The FDIC has authorized more than 50 lawsuits against former directors and officers of failed banks, according to an October 8, 2010 Bloomberg article. But merely because the lawsuits have been authorized does not necessarily mean we will see 50 lawsuits, as it appears that the FDIC approval was calculated in part to encourage pre-litigation settlements.

 

Since January 1, 2008, the FDIC has taken control of 294 banking institutions, as detailed here. The FDIC has been a very active litigant seeking to assert its rights of priority over other litigants’ claims against the directors and officers of failed banks, but the FDIC itself has filed only one lawsuit against the senior officials at a failed bank.

 

Though the FDIC has to date pursued relatively little litigation itself, it has asserted claims against individuals at failed banks. These claims have come in the form of demand letters nominally addressed to the individuals but also with copies to the failed institution’s D&O insurers.

 

For example, as discussed here, the FDIC filed a November 24, 2009 motion in the BankUnited Holding Company bankruptcy proceeding asserting its rights of priority to assert claims against Company’s bank unit’s directors and officer. Attached to the motion was a copy of a November 5, 2009 letter the FDIC’s attorneys sent to former directors and officers of BankUnited, in which the FDIC presented a demand for civil damages and losses. Copies of the letter were sent to the company’s primary and first level excess D&O insurers.

 

With its recent litigation authorization, the FDIC may now proceed to file more lawsuits against directors and officers of failed banks. However, the authorization (and surrounding publicity) may have been calculated to try to avoid litigation and encourage pre-litigation settlement in connection with some of the claims the FDIC has previously asserted in the form of demand letters like the one in BankUnited.

 

Along those lines, the Bloomberg article quotes an FDIC spokesman as saying that "the goal is to reach as many settlements as possible," adding further that "it’s both in our interest and theirs to try and settle this matter before it gets into court and we get into expensive litigation." Thus, it appears that the authorization and surrounding publicity is designed in part to encourage settlements before available funds have been reduced by defense expenses.

 

The article cites the FDIC’s estimate that the 50 authorized lawsuits would represent an effort to try to recoup more than $1 billion in losses. By way of comparison, and according to the NERA’ August 2010 report on failed bank litigation (about which refer here), during the S&L crisis, the FDIC recovered about $1.3 billion in D&O claims.

 

In terms of the number of lawsuits filed, the 50 currently authorized lawsuits would represent about 17% of the 294 banks that have failed since January 1, 2008. During the S&L crisis, the FDIC filed lawsuits in connection with about 24% of the 1.813 failed financial institutions — meaning roughly 435 lawsuits. Because the institutions failing during the current banking crisis are larger than the institutions that failed during the S&L crisis, the potential litigation recoveries in connection with many of the current failed institutions are proportionately larger.

 

Even though the FDIC want to try to settle cases if it can, it seems probable that it soon will be filing lawsuits, perhaps many of them in the days ahead. The Bloomberg article quotes the FDIC’s spokesman as saying that "we’re ready to go," adding that "we could walk into court tomorrow and file the lawsuits."

 

As a loyal reader said, commenting on the reports of the FDIC’s litigation authorization, "Game on." Indeed.

 

UPDATE: In picking up this story, various news sources have clarified that the FDIC did not authorize 50 lawsuits but rather authorized lawsuits against 50 individuals. Refer for example here. At least one knowledgeable source I consulted confirmed that what the FDIC authorzied was not 50 separate lawsuits, but rather lawsuits against 50 indiviudals. The expectation then is that there might be 5 to 10 lawsuits, which is quite a bit different than 50 lawsuits. Hard to see how the FDIC plans to get to $1 billion in recoveries from that level of litigation activity.

 

Special thanks to the several readers who sent me copies of the Bloomberg article.

 

Morgan Keegan Funds ’33 Act Subprime-Related Claims Survive Dismissal: In a September 30, 2010 order (here), Middle District of Tennessee Judge Samuel H. Mays, Jr. granted the defendants’ motions to dismiss the ’34 Act claims but denied the motions to dismiss the ’33 Act claims in the Regions Morgan Keegan Open-End Mutual Fund securities class action litigation.

 

Plaintiffs are investors in three Morgan Keegan select mutual funds. The defendants are the funds themselves, their corporately affiliated asset manager, related corporate entities, as well as their corporate parent. The defendants include individual officers and directors of the funds and related entities.

 

The plaintiffs’ allegation is basically that the funds invested in CDOs and other illiquid subprime mortgage-backed investments in excess of stated restrictions on the funds’ investments. The plaintiffs contend that their investment losses are not the result of normal market factors, but rather are due to the funds investment in lower-priority tranches of asset-backed securities. When the market for the instruments began to decline in 2007, the funds found themselves holding assets that quickly declined in value and which they could not readily sell because of the limited market for such investments. Two of the funds declined in value over 70 percent, the third declined over 20 percent.

 

In reviewing the motions to dismiss, Judge Mays noted that the plaintiffs’ amended complaint "exceeds four hundred pages, comprising 766 paragraphs and six appendices." This extraordinary length may in the end have weighed against the plaintiffs. Judge Mays observed that "when it is possible to ask legitimately, after reading a four-hundred page Complaint, who is being sued for what on a particular count, Plaintiffs have not met the PSLRA’s pleading standards," adding that "it is not for the Court or for Defendants to ask who is ‘relevant’ to a particular count. It is the plaintiffs’ duty to state clearly against whom they seek damages." Judge Mays found that dismissal of the ’34 Act claims on this basis alone is sufficient.

 

Judge Mays went on, assuming for the sake of analysis that the plaintiffs claims had been pled with sufficient particularity, to hold that the plaintiffs had not sufficiently pled scienter. In attempting to establish scienter, the plaintiffs had relied on the "group pleading" doctrine. Judge Mays assumed for purposes of his opinion that group pleading had survived the PSLRA, but nevertheless concluded that "plaintiffs have failed to demonstrate that the inference of scienter is at least as compelling as any opposing inference of nonfraudulent intent."

 

But while Judge Mays granted the defendants’ motion to dismiss the plaintiffs’ ’34 Act claims, he denied the defendants motions to dismiss the plaintiffs’ ’33 Act claims, finding that the plaintiffs had adequately identified the allegedly misleading statements in order to state a claim.

 

I have added the Morgan Keegan ruling to my running tally of subprime and credit crisis-related lawsuit dismissal motion rulings, which can be accessed here.

 

Indian Summer: Wikipedia’s various supposed explanations for the origins of the phrase "Indian Summer" seem equally implausible and lack the ring of truth. Whatever the origin of the expression, the weather to which it refers is a delight and a balm in our weary world. In a few short weeks, the winds will howl and the snows will blow. But for now, a beneficent sun shines in an azure sky arching over the changing leaves’ brilliant colors. It is enough to make your heart glad.

 

 

 

Horseshoe Lake, Shaker Heights, Ohio, October 9, 2010

　

　

Yet another securities class action lawsuit against a non-U.S. company has been dismissed based on the U.S. Supreme Court decision in Morrison v. National Bank of Australia. In a decision that specifically addresses many of the questions that have been discussed in the wake of Morrison, Southern District of New York Judge John Koeltl, in an October 4, 2010 opinion (here), granted the defendants’ motion to dismiss the Swiss Re subprime-related securities class action lawsuit..

 

Though the case was dismissed, the opinion does suggest some alterative approaches plaintiffs may use to try to avoid Morrison’s preclusive effect.

 

As discussed here, the plaintiffs first sued Swiss Re and certain of its directors and officers in 2008. As Judge Koeltl later put it in his October 4 opinion. "the gist of many of the plaintiffs’ alleged misstatements or omissions is that Swiss Re failed to disclose that it had issued two [credit default swaps, of CDSs] that insured CHF 5.3 billion of assets… It eventually suffered a CHF 1.2 billion loss on these CDS when it suddenly wrote down the value of the CDOs and sub-prime securities that were insured by the CDSs."

 

After the Supreme Court issued its opinion in Morrison, the defendants in this case moved to dismiss, contending that the Exchange Act did not apply to the plaintiffs’ purchases of their Swiss Re securities, which had taken place on a non-U.S. exchange.

 

The plaintiff, Plumbers Union Local No. 12 Pension Fund, argued that Morrison did not preclude their claims, even though the transaction on which they had acquired their shares had taken place on a London-based subsidiary of the Swiss stock exchange. The plaintiffs argued that they had decided to purchase their Swiss Re shares in Chicago, and that the purchase orders were placed electronically by traders located in Chicago. The plaintiffs contended that the purchase occurred when and where an investor places a buy order.

 

Judge Koeltl, citing the several recent decisions, held that the term purchase "cannot bear the expansive construction plaintiffs propose, at least for purposes of Morrison’s transactional test." A contrary ruling, Judge Koeltl said "would require a fact-bound, case-by-case inquiry into when exactly an investor’s purchase order became irrevocable. It would also produce the multiplicity that the Supreme Court directed courts to avoid."

 

Accoringly, Judge Koeltl held that "a purchase order in the United States for a security that is sold on a foreign exchange is insufficient to subject the purchase to the coverage of section 10(b) of the Exchange Act." He acknowledged that there might be "unique circumstances in which an issuer’s conduct takes a sale or purchase outside this rule," but "the mere act of electronically transmitting a purchase order from within the United States is not such a circumstance."

 

Judge Koeltl also expressly rejected the suggestion that merely because the purchaser was domiciled in the U.S., that the U.S. securities laws applied to the transaction, noting that "a purchaser’s citizenship does not affect where a transaction occurs; a foreign resident can make a purchase within the United States, and a United States resident can make a purchase outside the United States.." Where the decision to purchase took place and even the location of the harm are also irrelevant. .

 

Having determined that the U.S. securities laws do not apply to the plaintiffs’ shares, Judge Koeltl then addressed the plaintiffs’ argument that even if they could not assert claims under the U.S. securities laws, they could assert their claims under state common law and the Court would have diversity of citizenship jurisdiction over such claims.

 

The parties had previously stipulated that if the plaintiffs’ claims under section 10(b) where dismissed under Rule 12 (b)(6) for failure to state a claim on which relief could be granted (as opposed to a dismissal under Morrison), the dismissal would also be dispositive of any common law fraud claims.

 

Judge Koeltl then proceeded to address the defendants’ motion to dismiss the section 10(b) claim and granted the motion to dismiss, finding that the plaintiffs had failed adequately to allege that the defendants had made materially or misleading statements. Judge Koeltl also found that the plaintiffs had failed adequately to allege scienter. Based on this determination, he concluded granted the defendants’ motion to dismiss, which was determinative not only of plaintiffs’ section 10(b) claims but also the plaintiffs’ claims for common law fraud.

 

Discussion

There are a number of interesting things about this opinion. The first is the specificity of Judge Koeltl’s analysis about what factors are or are not relevant to the post-Morrison analysis of whether or not the U.S. securities laws apply. His analysis seems to make clear that the location on the exchange on which the transaction took place is going to be determinative, and neither the citizenship nor location of the purchaser is relevant.

 

This view, which is consistent with the growing string of post-Morrison decisions, suggest that the so-called "f-squared" cases (that is, involving claims by U.S. claimants who purchased their shares in a non-U.S. company on a non-U.S. exchange) seem increasingly unlikely to have remain viable post-Morrison.

 

Judge Koeltl’s opinion does not address the more controversial question, raised sua sponte by Judge Berman in his recent opinion in the SocGen case (about which refer here), that under Morrison even the claims of purchasers who acquired ADRs in domestic transactions are precluded. Indeed, Judge Koeltl’s opinion is silent on the question of whether Swiss Re ADRs trade in the U.S.

 

But though Judge Koeltl’s opinion does not address the claims of domestic purchasers of ADRs, his analysis seems to suggest that he would not have gone as far as Judge Berman and concluded that the securities don’t apply to U.S. ADR purchases. First, he states that "Morrison held that a domestic purchase or sale is necessary (and as far as the opinion reveals, sufficient) for section 10b) to apply to a security that is not traded on a domestic exchange" — which suggests that in Judge Koltl’s view, Morrison does not preclude claims even of domestic ADR purchasers who acquired their shares over the counter, rather than on an exchange.

 

The Swiss Re decision is the latest in a string of rulings suggesting that plaintiffs face significant hurdles in attempting to pursue securities claims against companies domiciled outside the U.S., particularly where the company’s share trade largely outside the U.S. However, the Swiss Re decision does suggest, albeit indirectly, some the ways the plaintiffs may attempt to circumvent these obstacles.

 

Thus, for example, even though Judge Koeltl’s ruling on the defendants’ motion to dismiss resulting in a dismissal of the plaintiffs’ common law claims, there was certainly nothing in his opinion that suggests that plaintiffs could not assert such claims. The fact is that Morrison only applies to claims under the Exchange Act. Although the plaintiffs’ common law claims were dismissed in Swiss Re, the clear suggestion is that in another case, sufficient allegations could survive a dismissal motion, in which circumstance the case would go forward, notwithstanding Morrison.

 

　

A footnote in the Swiss Re case suggests another possibility. In footnote 5, Judge Koeltl observes that "the plaintiffs also noted that they might have a claim under Swiss law, but they have not pursued that avenue." Whether the plaintiffs in fact would have had such a claim under Swiss law and whether the U.S. court would have had an appropriate jurisdictional basis for entertaining such a claim is not addressed in Judge Koeltl’s opinion. But at least the theoretical possibility is posed by the footnote. UPDATE: An October 6, 2010 Law.com article (here) reports that the plaintiff shareholdes in the Toyota securities class action lawsuit have amended their complaint to add allegations of violations of Japanese securities laws, which demonstrates that one way plaintiffs may attempt to circumvent Morrison is by asserting in a U.S. lawsuit alleged violations of the securities laws of the non-U.S. company’s home country.

 

Whether plaintiffs’ lawyers might ultimately choose to frame their U.S. claims against foreign companies based on common law or foreign law rights of recovery remains to be seen. But if the present trend of decisions continues, these alternatives may begin to look more attractive.

 

I have in any event added the Swiss Re decision to my running tally of subprime and credit crisis-related lawsuit dismissal motion rulings, which can be accessed here.

 

Special thanks to the several readers who sent me copies of the Swiss Re decision.

 

As discussed in an earlier post, the BankAtlantic subprime related securities lawsuit is headed to trial. According to an October 5, 2010 Law.com article (here), jury selection in the case will begin this Friday, October 8, 2010, in federal court in Miami.

 

The Law.com article suggests the case has become contentious as it has moved forward. Among other things, the article quotes defense counsel as saying that "I’m offended by this case," which he characterizes as "a completely made-up, frivolous claim." Defense counsel reportedly has moved for sanctions against the plaintiffs’ attorney. (The article does not mention that in connection with the motions for summary judgment, Judge Ursula Ungaro granted summary judgment for plaintiffs on the issue of falsity, as to certain of the allegedly misleading statements, as discussed here.)

 

If the case does proceed to trial it would represent one of one only a very small handful of securities class action lawsuits that have actually made it to trial since the enactment of the PSLRA in 1995.

 

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 have only been 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, if the BankAtlantic case actually does go forward, it would represent only the 28th case to go to trial since the enactment of the PLSRA, and only the 17th case since the enactment of the PSLRA involving post PSLRA conduct to go to trial. If the BankAtlantic case actually goes to verdict, it would represent only the tenth securities class action lawsuit to go to verdict post-PSLRA involving post-PSLRA conduct.

 

For those who are interested to know how the nine post-PSLRA verdicts have turned out, the current tally (taking into account post-verdict proceedings and reflecting only the current status of post-verdict proceedings) is as follows: Plaintiffs 5, Defendants 4. (The scoreboard is subject to revision pending the outcome of additional proceedings in several of the cases.)

　

With one lone exception, the FDIC has not yet itself pursued litigation against the directors and officers of a failed financial institution. However, the FDIC has already made it clear that it intends to assert its rights under FIRREA as the receiver of failed banks to take control of shareholders’ derivative lawsuits.

 

More recently, and perhaps more aggressively, the FDIC is now attempting to intervene in two direct shareholder actions where failed institutions’ aggrieved investors are asserting their own claims, rather than derivatively asserting those of the failed institution. These more recent moves may represent efforts not just to assert but to extend the FDIC’s litigation preclusion rights. The FDIC’s actions are interesting in and of themselves, but also for what the FDIC has claimed in asserting its rights.

 

The FDIC’s most recent move in this direction is its October 4, 2010 motion to intervene in the Haven Trust Bancorp securities class action litigation pending in the Northern District of Georgia. A copy of the FDIC’s memorandum in support of its motion to intervene can be found here. Haven Trust Bancorp was the parent corporation for Haven Trust Bank, a Duluth, Georgia failed bank of which the FDIC took control on December 12, 2008.

 

The FDIC has previously moved to intervene in the negligent misrepresentation lawsuit that individual investors had filed in Fulton County (Georgia) State Court against certain former directors and officers of Georgian Bancorp. A copy of the FDIC’s September 23, 2010 motion to intervene, and accompanying motion to remove the case to federal court upon grant of the intervention, can be found here. Georgian Bancorp was the corporate parent of Georgian Bank, of which the FDIC took control on September 25, 2010. My prior post about the Georgian Bancorp case can be found here.

 

Both of these lawsuits are direct, not derivative, actions. In each case the plaintiffs seek to recover damages in the form of their own lost investment interests. In asserting that it nevertheless has the right to intervene, the FDIC raises a number of interesting arguments.

 

First, in both cases, the FDIC asserts that both cases are basically just derivative lawsuits in disguise. Thus, for example, in the Haven Trust case, the FDIC asserts that "although Plaintiffs have attempted to frame their allegations of wrongdoing and damages in terms of securities fraud and misrepresentations …Plaintiffs’ alleged losses clearly emanate from the fact that the Bank, as sole asset of the Holding Company, became worthless upon the appointment of the FDIC as receiver for the Bank." In the Georgian case, the FDIC asserts that the plaintiffs’ claim is "in substance a derivative claim." The FDIC asserts, the shareholders’ claims are, in effect, "double derivative" claims.

 

Second, the FDIC asserts that as receiver of the respective banks, under 12 U.S.C. Section 1821 it has succeeded to "all rights, titles, powers, and privileges of the insured depository institution, and of any stockholder … of such institution with respect to the institution and the assets of the institution." In reliance on this provision, the FDIC asserts as an initial matter that it has priority rights to assert the claims presented in the respective plaintiffs’ complaints, because they are essentially derivative complaints.

 

The FDIC’s further argument in reliance on this statutory provision is with reference to the respective institutions’ D&O insurance policies. Thus, for example, the FDIC asserts in the Georgian case that among the assets with respect to which it assumed priority upon being appointed receiver was Georgian’s D&O insurance policy, which "provides limited and finite monies for claims covered by the Policy and may be the only source of recovery against the Defendants in this or any subsequent lawsuit."

 

The FDIC points out further that the D&O policy is a "wasting asset" that would be reduced by defending the plaintiffs’ claims. The FDIC has the right to intervene, it therefore asserts, because "its ability to recover in a subsequent lawsuit will be affected by any judgment in this action or protracted litigation."

 

The FDIC is even more explicit about the possibility of its pursuing claims in its intervention motion in the Haven Trust case. There the FDIC explicitly stated that its investigation includes examination of the "acts and/or omissions of the Bank’s former officers and directors in connection with their management of the Bank’s affairs." The FDIC states that after completing its investigation it will determine "whether claims should be brought against any individual or entity," noting that "several of the defendants in this case, as former officers and/or directors of the Bank, are potential targets."

 

There are a number of concerns with the grounds on which the FDIC is moving to intervene. First, the FDIC completely disregards the investors’ own legal right to assert their own claims for their own alleged financial injuries. Second, and perhaps more to the point, the investors are asserting their claims as shareholders of the parent holding companies of the failed banks, not of the failed banks themselves. The FDIC’s priority rights extend to its rights as receiver of the failed bank. Whether the FDIC can assert rights on behalf of the parent holding company of the failed bank is a potentially contentious proposition.

 

Section 1821 (d)(2)(A)(i), on which the FDIC relies to assert its priority rights, refers to the rights, titles, etc., of the "insured depositary institution, and of any shareholder …of such institution." However, the plaintiffs’ in this shareholder suits are not asserting rights as shareholders of the institution, but of the parent holding company. The FDIC may or may not be able to persuade a court to make the leap from its rights as receiver of the failed bank to the rights of the shareholders of the bank’s parent company, but the argument seems to strain the language of the provision.

 

Finally, the FDIC may indeed be interested in preserving the D&O policies, but there is nothing about Section 1821 that gives the FDIC priority to the proceeds of the policy, in preference to other prospective claimants. The insurance proceeds are not a cash fund like an investment account: rather, the proceeds are available only for payment of certain kinds of loss arising from claims. The policy itself may be an asset of the estate, but the proceeds are available only pursuant to the terms and conditions of the policy, only for payment of claims, and the rights of the insureds and the claimants to the proceeds of the policy are determined by the policy’s own terms.

 

Whatever else may be said about the FDIC’s actions in moving to intervene in these case, they do show both that the FDIC is actively considering pursuing its own lawsuits, and that it is will to move aggressively to preserve its own recovery prospects in the event it subsequently decides to pursue lawsuits. The pretty clear message is that the FDIC does intend to pursue lawsuits, too.

 

As if the prospect of competing lawsuits from both investors and regulators were not daunting enough for directors and officers of failed institutions (and their insurers), a lawsuit recently filed in South Carolina suggests yet another type of prospective claimant that may be asserting claims against failed banks’ directors and officers.

 

On September 29, 2010, the trustee for the estate of Beach First National Bankshares filed a lawsuit in the Bankruptcy Court for the District of South Carolina against certain directors and officers of the bankrupt company. A copy of the complaint can be found here. The company’s wholly owned subsidiary, First National Bank of Myrtle Beach, was closed on April 9, 2010 The Trustee’s complaint asserts claims for breach of fiduciary duty and negligence.

 

While the Trustee may have seized the initiative in this case, there would seem to be the possibility that the FDIC might yet seek to intervene in the Trustee’s case just as it did in the cases described above. Disappointed shareholders might also seek to assert their own claims for harm to their own investment interests, particularly since the First National holding company is a publicly traded company.

 

The possibility of claims asserted by these various prospective and active claimants underscores how one of the consequences of a bank failure may be a scramble for the proceeds of the insurance policy. The FDIC may well contend that under FIRREA it has certain priorities but other claimants are also highly motivated to circumvent the FDIC’s asserted rights.

 

Of course in the end the FDIC may establish its priority. But in the meantime, the scramble for the D&O insurance could become quite a circus. And in the center ring could be the directors and officers of the failed institutions – and their insurers – against whom the competing claimants will assert their claims. The likelihood for further D&O litigation involving failed banks’ directors and officers seems high.

 

One final thought about the FDIC’s interventions in the two case discussed above — there have been a fair number of shareholder class actions brought by investors in failed financial institutions. It will be interesting to see how far the FDIC goes with thie intervention tactic and whether it will seek to intervene in other cases involving larger financial institutions. Perhaps its initiatives in the two Georgia lawsuits are test cases that will determine whether it will seek to intervene elsewhere.

 

Many thanks to a loyal reader for providing copies of the various pleadings to which I linked above.

 

A copy of an October 3, 2010 Myrtle Beach Sun News article about the Beach First Trustee’s lawsuit can be found here. (Full disclosure, I was interviewed in connection with the article.)

There was a flurry of subprime related securities lawsuit dismissal motion activity at the end of last week, and although in some cases the motions were granted and in other instances large parts of the cases were dismissed, in several instances enough of the cases survived for the plaintiffs to tally the rulings in the win column. Among the cases where the plaintiffs retained enough to live for another day were at least one high profile case and another interesting auction rate investor case.

 

Fannie Mae: In a September 30, 2010 order (here), Southern District of New York Judge Paul A. Crotty granted in part and denied in part the defendants’ motions to dismiss the plaintiffs’ ’34 Act claims in the Fannie Mae subprime-related securities class action lawsuit. (In a November 29, 2009 order, here, Judge Crotty had previously granted the defendants’ motions to dismiss the plaintiffs’ claims under the ’33 Act).

 

The plaintiffs’ ’34 Act claims involved three principal allegations: (1) that the defendants had misrepresented Fannie’s exposure to subprime and Alt-A mortgage markets and related risks; (2) that the defendants had misrepresented the quality of Fannie’s internal risk controls (3) that Fannie had filed materially inaccurate financial statements.

 

Judge Crotty granted the defendants’ motions to dismiss both as to the allegations that Fannie had misrepresented its subprime and Alt-A exposure and as to the allegations that Fannie has filed inaccurate financial statements. However, Judge Crotty denied the dismissal motions of the company itself, its CEO and its Chief Risk Officer, with respect to the allegations that the defendants had misrepresented the quality of Fannie’s internal controls.

 

In granting the motions to dismiss as to allegations concerning Fannie’s exposure to subprime and Alt-A mortgages, Judge Crotty ruled that Fannie’s public filings contained cautionary language that warned investors about the risks of Fannie’s subprime and Alt-A investments. He also held that the plaintiffs had failed to explain why the defendants’ statements regarding Fannie’s subprime and Alt-A investments were false. Finally, he held that the plaintiffs had failed to allege that the defendants had acted with scienter in making statements about Fannie’s subprime and Alt-A exposure.

 

In granting the motions to dismiss as to the allegations that Fannie filed inaccurate financial statements, Judge Crotty held that the plaintiffs had not alleged sufficient facts to establish that Fannie’s financial statements were false at the time they were issued. Judge Crotty also noted that Fannie’s regulators had never claimed that Fannie had committed any GAAP violations and had never asked for restatements of any of Fannie’s financial statements for the class period, but at the same time reported repeatedly that Fannie was adequately capitalized.

 

In denying the motions to dismiss as to the plaintiffs’ allegations that the defendants had misrepresented the quality of Fannie’s internal risk controls, Judge Crotty relied heavily upon three emails that had gone between the company’s Chief Risk Officer and its CEO. In these emails, the Chief Risk Officer complained, among other things, that the company "was not even close to having the proper control processes for credit, market and operational risk."

 

Judge Crotty said that these statements "show that Fannie may have been saying one thing while believing another" and are sufficient to survive a motion to dismiss. However, because the plaintiffs had not shown that two of the other individual defendants were aware of the emails, Judge Crotty granted these two defendants’ motions to dismiss, while denying the dismissal motions of the company, its CEO and the Chief Risk Officer.

 

Perrigo Company: As discussed here, the auction rate securities lawsuit filed against Perrrigo and certain of its directors and offices did not involve the usual allegations that an auction rate securities seller had misrepresented the securities in connection with the securities’ sale; rather, Perrigo was an auction rate securities investor, and the plaintiffs, Perrigo shareholders, alleged that the defendants had misrepresented the company’s own investment exposure to auction rate securities.

 

Essentially, the plaintiffs alleged that during a period in 2008 and early 2009, the company failed to write down the value of its auction rate securities investments, and also failed to acknowledge publicly that it has purchased its auction rate securities from Lehman Brothers, and was therefore not going to benefit from the same kind of redemption as had other auction rate securities investors who had purchased their securities from, for example, Merrill Lynch, Citigroup and UBS. On February 3, 2009, the company reported that it had incurred a significant charge related to the write down of the auction rate securities and also revealed the Lehman connection.

 

In his September 30, 2010 order (here) denying the defendants’ motions to dismiss, Southern District of New York Judge Thomas Griesa had that the "plaintiffs argue persuasively that the identical factors that caused Perrigo to drastically write down the value of the ARS on February 3, 2009 – increased credit and liquidity risks – were operative and evident to defendants at the time they issued the November 6, 2008 statements." Judge Griesa also found that the plaintiffs had sufficiently alleged materiality, scienter and loss causation.

 

WaMu Mortgage Pass-Through Certificates: In a September 28, 2010 order (here), Western District of Washington Judge Marsha Pechman granted in part and denied in part the dismissal motions in the securities class action lawsuit that had been brought by investors who had purchased interests in certain Washington Mutual Mortgage Pass-Through Trusts. The defendants in the case included Washington Mutual and certain of its subsidiaries, as well as certain officers of the subsidiaries who had signed the offering documents, and the rating agencies which had provided credit ratings for the investments.

 

Judge Pechman first ruled that the named plaintiffs lacked standing to assert claims with respect to 25 of the 36 offerings at issue because the plaintiffs had not purchased securities in connection with those 25 offerings. In addition, Judge Pechman also dismissed allegations as to three other offerings as time-barred.

 

With respect to the remaining offerings, Judge Pechman found that the plaintiffs had adequately alleged misrepresentation in connection with the offering documents’ statements about the underwriting guidelines used in connection with the origination of the underlying mortgages. She observed that "in essence, Plaintiffs allege the underwriting guidelines ceased to exist," adding that "the absence of underwriting standards could make the identified statements misleading."

 

However, she held that the plaintiffs had not alleged actionable misrepresentations with respect to the offering documents’ statements about appraisals and loan to value ratio, noting that the "allegations on this issue are simply too conclusory." With respect to the alleged failure to disclose the credit ratings alleged conflict of interest, she concluded that "because reasonable investors knew that the rating agencies were paid by the issuers, the alleged misrepresentation is immaterial.

 

Judge Pechman also rejected the defendants’ arguments that the plaintiffs had not adequately alleged economic loss, since the plaintiffs have not alleged that they failed to receive an income stream from the certificates. Judge Pechman said that plaintiffs allegations "give rise to the inference that the value of the security is much less that the purchase price," and the "mere fact that Plaintiffs may have difficulty substantiating the exact nature of their loss in an illiquid market does not necessitate dismissal."

 

Oppenheimer Auction Rate Securities: In a September 29, 2010 order (here), Judge Loretta Preska granted the defendants’ motion to dismiss the auction rate securities lawsuit that had been brought against Oppenheimer Holdings and one of its subsidiaries. The Oppenheimer lawsuit is one of the conventional auction rate securities lawsuits, in that it had been brought by auction rate securities buyers against the firm that sold them the investments.

 

The plaintiffs contend that in connection with their purchase of the securities they had been misled about the nature and safety of the securities as well as the nature and operation of the market for the securities. The plaintiffs allege that as a result of the failure of the auction rate securities market in February 2008, they are stuck holding illiquid securities for which there is no market.

 

In granting the motions to dismiss, Judge Preska found that the plaintiffs had not sufficiently alleged scienter. Specifically, she found that the plaintiffs allegations of motive and opportunity were insufficient and that the alleged circumstantial evidence of scienter were also insufficient.

 

Among other things, Judge Preska found that the inference of scienter that plaintiffs urged "is not at least as strong as the inference that Oppenheimer negligently or carelessly provided insufficient training to its financial advisors and was merely negligent in not detecting and disclosing the imminent market collapse." The "more compelling inference" is that "Oppenheimer did not predict that all broker dealers would withdraw from the ARS market en masse."

 

Countrywide Asset-Backed Certificates Trust: In a mortgage-backed asset securities case that was not brought as a class action, on September 28, 2009 Judge Kevin Castel granted the motion of defendants Countrywide Home Loans and related entities, as well as certain Countrywide directors and officers, brought by two individual investors who had purchased mortgage backed securities from Countrywide. A copy of the order can be found here.

 

The plaintiffs, who had purchased over $540 million of the securities in their initial offerings, alleged that the offering documents contained material misrepresentations regarding the underlying loans, regarding the underwriting guidelines used in connection with the origination of the underlying loans; as well as regarding the selection and servicing of the underlying loans.

 

Judge Castel noted at the outset that this is the unusual case where the plaintiffs acknowledge that they knew that the underlying loans were "risky" and that the borrowers were "credit-blemished," but claim that they were misled because the loans were riskier than they were led to believe.

 

Judge Castle concluded both that the plaintiffs had insufficiently alleged misrepresentation and that the plaintiffs had insufficiently alleged scienter.

 

Discussion

In one sense, these dismissal motion rulings described above just represent a random selection of rulings as the courts continue to grind through the mountain of pending subprime and credit crisis related lawsuits. However I have some observations about this group of rulings.

 

First, though some subprime cases are dismissed outright and there are many other cases where substantial parts of the cases have been knocked out, in a substantial number of these cases the plaintiffs are either prevailing on the dismissal motions or at least managing to scrape out just enough to live to see another day. Thus for example in both the Fannie Mae and WaMu cases discussed above, even though huge parts of the cases were dismissed, enough remains for the plaintiffs to be able to continue to fight and to try to work toward an eventual payday.

 

Second, among the cases surviving in whole or in part are many of the highest profile cases. The Fannie Mae case is just the latest illustration of this, following close on the heels of the dismissal motion survival of the AIG case (refer here) and the Merrill Lynch/BofA merger case (refer here). This follow along with many of the other high profile cases such as the Countrywide, New Century and Washington Mutual. subprime related securities suits. The point is that while many of the subprime cases may have been dismissed along the way, the biggest, highest-profile cases are generally going forward.

 

Third, as the cases grind through, some important issues are being worked out. Thus, for example, as suggested in the Oppenheimer case, courts are now working through the merits of the auction rate securities cases. Up to this point, many of the auction rate securities cases that had been dismissed were based on mootness grounds, based on the defendants’ entry into regulatory settlements that more or less made plaintiffs whole. In Oppenheimer, the court addressed the merits of the plaintiffs’ allegations and found the allegations to be insufficient.

 

The Oppenheimer ruling is not the first auction rate securities lawsuit dismissal on the merits (refer for example here with respect to the Merrill Lynch auction rate securities case) but it does represent another instance suggesting that the plaintiffs in these auction securities cases are not doing particularly well.

 

By contrast, in the Perrigo case, the court found the plaintiffs’ allegations against Perrigo as an auction rate securities investor to be sufficient. The claimants in other cases against auction rate investors have not been as successful – refer for example here with respect to the dismissal motion grant in the securities suit brought against Mind M.T.I. Even though the plaintiffs’ record in these auction rate investor cases may be mixed, the Perrigo case at least shows that plaintiffs are overcoming initial pleading hurdles in at least some of these cases.

 

Finally, and notwithstanding the cases where the plaintiffs did manage to overcome the dismissal motion phase at least in part, there are still a number of cases where the defendants are succeeding in getting the cases dismissed, as evidenced in the Countrywide and Oppenheimer cases discussed above.

 

I have in any event added these decisions to my running tally of subprime and credit crisis-related dismissal motion rulings, which can be accessed here.

 

Many thanks to the several readers who forwarded copies of these decisions to me.

 

New securities class action lawsuit filings in the third quarter of 2010 remained below longer term historical averages, although consistent with filing levels in more recent quarters. There were 39 new securities class action lawsuits filed in the third quarter, bringing the 2010 YTD total number of new filings to 125, as of September 30, 2010.

 

The 125 new filings through the end of the third quarter compares with the 129 that were filed in the first three quarters of 2009, and implies a total of about 166 by year end 2010 (compared to 169 in 2009). The implied 2010 total is well below the annual average of 197 new securities class action lawsuits filed during the period 1996 to 2008.

 

Though the overall 2010 YTD filings levels remain below historical levels, new filings did turn up slightly in September 2010, when there were 21 new securities class action lawsuits filed, the highest monthly number of filings since 2008.

 

New filings against companies in the financial services sector remain an important component of new securities class action lawsuits. During the third quarter there were eight new filings in the 6000 SIC Code series (Finance, Insurance and Real Estate), and an additional three new filings involving firms without SIC Codes but that are financially related. These eleven total new filings against financially related firms represented about 28% of third quarter filings.

 

Subprime and credit crisis related securities class action lawsuits continue to be filed in the third quarter of 2010. Seven, or about 18%, of the third quarter filings were subprime or credit crisis-related.

 

While filings against financially related companies continue to predominate as they have since 2007, there were a number of other areas of concentration in the third quarter as well. As I have noted elsewhere, there was a proliferation of filings in the third quarter against for-profit education companies. A total of six for-profit educational companies were sued in the third quarter.

 

In addition, as has been the case over time, new filings against life sciences companies was also an important part of the third quarter filings. There were a total of seven new filings against companies in the life sciences sector, including four against companies in the 2834 SIC Code category (pharmaceutical preparations). .

 

For the first three quarters of 2010, there have been 26 new securities lawsuits filed against companies in the 6000 SIC Code series and another 15 against financially-related companies without SIC codes, for a total of 41 new lawsuits against financial companies, or about one third of all 2010 filings. 22 (or about 17.5%) of all 2010 filings have been subprime or credit crisis-related.

 

Filings against life sciences companies have also been a significant component of 2010 YTD filings. There have been 19 new securities lawsuits filed against companies in the life sciences industry, including 13 against companies in the 2834 and 2835 SIC Code categories. (SIC Code 2835 include in vitro and in vitro diagnostic substances).

 

There have been ten new securities class action lawsuits filed this year against foreign-domiciled companies, or about eight percent of the total. Interestingly, there have been four new securities class action lawsuits filed against foreign-domiciled companies since the U.S. Supreme Court issued its opinion in Morrison v. National Australia Bank.

 

Of the 125 YTD filings, 17 (or about 13.6%) represented so-called "belated filings" – that is, cases in which the filing date came more than a year after the proposed class period cutoff date. Though there have been a significant number of these belated filings this year, the number of these filings has slowed as the year has progressed. Only four of these 17 belated cases have been filed since June 30, 2010.

 

Apple Turnover: You may have missed it this past week, but the parties to the long-running Apple Computer options backdating-related securities class action lawsuit have reached a settlement, as reflected in their September 28, 2010 memorandum in support of their settlement stipulation. The Apple case is one of the last of the 39 options backdating related securities class action lawsuits to finally be resolved.

 

The Apple settlement incorporates a rather unusual feature. On the one hand, the parties have agreed to settle the case for two conventional settlement terms — a payment of $14 million in cash for the benefit of the plaintiff class and the company’s agreement to adopt certain corporate governance reforms. But in addition, the company has agreed to make payments totaling $2.5 million to 12 educational institutions’ corporate governance programs.

 

These payments work out to approximately $208,333 for each of the twelve institutions. The memorandum in support of the parties’ settlement stipulation reports that the lead plaintiff selected the twelve institutions "after conducting a review of corporate governance programs nationally."

 

While these corporate governance programs undoubtedly represent worthy causes, you do have to wonder about this settlement feature, which arguably provides no benefit either to members of the class or to current Apple shareholders. It also raises questions about compelled corporate philanthropy at shareholders’ expense.

 

I have in any event added the Apple settlement to my running table of options backdating related case resolutions, which can be accessed here.

 

Advisen’s Third Quarter Litigation Overview: On October 15, 2010 at 11:00 a.m. EDT, I will be participating in an Advisen webinar reviewing the Third Quarter Securities Litigation. Other participants include Scott Meyer from ACE, Adam Savett of Claims Compensation Bureau, and Dave Bradford of Advisen. The session will review Advisen’s analysis of third quarter 2010 Securities litigation and settlements and discuss the larger implications for underwriters, brokers and risk managers. Information about the free webinar, including registration instructions, can be found here.

 

So the U.S. Supreme Court held in Morrison that the investors who purchased their shares of a non-U.S. company on a foreign exchange cannot pursue claims under the Exchange Act, but securityholders who purchased American Depositary Receipts (ADRs) in the U.S. can still seek damages under the Exchange Act, right? Not according to a September 29, 2010 decision by Southern District of New York Judge Richard Berman in the Société Générale subprime-related securities class action lawsuit.

 

The defendants did not even raise the argument, and it may comes as somewhat of a surprise to some observers, but Judge Berman held, applying the U.S. Supreme Court’s decision in Morrison (about which refer here), that not even domestic purchases of SocGen’s ADRs can assert claims under the Exchange Act. As a result, Judge Berman wound up dismissing the entire case, and not just the claims of investors who purchased their SocGen shares on foreign exchanges.

 

As discussed below, if the Exchange Act does not even apply to domestic transactions in ADRs, the question that immediately arises as to who is left that might be able to assert Exchange Act claims against non-U.S. companies. The answer in many cases may be – well, nobody.

 

Background and Decisions

Investors had sued the French bank and certain of its directors and officers in 2008 following the revelations of Jérôme Kerviel 4.9 billion euro trading losses and the bank’s disclosures of its own losses from subprime mortgage related investments.

 

After the Supreme Court issued its opinion in Morrison, the defendants in the SocGen case had moved to dismiss the claims of two the three named plaintiffs. Both of the two were U.S. residents who had purchased their securities outside the U.S. Judge Berman quickly disposed of these claims, ruling (in reliance on, among other post-Morrison cases, the Credit Suisse case and the Alstom decision, about which refer here and here respectively) that the Exchange Act does not reach claims of such so-called "f-squared claimants."

 

Judge Berman didn’t stop there, but went on to consider the applicability of the Exchange Act to the claims of the third named plaintiff, UFCW, which had purchased ADRs over the counter in the United States. Even though the defendants had not even themselves raised the question, Judge Berman decided sua sponte that Morrison precludes UFCW’s claims as well.

 

In reaching this conclusion, Judge Berman said:

 

…even though Defendants do not argue that UFCW’s claims should be dismissed under Morrison, the Court concludes that the Exchange Act is inapplicable to UFCW’s ADR transactions. That is, the Court finds that because "[t]rade in ADRs is considered ‘predominantly a foreign securities transaction,’ Section 10(b) is inapplicable. An ADR ‘represents one or more shares of a foreign stock or a fraction of a share." Accordingly, UFCW’s claims are also dismissed.

 

Discussion

Judge Berman’s decision seemingly does not depend on the fact that UFCW purchased its ADRs over the counter, rather than on an exchange. His logic instead depends on the fact that what UFCW purchased were ADRs, the acquisition of which, he held, represents a fundamentally foreign transaction. — which appears to suggest that Judge Berman would apply the same analysis even to ADRs purchased on an exchange.

 

It is fair to say that Judge Berman’s ruling is unexpected Not even the defendants in the case saw it coming. I think it also raises several questions.

 

First, Judge Berman’s analysis seems to depend on his rather brief review of what an ADR is and the nature of the transaction involved in a domestic ADR purchase. This seems to me like an issue that would have benefitted from full briefing by all parties. Certainly before any other court chooses whether or not to follow Judge Berman, a comprehensive examination of the relation of the purpose and uses of ADRs would seem to be indicated.

 

Second, and perhaps more importantly, Judge Berman’s analysis of whether or not the Exchange Act applies to UFCW’s ADRs arguably would have benefitted from more detailed consideration of whether the UFCW’s ADR purchases are "domestic transactions in other securities" to which the Exchange Act applies under the second prong of the Morrison standard.

 

Third, Judge Berman’s conclusion seemingly put domestic ADR transactions in an odd category about which it may be asked – which jurisdiction’s laws apply to these transactions if not U.S. law?. Are ADR purchases transactions without a country? (Or to put it in a less contentious frame, what jurisdiction’s securities laws make more sense than those of the U.S. to apply to ADR transactions in the U.S.)?

 

To the extent it is (if ever) conclusively established that the Exchange Act does not even reach domestic ADR transactions, that holding would represent a significant blow to the U.S. securities class action plaintiffs’ bar, as it would eliminate in many instances all or virtually all of the claims that had seemed to be left after Morrison.

 

If domestic purchasers of ADRs cannot assert claims under the Exchange Act, there would be very few if any holders of securities of many foreign domiciled companies who could assert Exchange Act claims. One wonders whether Judge Berman’s holding could spell the end (or virtual elimination) of many of the current securities cases pending against foreign companies – not only cases such as Vivendi, where plaintiffs won a jury verdict on the issue of liability, but also in more recently filed cases such as those initiated against BP and Toyota.

 

Not only would that seem to dramatically narrow, if not eliminate, what claims seemed to remain against foreign domiciled companies in the wake of Morrison, but it could drastically limit opportunities for security holders of non-U.S. companies to file future lawsuits under the Exchange Act.

 

The Morrison decision itself was a surprise, now Judge Berman seems to have compounded that surprise by taking Morrison in a completely unexpected direction. Of course, where it will all lead remains to be seen. I think more will be heard on the issues Judge Berman has raised.

 

I have in any event added the SocGen decision to my running tally of subprime and credit crisis related lawsuit dismissal motion rulings, which can be accessed here.  Special thanks to a loyal reader for supplying a copy of the SocGen decision.

 

In a September 27, 2010 order (here), Judge Laura Taylor Swain denied the dismissal motions in the subprime-related securities class action lawsuit pending against AIG, certain of its former directors and officers, its accountant and its offering underwriters. Andrew Longstreth’s September 27 Am Law Litigation Daily article about the decision can be found here.

 

AIG, of course, was rescued from collapse only by a massive government bailout. Following the bailout, the company’s share price plummeted and securities class action litigation ensued. As discussed in detail here, the plaintiffs allege that the defendants violated the securities laws through various disclosures and omissions related to the company’s securities lending program and its credit default swap portfolio.

 

Both the credit default swap portfolio and the securities lending program entailed exposures to subprime mortgages. In many instances, the CDSs were placed in connection with securities backed by subprime mortgages. In the securities lending business, the cash received in exchange for the loaned securities was invested in mortgage-backed securities. Additional collateral requirements for these transactions triggered by the subprime mortgage meltdown led to the government bailout. The plaintiffs contend that these exposures were not adequately disclosed. The defendants moved to dismiss.

 

In her September 27 opinion denying the dismissal motions, Judge Swain held that the plaintiffs’ allegations were "adequate to plead material misrepresentations and omissions on the part of AIG," particularly with respect to the company’s exposure through its CDS portfolio to subprime mortgages.

 

Judge Swain rejected the defendants’ contention that the allegedly misleading statements were forward-looking statements protected by the bespeaks caution doctrine, observing that "generic risk disclosures are inadequate to shield defendants from liability for failing to disclose known specific risks" and that "statements of opinion and predictions may be actionable if they are worded as guarantees or supported by specific statements of fact." Judge Swain cited in particular the defendants’ alleged failure to disclose a litany "of hard facts critical to appreciating the magnitude of the risks described."

 

With respect to scienter, Judge Swain, after reciting a list of adverse undisclosed facts and developments allegedly known to defendants, concluded that the plaintiffs had "satisfied their burden of alleging facts giving rise to a strong inference of fraudulent intent," adding that "no opposing inference is more compelling."

 

Finally, Judge Swain also denied the defendants’ motion to dismiss on loss causation grounds. The defendants had argued that AIG’s stock price decline was "attributable to the decline experienced in the stock market generally, and in the financial services sector specifically." Judge Swain found that "the sharp drop in AIG’s stock price in response to certain corrective disclosures, and the relationship between the risks allegedly concealed and the risks that subsequently materialized, are sufficient to overcome the argument at the pleading stages" – although she added that the defendants ultimately may be able to prove that "some or all" of plaintiffs’ losses are "attributable to forces other than AIG."

 

Finally, Judge Swain held that the plaintiffs had standing to assert Section 11 claims, and that the Section 11 claims were timely, because, Judge Swain concluded, the plaintiffs were not on "inquiry notice" of possible misrepresentations until the September 2008 bailout. Judge Swain also denied the motions to dismiss the Section 11 claims against the offering underwriter defendants and AIG’s outside auditor.

 

Discussion

The AIG lawsuit is one of the highest profile cases filed as part of the subprime litigation wave. Given the magnitude and causes of the company’s losses, its near collapse, and the massive size of the government bailout, it may come as no surprise that this particular case managed to get passed the initial pleading hurdles.

 

But now that the case is going forward, the question arises of where the case ultimately will lead given the U.S. taxpayer’s stake in the company. Even if the company’s D&O insurance program is not substantially eroded by defense fees alone, the remaining insurance is unlikely to represent a significant percentage of the claimed losses of the plaintiff class. The underwriter defendants and auditor might be expected (at least by plaintiffs) to contribute substantially toward the case resolution, but the banks’ financial health is not what it once was.

 

All factors considered, especially the political peril associated with a significant taxpayer funded contribution toward settlement, there are certain questions about the ultimate resolution of this case.

 

The dismissal denial in the AIG case, coming close on the heels of the dismissal motion denial in the Sallie Mae case, does serve as a reminder that there are subprime-related lawsuits that are going to survive the initial motions stage, particularly those involving higher profile companies.

 

In any event, I have added the AIG opinion to my running tally of subprime and credit crisis lawsuit dismissal motion rulings, which can be accessed here.

 

Where are the Criminal Prosecutions?: As I noted in a recent post (here), members of Congress are asking why there have been so few criminal prosecutions in the wake of the subprime meltdown. Wayne State Law School Professor Peter Henning has an interesting September 27, 2010 column on the Dealbook blog (here) discussing these issues and presenting his theories on the reasons why there haven’t been more criminal cases.

 

NYSE Corporate Governance Commission Report: In yesterday’s post, the link to the NYSE Corporate Governance Commission’s report was faulty. I have now corrected the link. Readers who wanted the report but were unable to access it due to the faulty link can refer here for a copy of the report. I apologize for the faulty link (now corrected) in yesterday’s post.

 

NYSE Commission on Corporate Governance: On September 23, 2010, the NYSE Commission on Corporate Governance issued a report (here) following a two year review of governance issues and considerations. The Commission, chaired by Larry Sonsini of the Wilson Sonsini law firm, included more than two dozen members representing a broad range of constituencies, and its report presents an interesting and thoughtful review of the issues and statement of principles. The NYSE’s September 23, 2010 press release concerning the report can be found here.

 

The report’s centerpiece is its statement of ten principles of corporate governance, but in addition to distilling its analysis down to these ten principles, the report also helpfully reviews the history of events leading up to is report, including the recent history of corporate governance reform. In explaining its ten principles, the report states the Commission’s belief that "the respective roles of boards, management and shareholders needed greater understanding," and the principles primary focus is the respective roles of each of these three groups.

 

The board’s role, according to the report, is "to steer the corporation towards policies supporting long-term sustainable growth in shareholder value." While noting that other factors may affect long-term shareholder value, the report states (significantly in my view) that "shareholders have the right and responsibility to hold a board accountable for its performance in achieving long-term sustainable growth in shareholder value."

 

The report notes the critical role of management in establishing proper corporate governance, emphasizing that "successful governance depends heavily upon honest, competent, industrious managers." The report also noted that "constructive tension" between the board and management, if properly modulated, may be a characteristic of good corporate governance.

 

With respect to shareholders, the report takes a firm stand against short-termism. The report notes that investors have a responsibility to vote their shares in a "thoughtful manner." In a couple of different places, the report also expresses concern about the possibility of investors’ over-reliance on proxy advisory firms, noting that the decision to rely on advisory firms "does not relieve institutions from discharging their responsibility to vote constructively, thoughtfully and in alignment with the interests" of their clients.

 

The report is interesting, relatively brief and worth reading in its full length. Hat tip to the CorporateCounsel.net blog for the link to the report.

 

Norwegian Bank Files Individual Securities Suit Against Citibank: Citigroup may have settle the subprime-related enforcement action and even managed to get the court to accept the $75 million settlement (even if with certain provisos), but a separate subprime-related securities class action lawsuit on behalf of Citigroup investors remains pending. Despite the continuing existence of the class action, Norges Bank, which manages investments for the $450 billion Norwegian sovereign wealth fund, has now filed its own securities lawsuit, seeking separately to recover for the fund’s losses.

 

According to Victor Li’s September 24, 2010 Am Law Litigation Daily article (here), Norges filed a complaint in the Southern District of New York against Citigroup and 20 of its current and former directors and officers (including its current CEO, Vikram Pandit). The complaint alleges that because of the defendants’ misrepresentations about the company’s subprime exposure, Norges purchased Citi shares at inflated prices from January 2007 to January 2009. The bank claims it paid over $2 billion for the shares and claims to have lost over $835 million.

 

There are a number of interesting aspects to this case. The first is that the bank concluded that notwithstanding the existence of the shareholder class action lawsuit, its interests were better served by proceeding separately from the class. The other thing about the lawsuit is the sheer size of the claimed losses – its losses alone are far greater than the collective investor losses in most securities class action lawsuits.

 

The massive size of Norges’s claimed losses explains its desire to pursue litigation, but the initiation of a separate suit can only be explained either by Norges’s assumption that it will fare better separately than within the class, or perhaps that it will pay lower fees – or perhaps both.

 

The Norges lawsuit follows on the heals of the separate opt-out lawsuit filed against Merrill Lynch on behalf of the New York pension funds, about which I commented here. The phenomenon of large institutional investors electing to pursue their own claims was a characteristic of many of the lawsuits arising from the corporate scandals during the last decade. Though these kinds of cases had seemed to have died down for a while, the New York lawsuit against Merrill and the Norges suit suggest that the individual lawsuits may be back – and that large institutional investors may be considering them in preference to class actions.

 

The seeming rise of this phenomenon has been a matter of significant discussion and some concern, as the prospect of multiple individual lawsuits could overwhelm the putative procedural advantages and effectiveness of the class action process.

 

The magnitude of Norges Bank’s claimed losses may be sufficiently unusual to raise a question whether there may be other investors similarly motivate to pursue separate lawsuits – there simply are going to be few individual investors in few circumstance with losses of that magnitude. Of course, there is always the possibility of smaller investors with smaller losses getting into the act, which they might do if they too believe they will fare better separately rather than within the class.

 

The prospect for other investors to conclude that their interests are better served through an individual action is a prospect that could pose a host of challenges and represents a "worrisome trend," as I have previously discussed here.

 

My previous post discussing the Norwegian sovereign wealth fund can be found here.

 

More Credit Union Troubles: On September 24, 2010, the National Credit Union Administration announced a series of moves, including the seizure of three wholesale credit unions, as part of an overall effort to shore up the country’s credit union industry. The move also included the creation of a $30 billion guarantee to backstop the credit union industry in an effort to stave off further losses. The Wall Street Journal’s September 25, 2010 front page article about the NCUA’s actions can be found here.

 

Wholesale credit unions provide back office services to retail credit unions. Since March 2009, bad investments in mortgage-backed securities have resulting in the government takeover of five of the country’s 27 wholesale credit unions.

 

At least one of these wholesale credit union failures has resulted in a civil action by the NCUA against former directors and officers of the failed institution. As discussed here, on August 31, 2010, the NCUA initiated an action against former directors and officers of Western Corporate Federal Credit Union of San Dimas, California.

 

It is unclear from the NCUA’s latest announcement and actions whether the NCUA might pursue additional lawsuits against the directors and officers of other failed institutions. However, it is clear that the same kinds of difficulties that have beset the commercial banking sector are also troubling the credit union industry as well, and these troubles at a minimum additional may mean regulatory seizures and also present at least the possibility of further claims.

 

Finally, the NCUA’s moves are a reminder that two full years out from the most tumultuous moment of the credit crisis, the reverberations continue to vex the financial services industry.

 

Layoffs Mean More Job Bias and Disability Claims: According to Nathan Koppel’s September 24, 2010 Wall Street Journal article (here), layoffs arising from the economic downturn are resulting in a "rising number of claims" that companies "illegally fired workers on account of age, race, gender or medical condition." Among other things, the article cites EEOC statistics showing that for the six months ended April 30, 2010, more that 70,000 people had filed claims alleging job discrimination, which represents a 60% increase in bias claims compared to the same period a year earlier.

 

The article also notes that companies are also facing "a rising tide of disability claims," noting that more than 21,000 people filed disability claims last year, which represented a 10% increase over the prior year and a 20% increase over 2007. The article notes the difficulties financial troubled companies may face trying to accommodate disabled employees.

 

In a September 24, 2010 order (here), Southern District of New York William Pauley denied the dismissal motions of Sallie Mae and its former CEO, Albert Lord, but granted the dismissal motion of CFO (and later CEO), Charles Andrews, in the credit crisis-related securities suit against Sallie Mae first filed in 2008. The decision is interesting in a number of respects, particularly concerning scienter issues.

 

Sallie Mae is one of the country’s largest providers of student loans. The complaint, which Judge Pauley described as "a behemoth" containing "labyrinthine allegations," alleges that in a series of statements in 2007, the defendants misled the market about Sallie Mae’s financial performance for the purpose of inflating its share price.

 

Among other things, the company was attempting during this same period to complete a planned merger with J.C. Flowers, an investment firm, in a transaction that ultimately was not consummated and that resulted in separate litigation (later settled) between the company and Flowers.

 

The complaint alleges that during the class period, the company lowered its borrowing criteria to increase its portfolio of lower quality but higher margin private loans; hid defaults by changing its forbearance policy; and inflated profits through inadequate loan loss reserves. The defendants moved to dismiss. My prior post about the lawsuit can be found here.

 

In his September 24 order, Judge Pauley denied the motion to dismiss as to Lord and the company, but he granted the motion to dismissal as to Andrews.

 

Judge Pauley first concluded that the plaintiffs had adequately alleged falsity. The defendants had argued that the plaintiffs had not alleged particularized facts sufficient to establish the falsity of the loan loss reserves. However, Judge Pauley observed, the plaintiffs primary challenge to the accuracy reserves, made in reliance on the testimony of confidential witnesses, was that Sallie Mae had not accurately reported its loan default rate (which in turn led to insufficient loan loss reserves). Judge Pauley held that "given the error in the default rate metric and its impact on Sallie Mae’s other financial reports, such allegations are sufficient to plead falsity."

 

In concluding that the plaintiffs had adequately alleged scienter with respect to Lord and Sallie Mae, Judge Pauley noted three reasons on which plaintiffs relied which, "considered together," are "sufficiently concrete to give rise to an inference" that Lord and Sallie Mae "possessed the intent to defraud shareholders." The three reasons were the Flowers transaction, Lord’s stock sales, and certain equity forward contracts.

 

Judge Pauley found that Lord had financial incentives to try to complete the Flowers transaction, because upon completion of the deal he would have received a $225 million cash payment and been free to exercise options at above market prices. In addition, Judge Pauley found that, in order to keep merger prospects alive, Lord also had an incentive to keep the company’s share price above the trigger in its equity forward contracts, because had the price gone below the trigger, the company would have been required to repurchase about $2.2 billion in shares, which "would have torpedoed the merger and Lord’s payout."

 

Judge Pauley also found that Lord made "unusual" stock sales in February, August and December 2007. The December sales, which took place two days after the Flowers transaction collapsed, and which represented a "liquidation of 97% of his Sallie Mae holdings," were "unusual for a corporate officer by any measure."

 

Lord had offered explanations for his stock sales – the August sales allegedly "were necessary to pay the exercise price of expiring options and associated taxes" and the December sale was "necessary to satisfy a margin call" – but with respect to Lord’s exculpatory explanations, Judge Pauley said "these facts remain in dispute."

 

By contrast, Judge Pauley found that the allegation of scienter as to Andrews were insufficient. Andrews not only had sold no shares but the defendants alleged he had acquired shares.

 

Lord’s incentives to complete the Flowers transaction clearly influence Pauley’s decision. The insider sales alone seem less determinative, as the timing of his sales seemed less than profit maximizing. For example, his December sale, the one he contends was triggered by a margin call, came two days after the Flowers deal collapse). This sale seems inconsistent with the theory that it represented the culmination of a fraudulent scheme.

 

In other words, it was the presence of the unusual and case specific circumstance of the Flowers deal that in large part explains this case’s survival of the dismissal motions.

 

I have in any event added the Sallie Mae case to my running tally of subprime and credit crisis-related dismissal motion rulings, which can be accessed here.

 

Special thanks to a loyal reader for providing a copy of the Sallie Mae opinion.

 

Behemoth and Labyrinth: When Judge Pauley described the plaintiffs’ complaint as a "behemoth," he was invoking a literary reference with rather startling associations. According to Wikepedia, the word "behemoth" first appeared in the book of Job, which says the following about the beast:

15 Behold now the behemoth that I have made with you; he eats grass like cattle.
16 Behold now his strength is in his loins and his power is in the navel of his belly.
17 His tail hardens like a cedar; the sinews of his thighs are knit together.
18 His limbs are as strong as copper, his bones as a load of iron.
19 His is the first of God’s ways; [only] his Maker can draw His sword [against him].
20 For the mountains bear food for him, and all the beasts of the field play there.
21 Does he lie under the shadows, in the cover of the reeds and the swamp
22 Do the shadows cover him as his shadow? Do the willows of the brook surround him?
23 Behold, he plunders the river, and [he] does not harden; he trusts that he will draw the Jordan into his mouth.
24 With His eyes He will take him; with snares He will puncture his nostrils.

  

Judge Pauley also described the plaintiffs’ allegations as "labyrinthine," presuamably in reference to the Labyrinth from Greek mythology. According to Wikipedia (here), the Labyrinth’s elaborate structure was "designed and built by the legendary artificer Daedalus for King Minos of Crete at Knossos. Its function was to hold the Minotaur, a creature that was half man and half bull and was eventually killed by the Athenian hero Theseus. Daedalus had made the Labyrinth so cunningly that he himself could barely escape it after he built it. Theseus was aided by Ariadne, who provided him with a skein of thread, literally the "clew", or "clue", so he could find his way out again."

 

Geez, no wonder the complaint survived the dismissal motion.