The New Century Financial securities class action lawsuit – which was the first of the subprime-related securities class action lawsuits when it was filed in February 2007 – has been settled for $124,827,088, subject to court approval. The plaintiffs’ July 30, 2010 unopposed motion for settlement approval can be found here.

 

The settlement actually consists of three separate settlement stipulations and three corresponding settlement funds. Of the total settlement amount, $65,077, 088 will be paid on behalf of the thirteen former New Century directors and officers; $44,650,000 will be paid on behalf of KPMG, New Century’s auditor; and $15 million will be paid on behalf of the offering underwriter defendants.

 

The $65 million to be paid in the class action settlement on behalf of the individual directors and officers is actually part of a larger settlement on the individuals’ behalf. As reflected in the separate director and officer settlement stipulation filed in connection the motion for settlement approval, a total of $91,102,331.51 will be paid in cash by eleven directors’ and officers’ liability insurers (which are listed on page 11 of the stipulation) in order to settle in whole or in part not only the claims against them in the securities class action lawsuits but also the claims pending against some or all of the individuals in proceedings before the SEC, in separate litigation brought against them by other plaintiffs, as well as bankruptcy trustee claims.

 

As reflected at greater length here, plaintiff investors first filed their action against the defendants in February 2007. New Century filed for bankruptcy in April 2007. In March 2008, the New Century bankruptcy examiner filed a report (refer here) finding, among other things, that the company had "engaged in a number of significant improper and imprudent practices related to its loan originations" that "created a ticking time bomb that detonated in 2007." On December 3, 2008, Central District of California Judge Dean Pregerson denied the defendants’ motions to dismiss (refer here).

 

The New Century Financial case was one of the higher profile subprime-related securities class action lawsuits and one of the most prominent in which the motion to dismiss was denied. However, as reflected in my running tally of subprime related case resolutions and settlements (which can be accessed here), it is only the fourth largest subprime securities suit settlement so far, behind the Countrywide settlement ($624 million), the Merrill Lynch settlement ($475 million) and the Merrill Lynch bondholders settlement ($150 million).

 

Unlike those larger settlements, however, in the New Century Financial case there was no viable entity remaining to fund a larger settlement. The size of the insurers’ contribution and the number of insurers involved in the D&O settlement stipulation suggests that the remaining D&O insurance was exhausted to fund the D&O portion of the settlement. These figures also suggest that there were certain constraints on the possible size of the settlement. KPMG’s very sizeable contribution of $44.75 million toward the settlement represents a significantly greater contribution that it paid in the much larger Countrywide settlement ($24 million).

 

I suspect that this was an enormously difficult settlement to pull off. Given the number of parties, the number of proceedings, the number of insurers, and the amount of money at stake, trying to settle this case undoubtedly was challenging, particularly since continuing defense expenses eroded the amount of insurance remaining as the settlement negotiations went forward. I tip my hat to the lawyers involved in bringing this settlement together.

 

The SEC’s separate July 30, 2010 announcement of its settlement of its enforcement action pending against three former New Century directors and officers can be found here. The stipulation of settlement in the class action lawsuit specifies that the portion of the $91 million in insurance funds is to be paid in part on behalf of the three individuals in the SEC proceeding; however, the stipulation specifies that these amounts "shall not be applied towards penalties owed pursuant to" the SEC settlement.

 

Another Subprime Securities Suit Settlement: In addition to the New Century Financial case, the subprime-related securities class action lawsuit involving The PMI Group also recently settled. The company announced in its August 3, 2010 filing on Form 1-Q (here) that on July 13, 2010 the parties agreed to a proposed settlement of $31.25 million, subject to court approval. The settlement is to be funded entirely by The PMI Group’s insurers. Background regarding the case can be found here. Like the New Century Financial case, the PMI Group subprime-related securities class action lawsuit had also survived a motion to dismiss, as discussed here.

 

A Different Sort of Insurance Cover: Being an astronaut is a dangerous occupation, and those that climb into space launch vehicles understandably would want life insurance in case the worst were to happen. However, life insurers have proven reluctant to insure astronauts.

 

As reflected in this fascinating post on the UK Insurance blog (here), the interesting way the crews for the Apollo 11 through 16 dealt with this issue was for each crew member to sign specially issued, stamped and marked envelopes, with the idea that were the worst to happen, the value of the "insurance covers" would "sky-rocket" allowing the astronauts’ families to secure financial benefits without formal insurance.

 

Fortunately, none of the missions that used this makeshift form of insurance suffered any fatalities (though Apollo 1 did meet an unfortunate fate and later Space Shuttle Challenger and Columbia missions did suffer terrible disasters). The Apollo missions "insurance covers" were never used and now trade among collectors.

 

Special thanks to loyal reader Chris Areheart for sending along this interesting item.

　

　

In a series of recent posts (most recently here), I have been taking a look at the practical impact that the U.S. Supreme Court’s June 24, 2010 decision in Morrison v. National Australia Bank will have on securities litigation in the United States involving non-U.S. companies. Among the cases seemingly most impacted by the decision is the Vivendi securities class action lawsuit pending in the Southern District of New York. Not only is the defendant company domiciled outside the United States, but about three quarters of its shareholders reside in France and most presumably purchased their shares on non-U.S. exchanges.

 

The question of whether these shareholders may assert a claim in a U.S. court under U.S. law is particularly acute due to the verdict that the jury returned on behalf of the plaintiffs in the case in January 2010.

 

As Andrew Longstreth reported on July 27, 2010 in the Am Law Litigation Daily (here), the parties to the Vivendi case recently presented their arguments to the court on the impact of Morrison. Among other things, the article characterized the plaintiffs’ argument that the foreign plaintiffs may proceed in the case as "highly creative" and the article also quoted George T. Conway III of the Wachtell Lipton law firm – who briefed and argued the Morrison case for the defendants – as describing the plaintiffs arguments as "Completely nuts, N-U-T-S."

 

After I linked to the Am Law Litigation Daily article, counsel for the plaintiffs in the Vivendi case reached out to me to express their concerns that their position has been misunderstood and is not receiving a fair hearing in the press and the blogosphere. In response, I offered to host a guest blog post on this site, in which the plaintiffs counsel could present their position as they wished. What follows is the guest post submitted to me by Michael Spencer of the Milberg law firm.

 

　

 

 

The emerging conventional wisdom in legal circles and the media is that the Supreme Court’s decision in Morrison v. National Australia Bank sounded the death knell for use of Section 10(b) of the Securities Exchange Act on behalf of "foreign" purchasers of securities who were allegedly defrauded. Some are even suggesting that defrauded Americans who bought shares traded on a foreign exchange have no remedy.

 

Any fair and careful lawyer should find that conventional wisdom galling. The first part of the test articulated by the Morrison Court is being missed — or deliberately ignored. In assessing the so-called extraterritorial scope of Section 10(b), the Court applied the plain language of the statute and found coverage for "transactions in securities listed on domestic exchanges and domestic transactions in other securities." That holding is repeated several times in the Court’s decision, including in the final paragraph. But the first part of the test has been passed over in lower court decisions, legal commentary, and media reports in the month since Morrison was issued. It’s as though the words repeatedly used by Justice Scalia — "securities listed on domestic exchanges" — disappeared the moment he wrote them.

 

It is indubitable that many "foreign" companies’ ordinary (common) shares are registered under the Exchange Act and listed on the NYSE, even if the shares are not traded on the exchange and quoted in the Wall Street Journal. (Justice Scalia used "registered" and "listed" interchangeably; he said "The Act’s registration requirements apply only to securities listed on national securities exchanges.") That is not surprising, since many provisions of the Exchange Act, including Section 10(b), come into play when securities are registered under the Act. Any competent corporate lawyer practicing in this area will confirm that foreign companies sponsoring upper-level ADR programs in the U.S. must, and do, register and list. Some observers are confusing registration and listing with "trading," but the Court repeatedly used "registered" and "listed," the terms from the statute and regulations. And those who think only the particular custodial shares "underlying" an ADR program get registered should please refer to 17 C.F.R. § 240.12d1-1 ("Registration effective as to class or series"). It takes 20 seconds to google a foreign company’s Form 20-F cover page to ascertain the status of its shares.

 

Justice Scalia usually means what he says. Under the plain language of the Supreme Court’s holding, Section 10(b) covers transactions in shares "listed on a domestic exchange." Period. No matter whether the purchaser is foreign or domestic, no matter where the transaction occurred.

 

That result apparently gets defense lawyers in a dither. Wachtell partner George Conway, who represented the winner in Morrison, was quoted as calling the argument "N-U-T-S." As a plaintiffs’ lawyer, I’m happy to read that reaction — if Conway can respond only with a quip rather than a substantive answer, we are probably on to something. The argument wasn’t made by plaintiffs’ counsel in recent motion practice over whether claims even by domestic purchasers of Credit Suisse ordinary shares traded abroad survive after Morrison; SDNY Judge Marrero dismissed the claims, persumably without knowing that the company is registered and listed on the NYSE. SDNY Judge Holwell has the question squarely before him in post-verdict motions in Vivendi for both foreign and domestic ordinary share purchasers, and will probably rule within the next month or so. Today’s conventional wisdom should by right become tomorrow’s embarrassment.

 

　

 

 

I encourage readers who have comments in response to Michael Spencer’s guest post to add their comments to this post using the site’s Comment feature.

 

I would like to thank Michael Spencer for his willingness to submit this post and have it published on this site. I welcome the opportunity to publish guest posts from responsible observers on this site. Those who may be interested in publishing a guest post on this site should feel free to contact me using the Contact function in the upper right hand column of this site.

　

Though 268 banks have failed since January 1, 2008, there has been relatively little litigation related to the failed banks, as least so far. For example, the FDIC only recently filed its first action against former directors and officers of a failed bank (as discussed here). There have also been relatively few suits brought by private investors as well, though that could change. The failed bank lawsuits do continue accumulate, however, including an investor lawsuit recently filed in state court in Georgia that both has some interesting features and that may present some interesting potential D&O insurance coverage issues.

 

The case in question was initiated on July 22, 2010 in Fulton County (Georgia) State Court by three investors in Georgian Bankcorporation. The company operated Georgian Bank in Atlanta, which was taken over by regulators on September 25, 2009. The defendants are two of the company’s former directors and officers, one of whom was the company’s Chairman and CEO for several years, and the other of whom was the successor Chairman and CEO. A copy of the complaint can be found here.

 

All three of the plaintiffs were investors in the bank holding company. Two of the three plaintiffs served as company directors until 2003. All of the parties are residents of Georgia.

 

The complaint seeks damages for negligent misrepresentation. The plaintiffs allege that the defendants negligently misrepresented the negative effects of the economic slowdown was having on the bank; negligently failed to timely and fully report to plaintiffs various adverse regulatory actions taken against the bank and related regulatory findings; and negligently failed to inform plaintiffs that a key depositor was withdrawing its more than $200 million in deposits.

 

The complaint is emphatic that it is asserting claims only for negligent misrepresentation. Paragraph 11 of the complaint states that the plaintiffs "exclude and disclaim" any allegations under the federal and state securities laws; common law fraud; intentional, reckless or knowing misconduct; breach of fiduciary duty or mismanagement. In addition, in paragraph 12 the complaint emphasizes that the claims of it asserts are direct, on behalf of plaintiffs, and not derivative, on behalf of the company.

 

There are a number of interesting things about this complaint, beyond just the fact that it represents an example of a recent bank failure that resulted in a D&O lawsuit.

 

First, the complaint’s insistence that the plaintiffs are "disclaiming" a number of kinds of allegations suggests the narrow line the plaintiffs are trying to walk. Their disavowal of all securities law claims seemingly is calculated to try to avoid the initial pleading hurdles and defenses to which securities claims are vulnerable, as well as to avoid any possible federal question jurisdiction that might facilitate the case’s removal to federal court.

 

The other claims plaintiffs disavow, particularly the fraud and intentional misconduct allegations, may reflect a desire to avoid the conduct exclusions typically found in D&O insurance policies.

 

The plaintiffs’ insistence that they are asserting only direct not derivative claims is clearly an effort to fend off the FDIC, which might otherwise (and who knows, may yet) intervene to assert its rights as receiver under FIRREA to control litigation asserted in the right of the failed bank itself. (For more about the FDIC’s rights under FIRREA, refer here). The plaintiffs’ wariness about the FDIC’s interest in the lawsuit is apparently well founded, because, as I discussed in a prior post, the FDIC has sent letters to former officials at the failed bank detailed potential claims the FDIC may assert against them.

 

The complaint also raises a number of potential D&O insurance coverage issues.

 

The first has to do with the fact that two of the plaintiffs are former directors of the company. The typical D&O insurance policy has an "insured vs. insured" exclusion precluding coverage for claims brought by one insured against another insured. The two former directors would be insureds under most D&O policies, and so all else equal, their claim would involve an insured vs. insured claim. The exclusion potentially might preclude coverage for this claim.

 

However, the typical insured vs. insured exclusion also usually has multiple exceptions that carve back coverage for certain kinds of claims (derivative action, for example). In recent years, among the coverage carve backs found in many D&O policies is a carve back for claims brought by former directors and officers more than four year (sometimes three years) after they left their position. This new lawsuit presents an interesting example of a case where the inclusion of this coverage carve back could be crucial to preserving coverage.

 

A second interesting thing about this case from an insurance standpoint relates to the plaintiffs’ insistence that they are asserting only claims for negligent misrepresentation. The reason this is interesting is though the plaintiffs are asserting harm to their investment interests, they are not asserting claims base on the securities laws. Rather they are quite deliberately asserting claims solely under the common law.

 

The reason this is interesting is in connection with the definition of the term "securities claim" found in the typical public company D&O insurance policy. Many policy forms do not include within the definition claims asserted under common law, and so carriers are often requested to amend the definition of the term to include common law claims. Some carriers resist this change, arguing either that the change is unnecessary or that claimants will not assert claims on that basis.

 

The deliberately narrowed way the plaintiffs have framed their claims in this case both illustrates why the inclusion of common law claims in the definition of "securities claims" is appropriate and provides and example of a case in which the change could be critical.

 

The deliberately narrow way the plaintiffs framed their complaint also underscores the challenges claimants may face in trying to assert claims against former directors and officers of failed banks. Between worries that the FDIC will sweep in and try to take over the claim and concerns that D&O insurance coverage issues could eliminate possible insurance recoveries, prospective claimants face some formidable obstacles. Indeed these considerations may be among the reasons why there has been relatively little D&O litigation (so far) as a result of the current round of bank failures.

 

A July 27, 2010 Atlanta Journal Constitution article about the lawsuit can be found here.

 

Special thanks to Henry Turner, counsel for plaintiffs in the case, for providing a copy of the complaint.

　

On July 28, 2010, Cornerstone Research and the Stanford Law School Securities Class Action Clearinghouse issued the most recent entry in the series of mid-year 2010 securities class action litigation studies. Its report, entitled "Securities Class Action Litigation: 2010 Mid-Year Assessment" can be found here. The related July 28 press release can be found here.

 

Consistent with the earlier studies that have been released, the Cornerstone study reports that securities class action litigation continued to decline in the first-half of 2010. According to the study, there were 71 class action securities lawsuits in the first six months of 2010, which represents about a 15% decline from the 84 that were filed in the first half of 2009. The 2010 first half filings represent the lowest semiannual total since the first half of 2007. The 71 first half filings annualize to 142, which would be well below the 1997-2009 annual average of 195 filings.

 

One note about the way that Cornerstone "counts" lawsuits – unlike some of the other securities litigation reports (for example, the NERA Economic Consulting study released yesterday), the Cornerstone report counts all related lawsuits filed against the same defendants as a single lawsuit, even if filed in different judicial districts. This counting protocol helps explain why the Cornerstone tally appears to differ from other published lawsuit counts.

 

The Cornerstone report attributes the relative decline in class action lawsuit filings to the decline in the number of lawsuits relating to the credit crisis. However, though credit crisis-related lawsuits have declined, companies in the financial services industry remain the most frequently targeted. Health Care and Energy companies experienced a pick up in first half filings as well.

 

The Cornerstone study reports that the average "lag" between the end of the proposed class period cutoff date and the initial filing date declined in the first half of 2010 compared to recent periods, suggesting that the plaintiffs may be catching up on their lawsuit filing "backlog."

 

My own prior analysis of the first half securities litigation can be found here. Advisen’s study can be found here. NERA’s study can be found here.

 

The Supreme Court’s decision last month in the Morrison v. National Australia Bank precludes so-called "f-cubed" claims (claims brought by foreign plaintiffs who bought foreign stock on a foreign exchange). An unanswered question is whether Morrison also precludes "f-squared" claims – that is, claims by Americans who bought their shares of foreign companies on foreign exchanges. In a July 27, 2010 opinion, Southern District of New York Judge Victor Marrero ruled in the Credit Suisse Group case that Morrison also precludes the f-squared claims as well.

 

Background

As discussed at greater length here, In the majoirty opinion in Morrison, the U.S. Supreme Court said that the relevant portions of the U.S. securities laws related solely to "transactions in securities listed on domestic exchanges" and to claims relating to "domestic transactions in other securities." Unfortunately, the opinion does not say what is meant by "domstic transactions," although the opinoin does later provide an alternative formulation of this second prong, clarifying that the relevant scope of the securities laws includes "the purchase or sale of any other security in the United States."

 

As I recently noted (here), on July 16, 2010, Central District of California Judge Dale Fischer held in connection with the lead plaintiff motion in the Toyota securities class action lawsuit that the argument that Morrison precluded f-squared claims was "better supported" by the Supreme Court’s decision. However, Judge Fischer emphasized that she was not making a "final determination" of the issue, and that her analysis for purposes of the lead plaintiff motion would not preclude the plaintiffs in that case from arguing that U.S. residents who purchased Toyota common stock on the Tokyo stock exchange have claims under the U.S. securities laws.

 

Though Judge Fischer drew back from making a "final determination" in the Toyota case that Morrison precluded f-squared claims, at least one U.S. court has now made such a determination on the merits. In his July 27 opinion in the Credit Suisse case, Judge Victor Marrero concluded that, in addition to f-cubed cases, Morrison also precludes claims f-squared claims as well.

 

As detailed here, Credit Suisse shareholders first sued the company and certain of its directors and officers in April 2008. The plaintiffs alleged that defendants failed to record losses on the deterioration in mortgage assets and collateralized debt obligations ("CDOs") on Credit Suisse’s books; that Credit Suisse’s internal controls were inadequate to ensure that losses on residential mortgage-related assets were accounted for properly; and that Credit Suisse’s traders had put incorrect values on CDOs and other debt securities, concealing the exposure the Company had to losses.

 

As discussed here, Judge Marrero had initially dismissed the plaintiffs’ claims, but in a February 11, 2010 decision, he held that the plaintiffs’ proposed Second Amended Complaint was sufficient to overcome the initial defects and he allowed the case to go forward as to plaintiff shareholders who had purchased Credit Suisse ADRs on the NYSE and as to U.S.-based shareholders who had purchased Credit Suisse shares on the Swiss Stock Exchange. However, he also ruled that he also ruled that the court lacked jurisdiction over the claims of plaintiffs that resided outside the U.S. and that had purchased their shares outside the U.S. – that is, he previously precluded the f-cubed claimants’ claims.

 

The July 27 Decision

Judge Marrero’s July 27 ruling related to one of the two groups of claimants whose claims he had previously ruled could go forward – that is, the U.S.-based shareholders who bought their shares outside the U.S. The defendants in the Credit Suisse case moved, in light of the Morrison decision, for a partial judgment on the pleadings to dismiss the plaintiffs who had purchased their Credit Suisse shares on the Swiss Stock Exchange. In his July 27 opinion, Judge Marrero granted the defendants’ motion.

 

In opening his discussion of the issues, Judge Marrero said that Morrison had "buried the venerable ‘conduct or effect’ test." For the remainder of the opinion, Judge Marrero worked this metaphor that the prior test is dead and buried. Thus, he characterized plaintiffs’ arguments by saying that the plaintiffs "seek to exhume and revive the body." However, the jurisprudence on which the plaintiffs seek to rely is now a "dead letter" and the plaintiffs’ "cosmetic touch-ups will not give the corpse a new life."

 

The Morrison court had held that Section 10(b) related only to the purchase or sale of a security listed on an American exchange or the purchase or sale of any other security in the United States. Judge Marrero said that "a corollary of this rule" is that the Act’s provisions "would not apply" to transactions involving the purchase or sale, wherever it occurs, of securities listed only on a foreign exchange or a purchase or sale of securities, foreign or domestic, which occurs outside the United States.

 

Judge Marrero said that the Morrison court had eliminated the prior doctrine and replaced it with "a new bright-line transactional rule embodying the clarity, simplicity, certainty and consistency" that the prior rule lacked. He said further that nothing in Morrison envisions the "exceptions and embellishments with which Plaintiffs seek to embellish the rule" – indeed an exception for U.S.-based investors who purchases shares on foreign exchanges would, Judge Marrero said, merely reinstate the old "effects" test and an exception because portions of the transactions took place in the U.S. would restore the old "conducts" test.

 

The urged exception, Judge Marrero said, would "defeat the various purposes the Supreme Court’s rule seeks to achieve" and would also, contrary to require U.S. courts to "enforce American laws regulating transactions in securities that are also governed by the laws of the foreign country."

 

The plaintiffs had argued that the Morrison court had not decided any of these issues, and that Morrison appropriately should be limited to its facts and limited holding. Judge Marrero said, however, that the Supreme Court’s decision in Morrison cannot be "squeezed, as in spandex, only into the factual straightjacket of its holding." The Supreme Court, Judge Marrero said, "went out of its way to fashion a new rule designed to correct the enumerated flaws" of the prior "conduct and effects" test, and the "geographic exception" "would not satisfy the new rule."

 

Judge Marrero concluded by saying that in the Morrison case, the Second Circuit’s conduct and effect doctrine "took a great fall" and "neither the Plaintiffs’ law horses nor this Court’s pen can put the pieces together again."

 

Discussion

Despite the tone of certainty of Judge Marrero’s opinion, it remains to be seen whether or not other courts will similarly conclude that Morrison precludes f-squared claims. His opinion depends fundamentally on what he describes as the "corollary" of the Supreme Court’s holding in Morrison – the issues he decided were not, strictly speaking, before the Supreme Court in Morrison. Plaintiffs in other cases will undoubtedly argue, as the plaintiffs attempted to argue here, that the Supreme Court’s holding simply did not reach these issues, which were not before the Court.

 

But Judge Marrero in the Credit Suisse case, as well as Judge Fischer in the Toyota case, had no problem concluding that Morrison required them to reach the result they did, and it clearly will be challenging for plaintiffs in other cases to argue that the "transaction" test enunciated in Morrison left enough room for U.S-based shareholders of who purchased their shares on foreign exchanges – particularly with these lower court decisions on the books.

 

Fundamentally, the claimants in other cases will have to argue that the second prong of the Supreme Court’s "transactional" test – that is "(ii) the purchase or sale of any securitiy in the U.S." — preserved courts’ authority to reach claims of U.S.-based purchasers, even where the transaction may have taken place outside the U.S. If Judge Marrero’s opinion is any indication, these claimants may face an uphill battle.

　

Special thanks to the several loyal readers who sent me copy of Judge Marrero’s opinion.

 

Did the Dodd-Frank Act Change Anything?: Judge Marrero notes in a final footnote to his opinion, for "whatever comfort it may bring to Plaintiffs and counsel," that Section 929(b) of the Dodd-Frank Act granted federal courts extraterritorial jurisdiction under the conduct or effect test for proceedings brought by the SEC. (The Act also calls for further SEC study of the issue of the extraterritoriality of the U.S. securities laws.)

 

However, according to a July 21, 2010 memo by George T. Conway, III of the Wachtell Lipton law firm, as a result of a "drafting error," the new provision purporting to give the SEC extraterritorial authority under certain circumstances is ineffective. (Conway, it should be noted, briefed and argued the Morrison case for the defendants.) Conway points out that the new statutory provision unambiguously refers only to the "jurisdiction" of the U.S. courts, which he says, is not sufficient to extend court’s authority in light of the Morrison case:

 

In National Australia Bank, the Supreme Court reiterated the longstanding principle that the territorial scope of a federal law does not present a question of "jurisdiction," of a "tribunal’s power to hear a case," but rather a question of substance—of "what conduct" does the law "prohibit"? The new law does not address that issue, and accordingly does not expand the territorial scope of the government’s enforcement powers at all.

 

Of course, Conway notes, some courts may be "tempted" to find that Section 929(b) extended the courts’ reach, but courts generally are admonished to refrain from correcting Congressional drafting errors. In other words, Congress may have to go back and tone up the language in Section 929(b) in order for the SEC effectively to be able to exercise the authority Congress intended to extend in that provision.

 

Meanwhile, Vivendi Plaintiffs Get "Creative": The defendants in the Vivendi securities class action case are also trying to narrow the plaintiffs’ claims in their case, which is an exercise of considerable import give the jury verdict entered on behalf of plaintiffs in the case in January 2010. According to Andrew Longstreth’s July 27, 2010 Am Law Litigation Daily article (here), the plaintiffs are getting rather "creative" in their efforts to argue that Morrison does not preclude the claims of the claimants who purchased their Vivendi shares outside the U.S.

 

The plaintiffs arguments are complicated but basically they are arguing that because Vivendi ADRs trade on the NYSE, and the ADRs are backed by common shares, the company’s common shares trade in the U.S. (there may be more to it than that, but I have to admit I really didn’t understand the argument after a couple of tries). The article quotes George Conway (whom I cited in the preceding item) as saying that the plaintiffs’ arguments are "Completely nuts. N-U-T-S."

 

The point is that plaintiffs in many pending are scrambling to try to preserve what they can in the wake of the Morrison decision. For many plaintiffs, it is going to be an uphill battle.

 

Largely as a result in the decline of the number of new credit crisis related cases, the number of new securities class action lawsuits filings is "on track to decline for a second successive year from their 2008 peak," according to a NERA Economic Consulting report entitled "Trends 2010 Mid-Year Study: Filings Decline as the Wave of Credit Crisis Cases Subsides, Median Settlements at Record High," released on July 27, 2010. The report can be found here and NERA’s July 27, 2010 press release about the report can be found here.

 

According to NERA, there were 101 securities class action lawsuit filings in the first half of the year. That filing level projects to 202 filings for the year, which would represent a decline from the 221 filings in 2009 and the 221 filings in 2008, as well as the 1997-2004 average of 231.

 

A note about how NERA counts filings – as reflected in a footnote in the report, NERA counts multiple filings in separate circuits that may relate to the same fraud as separate filings until they are consolidated. It addition, NERA reports multiple filings if different cases are filed on behalf of securityholders. These counting protocols may result in NERA’s filings figures appearing slightly higher than those in other reports published by other observers who may count each of these types of filings only once.

 

Though NERA’s numbers may differ in the details, its figures are directionally consistent with other published analyses of mid-year filing levels, including the Advisen’s recent report (about which refer here). My own analysis of mid-year filing can be found here.

 

According to the report, the drop off in securities class action lawsuits has been partially offset by an increase in other types of lawsuits, including cases alleging breaches of fiduciary duties. And though the numbers of credit crisis related cases have declined compare to recent years, the credit crisis "continues to generate a substantial volume of litigation" beyond just securities class action litigation, including state court derivative litigation, ERISA litigation and other types of cases.

 

Despite the decline in credit crisis cases, companies in the financial sector remained the most frequent securities class action lawsuit target in the first half of 2010, though the health technology sector saw the largest percentage increase in filings between 2009 and annualized 2010. The report notes in particular the growth in the first half of 2010 in cases alleging product and operational defects. This category encompasses both traditional, tangible goods and financial products like ETFs and CDOs, but the more traditional allegations (such as those relating to the Gulf of Mexico oil spill and the Toyota vehicle recall) were most frequent.

 

According to the NERA report filings against foreign-domiciled companies represented about 16% of all first half filings, a larger share than any year since the PSLRA’s enactment. However, the report also notes that the U.S. Supreme Court’s Morrison v. National Australia Bank case could substantially affect these filing levels going forward.

 

The average time to filing from the end of the proposed class period to the date of the first filing was 231 days, which though below the 272 day average during the second half of 2009, is still well below the average of 141 days during the period 2007 to mid-2009. However, more than half of the first have filings were made within 66 days, which the report notes that the filing lag may have been attributable to plaintiffs’ attorneys catching up on a filing backlog.

 

Though average securities class settlements, when factored for outlier settlements, were slightly down in the year’s first half, the median settlement in the first six months of 2010 was $11.8 million, which continues in the generally upward trend in median settlements. The median in 1996 was $3.7 million, and only exceeded $6 million once between 1996 and 2004. However, since 2005, the median has exceeded $7 million every year, and the first half 2010 median is more than three times the 1996 median.

 

The report contains a number of other interesting analyses, including a detailed study of the amount of time required for securities class action case resolutions and the percentage of plaintiffs’ attorneys’ fees as proportions of settlement amounts. The analysis of plaintiffs’ attorneys’ fees shows that the percentage of fees is markedly smaller for larger cases – though the fees represent as much as a third for settlements below $5 million, they represent only about 8.8% of settlements over $500 million.

 

The report notes that median investor losses for cases filed in the first half of 2010 fell for the first time since the credit crisis began. The lower median losses "indicate that the typical settlement may eventually fall from its current high level," though the higher investor losses involved in the many pending credit crisis cases "suggests that there may be a number of large settlements in the pipeline."

 

A couple of years ago, a "worrisome trend" developed in securities class action litigation, in which large institutional investors began routinely opting out of plaintiff class to separately pursue their own individual claims under the securities laws. The settlement of these individual opt out actions in many cases rivaled, in the aggregate, the amount of the class action settlement, and often exceeded the class settlement in terms of percentage of shareholder losses recovered.

 

These developments caused some observers to question whether we were headed toward a two-tiered system of securities litigation, where the large institutional investors separately pursued their own claims and the class action proceeded on behalf of other investors.

 

As it turned out, however, the phenomenon of the large individual opt out settlement separate from the class has ceased to be as prominent as it briefly was during the period 2006 to 2008. Since that time, there have been fewer high profile opt out settlements, and the predictions about fundamental alterations of securities class action litigation have died down.

 

However, in a development that seems to raise the possibility that the high profile opt-out action may be back, on July 22, 2010, New York Comptroller Thomas P. DiNapoli announced that he had filed two separate individual actions on behalf of New York state pension funds against Merrill Lynch and Bank of America and their respective individual directors and officers.

 

In the Merrill Lynch complaint (a copy of which can be found here), DiNapoli alleges that between October 17, 2006 and December 31, 2008, the defendants misrepresented the company’s "true exposures to poorly underwritten subprime mortgages, as well as the value of the Company’s subprime-exposed assets and liabilities and the effectiveness of Merrill’s risk management. The complaint alleges beginning in October 2007 the company began a series of stair step writedowns of the value of the company’s toxic assets, and that ultimately the company was forced to merge with Bank of America as a result of its exposure to subprime mortgages.

 

In the Bank of America Complaint (a copy of which can be found here), DiNapoli alleges in the documents for BoA’s merger with Merrill, the company and three of its senior executives failed to disclose Merrill’s massive fourth quarter 2008 losses and also failed to disclose BofA’s and Merrill’s agreement to permit Merrill to pay up to $5.8 billion in bonuses. The Complaint also alleges that the defendants violated the securities laws through a series of misleading statements and omissions during the period September 15, 2008 (when the merger was announced) and January 21, 2009 (when the information about the fourth quarter losses and the bonuses were made public).

 

The New York State Pension funds owned 17.7 million BofA shares at the time of the merger and acquired another 3 million between September 15, 2008 and January 21, 2009.

 

The circumstances described in DiNapoli’s complaints have previously been the subject of extensive litigation. Among other things, the allegations in DiNapoli’s complaint against the Bank of America defendants previously were the subjective of a high profile SEC enforcement action that ultimately resulted in a $150 million settlement. (For a discussion of the events surrounding this SEC settlement, refer here.)

 

In addition, there previously have been securities class action lawsuits filed against both the Merrill defendants and Bank of America defendants. The Bank of America class action lawsuit is in fact being driven by a group of public pension fund defendants, led by Ohio Attorney General Richard Cordray on behalf of Ohio public pension funds.

The circumstances referenced in DiNapoli’s Merrill Lynch complaint were also the subject of a separate securities class action lawsuit, about which refer here. Indeed, the parties to the Merrill Lynch lawsuit have already entered a $475 million settlement on behalf of the class, which the Southern District of New York Judge Jed Rakoff approved on August 4, 2009.

 

In bringing his separate lawsuits on behalf of the New York public pension funds, DiNapoli has made a conscious and deliberate decision to opt out of the preexisting class action litigation against the two sets of defendants. Public statements by representatives of DiNapoli’s office made it clear the reason he took the separate action on behalf of the public pension funds is because "our attorneys believe this gives us a chance to get a better recovery." The possible recovery on behalf of the funds could reach "tens of millions of dollars."

 

DiNapoli’s action to opt out of the class action on the theory that the funds’ recovery will be greater if they proceed individually rather than part of the class is exactly what commentators had been predicting a couple of years ago, before the opt-out phenomenon faded into the background. DiNapoli’s action is all the more noteworthy with respect to the Merrill Lynch suit is all the more noteworthy, given the fact that the class has already entered a massive $475 million settlement. DiNapoli’s action not only raises the question whether other institutional plaintiffs might opt out in these cases, but whether the plaintiffs will opt out in other cases as well.

 

The interesting thing about the public explanations for DiNapoli’s action is that the decision seems to be the result of persuasion from the attorneys who convinced DiNapoli’s office to opt out. The presence of an entrepreneurial group of plaintiffs’ lawyers motivated to try to obtain individual institutional investor representations by convincing the investors to opt out of the class suggests that, even if the prevalence of high profile opt out actions may have faded into the background, we are likely to continue more of these kinds of developments going forward. The political motivations of public pension fund representatives clearly support these developments.

 

Of course, it remains to be seen if the New York funds will actually fare better than the classes in these cases. As Adam Savett pointed out in an interesting January 22, 2010 post on the Securities Litigation Watch, even if some claimant fare better by opting out, there can also be a "downside." The post refers to the claimants that opted out of the Aspen Technology class action (which settled for $5.6 million) but ultimately had their claims dismissed based on lack of proof of fraud, and so received nothing.

 

Nevertheless, if other institutional investors are persuaded that they will do better by proceeding individually, securities class action litigation could become even more complicated than it already is. The existence of separate proceedings could both drive up total litigation costs and increase both the cost and complexity of case settlements. My prior discussion of the potential problems the opt-out phenomenon might represent can be found here.

 

DiNapoli’s decision to separate the New York funds from the Bank of America class action, in which the Ohio Attorney General is taking the lead, presents an interesting contrast to DiNapoli’s actions in connection with the securities litigation pending against BP, in which the Ohio AG and DiNapoli are collaboratively pursing the class action litigation on behalf of their respective states’ pension funds, and, as reflected here, are in fact together seeking lead plaintiff status in the litigation. Whatever else might be said, it seems that DiNapoli has not been persuaded that the New York funds will always do better outside of the class action process.

 

Understanding the Global Economy: If like me you find so much about the current circumstances of the global economy confusing, you will want to watch the following John Clark and Bryan Dawe video in which they summarize the basics in an admirable fashion, particularly the way the unbroken chain of governmental borrowing ultimately presents unanswerable questions. (Special thanks to the CorporateCounsel.net blog for the link to this entertaining video.)

https://youtube.com/watch?v=5D0VhS8qXT0%26hl%3Den_US%26fs%3D1

 

My primary objective on this blog is to address important developments in with world of directors’ and officers’ liability as they occur. From time to time, however, readers contact me with more fundamental questions about executive liability and protection, particularly regarding the basics of indemnification and D&O insurance. In response to these recurring questions, I intend to prepare a series of posts, to be published intermittently in the weeks ahead, discussing these more basic issues.

 

This post is the first of the series and will address the basics about indemnification and insurance and how they interact.

Introduction

It is a basic fact of life in this day and age that individuals serving as corporate directors and officers face a significant litigation exposure. Claims are regularly brought against corporate officials on a wide variety of legal theories, including, for example, allegations of breach of fiduciary duty or of securities law violations. These lawsuits are expensive to defend and they also potentially expose the individuals to significant personal liability.

Companies typically protect their executives from these legal expenses and liability exposures through indemnification and insurance.

Indemnification

Corporate officials’ front line of liability protection is indemnification. This statutorily authorized protection is usually embodied in corporate documents such as articles of incorporation or by-laws, and generally encompasses the rights to both advancement of defense expenses and indemnification.

Corporate indemnification represents important protection for company officials, even for those at companies that purchase and maintain significant levels of D&O insurance. D&O insurance is subject to limits of liability, whereas indemnification is theoretically unlimited (although, of course, practically limited by the indemnifying company’s financial resources). Indemnification is often very broad, often extending “to the maximum extent permitted by law”, whereas D&O insurance polices contain numerous exclusions and conditions. In addition, D&O insurance must be renewed each year, with possible changes in terms and conditions. Indemnification rights are much less likely to be changed, particularly for corporate officials who negotiate their own indemnification contracts.

The company’s indemnification provisions specify the procedures individuals must follow in order to obtain indemnification. It is worth considering that indemnification questions often arise at a time of corporate turbulence, which may complicate an individual’s efforts to obtain indemnification or advancement. A separate written indemnification provision can not only provide much greater procedural specificity but it can also provide certain protections against wrongful withholding of indemnification, by providing presumptions in favor of indemnification and providing for “fees on fees” (that is, fees incurred in order to enforce rights to advancement or indemnification).

Although corporate indemnification is broad, it is not unlimited. There are times when a corporation may not indemnify an individual – for example, there generally are limitations on a corporation’s ability to indemnify individuals found liable in shareholders’ derivative suits. In addition, insolvency may prevent a company from honoring its indemnification obligations.

D&O Insurance

D&O insurance provides protection for company officials when corporate indemnification is not available, whether due to insolvency or legal prohibition. D&O insurance also provides a mechanism for corporations to be reimbursed when they do indemnify their executives.

The coverage provision in which the D&O policy provides individuals with insurance protection when indemnification is not available is commonly referred to as Side A coverage. The D&O insurance policy’s provision for reimbursement of a company’s indemnification obligations is referred to as Side B coverage.

In more recent years, many D&O insurance policies have also incorporated a Side C coverage as well, which provides insurance protection for the corporate entity’s own liability exposures. In D&O insurance policies for public companies, this Side C protection is usually limited just to the company’s liabilities under the securities laws.

Coverage B and C essentially operate as balance sheet protection for the company. Coverage B also provides a way for companies to contractually transfer their indemnification obligations to the insurer (subject of course to all of the policy’s terms and conditions).

Coverage A is essentially catastrophe protection for the individual executives. It provides a way to ensure that litigation protection is still available to them even if the company is financially unable to indemnify them or legally prohibited from doing so.

D&O insurance policies are generally built to complement other types of insurance that most companies carry. For example, D&O policies will typically exclude coverage for loss arising from bodily injury or property damage, because those exposures are addressed in the company’s general liability and property insurance policies. The D&O policy, by contrast to these other types of coverage, protects the insured persons from economic loss arising from claims made against the insured persons for wrongful acts in their insured capacities.

Many companies find that the amount of insurance available in a single policy of D&O insurance insufficient to provide adequate protection and so they purchase additional limits of liability through excess D&O insurance policies as part of a tower of insurance arranged in various layers.

One of the most important functions of D&O insurance is to protect the individuals when the company has become insolvent and unable to honor its indemnification obligations. This protection is afforded under Side A, as discussed above. Because of the critical importance of this insurance protection, some companies choose to buy additional amounts of insurance providing additional limits of liability just for this Side A coverage, in the form of Excess Side A insurance.

In the current marketplace, this Excess Side A insurance often provides certain additional insurance protection in the form of coverages whereby the Excess Side A insurance will “drop down” and provide first dollar protections. These additional coverages are in the form of “Difference in Condition” (or “DIC”) protection, and would apply, for example, in the event an underlying D&O insurance carrier is insolvent or if the underlying policy is rescinded.

Many D&O insurance buyers are very sensitive about the cost of the insurance — and appropriately so, as D&O insurance is often perceived as expensive (although currently relatively less expensive than it has been at times in the past). However, the scope of insurance protection afforded is much more important than the cost. Small incremental cost savings sometimes available pale by comparison to the potential financial significance of the scope of coverage afforded.

There is no standard D&O insurance policy. Each D&O insurance carrier has forms that differ from their competitors’ and most policies are generally the subject of extensive negotiations. In order for D&O insurance buyers to be assured that they have the broadest available terms and conditions and the appropriate insurance structure put in place, it is critically important that they associate a knowledgeable and experienced broker in their acquisition of the insurance. The best brokers also have skilled and experience claims advocates available to protect their clients’ interests in the event of a claim.

If you are one of those people who still need persuading that the increasing crack-down on corrupt behavior is a big deal, you will want to take a look at The FCPA Blog’s recent breakdown of the top ten Foreign Corrupt Practice Act settlements, which can be found here. As Dick Cassin, the blog’s author elaborated in a subsequent post, the top ten settlements collectively total $2.8 billion, but the top six, all of which took place just in the last 20 months, represent 95% of the total. Four of the top six settlements were reached just in 2010.

 

As if this past activity were not enough, the newly effective Dodd-Frank Wall Street Reform and Consumer Protection Act seems likely to lead to even further enforcement activity. As noted in a July 20, 2010 memorandum from the Proskauer law firm, Section 922 of the Dodd-Frank Act contains new provisions designed to encourage whistleblowers to report securities law violations. Among other things, the Section provides that if the whistleblower’s information leads to the imposition of sanctions in excess of $1 million, the whistleblower will receive between ten and thirty percent of the total.

 

The law firm memo comments that "if the whistleblower provisions Congress previously provided in other areas are an accurate indication, the Dodd-Frank Act will increase dramatically the likelihood that suspected violators of the securities laws will face costly enforcement actions."

 

This threat, the memo notes further, is "particularly great" with respect to FCPA violations, precisely because of the massive scale of the settlements that the SEC has been achieving in this area. Given the size of these settlements, the potential rewards for whistleblowers are enormous. The potential rewards are so massive that some commentators have referring to these provisions as the "whistleblower bounty provision."

 

A detailed overview of the Dodd-Frank Act’s whistleblower provisions can be found on the FCPA Professor blog, here. Among other things, Professor Mike Koehler, the blog’s author, points out the danger that these whistleblower provisions represent, because the standards for violation of the FCPA are so ill-defined and because so many companies find it expedient to settle FCPA allegations rather than to try to test them in Court. Against this backdrop, he questions the wisdom of offering whistleblowers rewards of up to 30%.

 

However, Professor Koehler, unlike many commentators, conjectures that the whistleblower provisions may have a "negligible impact." in part because the whistleblower provisions are only triggered when public company issuers are involved, whereas many companies targeted in FCPA enforcement actions are private companies. He also points out that the whistleblower provisions create huge incentives for companies to self-report violations. If a company has self-reported, then the whistleblower’s information is not "original" and the whistleblower is not entitled to the bounty.

 

By contrast, and as Ross Todd reports in a July 21, 2010 article on the AmLaw Litigation Daily (here), many commentators, including the former head of FCPA enforcement at the Department of Justice, are advising that we should expect the size and scope of FCPA enforcement cases to increase.

 

Meanwhile, there are important developments across the ocean with respect the UK Bribery Act, which received Royal Assent on April 8, 2010. On July 20, 2010, the U.K. Ministry of Justice released its timetable for the implementation of the Bribery Act, setting April 2011 as the effective date. The Act is widely viewed as in several important respects more "far-reaching" than the FCPA, and is likely to have significant impacts on business that either are based in the U.K. or have significant parts of their operations in the U.K.

 

The April 2011 effective date represents something of a delay, as noted in a July 20, 2010 memo from the Morgan Lewis law firm. The FCPA Professor blog has a detailed discussion here of the possible reasons behind the delayed implementation. Essentially, the extension is intended to allow business to become familiar with the law and to permit the U.K. government to launch a "shore consultation exercise" to provide "guidance" firms can adopt to prevent bribery.

 

Though the U.K. provisions may be somewhat delayed and though the impact of the new Dodd-Frank Act whistleblower provisions may be uncertain, there is no question that this is an area where many things are happening. Anti-corruption enforcement represents a significant and growing area of liability exposure for corporate officials, especially in light of the government’s apparent willingness to resort to sting tactics and other prosecutorial techniques as part of the heightened enforcement.

 

These developments also have significance for purposes of the structure and implementation of insurance calculated to enforce corporate officials. The fines and penalties associated with these kinds of enforcement actions typically would not be covered under a D&O policy, but the defense fees, at least for the individuals might well be. However, the Dodd-Frank Act whistleblower provisions, for example, may raise concerns under the typical D&O policy’s insured vs. insured exclusion.

 

The potential implications of these developments within the D&O insurance context represent a significant area of concern for D&O insurance professionals. It is worth noting that I will be participating in a panel entitled "Foreign Corrupt Practices Act: Unexpected Liabilities for D&O Insurers" at the November 2010 PLUS International Conference. I will be participating on the panel, which will be chaired by my friend, Joe Monteleone of the Tressler law firm.

 

The U.S. Supreme Court’s decision last month in the Morrison v. National Australia Bank case made it clear U.S. securities laws do not allow so-called "f-cubed" cases — securities claims against foreign domiciled companies and brought by foreign-domiciled claimants who purchased their company shares on foreign exchanges — in U.S. courts. The securities laws, the Court said in Morrison, relate solely to "transactions in securities listed on domestic exchanges" and to claims relating to "domestic transactions in other securities."

 

But what did the Court mean when it referred to "domestic transactions"? Unfortunately the Court didn’t say. As the recent lead plaintiff decision in the securities class action lawsuit involving Toyota demonstrates, this question could be a problem in many cases involving foreign companies, particularly where the cases involve claims brought by or on behalf of U.S. domiciled investors who bought their shares in the foreign companies on foreign exchanges – the so-called "f-squared" claimants.

 

These issues were addressed recently in the lead plaintiff decisions in the Toyota class action securities litigation. As discussed at greater length here, in February 2010, Toyota and certain related corporate entitles, as well as certain of its directors and officers, were sued in securities class action lawsuit in the Central District of California. The plaintiffs allege that Toyota misled investors by allegedly failing to disclose that there was a design defect in Toyota’s acceleration system that could cause its cars to accelerate suddenly.

 

Toyota’s common stock trades on the Tokyo stock exchange and its American Depository Shares trade on the NYSE.

 

The Supreme Court’s Morrison decision became relevant in connection with the court’s selection of lead plaintiff in the Toyota case. As reflected in her July 16, 2010 memorandum opinion, Judge Dale Fischer had to determine whether or not the Morrison decision allows claims under the securities laws by domestic U.S. shareholders who purchased their shares in a foreign company on a foreign exchange. She had to determine for purposes of the lead plaintiff motion whether the claims of U.S. purchasers of Toyota common stock on the Tokyo exchange were relevant for purposes of the lead plaintiff selection.

 

In her July 16 opinion, Judge Fischer noted the Morrison decision’s statement that the securities laws allows claims relating to "domestic transactions in other securities," which the decision also refers to as "the purchase or sale of any security in the United States." In exploring what these phrases from the Morrison decision might mean, Judge Fischer said:

 

One view of the Supreme Court’s holding is that if the purchaser or seller resides in the United States and completes a transaction on a foreign exchange from the United States, the purchase or sale has taken place in the United States. However, an alternative view is that because the actual transaction takes place on the foreign exchange, the purchaser or seller has figuratively traveled to that foreign exchange – presumably via a foreign broker – to complete the transaction. Under this second view, "domestic transactions" or "purchase[s] or sales[s]…in the United States" means purchases and sales of securities explicitly solicited by the issuer within the United States rather than transactions in foreign-traded securities where the ultimate purchaser or seller has physically remained in the United States.

 

Judge Fischer concluded that the latter of these two positions was "better supported" by Morrison, largely because the Morrison decision emphasized that the U.S. securities laws were not intended to regulate the foreign exchanges.

 

Having worked through this analysis of whose claims were proper under the U.S. securities laws, Judge Fischer then selected as lead plaintiff the proposed lead plaintiff that had the larges alleged American Depository Share loss.

 

However, Judge Fischer did say at the outset of her opinion with respect to her analysis of whose claims the Court could properly entertain that "this is not a final determination of the issue and Plaintiffs are not foreclosed from arguing that domestic purchasers of Toyota common stock [as opposed to domestic purchasers of Toyota’s American Depository Shares] have claims" under the securities laws." She added, however, that "the Court currently believes that a fair reading of Morrison excludes those claims" – that is, the claims of domestic U.S. shareholders who purchases Toyota’s common stock on the Tokyo stock exchange.

 

When the U.S. Supreme Court released its opinion in the Morrison case, it was immediately apparent that the decision would have a significant potential impact on pending and future securities cases involving foreign-domiciled companies. However, as the lead plaintiff decision in the Toyota case shows, it may not be entirely clear how the Morrison decision will affect the cases against foreign companies.

 

It remains to be seen whether or not "f-squared" cases will be precluded on the Morrison decision, but it seems likely that this will be a hotly contested battleground in many of the cases involving foreign companies.

 

Very special thanks to a loyal reader for providing me with a copy of Judge Fischer’s July 16 opinion.

 

My pre-Morrison discussion of an" f-squared claimant" case involving European Aeronautic Defence & Space Co. (EADS) can be found here.