Every fall since I first started writing this blog, I have assembled a list of the current hot topics in the world of directors’ and officers’ liability. This year’s list is set out below. As should be obvious, there is a lot going on right now in the world of D&O, with further changes just over the horizon. The year ahead could be very interesting and eventful. Here is what to watch now in the world of D&O:

　

1. What Impact Will Dodd-Frank Have on D&O Liability?: The massive Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which Congress enacted this past July, represents the most significant reform of financial regulation in decades. It will affect virtually every aspect of our financial system. However, exactly what the impact will be and how that might affect the liability of directors and officers remains to be seen.

　

Among the few things that are clear at this point is that some of the proposed reforms were not incorporated into the final version of the Act. Thus, for example, the law did not, as was proposed, legislatively overturn the U.S. Supreme Court’s decision in Stoneridge and enact a private right of action for aiding and abetting. The Act also did not incorporate a proposed legislative provision that would have extended the extraterritorial jurisdiction of the U.S. securities laws in cases brought by private litigants. (The Act did include a provision regarding the SECs extraterritorial jurisdiction, however).

　

One reason that the Act’s ultimate implications remain unclear is that much of the work still remains to be done. The Act calls for more than 240 rulemaking efforts and nearly 70 studies by 11 different regulatory authorities. Most of the details of the key provisions, and the ways those provisions will be implemented, remain to be spelled out by the various regulators in the months ahead.

　

But though much of the picture has yet to be fleshed out, there are certain provisions that clearly will impact directors and officers, even if the ultimate effect is uncertain. First, the Act provides rules regarding executive compensation and corporate governance generally applicable to U.S. public companies, including requirements on shareholder "say on pay;" broker discretionary voting; compensation committee independence; executive compensation disclosures; executive compensation "clawbacks;" disclosure regarding employee and director hedging; disclosures regarding Chairman and CEO structures; and shareholder proxy access.

　

These provisions do not expressly create new causes of action against directors and officers, but they do create a host of new obligations that undoubtedly will drive shareholder expectations. The probability of claims arising from these new requirements seems high, particularly with respect to the new disclosure requirements.

　

Among the specific parts of the Act that also seem particularly likely to lead to future claims are the new whistleblower provisions. The whistleblower provisions include the creation of a new whistleblower bounty pursuant to which individuals who bring violations of securities and commodities laws to the attention of the Securities and Exchange Commission or the Commodities Futures Trading Commission will receive between 10 percent and 30 percent of any recovery in excess of $1 million.

　

Many commentators have predicted that these incentives could lead to a dramatic increase in complaints of accounting misconduct, corrupt practices, and other violations. (The specific possibilities for increased reporting related to the Foreign Corrupt Practice Act are discussed below.) The likely increased enforcement activity also seems likely to generate a related upsurge in follow-on civil litigation, as the underlying violations are disclosed.

　

There are many ways that the impact of Dodd-Frank Act can be anticipated or at least conjectured, but the Act’s overall impact and significance wil only become apparent over the long haul. At 2,319 pages, the Act’s scope is so sweeping that many of its specific implications inevitably will reveal themselves only with the passage of time. Be prepared for years of commentaries about the Act that begin "Though the provision was little-noticed at the time that the Dodd-Frank Act was enacted, …" In the meantime, the laws of unintended consequences will be hard at work.

　

2. What Happens Next with the Subprime and Credit Crisis-Related Litigation Wave?: For several years beginning in 2007, corporate and securities litigation was largely driven by lawsuits arising out of the subprime meltdown and the global credit crisis. Beginning in the second half of 2009, the litigation wave began to lose steam, and the related lawsuits dwindled as we headed into 2010.

　

But while the pace of new lawsuit filings has dwindled, new filings have not entirely gone away. Even now, well into 2010, the credit crisis-related lawsuits continue to arrive (although as time goes by, it become harder and harder to maintain absolute definitional certainty around what makes a particular case "credit crisis-related."). By my count, there have been as many as 19 new subprime and credit crisis related lawsuits filed during 2010, out of approximately 104 new securities class action suits so far this year (as of September 3, 2010).

　

In the meantime, the vast amount of litigation that accumulated over the last four years continues to work its way through the system. There have been over 220 subprime and credit-crisis related securities class action lawsuits filed overall since the first was filed back in 2007. About two-thirds of the cases remain pending and many have yet to reach the motion to dismiss stage, though the dismissal motion rulings are starting to accumulate.

　

And while a number of courts have seemed skeptical about the fraud allegations in light of the magnitude of the global financial crisis, there have also been a number of decisions were the court have found the plaintiffs’ allegations sufficient. My running tally of the various subprime and credit crisis-related lawsuit dismissal motion rulings can be found here.

　

With the increasing number of dismissal motion rulings, the cases that survive are likely to head towards settlement. Just in the last few months, there have been several very high profile subprime-related lawsuit settlements, including the $624 million settlement in the Countrywide case, the roughly $124 million settlement in the New Century Financial case, and the $235 million total settlement in the Schwab Yield Plus case. (All settlement figures reflect aggregate settlement amounts) By my calculation, though there have been only 15 subprime and credit crisis related lawsuit settlements so far, those few settlements alone total over $1.8 billion.

　

The one thing that seems clear is that when all is said and done on the subprime and credit crisis-related litigation wave, the total costs will be staggering. The defense costs alone associated with this litigation will be enormous. (By way of illustration, the defense expenses associated just with the Lehman bankruptcy are running at about $ 5 million a month, and those costs are likely to accelerate in the event the SEC files an enforcement action or the DoJ files criminal charges.) Though not all of these costs will be insured, many of them will be.

　

In the aggregate the subprime meltdown and credit crisis represents an enormous event for the D&O insurance industry. Just how big of an event it is will continue to unfold in the weeks, months and years ahead.

　

3. Will the Wave of Bank Failures Lead to a New Wave of Failed Bank Litigation?: Since January 1, 2008 and through September 3, 2010, 283 banks have failed in the United States, and the total number of failed banks continues to grow. Indeed, in its most recent Quarterly Banking Profile, the FDIC reported that one out of ten banks in the United States is a "problem institution" (meaning rated a "4" or "5" on a scale of one-to-five on lineup of financial and operational criteria).

　

During the S&L crisis, the banking regulators pursued claims against the directors and officers of the failed institutions in connection with about a quarter of the bank failures. These efforts proved worthwhile for the FDIC, since its S&L crisis D&O claims led to recoveries of about $1.3 billion, out of total professional liability claims recoveries of about $3.25 billion. Given that history, it seems probable that the FDIC will pursue D&O litigation as part of the current bank wave.

　

Though the FDIC, as part of the current bank failure wave, has to date filed only one lawsuit against former directors and officers of a failed banks, there is every reason to expect that there will be more claims to come, perhaps many more. The FDIC has sent claims notice letters to the directors and officers of many failed banks, and otherwise taken steps to preserve its right to pursue claims and also to assert its priorities over other claimants.

　

During the S&L crisis, the lag between the peak of the failed banks and the timing of the FDIC’s peak recoveries was about three years. Since the current wave of bank failures did not really start to take off until late 2008 and did not really gain serious momentum until 2009, and in light of the lag in the FDIC’s recovery during the S&L crisis, it would seem that the FDIC’s failed bank lawsuit will begin to accumulate in earnest some time during 2011.

　

In the meantime, other claimants are also asserting claims against the failed banks’ former directors and officers . Unlike during the S&L crisis, when most of the failed institutions were privately held, many of the banks that have failed during the current wave were publicly traded. According to a recent NERA report, about 45 of the subprime and credit crisis related securities class action lawsuits have involved depositary institutions. Of the 20 failed banks that produced the largest losses prior to 2010, 13 involved publicly traded securities, of which eight had been named in securities class actions as of the end of 2009.

　

Even in privately held banks’ investors are pursuing claims, although they are crafting their claims very carefully to avoid running afoul of the FDIC’s priority rights to the claims of the failed institutions.

　

In some respects these investor lawsuit could be competing with the FDIC for the proceeds of the D&O insurance policies insuring the directors and officers of the failed institutions. However, while the FDIC generally has priority, the investors may be able to access the policies proceeds when the FDIC may not, if, for example, the relevant policies have exclusions precluding coverage for claims by regulatory bodies.

　

For now, the extent to which the FDIC will pursue litigation against former directors and officers of the failed institutions is uncertain, although the likelihood is that there will be extensive litigation ahead. In the meantime, numerous investors are pressing ahead with their own claims. In all likelihood, an extensive amount of litigation related to failed and troubled banks seems likely to accumulate as we head into next year.

　

4. Will the Mix of Litigation Involving Directors and Officers Continue to Shift Away from Securities Class Action Lawsuits?: One of the more interesting litigation phenomena of the last several years, at least as relates to the exposure of directors and officers, as been the material shift of litigation away from securities class action lawsuits and towards other types of lawsuits.

　

This shift was first discernable in the litigation that arose from the options backdating scandal, beginning in 2006. Though there were over 30 options backdating related securities class action lawsuit file, there were more than 160 options backdating related shareholders derivative lawsuits filed.

　

According to the mid-year 2010 corporate and securities litigation study by the insurance information firm Advisen, this shifting mix of litigation away from securities class action lawsuits has continued and securities class action lawsuits have represented a progressively smaller proportion of overall corporate and securities litigation for several years now. Thus, whereas prior to 2006, securities class action litigation represented over half of all corporate and securities litigation, through the middle of 2010 securities class action litigation represented less than 20% of all corporate and securities lawsuits.

　

What is making up the remainder of the corporate and securities lawsuits are a broad mix of kinds of claims including individual securities lawsuits, shareholder derivative lawsuits, and breach of fiduciary duty lawsuits.

　

This shifting mix has a number of important considerations. The first is that the dialog about litigation levels tends to focus on securities class action lawsuit filing patterns. Though class action lawsuit filings levels have always ebbed and flowed over time, it seems that every time the filing levels decline or climb (as they inevitably do), some commentator will make some sweeping generalizations about permanent changes in the filing levels.

　

The fact is, the dialog about shifting class action filing levels may be beside the point. The real story may be that the kinds of cases that are getting filed have changed.

 

In any event, the growing importance of lawsuits other than securities class action lawsuits does alter the issues that should be considered in the context of directors’ and officers’ liability exposures. The changing mix of litigation could have important implications for D&O insurance terms and conditions and limits of liability.

　

At a minimum, the changing litigation mix provides an important context within which to consider information relating to securities class action filing levels. Even if fewer class action lawsuits are being filed (at least lately, anyway), that does not mean the overall threat of litigation has declined. To the contrary, the Advisen report shows that the threat of corporate and securities litigation generally continues to increase. That is, the litigation threat is not declining, it is simply changing.

　

5. What Will Be the Impact of the Supreme Court’s Most Recent Securities Law Decisions?: Every year it seems, at least recently, the U.S. Supreme Court has issued important decisions affecting securities litigation. The Court’s most recent term, which was completed in June, proved to be no exception. The Court issued two cases of particular significance that potentially could have significant impact on future securities lawsuit cases and filings.

　

First, on June 24, 2010, the Supreme Court issued its long awaited ruling in the Morrison v. National Australia Bank case. The case was much anticipated because it was expected to provide much-needed guidance on the questions of the extraterritorial jurisdiction of the U.S. securities laws.

　

The Court threw everybody a bit of a curve ball, when it discarded many decades of jurisprudence analyzing when there was sufficient "conduct" in the U.S to support the application of the U.S. securities laws to a foreign company. The Court said that rather than a "conduct" based test, the securities laws required a "transaction" test, and effectively held that the U.S. securities laws do not apply to transactions that take place outside the U.S.

　

The Morrison case clearly rules out so-called "f-cubed" cases, which involve claims asserted against foreign-domiciled companies by foreign domiciled claimants who bought their shares on foreign exchanges.

　

Since the Morrison case came down, plaintiffs in other cases have tried to argue that Morrison does not preclude so-called "f-squared cases" – that is, cases in which U.S. investors bought a foreign company’s shares on a foreign exchange. So far, courts have not proven receptive to that argument but the issue is far from resolved.

　

In the meantime, the Morrison case seems likely to affect the many U.S. securities cases that have been filed in recent years against foreign domiciled companies. At a minimum, the cases in which the complaints have sought to assert claims on behalf of "f-cubed" claimants seem likely to be narrowed to exclude those claims. (I know many plaintiffs’ lawyers may contest the extent of this statement, and in recognition of their arguments I duly acknowledge their objections here.)

　

The larger impact of Morrison may be there will be fewer, or at least narrower, U.S. securities lawsuits filed against foreign domiciled companies. The many claimants who may now be unable to pursue claims in the U.S. may seek to resort to the courts and laws of their home countries, and perhaps, to the extent the home country laws fail to provide adequate relief, seek legislative change to allow greater investor protections.

　

The other significant decision this past term was the Court’s April 2010 ruling in the Merck case, in which the U.S. Supreme Court addressed the question of what is sufficient to trigger the running of the statute of limitations for securities claimants. The Supreme Court held that the running of the statute of limitations is not triggered until the plaintiffs have, or with reasonable diligence could have had, knowledge of facts constituting the violation, including facts constituting scienter.

　

The practical effect of the Court’s decision in Merck is that it could postpone the running of the statute of limitations, potentially lengthening the time within which plaintiffs might file their claim. This effect seems particularly significant in light of the relatively recent phenomenon that has developed in which plaintiffs have been filing securities lawsuits well after the proposed class period cutoff date.

　

Although so far there have been relatively few new filings that have reflected potential longer limitations periods, the possibility for an increase in belated filings remains. The challenge this presents for D&O insurance underwriters and companies alike is that it is harder to be sure when a company that has had adverse developments in the past may be "out of the woods" as far as possible securities lawsuits.

　

6. What Will Be the Impact of Securities Cases the Supreme Court Will be Considering in the Upcoming Term?: For whatever reason, the U.S. Supreme Court in recent years has seemed  particularly interested in taking up securities cases, and the Court’s docket for the upcoming October 2010 term is no exception. With Justice Kagan newly added to the Court’s lineup, the Court will be considering at least two potentially significant securities cases.

　

First, the Court has granted a writ of certiorari in the Matrixx Initiatives case. The question presented is whether plaintiffs must allege that adverse event information is "statistically significant" in order to establish that the defendants’ alleged failure to disclose the information was material. Though the issues involved appear narrow, the case potentially could address broader issues of securities claim pleading sufficiency.

　

Even if the Court confines itself just to the narrow question of statistical significance, the Court’s consideration of this issue has the potential to be important, since companies are regularly receiving customer complaints and must decide when the level of complaints are significant.

　

The larger possibility for this case is that the Court might take the occasion as an opportunity for a more comprehensive consideration of the issue of materiality. Were the Supreme Court to take up this larger question, the Court’s ruling potentially could have significant ramifications for many future securities class action lawsuits.

　

Second, the Court also granted certiorari in the Janus Capital Group case, which involved the question of who may be a "primary violator" under the securities laws. The defendants in the case are the holding company and the management company for a family of mutual funds. Investors claim they were misled by statements that the funds did not engage in market timing; the funds later entered a settlement for market timing.

　

As the Supreme Court recently affirmed in its Stoneridge case (about which refer here), there is no private action for aiding and abetting liability under the federal securities laws. Accordingly, the Janus entities can be liable if at all if they are "primary violators," that is, if they are directly responsible for the allegedly wrongful conduct. The Janus entities contend that as mere service entities for the actual funds, they cannot be held primarily liable.　

　

The Fourth Circuit ruled that "a service provider can be held primarily liable in a private securities fraud action for ‘helping’ or ‘participating’ in another company’s misstatements." The Fourth Circuit’s ruling is at odds with the decisions of other Circuit courts. Some courts hold that only someone that "makes" a statement and has it attributed to him can be held liable as a primary violator. Other courts, similarly to the Fourth Circuit, have held that someone that "substantially participates" in the activities that led to the creation of the allegedly misleading statement can be held liable as a primary violator, even if the statement is not attributed to him or her.

　

At some level, this "substantial participation" test starts to sound a lot like the "aiding and abetting liability" that the Supreme Court had rejected in connection with private lawsuits in the Stoneridge case. That may, in fact, be why the Supreme Court took up the case – not just to reconcile an apparent split in the Circuits, but to align the principles of primary violator liability with those of the secondary violator jurisprudence. In any event, and at a minimum, the case will draw greater clarity around what constitutes a primary violation of the securities laws.

　

7. What Will Happen to the Level of Business Bankruptcy Filings?: According to the latest report from the Administrative Office of the U.S. Courts, business bankruptcy filings rose 8.34% for the 12-month period ending June 30, 2010. Not only did the filing levels rise relative to the prior period, but they remain well above levels in recent years – for example, the filing rate during the twelve month period ending June 30, 2010 is 76% greater than the comparable period ending June 30, 2008, and 150% greater than the comparable period ending June 30, 2007.

　

The level of business bankruptcy filings directly affects the overall level of D&O claims activity, because so many bankruptcies involve claims against the former directors and officers of the failed entity. These claims are asserted by investors, creditors, the bankruptcy trustee and others. As long as the business bankruptcy filing rate remains at relatively elevated levels, D&O claims activity levels will also remain at higher levels.

　

The one positive note from the recent bankruptcy filing statistics is that the rate of business related filings may be slowing, albeit while remaining at relatively elevated levels. Thus, during the period ending June 30, the number of business-related filings declined during each of the three months periods during the twelve month stretch. During the first three months of the twelve month period, there were 15,303 business related filings; in the second three months, there were 15,156 business-related filings; in the third three-month period there were 14,697; and in the final three months, there were 14,452.

　

We can all hope that the continuing economic recovery will lead to fewer business-related bankruptcy filings in the months ahead. However, as long as the filing levels remain elevated compared to historical norms, D&O claims activity will also be elevated.

 

These issues are important because the interaction between the D&O insurance policy and the processes of the bankruptcy court are intricate and fraught with complexities. The ongoing heightened risk of business bankruptcy has important implications for D&O claims exposure as well as for issues surrounding the D&O insurance placement process.

　

8. What Will be the Next Sector to Get "Hot"?: One of the well-established patterns of securities class action lawsuit filings is that periodically some industrial sector will get "hot" and suddenly numerous companies in that sector will find themselves the targets of securities class action lawsuits.

　

Companies in the for-profit education sector saw that during August this year, when, following a government report suggesting the possibility of education loan fraud, nearly a half dozen companies in the sector were hit with securities suits within the space of just a few days. In just about the same way, late last year, a host of exchange traded funds were hit with securities class action lawsuits over a very short time period.

　

The recent industry-specific litigation outbreak in the for-profit education sector is a reminder of the many odd and circumstance-specific events that can drive securities class action lawsuit filings. Many things determine filing levels, many of which cannot be captured or predicted in historical filing data. As a result, it can be misleading to try to generalize from short term trends about future filing levels. Simply put, the numbers vary over time, because, for example, contagion events and industry epidemics happen.

　

　

9. Will Heightened FCPA Enforcement Activity Lead to Increased Follow-On Civil Litigation?: One of the relatively well-established trends in recent years has been that increasing Foreign Corrupt Practices Act enforcement activity has led to increasing levels of follow on civil litigation, in which the claimants assert that mismanagement and poor internal controls allowed the corrupt activity to occur. In addition shareholders also claim to have been misled about controls, as was alleged, for example, most recently in the securities class action lawsuit filed in August against SciClone Pharmaceuticals and certain of its directors and officers.

　

For at least a couple of reasons, the heightened level of anticorruption enforcement activity seems likely to accelerate in the months ahead.

 

First, as noted above, the recently enacted Dodd-Frank Act contains a whistleblower bounty provision that seems likely to produce heightened whistleblower activity in connection with FCPA violations. Under these whistleblower provisions, whistleblowers can receive rewards of up to 30 percent of recoveries over $1 million. These kinds of rewards could produce some enormous bounties in the FCPA enforcement context, where recent enforcement penalties have been in the range of tens and hundreds of millions of dollars.

　

Indeed, the top ten FCPA 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. Because of the massive scale of the settlements that the SEC has been achieving in this area, the potential rewards for whistleblowers are enormous.

　

Second, the UK Bribery Act 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.

　

Though the U.K. provisions may be somewhat delayed and though the impact of the new Dodd-Frank Act whistleblower provisions may be as yet undeveloped, 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 protect 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.

　

Finally, the increased levels of anticorruption enforcement may also represent a growing area of civil litigation exposure, as these kinds of enforcement actions frequently lead to follow-on civil lawsuits. Altogether, exposures arising from anticorruption laws represent an important and growing area of potential liability of corporate officials.

　

10. What Does All of This Mean for the D&O Insurance Marketplace?: The astonishing pace of legislative and judicial changes just over the last few months alone underscores how rapidly the liability exposures in the directors and officers arena can be transformed. Given the absolute whirlwind of recent changes, D&O insurers might be excused for taking a conservative approach to risk. Indeed, those outside the industry often assume that is what the carriers would be doing now.

　

But despite everything, the D&O insurance industry remains competitive, and all signs are that it will remain that way for the foreseeable future. Most insurance buyers, particularly those outside the financial sector and those with reasonably solid financials, can expect to obtain insurance with broad terms and conditions at relatively attractive prices. Though pricing is not declining at the pace we saw in recent years, pricing remains stable at relatively lower levels.

　

The iron laws of supply and demand are impervious to more trivial forces like legislative or judicial change. On the supply side, the insurance industry is operating with ample capacity, largely due to the absence of large-scale catastrophes. As a result, the D&O insurance marketplace is characterized by a large number of competitors all of whom are continuing to seek to write business. On the demand side, the number of businesses has been cut down by bankruptcies. Shrinking labor forces and diminished budgets have also reduced insurance demand.

　

In the absence of some large external event that substantially erodes insurance capacity, the likelihood is that insurance buyers (or at least those buyers outside the financial sector with relatively stable financials) will continue to enjoy a relatively favorable marketplace.

 

Nevertheless, the liability landscape for directors and officers is changing rapidly, and well-advised insurance buyers will want to make sure that their D&O insurance program is properly positioned to respond to these changing exposures.

　

Discount for Readers of The D&O Diary: On November 30 and December 1, 2010, I will be co-chairing the American Conference Institute’s 16th Annual Summit on D&O Liability. This conference is a great event every year, and once again the conference will feature an impressive array of the D&O insurance industry’s thought leaders. Background information about the conference, including the event brochure and registration information, can be found here.

　

The D&O Diary is a conference media partner for this event, and as a result the conference organizers are offering a $200 discount to readers of The D&O Diary. In order to obtain this discount, just use the code "D&O Diary" on the registration form. Hope to see everyone at the conference.

If the number of out of office messages sent back when I sent out new blog post email notifications during August are any indication, many readers have been away for some or all of the past few weeks. I hope you saved the little paper umbrella from the fruity drink that you and your spouse shared on the terrace of the outdoor café and that you are still finding sand in your tennis shoes.

 

Sadly, the summer eventually ends and everyone eventually has to go back to school.

 

 

Now that you are back at your desk, you will want to get caught up, especially because while you were away, the blogosphere continued to gyrate, and The D&O Diary continued to publish new posts. Here’s just some of what you missed:

 

 

The Nuts and Bolts of D&O: I have now published three installments in my ongoing series about the nuts and bolts of D&O insurance, the latest of which relates to the policyholder’s obligations under the D&O policy. The prior posts in the series related to the relationship of indemnification and insurance, and to the insuring agreement in the Policy. Additional installments will be forthcoming in the weeks ahead.

 

 

Guest Posts: I have been delighted to be able to publish a number of interesting guest posts over the past several weeks.

 

 

First, I published, in the form of two separate posts (here and here), an interesting exchange between Milberg partner Michael Spencer and Minnesota Law Professor Richard Painter, on the question of the impact of the Morrison v. National Australia Bank case.

 

 

Second, I published a post from Jones Day partner John Iole on the topic of conflicts in the insurance transaction.

 

 

And finally, I published a post (here) written by former plaintiffs’ securities attorney Bill Lerach, who had some spirited comments about my prior post discussing an article by three academics about whether corporate defendants that settle securities suits suffering continuing financial detriments. I published the academics’ response to Mr. Lerach over this past weekend.

 

 

Failed Banks: The number of banks that have been closed as a result of the current failed bank wave continues to grow.  Indeed, according to the FDIC’s most recently quarterly report, one out of ten banks in the U.S. is a “problem institution.” The FDIC has filed its first lawsuit, as part of the current failed bank wave, against former directors and officers of a failed bank. Meanwhile, investor litigation involving failed banks continues to move forward. For example, in the PFF Bancorp and Banco Popular cases the dismissal motions were denied, although in the Raymond James loan loss reserve case the dismissal motion was granted. In the meantime, at least one investor lawsuit involving a troubled bank appears headed to trial. NERA has published a comprehensive report on failed bank litigation.

 

 

Subprime Cases: There have been a number of significant dismissal motion rulings in subprime-related securities cases, including the partial dismissal in the BofA/Merrill merger case and the dismissal in the SunTrust case. In addition, the New Century Financial case settled for about $125 million. My updated list of subprime and credit crisis-related lawsuit dismissal motion ruling can be found here.

 

 

Coming Attractions: Now that everyone is caught up, tomorrow morning I will be publishing my annual survey of the D&O marketplace, “What to Watch Now in the World of D&O.” Watch this site.

 

 

Speakers’ Corner: On September 29, 2010, I will be speaking at C5’s 5th European Forum on D&O Liability Insurance in Cologne, Germany. I will be participating on a panel with Maurice Pesso of the White & Williams law firm on the topic “Why European Directors of U.S. Companies Should Worry About Their Exposure to U.S. Class Action Claims” – a topic that has changed pretty dramatically in the last few months. Information about the conference can be found here. I will look forward to seeing and greeting my European readers at this upcoming conference.

 

A recent article by three academics raising the question whether corporate securities lawsuit defendants underperform financially after their case settles has generated significant commentary on this site. In this post, the professors respond to the commentary.

 

The article in question is a March 18, 2010 paper entitled "Lying and Getting Caught: An Empirical Study of the Effect of Securities Class Action Settlements on Targeted Firms" (here) by Cincinnati Law Professor Lynn Bai, Duke Law Professor James Cox, and Vanderbilt Law Professor Randall S. Thomas.

 

 

The article describes the professors’ research in which they sought to discover whether getting hit with a securities a lawsuit and then subsequently entering into a settlement "weakens the defendant firm so that from the point of view of well-received financial metrics the firm is permanently worse off as a consequence of the settlement."

 

 

My initial post about the article provoked an unusual amount of reader commentary, including a comment about the academic’s research and analysis posted by former plaintiffs’ securities attorney, Bill Lerach. With Mr. Lerach’s consent, I republished his comment as a separate guest post, here.

 

 

The professors have prepared and submitted a response to the various comments about their paper.  Here is the professors’ response:

 

 

The comments seem to have concentrated on the possible alternative causation of the underperformance of defendant companies involved in securities class actions, i.e., these companies had financial problems prior to the lawsuit and it was likely that these pre-existing problems prompted the companies’ management to lie, and thus, it should not be surprising to see that these companies underperform their peers after settlement. We do not deny that this could be an alternative explanation to the underperformance that we have seen in the data, and indeed we have explicitly talked about this alternative explanation at a number of places in our paper. However, our study has also revealed empirical evidence that is inconsistent with this intuitive explanation, and we thought we should report such evidence in the paper so that people can think about them and perhaps follow up with more research.

 

 

First, we are not seeing deterioration (post-lawsuit and post-settlement compared to pre-class period) in the defendant firms’ sales numbers. This holds true both in terms of defendant firms’ absolute sales numbers and relative performance to their peers. We know that sales reflect the bottom line of the financial health of a company and the robust sales shown in the data are inconsistent with the story that these firms are deteriorating on their own independent of the lawsuit.

 

 

Second, we are seeing deterioration in liquidity in post-settlement period but not in the post-lawsuit-but-pre-settlement period. If the liquidity constraint is caused primarily by other factors such as banks’ withdrawal of credit as a result of revelation of fraud (as Bill Lerach suggested), why are we seeing significant constraints only in the post-settlement period?

 

 

Thirdly, although the average Altman Z-scores for defendant firms were lower in post-lawsuit and post-settlement periods compared to the pre-class period, the inferiority was more prominent in the post-settlement periods. The significantly lower Altman z-score in post-settlement periods seems consistent with the heightened liquidity constraint we observe in the post-settlement period. Again, we do not rule out the possibility that defendant firms are deteriorating on their own, but we want to point out that the data can also be consistently explained by an alternative hypothesis, i.e., lawsuit and settlement had an independently negative effect on the financial health of the defendant firms.

 

 

The comments are legitimate and we appreciate the interest that people have shown in this topic.  We have certainly thought about the causation issue in our research, but we could not explain completely what we were seeing in the data by the hypothesis that defendant firms were destined to underperform even if they were not dragged into a lawsuit. We have dutifully reported what we saw in the data.

 

 

I would like to thank the professors for taking the time to prepare a thoughtful response and for their willingness to have the comments posted on this site. My thanks to all of the readers who have engaged in this dialog. Further comments are still very much welcome.

 

Many observers have been waiting to see whether and to what extent the FDIC will pursue claims against former directors and officers of banks that have failed during the current bank failure wave. So far, the FDIC has filed just a single suit, against former officers of a subsidiary of IndyMac.

 

However, on August 31, 2010, federal regulators filed a complaint in the Central District of California against 16 officer and directors of a failed financial institution – but the agency filing the lawsuit was not the FDIC and the failed institution was not a bank. Rather, the agency filing suit was the National Credit Union Administration, and the failed institution was a credit union, Western Corporate Federal Credit Union (or WesCorp) of San Dimas, California.

 

A copy of the NCUA’s complaint can be found here. A copy of the NCUA’s August 31, 2010 press release can be found here.

 

Prior to its closure, WesCorp had operated as a wholesale or corporate credit union, providing back office services to other credit unions. As reflected in the agency’s press release at the time, on March 20, 2009, the NCUA placed WesCorp in conservatorship. At the time, WesCorp had $23 billion in assets and 1,100 retail credit union members.

 

As reported in the Agency’s August 31 press release, the former directors and officers were originally sued in November 2009 in Los Angeles County Superior Court in action brought by seven WesCorp member credit unions. The NCUA intervened in that suit and sought leave to substitute the NCUA as the proper party plaintiff. The court granted the NCUA’s motion and to file an amended complaint by August 31. The NCUA’s complaint supersedes the initial complaint filed by the member credit unions.

 

The NCUA’s complaint alleges beginning in 2002, after Robert Siravo became the institution’s CEO, WesCorp embarked “an aggressive campaign” to grow, which was successful due to the institution’s reliance on borrowed funds to make investments in mortgage backed securities. While WesCorp grew, so did its borrowings, which eventually equaled over 30% of the institution’s assets. As the firm grew, so too did its exposure to exotic mortgage backed assets, particularly securities backed by Option ARM mortgages.

 

In 2009, WesCorp was forced to record $6.9 billion in losses, rendering the institution insolvent. About two-thirds of the losses were from Option ARM securities WesCorp purchased in 2006 and 2007.

 

In addition to allegations against all defendants alleging negligence and breach of fiduciary duty, the NCUA complaint also allege that Siravo and the former head of Human Resources manipulated their retirement accounts to make them more lucrative, resulting in over $4.4 million in overpayments, including an extra $2.3 million to Siravo.

 

One of the defendants in the case is William Cheney, who was a member of WesCorp’s board from May 2002 to February 2006. Cheney is currently the President of the CUNA, which is the credit union industry’s national trade association.

 

At the time that the NCUA took control of WesCorp, the institution was the largest of the corporate credit union. The credit union industry, along with the rest of the financial sector, had been suffering some turbulence over the last several years. The NCUA has closed 14 retail credit unions in 2010, and closed 12 retail credit unions in 2009. There were 7,554 federally insured credit unions as of December 31, 2009.

　

The Wall Street Journal’s September 2, 2010 article about the NCUA’s lawsuit can be found here.

　

Be Excellent to Each Other: San Dimas is not only the pre-conservatorship home of WesCorp. It is also the home of San Dimas High School, which is of course where Bill and Ted went to school in the most excellent 1989 movie, Bill and Ted’s Excellent Adventure. (I wonder if Bill and Ted went on to work at WesCorp after their high school graduation. Perhaps in the investment division.) I am sure that when Bill and Ted learned that WesCorp had been put into conservatorship, they said something like “Bogus. Heinous. Most non-triumphant.”

 

In honor of San Dimas High School and the school’s two most famous alums, here’s a video tribute to Bill and Ted, showing their history report at a San Dimas high school assembly:　

　

https://youtube.com/watch?v=ijqnsRqSo2k%3Ffs%3D1%26hl%3Den_US%26rel%3D0

 

One of the most interesting aspects of the complicated sequence of events surrounding the Bank of America/Merrill Lynch merger is the suggestion that Treasury Secretary Henry Paulson instructed BofA’s CEO Ken Lewis not to disclose to BofA shareholders that the government, in order to keep BofA from backing out of the deal, was backstopping BofA to the tune of billions of dollars of additional TARP funds and asset guarantees.

 

As I recently pointed out in my discussion of the opinion, Southern District of New York Judge Kevin Castel, in his August 27, 2010 dismissal motion ruling in the BofA/Merrill securities suit, found that the plaintiffs had not sufficiently alleged scienter in connection with BofA’s alleged failure to disclose this federal backstop.

 

In support of this conclusion, Castel said the defendants were "acting at the instruction of the Treasury Secretary during a moment of acute economic and political uncertainty. There are no allegations of personal gain derived from the federal funds, or a violation of a statute or regulation in a ‘highly unreasonable’ manner."

 

Castel doesn’t say that BofA didn’t have a duty to disclose the existence of the federal backstop. But if BofA had a duty to disclose the information, what difference does it make under the federal securities laws that Paulson told Lewis not to disclose it? As CNN Money journalist Colin Barr noted on September 1, 2010 in his Street Sweep blog post entitled "Judge Embraces ‘Paulson Made Me’ Defense" (here), Castel’s ruling has "left some observers scratching their heads."

 

Is Castel suggesting that there is some kind of governmental instruction or national emergency exception to the disclosure requirements under the federal securities laws? On what basis? Whose instruction is sufficient? What level of exigency is sufficient and who decides?

 

I was glad to see Barr’s post focusing on this aspect of Judge Castel’s ruling. I think these issues are both interesting and important, but for whatever reason, this part of Castel’s opinion has largely gone without public comment.

 

I did explore these issues in my prior post about Judge Castel’s opinion. Because I think these issues are worthy of attention and further consideration, and at risk of appearing a little too self-referential, I am reproducing here my prior comments about this aspect of Judge Castel’s ruling, in order to try to highlight these issues and to try to encourage further discussion of these questions. Here are my thoughts on this issue:

　

The BofA/Merrill Lynch merger was one of highest profile events during the peak of the global financial crisis in late 2008 and early 2009. The disclosures in early 2009 about Merrill’s losses and about the bonus payments were highly controversial. As a result, Judge Castle’s opinion in the consolidated shareholder litigation undoubtedly will provoke extensive scrutiny and commentary. There are indeed a number of parts of the opinion that are worthy of discussion, but the part this is the most interesting to me is his conclusion regarding the inadequacy of the scienter allegations in connection with the alleged failure to disclose the federal bailout that Lewis negotiated with Paulson.

　

As alleged in the complaint, this massive federal package was negotiated after the shareholder vote but before the deal closed. Its existence was apparently critical to the BofA board’s vote to go forward with the deal rather than to invoke the MAC clause. Moreover, it was understood that Paulson’s verbal agreement would have to be disclosed if it were reduced to writing – and accordingly, it was not reduced to writing so it wouldn’t have to be disclosed.

　

In concluding that these actions, which seem to have been taken precisely so that something everyone recognized as important would not have to be disclosed prior to the merger closing, do not give rise to a strong inference of scienter, Judge Castel relied on two considerations: (1) Paulson "instructed" Lewis not to disclose the federal package; and (2) Lewis had nothing to gain personally from withholding disclosure.

　

Though these factors undoubtedly are relevant, it strikes me that these points do not necessarily answer the question whether or not Lewis consciously misled BofA shareholders of acted with reckless indifference to the truth.

　

It could be argued that the allegations strongly suggest that Lewis did not want the BofA shareholders to know that the only reason the BofA board was willing to go forward with the deal was the existence of massive federal support. A plausible inference is that he, like Paulson, feared the chaos that would have emerged if these facts were revealed before the deal closed. It is also plausible to infer that Lewis and others didn’t want to anger Paulson and risk losing the proffered federal support.

　

These might all have seemed like good and sufficient reasons to withhold the information, but whether or not the reasons might have seemed good and sufficient does not answer the question whether Lewis and others acted with awareness of or conscious disregard whether BofA shareholders would be misled.

　

The fact that Paulson "instructed" Lewis to withhold disclosure does not answer the question whether or not Lewis was aware BofA shareholders would be mislead; to the contrary, it might actually suggest a concern that BofA’s shareholders couldn’t be trusted with the truth. (Indeed, Paulson’s instruction arguably does nothing more than make him complicit in the alleged deception, which in Paulson’s case, encompassed not just BofA shareholders but also U.S. taxpayers.)

　

Why is Paulson’s "instruction" relevant at all to the question whether or not the securities laws were violated? Is Castel suggesting that there is some sort of immunity from securities liability if the actions were at the request of a government official? It seems to me that the supposed relevance of Paulson’s instruction is surprisingly unexamined in Castel’s opinion, and the entire discussion of the issue is disconnected from the question whether or not Lewis knew that the shareholders would be misled.

　

Judge Castel’s emphasis on Lewis’s lack of personal benefit, while not irrelevant, is also beside the point. Lewis’s lack of personal benefit certainly doesn’t answer the question whether Lewis and others were deliberately taking steps to avoid disclosing material information because they were afraid of what would happen if they did.

　

In the final analysis, I think Judge Castel’s ruling can perhaps only be understood by his observation that these events took place "during a moment of acute economic and political uncertainty." While this fact has nothing to do with whether or not Lewis was consciously withholding information from BofA shareholders, it does suggest Castel is simply unwilling to permit liability for actions taken at the direction of senior public officials at a time of national exigency. It is almost as if he is saying, with shrugging shoulders, "What else was BofA going to do?" I certainly understand this way of looking at these circumstances. The problem is that it doesn’t necessarily address the questions required by the securities laws.

　

Judge Castel does not actually say he is inferring either an official instruction or national emergency exception to the requirements of the securities laws. But by emphasizing those aspects of the situation, he seems to be suggesting that these exceptions exist and apply.

　

To be sure, Judge Castel did observe that the scienter allegations regarding the nondisclosure of the federal package, which he characterized as "thin," might have been sufficient if they were accompanied by adequate allegations of motive or recklessness. It could be argued that his ruling is simply a reflection of insufficient factual pleading, which may be the case. Nevertheless, his analysis raises many questions that in my view are insufficiently examined, whether or not the scienter allegations themselves were or were not sufficient.

　

Given the high profile nature of this case, I suspect there will be much discussion of Judge Castle’s opinion in the weeks and months ahead. Legal proceedings arising out of these circumstances do seem to attract controversy – as, with for example, Judge Rakoff’s high profile rejection of the SEC’s settlement of its enforcement action against BofA arising from these circumstances.

　

Back to School: Add one more company to the list of for-profit education companies that have recently been sued in securities class action lawsuits. As I discussed in a recent post, within the space of just a few days in August, plaintiffs’ lawyers filed a cluster of lawsuits against for-profit education companies. On August 31, 2010, plaintiffs’ lawyers added one more company to the list when they sued Corinthian Colleges and certain of its directors and offices, based on allegations similar to those raise against the other for-profit education companies. A copy of the plaintiffs’ lawyers’ press release can be found here.

　

Old School: I wonder if this for-profit education company’s schools cover their chairs with Soft Corinthian Leather. For those who miss the reference, and in respectful memory of Ricardo Montalban, here is the original Chrysler Cordoba advertisement to which I was referring :

　　

https://youtube.com/watch?v=vIL3fbGbU2o%3Ffs%3D1%26hl%3Den_US%26rel%3D0

According to the FDIC’s Second Quarter 2010 Quarterly Banking Profile, which the agency released on August 31, 2010, aggregate indicators of banking institutions’ financial health are improving, but at the same time the number of "problem institutions" also continues to increase. The FDIC’s August 31, 2010 press release about the Quarterly Banking Profile can be found here.

 

The positive news is that the industry’s 2Q10 earnings of $21.6 billion are the highest since the third quarter of 2008. Almost two-thirds of the banks reported higher year-over-year quarterly net income. However, 20 percent of institutions did report quarterly net losses (compared to 29 percent 2Q09).

 

The quarterly report also reflects that provisions for loan losses, while "still high by historic standards," represented the smallest total since the first quarter of 2008. Fewer borrowers are falling behind on their loan payments. With respect to just about every type of loan, troubled loans declined for the first time in more than four years. The only exception was commercial real estate loans, which continued to show increased weakness.

 

Despite this relatively good news, the number of problem institutions increased in the second quarter, to 829, up about 7% from the 775 problem institutions at the end of 1Q10, up 18% from the 702 problem institutions at the end of 2009, and up almost 100% from the 416 at June 30, 2009. (The FDIC defines a "problem institution" as those it rates as "4" or a "5" on its one-to-five scale of rating banks’ financial and operating criteria. The FDIC does not disclose the names of the problem institutions.)

 

The number of problem institutions is the highest since March 31, 1993, when there were 928.

 

To put the latest number of problem institutions into perspective, at the end of the second quarter, there were a total of 7,830 insured institutions. So the 829 problem banks represent about 10.6% of all insured institutions.

 

Or to put it a different way, one out of every ten banks in the United States is a problem institution. (And that’s after the 283 banks that have failed since January 1, 2008 have been taken out of the equation).

 

Though the number of problem institutions increased in the quarter, the assets associated with these banks did decrease. The 829 problem institutions at the end of the second quarter represented assets of about $403 billion, down slightly from the $431 billion that represented by the 775 problem institutions at the end of 1Q10.

 

To put the assets associated with the problem institutions into perspective, the collective assets of all insured institutions totals $13.2 trillion. The $403 billion in assets associated with the problem institutions represents about 3.1% of the industry’s total assets.

 

One other sign that the banking industry as a whole may not yet be in the clear, notwithstanding the relatively positive industry news overall, is that during the second quarter and for the first time in the 38 years for which data is available, there were no new insured institutions.

 

Since January 1, 2008, 283 banks have failed, 118 in 2010 alone. But even with the growing numbers of failures (each one of which presumably reduces the number of problem institutions by a count of one), the number of problem institutions continues to grow. The likelihood seems to be that the number of failed banks will continue to grow for some time to come.

 

Eric Dash’s August 31, 2010 New York Times article about the report can be found here.

 

Ain’t Too Proud to Beg: The D&O Diary has been selected as a nominee candidate for the LexisNexis Top 25 Business Law Blogs of 2010. The ultimate list of the Top 25 blogs will be chosen based on comment submited by members of either of two LexisNexis business law communities, the Corporate & Securities Law Community and the UCC, Commercial Contracts and Business Law Community. If you are a registered member of either of these communities, I would appreciate your comment in support. Members of the Corporate & Securities Law Community can submit comments here, and members of the UCC, Commercial Contracts and Business Law Community can submit comments here. The deadline for comments is October 8, 2010.

In a post last week, I discussed a recent article by three academics in which they considered whether companies involved in securities lawsuits  financially underperform after the cases are settled. The prior post provoked an unusual level of reader commentary. Among the comments posted was one from former plaintiffs’ securities class action attorney William Lerach.

 

Because I know readers enjoy a spirited discussion as much as I do, and because I believe this blog can and should encompass a wide variety of viewpoints, I communicated with Mr. Lerach to see if he would allow me to republish his comment in the form of a guest post on this site. Mr. Lerach agreed and so his comment is reproduced below. In order to appreciate the context for Mr. Lerach’s remarks, I strongly recommend reading the prior post on which he is commenting. Here are his comments:

 

After reading Kevin’s description of this study concerning the post settlement performance of companies sued for securities fraud and his own evaluation of the paper I don’t know whether to characterize them both as silly or stupid. They’re probably a combination of both. Almost everything about the study and the associated commentary ignores the basic realities of the circumstances that surround the vast majority of securities fraud litigations. Most companies end up being sued for securities fraud––and then end up (with the help of directors’ and officers’ liability insurance) paying a settlement––because they have lied to the marketplace about the quality of the corporation’s business or its products or finances. Frequently the revelation of the truth results and not only a sharp drop in the stock price but adverse financial revelations, a drop in revenues and cash flow, violation of bank or lending covenants and management shakeups. So are we surprised that companies with these characteristics suffer "greater risks of financial distress" after they later settle a lawsuit. Of course they face such risks because they were lying about the nature of their business earlier–to cover up flaws in products, performance or the business model itself. Often such companies face a" liar’s discount" in the marketplace as a consequence of their prior bad conduct. It’s not the lawsuit or the settlement of the lawsuit that injures the company-or impairs it ongoing performance of financial condition-it is the misconduct, the lying and the financial falsification of the executives that got the company sued in the first place that undermines the future performance and financial health of the company. We should not be surprised that companies that have committed securities fraud––whether it’s stuffing the channel, lying about their products, or falsifying their financials, "perform worse than their peers". What is it about such companies and their managements that would cause us to believe that they would perform better than their peers? Kevin’s conclusion that this flawed study suggests that suits are better directed at the individuals who perpetrated the misconduct i.e. the officers of the company– and that this would somehow spare the corporate entity the financial distress of the settlement -ignores the reality of the indemnification obligation of the company which in virtually every case causes the company to fund the bulk of any settlement on behalf of the officers directors and then only to the extent it has not been paid for by directors and officers liability insurance, a contributor which would have no material adverse impact on the corporate entity. Underlying the study and Kevin’s commentary on it is the notion somehow that suits brought on by half of shareholders merely transfer money from one group of shareholders to another and therefore really don’t benefit anyone– but harm the company. Not only does this ignore the reality that the bulk of the settlement monies in these cases comes from directors and officers insurance but it completely misses the point that the vast majority of settlement proceeds go to former shareholders of the company––those investors who purchased the shares of the company at an inflated price during the fraud period but who in most instances, out of anger , frustration, or even for tax considerations later sell the shares at a loss and have no further interest in the corporate entity. These are former shareholders not current shareholders with the equivalent of a tort claim against the company. I normally am not moved to comment on the academic work done concerning securities lawsuits but the simplistic nature of this study is so obvious that I could not resist pointing out these shortcomings. It may well be that there are many defects with securities fraud class action lawsuits but any financial underperformance of companies that follows their settling such lawsuits against them and their officers and directors is not one of them.

 

I would like to thank Mr. Lerach for taking the time to communicate his reaction to my prior post and for allowing me to reproduce his thoughts here. As I have already had my say on this topic, and because my business partners prefer that I attend to my day job from time to time, I will not respond here to Mr. Lerach’s comments. However, I expect some readers may have their own reactions to Mr. Lerach’s remarks, and I encourage everyone to consider adding their thoughts to this post using the blog’s comment feature. I have always hoped this site would serve as a platform for the exchange of ideas, and I encourage all readers to use post their thoughts for the benefit of other readers.

 

In a prior post (here), I reviewed the recent biography of Mr. Lerach, Circle of Greed. My interview with the book’s authors can be found here.

 

That’s Reassuring:  I am still trying to work out whether I am silly or stupid. Or perhaps both. In the meantime, I take some consolation from the fact that Lexis Nexis has selected The D&O Diary as one of the Top 50 Insurance blogs, as reflected in the icon embedded in the right hand margin.

 

In addition, George Mason Law Professor J.W. Verret, writing in the Truth on the Market blog on Monday, included The D&O Diary as one of twelve blogs he lists as his "favorite corporate law blogs." UCLA Law Professor Stephen Bainbridge, commenting on Verret’s list on  the ProfessorBainbridge.com blog, also included The D&O Diary on his (somewhat longer) list of corporate law blogs he reads regularly.  My thanks to both venerable Professors (and fellow bloggers). I should add that my blog list is very much like theirs and that my list also includes both of their blogs.

 

In an August 27, 2010 opinion so massive that its table of contents alone is five pages long, Southern District of New York Judge Kevin Castel granted in part and denied in part the motions to dismiss in the consolidated securities and derivative litigation arising from Bank of America’s January 2009 acquisition of Merrill Lynch and related events. Though the opinion dismisses parts of the lawsuit, other substantial pieces, particularly those related to the controversial bonuses paid to Merrill employees at the end of 2008, will be going forward.

 

Background

In the whirlwind of events in mid-September 2008 that included the collapse of Lehman Brothers and the dramatic government bailout of AIG, BofA agreed to acquire Merrill Lynch. According to the allegations in the subsequent lawsuits, one of the important features of the merger negotiations related to 2008 bonuses scheduled to be paid to Merrill employees in January 2009. The complaint alleges that BofA agreed to a $5.8 billion bonus pool and agreed that the bonus payments could be accelerated so the payout occurred prior to year end 2008 and before the merger transaction closed on January 1, 2009.

 

The complaint alleges that these bonus arrangements were not disclosed to BofA shareholders in the proxy materials that were sent to shareholders on November 3, 2008. (The arrangements were described in a "Disclosure Schedule" that was not available to shareholders prior to the shareholder vote).

 

On October 7, 2008, after the merger was announced but prior to the proxy vote, BofA conducted a $9.9 billion secondary offering. In October and November 2008, while shareholder approval of the transaction was pending, Merrill suffered losses of over $15 billion and also took a $2 billion goodwill impairment charge. The Complaint alleges that BofA’s senior officials were aware of these losses as they occurred. The Complaint alleges that the losses were so significant that BofA management discussed terminating the transaction, prior to the December 5, 2008 shareholder vote on the merger, in which BofA shareholders approved the merger.

 

In discussions after the merger vote about Merrill’s deteriorating condition, BofA senior management considered whether BofA had the right to terminate the merger under the merger agreement’s "material adverse change" (MAC) clause. On December 17, 2008, BofA Chariman and CEO Kenneth Lewis called Treasury Secretary Henry Paulson to advise him that BofA was "strongly considering" invoking the MAC clause. At Paulson’s invitation, Lewis flew to Washington for a face-to-face meeting, at which Paulson and Federal Reserve Board Chair Ben Bernanke urged Lewis not to invoke the MAC clause.

 

In subsequent conversations, Lewis again advised the government officials that BofA intended to invoke the MAC clause. According to the complaint, BofA’s board voted on December 21, 2008 to invoke the MAC clause, but on the following day, the Board voted to approve the merger, apparently in part based on Lewis’s statement that he had received verbal assurances from Paulson that BofA would received a capital infusion and a guarantee against losses from risky assets if the merger concluded. Lewis allegedly told the Board that the company would not enter into a written agreement concerning the federal funds because he could not risk public disclosure of the government loans prior to the transaction’s scheduled January 1, 2010 closing. Instead, the government bailout package would be disclosed at the time of the company’s earnings release later in January.

 

On January 16, 2010, BofA disclosed the fourth quarter losses of both BofA and Merrill and also revealed the federal funding package, which included $20 billion in capital and protection against further losses on $118 billion in assets. In following days, news about Merrill’s bonus arrangement broke.

 

In response to this news, BofA’s share price declined, and shareholder litigation ensued. The plaintiffs alleged that the defendants misstated and concealed matters related to the Merrill bonuses, the losses that accrued in the Fourth Quarter of 2008 after the merger was announced, and the pressure to consummate the deal from government officials. After the securities and derivative lawsuits were consolidated, the defendants moved to dismiss.

 

The August 27 Order

Judge Castel’s massive August 27 memorandum opinion and order covers a lot of ground, much of which cannot be easily summarized. For simplicity’s sake, I have summarized here only his rulings pertaining to the major categories of factual allegations.

 

Merrill Lynch Bonus Payments: First, Judge Castel held that the plaintiffs had sufficiently alleged actionable misstatement with respect to the parties’ "undisclosed written agreement authorizing the payment of bonuses to Merrill," because the proxy "portrayed bonus payments to Merrill employees as a contingent event, when, in reality, the parties had reached agreement as to the timing and range of bonuses." Accordingly, the proxy materials "omitted information necessary to render the statements truthful" and the omission "was material."

 

Judge Castel also held that the plaintiffs had sufficiently alleged scienter in connection with the Merrill Lynch bonus allegations, at least other than with respect to two specific BofA officials (Price and Crotty) who were not sufficiently alleged to have been involved in the negotiations or disclosures.

 

Judge Castel found that "the Securities Complaint explicitly alleges awareness of the bonus arrangement on the part of Lewis and [Merrill CEO John] Thain, which was memorialized in the secret Disclosure Schedule." Both of these men, Judge Castle said, "were closely involved in the details of the bonus negotiations, the resolution of which was concealed from BofA shareholders." These allegations, Judge Castle said, "raise an inference of recklessness that is ‘at least as compelling as any opposing inference of nonfraudulent intent.’"

 

With respect to the BofA directors, Judge Castel concluded that the allegations of scienter were insufficient, but the allegations were sufficient to allege negligence, and therefore, while not stating a claim under Section 10(b), were sufficient to state a claim under Section 14(a). Judge Castel observed with respect to the BofA directors that if they "were aware that the Joint Proxy was materially deficient (as is alleged) or if they should have been aware of deficiencies but took not steps to remedy or inquire about them (as is also alleged), the negligence standard of Section 14(a) would be satisfied." The allegations against Price and Crotty were insufficient event to establish negligence.

 

Fourth Quarter Losses: Judge Castel also concluded that the plaintiffs had sufficiently alleged actionable misstatements with respect to the alleged failure to disclose the fourth quarter losses. However, while concluding that the complaints adequately allege that the magnitude of the losses was material, the Complaint does not "sufficiently allege how the failure the failure to disclose the losses was ‘highly unreasonable’ and "represented an extreme departure" from the standards of ordinary care."

 

Judge Castel added that the securities complaint fails "to adequately and plausibly explain why a defendant would be motivated to accurately disclose a ‘turbulent’ and ‘tumultuous’ economic forecast for the quarter yet recklessly or intentionally conceal the dire reality as the quarter unfolded." Accordingly he concluded that the securities complaint "fails to allege scienter as to defendants’ failure to disclose the fourth quarter losses."

 

　

However, while Judge Castel concluded that the securities complaint "does not satisfy the threshold for alleging fraud" it does "adequately set forth a theory grounded in negligence." Accordingly he denied the defendants’ motion to dismiss securities plaintiffs’ Section 14(a) claims, as well the derivative plaintiffs’ claims, based on the failure to disclosure the fourth quarter losses.

 

Undisclosed Federal Bailout Arrangements: Judge Castel found that the plaintiffs had sufficiently alleged an actionable misstatement or omission with respect to the bailout understanding that Lewis reached with Paulson. He found that "detailed, non-conclusory allegations plausibly allege that BofA received concrete assurances from officials …that BofA would receive a massive capital infusion in exchange for proceeding with the Merrill acquisition" but that this agreement was "intentionally not memorialized to avoid public disclosure." Judge Castel concluded that these allegations "adequately alleged the particulars of fraud."

 

However, Judge Castel found that the allegations about the nondisclosure of the federal agreement fail to satisfy the requirements for pleading scienter. He noted that "the scienter allegations are thin" and that the complaint only explicitly asserts scienter as to Lewis.

 

Judge Castel noted that the complaint alleges a consciousness on Lewis’s part of avoiding liability because he sought a letter from Bernanke providing immunity from civil claims. Judge Castle observed that the securities complaint does not allege that Lewis or any other defendant "stood to gain from non-disclosure" and to not allege "a quid pro quo type arrangement" or that failing to disclose the federal funding brought a benefit to any defendant.

 

Judge Castel noted further that "the decision not to disclose federal support originated in an instruction by Paulson." There is, Judge Castel noted, "no allegation that Lewis or any other defendant hatched a scheme to avoid public disclosure of the federal capital support." Rather than "self-interested motivations," Lewis "acted as ‘instructed’ by Paulson." Judge Castel added that "while Paulson’s instruction would not necessarily preclude a finding of scienter if other allegations established motive or recklessness, it anchors the defendants’ concealment to Paulson’s directions."

 

The defendants, Judge Castel noted, "were acting at the instruction of the Treasury Secretary during a moment of acute economic and political uncertainty. There are no allegations of personal gain derived from the federal funds, or a violation of a statute or regulation in a ‘highly unreasonable’ manner."

 

The October 2008 Offering: Judge Castel denied the defendants’ motion to dismiss the securities plaintiffs’ ’33 Act claims, except to the extent the allegations related to non-actionable puffery.

 

Other Holdings: Judge Castel dismissed both the securities plaintiffs’ and the derivative plaintiffs’ allegations relating to the defendants’ disclosures regarding the defendants’ failure to invoke the MAC and the alleged failure to disclose the defendants’ consideration of possible invoking the MAC. Judge Castel also dismissed the plaintiffs’ claims relating to statements about the adequacy of BofA’s due diligence. Judge Castel also rejected the plaintiffs’ claims relating to a number of post-merger statements.

 

Demand Excused: Judge Castel concluded that the demand was excused on the derivative plaintiffs’ Section 14(a) claims because the directors "faced a ‘substantial likelihood’ of personal liability on the Section 14(a) claim at the time the suit was commenced," which would have "prevented them from exercising their disinterested and impartial judgment to a demand request." However, Judge Castel concluded that demand was not excused as to the derivative plaintiffs’ breach of fiduciary duty claims against the BofA board for approving the merger.

　

Discussion

The BofA/Merrill Lynch merger was one of highest profile events during the peak of the global financial crisis in late 2008 and early 2009. The disclosures in early 2009 about Merrill’s losses and about the bonus payments were highly controversial. As a result, Judge Castle’s opinion in the consolidated shareholder litigation undoubtedly will provoke extensive scrutiny and commentary. There are indeed a number of parts of the opinion that are worthy of discussion, but the part this is the most interesting to me is his conclusion regarding the inadequacy of the scienter allegations in connection with the alleged failure to disclose the federal bailout that Lewis negotiated with Paulson.

 

As alleged in the complaint, this massive federal package was negotiated after the shareholder vote but before the deal closed. Its existence was apparently critical to the BofA board’s vote to go forward with the deal rather than to invoke the MAC clause. Moreover, it was understood that Paulson’s verbal agreement would have to be disclosed if it were reduced to writing – and accordingly, it was not reduced to writing so it wouldn’t have to be disclosed.

 

In concluding that these actions, which seem to have been taken precisely so that something everyone recognized as important would not have to be disclosed prior to the merger closing, do not give rise to a strong inference of scienter, Judge Castel relied on two considerations: (1) Paulson "instructed" Lewis not to disclose the federal package; and (2) Lewis had nothing to gain personally from withholding disclosure.

 

Though these factors undoubtedly are relevant, it strikes me that these points do not necessarily answer the question whether or not Lewis consciously misled BofA shareholders of acted with reckless indifference to the truth.

 

It could be argued that the allegations strongly suggest that Lewis did not want the BofA shareholders to know that the only way the BofA board was willing to go forward with the deal was the existence of massive federal support. A plausible inference is that he, like Paulson, feared the chaos that would have emerged if these facts were revealed before the deal closed. It is also plausible to infer that Lewis and others didn’t want to anger Paulson and risk losing the proffered federal support.

 

These might all have seemed like good and sufficient reasons to withhold the information, but whether or not the reasons might have seemed good and sufficient does not answer the question whether Lewis and others acted with awareness of or conscious disregard whether BofA shareholders would be misled.

 

The fact that Paulson "instructed" Lewis to withhold disclosure does not answer the question whether or not Lewis was aware BofA shareholders would be mislead; to the contrary, it might actually suggest a concern that BofA’s shareholders couldn’t be trusted with the truth. (Indeed, Paulson’s instruction arguably does nothing more than make him complicit in the alleged deception, which in Paulson’s case, encompassed not just BofA shareholders but also U.S. taxpayers.)

 

Why is Paulson’s "instruction" relevant at all to the question whether or not the securities laws were violated? Is Castel suggesting that there is some sort of immunity from securities liability if the actions were at the request of a government official? It seems to me that the supposed relevance of Paulson’s instruction is surprisingly unexamined in Castel’s opinion, and the entire discussion of the issue is disconnected from the question whether or not Lewis knew that the shareholders would be misled.

 

Judge Castel’s emphasis on Lewis’s lack of personal benefit, while not irrelevant, is also beside the point. Lewis’s lack of personal benefit certainly doesn’t answer the question whether Lewis and others were deliberately taking steps to avoid disclosing material information because they were afraid of what would happen if they did.

 

In the final analysis, I think Judge Castel’s ruling can perhaps only be understood by his observation that these events took place "during a moment of acute economic and political uncertainty." While this fact has nothing to do with whether or not Lewis was consciously withholding information from BofA shareholders, it does suggest Castel is simply unwilling to permit liability for actions taken at the direction of senior public officials at a time of national exigency. It is almost as if he is saying, with shrugging shoulders, "What else was BofA going to do?" I certainly understand this way of looking at these circumstances. The problem is that it doesn’t necessarily address the questions required by the securities laws.

 

Judge Castel does not actually say he is inferring either an official instruction or national emergency exception to the requirements of the securities laws. But by emphasizing those aspects of the situation, he seems to be suggesting that these exceptions exist and apply.

 

To be sure, Judge Castel did observe that the scienter allegations regarding the nondisclosure of the federal package, which he characterized as "thin," might have been sufficient if they were accompanied by adequate allegations of motive or recklessness. It could be argued that his ruling is simply a reflection of insufficient factual pleading, which may be the case. Nevertheless, his analysis raises many questions that in my view are insufficiently examined, whether or not the scienter allegations themselves were or were not sufficient.

 

Given the high profile nature of this case, I suspect there will be much discussion of Judge Castle’s opinion in the weeks and months ahead. Legal proceedings arising out of these circumstances do seem to attract controversy – as, with for example, Judge Rakoff’s high profile rejection of the SEC’s settlement of its enforcement action against BofA arising from these circumstances.

 

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

 

As reflected in their agreement filed on August 26, 2010, the parties to the New York and Delaware derivative actions involving former AIG CEO Maurice Greenberg, as well as certain other former AIG directors and officers, have agreed to settle the case for a payment to AIG by its D&O insurers of $90 million. The agreement also provides that the insurers will pay $60 million to Greenberg and Howard Smith, AIG’s former Chief Financial Officer, for their legal fees.

 

The settlement is subject to the approval of Delaware Chancery Court Vice Chancellor Leo Strine. Jef Feeley and Hugh Son’s August 27, 2010 Bloomberg article about the settlement can be found here.

 

This derivative lawsuit settlement follows AIG’s $725 settlement of a related securities class action lawsuit, and also follows the $115 million settlement in 2008 of a separate shareholders derivative lawsuit involving directors and officers of AIG.

 

Background

In 2004, the first of many separate shareholders derivative lawsuits (later consolidated) were filed in New York and in Delaware, against AIG as nominal defendant, and against numerous former AIG directors and officers, including Greenberg and Smith. The investors alleged that AIG insiders to misstated AIG’s financial performance in order to deceive investors about AIG’s financial condition.

 

The centerpiece of the lawsuit was an allegedly fraudulent $500 million reinsurance transaction in which various AIG insiders staged an elaborate artificial transaction with Gen Re Corporation. The complaint also alleged AIG insiders allegedly used secret offshore subsidiaries to mask AIG losses, misstated accounts with no basis for their adjustments, failed to correct well-documented accounting problems in an AIG subsidiary, and hid AIG’s involvement in controversial insurance policies that involved betting on when elderly people would die. The complaint also related to alleged bid-rigging allegations and alleged sale of illegal financial products.

 

In a lengthy February 2009 opinion, Delaware Vice Chancellor Leo Strine denied the motions to dismiss of Greenberg, Smith and certain other senior former AIG officials, although he granted the motion as to certain other individuals. Strine observed, among other things, "The Complaint fairly supports the assertion that AIG’s Inner Circle led a — and I use this term with knowledge of its strength — criminal organization. The diversity, pervasiveness, and materiality of the alleged financial wrongdoing at AIG is extraordinary."

 

Following further procedural wrangling and developments, the parties participated in a series of mediations involving retired Judge Layn Phillips, which resulted among other things in this settlement agreement.

 

The Settlement

The August 26 agreement seems to resolve all of the litigation involving all of the parties. However, the agreement is also not self-sufficient, as it is "conditioned upon execution of and compliance with a written settlement agreement under which the D&O carriers" pay the agreed upon amounts. I have not been able to obtain a copy of the separate insurance agreement and indeed the wording of the August 26 agreement suggests that at least at the time the August 26 agreement was drafted, the implied insurance agreement had not yet been drafted or fully executed.

 

The August 26 agreement does recite that the applicable insurance consists of AIG’s 2004-2005 D&O insurance tower, which has aggregate limits of liability of $200 million. The agreement does not identify the insurers in the tower or their respective limits of liability. The agreement also recites that the parties to the August 26 agreement have claims pending against the insurance tower in excess of its $200 million limit.

 

The agreement also states that the insurers "dispute that the D&O Insurance Tower is available to pay the claims made under the policies," but that the parties "desire to resolve their disputes regarding the appropriate allocation of their respective rights to the D&O Insurance Tower."

 

The agreement also incorporates certain understandings as the plaintiffs’ attorneys’ fees. Among other things, the agreement provides that the Delaware plaintiffs’ attorneys shall seek and the other parties shall not oppose attorneys’ fees of no more than 22.5% of the Settlement Amount (i.e. no more than $20.25 million) and no more than $1 million in expenses. The New York plaintiffs’ attorneys will seek a fee of no more than $2.5 million. If the two sets of attorneys were to realize the full amount of these fee awards and expenses, the net recovery to AIG from the settlement would be $66.25 million.

 

Discussion

There are a number of interesting things about this settlement. First, the cash payments specified in the agreement are to be funded exclusively with the proceeds of the D&O Insurance Tower.

 

Indeed, the Bloomberg article linked above quotes Greenberg’s attorney as saying that all of litigation by or on behalf of AIG again Greenberg "was settled with Mr. Greenberg paying nothing and other parties paying money to Mr. Greenberg." (This statement is probably worthy of an entire blog post some day all on its own.). Victor Li’s August 27, 2010 Am Law Litigation Daily article (here) about the settlement quotes the Delaware litigation lead plaintiffs’ attorney as saying that as a result of the settlement, $90 million is going to AIG that otherwise would have gone to Greenberg and other defendants based on a 2009 settlement between AIG, Greenberg and Smith, under which AIG agreed to reimburse up to $150 million of their legal fees.

 

While others can debate who gave or got what in this settlement, the bottom line is that the money for this settlement is coming entirely from insurance.

 

Without details about the separate insurance settlement referenced in the August 26 agreement, it is hard to know for sure, but it seems as if the $150 million of insurance funds exhausts the remaining funds under the D&O Insurance Tower, either by actual payment of loss or by compromise. (There obviously is some linkage between the $150 million total of payments in the August 26 agreement and the November 2009 agreement between AIG and Greenberg, but the precise connection isn’t apparent from the face of the documents I have seen so far.)

 

In addition to the fact that the August 26 agreement recites that the parties claims on the D&O Insurance Tower exceed the Tower’s $200 million aggregate limits of liability, another reason I assume that the Tower is actually or effectively exhausted is the interpleader action the primary insurer in this Tower filed against Greenberg and AIG, in order to avoid or resolve an arbitration dispute about priority rights to the proceeds of the $15 million primary policy. By interpleading the $15 million limits of liability, the primary insurer was effectively disclaiming any rights to those funds, indicating that those amounts at least consumed by claims costs. The next layers up above the primary insurance undoubtedly were also substantially eroded if not consumed by claims costs as well.

 

My final observation about the $90 settlement on behalf of Greenberg with AIG is that this represents yet another jumbo settlement of a shareholders’ derivative suit. There was a time when a derivative lawsuit settlement involving substantial cash payments was very unusual, but in recent years substantial payment of cash in connection with the settlement of derivative lawsuits has become increasingly common.

 

In addition to the $115 million settlement of the prior AIG derivative suit, other large recent derivative lawsuit settlements include the $118 million Broadcom options backdating related derivative settlement, the $122 million Oracle settlement and the $225 million Comverse Technology options backdating related derivative lawsuit settlement. It is particularly noteworthy that all of these payments are outside the insolvency context.

 

One consequence of this outbreak of jumbo settlements in derivative lawsuits is that the possibility that Excess Side A insurance might be called upon to pay loss – even outside of the insolvency context — seems to be increasing. Certainly these massive settlements provide increasing evidence for the value to insureds of these kinds of insurance structures, whether or not the recent AIG settlement did or did not actually involve contributions from Excess Side A insurers. The increasing numbers of derivative settlements involving large cash payments certainly underscores that the Excess Side A insurers are exposed to potential losses — even outside of the insolvency context — an exposure that actually seems to be increasing over time.

 

Special thanks to Jef Feeley for providing a copy of the August 26 agreement.

 

Most securities lawsuits settle. The common assumption is that once the cases are settled, the litigation wraps up and everybody moves on. But does the litigation have a lingering effect on the defendant company? Is there a "hidden dark side" for companies that settle securities lawsuits?

 

That is the question asked in a March 18, 2010 paper entitled "Lying and Getting Caught: An Empirical Study of the Effect of Securities Class Action Settlements on Targeted Firms" (here) by Cincinnati Law Professor Lynn Bai, Duke Law Professor James Cox, and Vanderbilt Law Professor Randall S. Thomas. (Hat Tip to the Class Action Countermeasures blog, which has a post about this paper here.):

 

Through their research, the authors sought to discover whether getting hit with a securities a lawsuit and then subsequently entering into a settlement "weakens the defendant firm so that from the point of view of well-received financial metrics the firm is permanently worse off as a consequence of the settlement."

 

In order to examine this question, the authors examined 480 companies that were defendants in settled post-PSLRA securities class action lawsuits. The authors then examined whether there is any change in the defendants’ financial well-being and stock performance relative to their peer group over time.

 

The authors compared the defendants’ performance with that of comparable companies over several time periods. "Comparable" companies consisted of those with the same SIC Code and the same asset size but that had not been involved in a securities class action lawsuit during the relevant time periods.

 

The authors compared the defendant companies to the comparable companies using seven performance criteria, including asset turnover; return-on-assets: the ratio of Earnings Before Income and Tax payments to total assets; the current ratio; the Altman Z-Score (a bankruptcy prediction measure); the market to book ratio; and the one-year stock price return. The authors looked at changes in defendants’ performance according to these measures over time using multivariate regressions.

 

The authors’ research produced a number of results which even they characterized as "puzzling." On the one hand, companies that settled securities class action lawsuits experienced no decline in sales opportunities, but did "experience a reduced level of operating efficiency while the lawsuit was pending (but not after it was settled)."

 

More significantly however, the authors did also observe that "defendant firms experience liquidity problems post-settlement and worsening Altman-Z scores." The authors wrestle with how to interpret these latter findings. On the one hand, the deterioration of the Altman Z-scores could suggest that "settlements drive firms toward financial distress (i..e., settlements are causally related to the worsening situation)," but on the other hand these data could suggest that "the financial deterioration observed in earlier time periods continues downward." Or perhaps it could be some combination.

 

The authors concede that their analysis could support alternative conclusions, but they nevertheless offer their own interpretations as well. Among other things, they note that "while uncertainty persists about the precise connection between the settlements and financial distress, there is no uncertainty that firms that are involved in securities class action litigation experience statistically greater risks of financial distress than their cohort firms."

 

The authors also conclude that their findings "lend strong support for the view that such suits are better directed toward the officers, advisors and other individuals who bear responsibility for the fraudulent representation(s) that spawned the suit."

 

Discussion

The authors’ findings about the post-litigation performance of companies settling securities class action lawsuits are interesting. With full recognition that the question of the causation for that diminished performance is uncertain, the conclusion that companies experiencing securities suits perform worse than there peers is relevant information, both from an investment and a D&O insurance underwriting standpoint.

 

One implication of the authors’ analysis is particularly interesting to me, because one factor implicitly contributing to the negative post-litigation performance is the financial burden the litigation and the settlement imposed on the company. This implication (if indeed my interpretation is valid) seems at odds with other recent research, particularly that of Stanford Law Professor Michael Klausner, who in a recent article published with a colleague concluded that "on the whole D&O insurance pays substantial portions of settlements in a large majority of cases, and that both corporate and individual defendants are highly protected."

 

There seems to be a tension in the analysis between these two academic studies, since if it is the case that D&O insurance substantially protects corporate defendants in securities class action lawsuits, why should there be lingering negative financial effects on the defendants companies?

 

Perhaps the answer may be that the reason for the negative performance relative to the companies’ peers post-litigation may not be financially related, but may be operationally related, and the same below standard operational performance post-litigation in some cases may be related to the factors that led to the litigation in the first place.

 

An alternative explanation may be that while the D&O insurance funds a "substantial portion" of settlements, that still leaves a substantial portion unfunded, and the burden on the companies to fund the difference harms them financially. The authors even note that their analysis insurance in consistent with the conclusion that insurance "provided less than full coverage of the settlement amounts and that the defendants paid the discrepancy out of their current assets. The settlement payment exacerbated liquidity constraints, making the defendants more vulnerable to liquidity crunches and prone to bankruptcy."

 

In other words, it may be that once the case is settled, everyone may move on to other things, but the company is left financially impaired in a way that undermines its future performance – which obviously harms the interests of the company’s shareholders. All of which does leave you wondering about the ultimate value of a process carried out in the name of shareholders but that leaves shareholders’ interests indelibly impaired. .