financial statements, and thus materially overstated net income." The plaintiffs alleged that the defendants (the bank holding company and five of its individual directors and officers) had made misleading statements about the quality of the bank’s loan portfolio, the bank’s exposure to loan losses and the bank’s loan loss reserves.

 

As noted here, the plaintiff’s initial complaint had failed to survive the defendants’ motion to dismiss, but the amended complaint survived the defendants’ renewed dismissal motion.

　

According to information compiled by Adam Savett, the Director of Securities Class Actions at the Claims Compensation Bureau, since the enactment of the PSLRA, there had previously been only nine securities class action lawsuits based on post-PSLRA conduct that have actually been tried to a jury verdict. (Another seven cases alleging post-PSLRA conduct went to trial but were compromised or otherwise resolved prior to verdict. An additional eleven securities cases have gone to trial post-PSLRA but involved pre-PSLRA conduct.)

 

In other words, the verdict in the BankAtlantic case represents only the tenth securities class action lawsuit verdict since the enactment of the PLSRA based on post-PSLRA conduct.

　

The current tally (taking into account post-verdict proceedings and reflecting only the current status of post-verdict proceedings) is as follows: Plaintiffs 6, Defendants 4. (The scoreboard is subject to revision pending the outcome of additional proceedings in several of the cases.)

　

With the plaintiffs’ verdict in the BankAtlantic case, the securities class action jury verdict scoreboard (taking into account post-verdict proceedings and reflecting only the current status of post-verdict proceedings) is as follows: Plaintiffs 6, Defendants 4. (The scoreboard is subject to revision pending the outcome of additional proceedings in several of the cases.)

　

The BankAtlantic case will now undoubtedly head into post trial motions, and perhaps even later appeals. As has been shown in the Apollo Group securities class action case (about which refer here), in which there the plaintiffs’ jury’s verdict has been set aside in post trial motions only to have the verdict reinstated on appeal, the verdict itself can effectively wind up as only one stop in a very long procedural grind. Stay tuned for further proceedings.

 

In a statement to The D&O Diary, Matthew Mustokoff, a partner in the Barroway Topaz law firm said "The jury’s verdict vindicates our position from the outset that this was a case with merits and it delivers a message that a financial institution can’t mislead their shareholders about the riskiness of its loans." The Barroway Topaz firm was co-lead counsel for the plaintiff on the case. The other lead attorneys were Andrew Zivitz of the Barroway Topaz firm and Mark Arisohn of the Labaton Sucharow firm.

 

A November 18, 2010 South Florida Business Journal article describing the verdict can be found here.

　

　

From time to time, readers suggest blog topics to me. I am always interested in the range of topics suggested. Very late at night (or perhaps early in the morning) in the bar at the recent PLUS International Conference in San Antonio, a loyal reader whom I had only just met for the first time suggested that I write a blog post about my favorite business books. Unsurprisingly, it seemed like a good idea then. Surprisingly, it still seemed like a good idea later.

 

My notion of the books worth recommending may diverge from what the reader had in mind when he made the suggestion. I figure that no one really needs me to suggest the usual fare from the business section at the book store, like, for example, The Smartest Guys in the Room or Liar’s Poker. If those books interest you, by all means, read them.

 

The problem with the vast run of business books is that they rarely aim for anything higher. To find anything of more lasting value, you must look elsewhere. So my suggested "business" books won’t be found in the business section, and in fact may not necessarily meet anybody’s idea of what constitutes a business book. But these books have more to say about the business of life and the life of business than the more conventional fare. Here are a half- dozen essential books I suggest to anyone looking for something a little more substantial:

 

The Way We Live Now: Regrettably, the books of Anthony Trollope are not much read these days, perhaps because he was such a prolific writer and not all of his works were equally good. But he wrote several very fine books, including Orley Farm and Doctor Thorne. By far his best novel is The Way We Live Now, a scathing and bitter satire of late 19th Century English society and morals.

 

The central character is this vast book is Augustus Melmotte, a foreign financier with an uncertain past who sets all of London society ablaze with his seemingly immense wealth. He schemes to procure actual wealth through an American railroad development project, intending drive up the share prices so he can extract gains at others’ expense.

 

Melmotte is surrounded by a crowd of witting and unwitting accomplices whose greed, vanity or self-deception allow them to be carried along in the plot, which becomes increasingly complex as the story unfolds. The catalog of characters and sub-plots is rich, thick and entertaining.

 

No one can turn back time, but there are squadrons of heartbroken investors who might have spared themselves financial tragedy if they had only been first introduced to Melmotte before they met Madoff.

 

The House of Rothschild: One of the great financial historians of our time is Niall Ferguson, whose book The Ascent of Money makes a compelling case that the development of currency and banking was the indispensible prerequisite for the emergence of modern civilization. But I think Ferguson’s most valuable work is his two-volume history of the rise of the Rothschild banking family. Anyone who wants to understand the rise of modern finance, and also to appreciate the interplay of historical forces and familial ambitions, will be amply rewarded for reading these books.

 

The story of how the five sons of Meyer Amschel Rothschild went on to establish themselves as the premier bankers in Europe and to become the financiers to the sovereigns across the continent is well-told and instructive. The firm’s inviolable founding principles kept the family establishment together across borders and across generations, as well as through wars and economic crises, and allowed the family to ride the changing tides of history and survive the ever-present anti-Semitism to establish a dynasty more durable (and vastly better financed) than all of the royal houses.

 

Dombey and Son: The novels of Charles Dickens vividly capture the life of so many late 19th century British institutions. Given that Dickens wrote in and of a country that has been derided as "a nation of shopkeepers," it is perhaps indispensible that Dickens also captured the life of street level commerce and it is entirely fitting that one of Dickens’ finest novels revolves around a trader and his ambitions for himself and for his firm and family.

 

Dombey’s huge (and ultimately thwarted) ambitions for his son set the frame for a narrative that races on even as it races away from Dombey’s own ability to trace and track his own interests. His frustrated ambitions leave him aged and bitter, but his ultimate reunion with his estranged daughter, Florence, provide a measure of redemption at the end.

 

The House of Medici: Before the Rothschilds, before the processes of institutions of finance evolved all of their modern forms, the Medici were the premier banking family in Europe. In later generations, they went on to wed kings and to serve as Popes, but they began as textile traders. Only later, Cosimo de’Medici, transformed the family’s growing banking influence into the foundation of a political dynasty that lasted for generations.

 

Although the family has a modern reputation for ambition and ruthlessness, their success, at least in its origins, was more mundane. As retold in Christopher Hibbert’s book, The House of Medici, a notable contribution to the family’s success was their early adoption of the double-entry bookkeeping system for keeping track of debits and credits.

 

And although they amassed great wealth, they were among the most important benefactors of the Italian Renaissance. Among the many artists the family sponsored were Brunelleschi, Michelangelo, Donatello and Fra Angelico. The family’s collection serves as the core of the Uffizi Gallery in Florence.

 

While the family’s glory and wealth is well remembered, the family’s fortunes ebbed and flowed. Hibbert’s one-volume account captures the travails and misfortunes, which included exile, assassination attempts, and financial declines, as well as the periods of the family’s astonishing ascendancy.

 

Buddenbrooks: This novel is one of my favorite books, even though it is, admittedly, a total downer. Thomas Mann’s novel, Buddenbrooks, tells the story of four generations of the Buddenbrooks family and its merchant trading business in 19th century Lubeck. The story  begins at what only later becomes apparent is the family’s high water mark, when old Johann and Frau Counsel Buddenbrooks are enjoying the simple fruits of prosperity while still living over the trading house.

 

At the book’s center are the struggles and ambitions of the next generation, Thomas Buddenbrooks and his sister Antonie. Thomas takes over the family business, which prospers at first. But then due to the pressure of maintaining the business and living up to society’s and his own expectations, he is ultimately consumed with self-doubt. He finally puts all of his hopes and ambitions in his son, who is more interested in art than business. Antonie, who marries badly in order to serve the family interests, also finds herself unable to find her way and assist her brother.

 

Although the family’s decline seems preordained, there are many choices along the way that were not inevitable and that could have avoided later disasters. Antonie’s unsustainable devotion to luxury is but one of the weaknesses that leads to her own poor decisions. Thomas’s ill-fated decision to possess a grand house similarly undermines his self-confidence, as the house comes to possess him. The turning away of the subsequent generations from the simplicity and thrifty frugality of the family business’s founder seems to underlie the family’s ultimate decline.

 

In recommending this book once, I said that "what this book is about is life." It is an epic story of the ebb and flow of family fortunes, the blessings and burdens of prosperity, and the difficult challenges that face all of us as we navigate across the years.

 

The Meditations of Marcus Aurelius: According to tradition and at least some evidence, the Roman Emperor Marcus Aurelius wrote his Meditations while campaigning against the empire’s many foreign enemies. Marcus composed these brief statements of Stoic philosophy and self-discipline to exhort himself to be a better version of himself.

 

Marcus recorded his thoughts as a way to examine his own strengths and weaknesses, in order to determine how best he should live. He articulates a strong personal philosophy based on his own responsibility for his own actions as well as the need to maintain equanimity for the things he cannot control, including both the actions of others and (ultimately) death.

 

The Mediations are fully of many good, noble and thought-provoking statements and ideas that are all the more powerful given that at the time Marcus recorded these thoughts, he was probably the most powerful person on the planet. He writes with simplicity and clarity, and repeatedly calls himself simply to achieve a good life well lived.

 

In the business of life, we all encounter periods when we too find ourselves compelled to battle enemies who threaten all that we have worked to achieve. To persevere under these circumstances are among life’s great challenges. The thoughts Marcus recorded during his own times of crises are a substantial help and guide. As Marcus wrote, the important thing is to be the best and most noble person you can be: ‘The best revenge is not to be like your enemy.’

　****

Though I have assembled here a list of half-dozen essential books, there undoubtedly are many more books that might be added to this list. I encourage readers to suggest their own candidates by using this blog’s Comment feature. Please take the time to share your own thoughts and suggestions with me and with other readers.

　

For reasons I am sure they find good and sufficient, Chinese companies have been seeking listings on the U.S. securities exchanges. The Chinese companies (or at least some of them) have also been discovering an added side-effect of a U.S. listing – that is, exposure to a class action lawsuit under the U.S. securities laws.

 

The latest Chinese company to be sued is RINO International Corporation, which has its headquarters in Dalian, in China’s Liaoning province. As reflected in their November 15, 2010 press release (here), plaintiffs’ lawyers have filed a complaint against the company and certain of its directors and officers in the Central District of California.

 

The complaint (which can be found here) alleges that in RINO’s SEC filed annual report for fiscal 2009, RINO reported $193 million of revenue, but in the annual report RINO filed for 2009 with the China State Administration for Industry and Commerce, it reported only $11 million of revenue. This discrepancy, "along with other accounting inconsistencies and questionable transactions between RINO and its management, has raised red flags and prompted an internal review."

 

RINO joins a growing list of Chinese companies that have been named as defendants in securities class action lawsuits in the U.S. in 2010. There have been as many as 14 new securities class action lawsuits filed against foreign domiciled in 2010 (out of a total of about 154 new lawsuits filed this year), but seven of the 14 (including the new lawsuit against RINO) involve Chinese companies.

 

The other six Chinese companies to be sued are Fuqi International (about which refer here), China Natural Gas (here), China-Biotics (here), Duoyuan Printing (here), Duoyuan Global Water (here), and China Green Agriculture (here). Interestingly six of the seven have been filed just since the last week of August 2010, all of which of course were filed after the U.S. Supreme Court’s decision in the Morrison case (about which refer here), which seemingly narrowed the range of foreign-domiciled companies U.S. private securities litigation exposure.

 

Taken collectively, these lawsuits could be interpreted to suggest that at least some Chinese companies have experienced some difficulties adapting to the burdens and responsibilities involved with a U.S. listing.

 

But there seems to be more going on here that just that. A review of the basic allegations in these cases suggests a common thread among at least some of the cases. In three of the cases – the ones involving China-Biotics, China Green Agriculture, and RINO – the allegation is that the companies reported different revenue and other financial information to the Chinese authorities than they reported in the SEC filings.

 

One might conjecture on the possible reasons why these companies might have reported different figures to their domestic authorities than they did in their SEC filings. For example, the companies might have been seeking to avoid domestic tax liabilities. (Of course, there is always the possibility that the differences in the reports are attributable to differing reporting conventions, but you would think that it that were the explanation, that would be disclosed in their SEC filings.) These companies’ reporting discrepancies are more than a little bit puzzling, as it seems probable that the differences would be detected, given the public availability of the SEC filings.

 

It probably should be added that while the recent upsurge in new lawsuit filings against Chinese companies is unquestionably noteworthy, this observation should also be put in context. According to news reports, 226 Chinese companies are currently listed on the NYSE, AMEX and NASDAQ. In the context of these 226 Chinese companies whose securities trade in the U.S., the seven securities lawsuits this year involving Chinese companies may appear less significant.

 

Nevertheless, when you have multiple companies domiciled in a single country outside the U.S. being sued in securities class action lawsuits over the course of just a few weeks, the phenomenon seems worthy of note.

 

Indeed, though the number of Chinese listings has continued to surge, questions about the listed companies have also followed, as for example in the August 26, 2010 Barron’s article "Beware This Chinese Export" (here). The Barron’s article particularly warns about Chinese companies that achieve their U.S. listing through a reverse merger with a domestic shell company. Among other things the article notes that:

 

The group has been a minefield of revenue disappointments and earnings restatements. Financial filings the companies make with the Securities and Exchange Commission often diverge from those filed with the Chinese government—by drastic amounts. Investor and analyst visits to corporate facilities in China reveal operations smaller and less impressive than shown in U.S. presentations. The companies too often select auditors who have previously signed off on the financials of companies that turned out to be busts. Some companies’ securities filings don’t disclose the involvement of promoters in China or the U.S., who …have disquieting track records in the stock market.

 

Similar concerns prompted the PCAOB to issue a July 12, 2010 warning about accounting practices associated with these Chinese companies, particularly those whose U.S. listing originated with a reverse merger. Securities analysts have expressed a certain wariness of these U.S. listed Chinese companies as well.

 

Given these concerns, it probably comes as no surprise that litigation has arisen. The likelihood seems to be that more securities suits involving Chinese companies will follow.