In prior posts published as part of a continuing series, I have been exploring the basics of D&O insurance. In this third post in the series, I continue the discussion of the nuts and bolts of D&O insurance with a discussion of the policyholder’s policy obligations and requirements.

 

When most people think of insurance, they are usually thinking about the insurer’s obligation to pay claims. And rightly so, as the insurer’s claims payment obligation is the very essence of the insurance agreement. Unfortunately, from time to time the insurer does not pay claims, or does not pay them completely or in a timely fashion. On some occasions, the insurer’s failure to fulfill or complete its payment obligation is the result of good faith coverage disputes. But it also sometimes happens that the insurer’s delay or failure to pay is the result of the insurer’s contention that the policyholder has not taken or completed some action required under the policy.

 

The purpose of this post is to discuss the policyholder’s obligations under the D&O insurance policy. This topic is critical for many policyholders, because the insurer’s contention that the policyholders have not taken or completed required steps is at the center of many insurance disputes.

 

As a preliminary matter, it should be noted that not all of the policyholder’s policy obligations and requirements are claim related. First and foremost, the policyholder must pay the required policy premium. And there are also other D&O insurance policy obligations that impose requirements on the policyholder outside the claims context.

 

By way of illustration, the typical D&O insurance policy has "organizational change" provisions specifying how the policy will respond, for example, if the company is sold. These provisions also specify how the policy will respond if the insured company acquires another company with assets greater than a specified threshold amount. These after-acquired subsidiary provisions often require the policyholder to notify the insurer in writing of the "full particulars of the new Subsidiary," in order for the policy’s coverage to extend to the new subsidiary. Private company policies often have similar notice requirements if the company conducts a public securities offering. In both instances, the insurer may also require the payment of additional premium.

 

But while there are some policyholder requirements that are not claim related, many of the typical D&O policy’s other policyholder requirements are claim-related.

 

Notice of Claim: First, the policy requires the insured, as a condition of coverage, to provide notice of claim within a specified time or time frame (that is, either within a set number of days or "as soon as practicable"). In the absence of notice or if notice is tardy, the carrier may take the position that it is relieved of its obligation to pay – although some courts require the carrier to establish that the notice failure prejudiced the insurer’s rights in order to disclaim coverage.

 

Consent to Counsel: Second, most D&O policies require the policyholder to get the carrier’s consent for the lawyers that will be defending the claim. Some policies to have so-called "panel counsel," which is a list of authorized law firms, but most other policies allow the insured to select the lawyers, subject only to the carrier’s consent.

 

Though the carrier’s consent should be (and often is) a very straightforward matter, issues can and often do arise. The typical carrier objections are to the selected lawyer’s or selected law firms hourly rates. The carrier sometimes objects to the number of lawyers involved. Less frequently, the carrier raises concerns about the lawyer’s qualifications to handle the claim.

 

It may be impossible to completely eliminate these kinds of disputes, but there are certain steps policyholders can take to reduce the likelihood of disputes. The most important step is to notify the carrier as soon as practical of the names and hourly rates of the attorneys involved. (Often this can even be addressed before any claims have arise, which is a good practice that can avoid problems if claims do later arise.) It should be kept in mind that because defense expenses erode the policy limits, both the carrier and the policyholder have an interest in ensuring that the defense goes forward in the most cost effective way possible, in order to preserve limits for the payment of settlements and judgments.

 

Cooperation: Third, once the claim is underway, policyholders have another obligation, and that is the requirement to cooperate. The specifics of this cooperation duty usually are not provided, but it basically refers to the insured’s obligation to take steps to support, and to refrain from taking steps that interfere with, the defense of the claim.

 

Though the policy does not specify, many carriers will also contend that the cooperation clause requires the policyholder to keep the carrier informed about the claim, to provide copies of pleadings and other key documents, and to provide the carrier with information related to the defense (in particular, with defense expense information and fee statements).

 

Whether or not these kinds of steps truly are required by the cooperation clause, taking these steps is simply good practice and is more likely to result in smoother claim resolution. By the same token, failure to take these steps is the often the source of claims handling frictions and frequently contribute to issues with the carrier’s fulfillment of its payment obligations.

 

Consent to Settlement: Fourth, the typical D&O insurance policy requires the insurers consent to settlement. The failure to keep the insurer informed about settlement discussion is a frequent source of tension. The important thing for the policyholder to remember is that the insurer’s consent really is required. Where problems sometimes arise is in connection with excess insurers, when settlement amounts unexpectedly pierce upper layers of insurance. These kinds of recurring disputes underscore the fact that the consent of all of the affected insurers is required, and that keeping the insurer informed about the claim really means keeping all of the carriers involved and potentially involved informed about the claim.

 

I know many readers will be surprised that I have chosen to write about policyholders’ policy obligations, as it is the carrier’s claims payment obligation that is the heart of the insurance contract. Some readers may also be bothered by the fact that the insurance policy has so many policyholder requirements. But whether or not as a philosophical matter it is or is not appropriate for the insurance policy to incorporate so many policyholder requirements, the fact is that these requirements are found in most D&O policies, and so the best approach is to recognize and address these requirements.

 

Far too many claim disputes arise when carriers take the position that policyholders have failed to fulfill one or more of these requirements. My hope is that by highlighting these requirements, more of these process related disputes might be avoided.

 

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

　

　

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

　

Executive Protection: D&O Insurance – The Insuring Agreement

　

　

In an August 19, 2010 order (here), Northern District of Georgia Judge Thomas Thrash granted the defendants’ motion to dismiss the subprime-related securities class action lawsuit that had been filed against SunTrust Inc and certain of its directors and officers. The opinion is noteworthy for the harshness of its tone, the comprehensiveness of the dismissal, and for the court’s willingness to consider the larger context of the overall global financial crisis.

 

As reflected in greater detail here, the plaintiffs first filed their action against SunTrust in March 2009. SunTrust is the parent holding company of it wholly-owned banking subsidiary, SunTrust Bank. As reflected in the lead plaintiffs’ amended complaint, the plaintiff alleges that in the second and third quarter of 2008, SunTrust tried to hide the extent of its increase in nonperforming loans by classifying some of these loans as "in-process" loans, which permitted the company to report better financial results.

 

These loans were later reclassified in the fourth quarter of 2008, which cause the company’s nonperforming loans to increase, which in turn, the plaintiff asserts, caused the company’s share price to drop eleven percent in a single day.

 

In reviewing plaintiff’s allegations in his August 19 opinion, Judge Thrash noted that plaintiff "never explicitly alleges facts" that would support its claim of a half billion dollars of misclassified loans, a "figure," Judge Thrash notes, that "seems to be plucked out of thin air."

 

Judge Thrash said that the plaintiff’s "theory" about the misclassification "collapses" in the face of the defendants’ showing that the average daily nonperforming loan balance was greater at the end of each quarter during this period than at the beginning, which, Judge Thrash said, is "entirely consistent with the continuing deterioration of SunTrusts’s loan portfolio over the course of the financial crisis" and is "entirely inconsistent with the Plaintiffs’ theory of large scale misclassification of nonperforming loans at the end of each quarter."

 

Judge Thrash notes that in its opposition to the motions to dismiss, the plaintiff shifted its liability theory from the misclassification allegation to alleged understatement of reserved for nonperforming loans. Judge Thrash found plaintiff’s inadequate loan loss reserve allegations insufficient, noting that "the fact that SunTrust substantially increased its reserves for nonperforming loans in the fourth quarter of 2008 is not evidence of fraudulent accounting practices in earlier periods."

 

"Life," Judge Thrash noted, "is too short to say more about this."

 

Judge Thrash also found that the plaintiff’s scienter allegations were also insufficient. Specifically, Judge Thrash found that the plaintiff’s allegations of intentional wrongdoing, access to information, motive were insufficient to support an inference of scienter. He also found that "competing inferences totally overwhelm any inference of scienter." especially in light of the fact that there were no suspicious stock sales and the totally speculative nature of the supposed benefit the defendants theoretically might have gained from a putative merger.

 

Finally Judge Thrash concluded that the plaintiff had not established loss causation, noting among things that the eleven percent stock price drop on which the plaintiff sought to rely to plead loss causation "occurred during a financial crisis that hit the financial services industry hard." The company’s share prices had already lost two-thirds of its value prior to the supposedly corrective disclosure, and though it fell an additional 11% on the disclosure date, other banks also had significant share price declines that day, some of which were even greater as a matter of percentage than SunTrust’s.

 

Judge Thrash concluded that the complaint’s allegations "cannot support an inference that SunTrust’s misstatements – rather than general market conditions – proximately caused the Plaintiffs’ loss."

 

Although the Opinion does not explicitly state whether or not it is with prejudice, Judge Thrash did not expressly grant plaintiffs leave to amend and in fact entered judgment for the defendants.

 

Special thanks to a loyal reader for providing me with a copy of Judge Thrash’s opinion.

 

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

　

　

The FDIC closed took control of eight more banks this past Friday night, bringing the 2010 total of failed banks to 118. The eight closures is the largest single day total since April 16, 2010. The pace of closures remains well ahead of last year’s closure rate – the FDIC did not reach its 118th closure in 2009 until November. The FDIC is on pace for 180 bank closures this year, compared to 140 in 2009.

 

There have now been 283 bank failures since January 1, 2008. The state with the largest number of closures during that period is Georgia, with 41. However, during 2010, the state with the highest number of bank closures is Florida, with 22 bank failures this year and 38 since January 2008 (which ranks second overall). Two of the banks that closed this past Friday night were based in Florida.

 

One of the banks closed on Friday was in Illinois, which has the second highest number of bank closures in 2010 (15), and is the third highest since 2008 with 37. Four of the banks that closed this past Friday were based in California, which now has 10 bank closures in 2010, and 32 overall.

 

Those four states – Georgia, Florida, Illinois and California – account for 148 (52%) of the banks that have closed since January 1, 2008, and 58 (49%) of the 2010 bank closures.

 

Of the 118 bank closures in 2010, 97 (82%) had assets of less than $1 billion. 27 (23%) had assets under $100 million. Overall, since January 1, 2008, 225 (79.5%) of the failed banks have had assets under $1billion, with 56 (19.7%) under $100 million. There have already been more closures of banks with assets of under $100 million in 2010 (27) than in all of 2009 (24).

 

39 States and Puerto Rico have all had at least one bank closed in since January 1, 2008. The states that have not had any banks closed during that period are: Alaska, Delaware, Connecticut, Hawaii, Maine, Montana, New Hampshire, North Dakota, Rhode Island, Tennessee, and Vermont. So – small states, new states, northeastern and upper plains states, and, inexplicably, Tennessee.

 

Morgan Stanley Subprime Mortgage-Related Lawsuit Dismissed: On August 17, 2010, Southern District of New York Judge Laura Taylor Swain granted the defendants’ motion to dismiss a securities class action lawsuit filed on behalf of purchasers of mortgage pass-through certificates sold by 31 Morgan Stanley trusts. In her opinion, Judge Swain held that lead plaintiff, which had bought shares in only one of the trusts, lacked standing to assert claims in connection with the other thirty, and that the claims in connection with the trust certificates it had purchased were time barred.

 

Judge Swain’s dismissal as the 30 trusts in which the lead plaintiff had not bought shares was with prejudice; however, the dismissal as to the trust in which the plaintiff had purchased shares was without prejudice, as plaintiffs were given leave to replead as to those allegations.

 

Andrew Longstreth’s August 20, 2010 Am Law Litigation Daily article about the decision can be found here. I have added the ruling to my running tally of subprime and credit crisis-related lawsuit dismissal motion rulings, which can be found here.

 

All the World’s a Stage: Michael Maslanka, a Dallas-based labor lawyer wrote an interesting August 20, 2010 Texas Lawyer column entitled "What Can Lawyers Learn From ‘Othello’" (here), in which he examines the lessons for lawyers exemplified in the play’s two lead male characters, Othello and Iago.

 

For those readers unfamiliar with the play, Iago manipulates Othello into believing that his wife, Desdemona, has been false with him by having an affair with Cassio. In a jealous rage, Othello kills Desdemona, though it is a heart-breaking scene for the audience, not only because Desdemona has been falsely accused, but also because Othello clearly still loves her.

 

Maslanka’s analysis extracts some important lessons from the play. From Iago’s character, Maslanka draws lessons about the pitfalls of manipulation, and from Othello, he draws lessons about rationalization.

 

Though Maslanka’s analysis is perceptive, there is another character in the play whose role may have yet another and perhaps more important lesson. The character is Iago’s wife, Emilia, who is Desdemona’s attendant and friend. In a peculiarly modern twist, Amelia plays the role of whistleblower, by revealing – at hazard to her own life — Iago’s falsity and proving Desdemona’s innocence.

 

Emilia’s role, though relatively small, is crucial, for without her brave willingness to protect Desdemona’s innocence and reveal Iago’s perfidy, Iago’s nefarious scheme might have gone undetected.

 

Emilia has a special role in Shakespearean literature for the speech she delivers at the end of Act IV, Scene iii, in which she recognizes the centrality of the struggle between men and women, a struggle for which she places the responsibility squarely on the men – "I do think it is their husbands’ fault." Her observations seem particularly apt in a play where both male leads murder their wives, both of whom are innocent, in the play’s final act.

 

The subprime-related securities lawsuit pending against BankAtlantic Bancorp and certain of its directors and officers is headed to trial on October 6, 2010 in Miami, following the recent summary judgment rulings in the case. Southern District of Florida Judge Ursula Ungaro’s 62-page ruling, issued August 18, 2010, which granted in part and denied in part the parties’ cross-motions for summary judgment, contains a number of interesting features, discussed below.

 

BankAtlantic Bancorp is the publicly traded parent company of Bank Atlantic, a federally chartered bank. As reflected in greater detail here, plaintiffs first filed their securities class action lawsuit in October 2007. Judge Ungaro granted the defendants’ initial motion to dismiss the plaintiffs complaint, but allowed the plaintiffs leave to amend. However, in May 2009, Judge Ungaro denied the defendants’ renewed motions to dismiss after plaintiffs’ their amended complaint.

 

The plaintiffs’ amended complaint basically alleges that the defendants made misleading statements about the credit quality of certain land loans in the bank’s commercial real estate portfolio; failed to follow conservative lending practices as described in its underwriting policies, and therefore its loan portfolio was exposed to a higher level of risk than represented to investors, and misrepresented that BankAtlantic’s loan loss reserves were adequate.

 

Plaintiffs contend that when the truth about the banks loan portfolio was revealed between April and October 2007, the company’s stock price fell and investors were harmed.

 

In her August 18 order, Judge Ungaro addressed the plaintiffs’ motion for partial summary judgment with respect to the falsity of certain July 2007 statements by the company’s former Chairman and CEO, as well as the defendants’ motions for summary judgment as to all of plaintiffs’ claims.

 

Plaintiffs’ conceded that the defendants were entitled to summary judgment as to all claims for the period prior to October 18, 2006 and as to all claims arising from alleged misstatements about loan loss reserves, and accordingly Judge Ungaro granted defendants summary judgment as to those issues.

 

A significant portion of Judge Ungaro’s opinion is focused on defendants’ motion to exclude the testimony of the plaintiffs’ expert on the issues of market efficiency, materiality, loss causation and damages, which Judge Ungaro addressed because she considered the motion relevant to the summary judgment motion.

 

Judge Ungaro largely granted the defendants’motion to exclude the expert’s testimony on the issue of loss causation and materiality, ruling that the expert may testify on only narrow parts of these issues, although she ruled that the expert may testify as to the cause of certain specific aspects of the decline in the company’s share price. Judge Ungaro also excluded certain aspects of the expert’s testimony on damages, but ruled that the testimony will be permitted on other damages issues.

 

With respect to the defendants’ motions for summary judgment on the plaintiffs’ claims, Judge Ungaro held that the "the evidence raises genuine issues of material fact as to whether Defendants’ statements beginning in April of 2007, focusing solely on the credit and repayment problems with [builder land bank, or BLB] loans and omitting mention of the problems the non-BLB land loans were contemporaneously experiencing were misleading."

 

Judge Ungaro also concluded that the defendants were not entitled to summary judgment on the issue of scienter, concluding that the evidence raised genuine issues of fact as to whether the defendants knew their class period statements creased a "an obvious danger of misleading investors" as to "the true credit quality of the land loan portfolio"; as to "the accelerating deterioration of credit quality throughout the land loan portfolio"; and as to the "worsening credit and repayment problems with the BLB loans."

 

Finally, on the issue of loss causation, Judge Ungaro concluded that there were genuine issues of material fact regarding the April 26, 2007 and October 26, 2007 price declines, but not as to the October 29, 2007 price declines.

 

Judge Ungaro then turned to the plaintiffs’ motion for partial summary judgment on to certain statements by the company’s former Chairman and CEO in a July 25, 2007 analyst conference call. In response to a specific question in the call about the Bank’ BLB loans, the Chairman made a number of reassuring statements, including the statement that "the portfolio has always performed extremely well, continues to perform extremely well."

 

In reliance on prior email exchanges in which the Chairman and CEO participated, as well as the testimony of other bank officials, Judge Ungaro concluded that there were not genuine issues of material fact that the July 25, 2007 statements were false when made, and accordingly ruled that the plaintiffs are entitled to summary judgment on this issue.

 

Discussion

This decision is noteworthy if for no other reason it means that (absent intervening events) a trial in this case will commence in just a few short weeks. As most readers of this blog know, trials in securities class action cases are quite rare, and it would be a significant and noteworthy event if this case were to go to trial beginning on or about October 6.

 

The decision is also noteworthy for Judge Ungaro’s detailed explication of the issues on which the plaintiffs’ expert will be permitted to testify. Again, because so few of these cases actually go to trial, there is relatively little judicial authority on questions concerning the issues on which expert testimony will be admitted. The absence of this authority can present a challenge when parties attempt to rely in expert testimony, for example, in connection with settlement negotiations, which can be vexing without knowing whether the expert’s views are relevant in any way. However, because Judge Ungaro’s analysis of these issues is very case and fact specific, her analysis of the expert testimony questions, though interesting, may be of limited value in other cases.

 

But perhaps the most interesting thing about this ruling is Judge Ungaro’s grant of partial summary judgment for the plaintiffs on the issue of falsity. It is relatively rare for any case to get to the point where a decision on this kind of issue is even ripe, and in most cases courts are inclined to leave these kinds of issues to the jury. I actually can’t recall ever having seen a court granting summary judgment in the claimants’ favor on the issue of falsity.

 

The plaintiffs will still have to prove that these false statements were materially misleading, were made with scienter, and cause damages. However, it will be a singular development when the court instructs the jury that the court has already concluded that the statements are false.

 

And so, if this case does go to trial on October 6, it will be interesting to watch, for a number of reasons.

 

I have in any event noted Judge Ungaro’s August 18 order in my running tally of rulings in subprime and credit-crisis related cases, which can be found here.

 

Special thanks to a loyal reader for sending me a copy of Judge Ungaro’s ruling.

 

Bankruptcy filings overall rose by 20 percent in the twelve-month period ending on June 30, 2010, according to information released on August 17, 2010 by the Administrative Office of the U.S. Courts. Though this filing surge was largely driven by non-business filings, business related filings also remained at elevated levels during the 12 months ended June 30.

 

According to the Administrative Office’s data, there were 59,608 business related bankruptcy filing in the 12 months ending on June 30 this year, compared to 55,021 in the 12 months ending on June 30, 2008, which represents an increase of 8.34%. The 59,608 for the twelve months ending on June 30, 2010 is the highest number of business-related filings for that 12 month period since the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 took effect.

 

The number of business filings for the 12 months ended June 30, 2010, though only slightly greater than the comparable period in 2009, is also over 76% greater than the number during the comparable period in 2008, and almost 150% greater than during the comparable period in 2007.

 

Though the number of business-related filings remained at elevated levels during the 12 month period ended June 30, the number of business-related filings declined during each of the three month periods within that 12 month period. Thus, during the first three months of the 12-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.

 

As reflected in an August 17, 2010 analysis of the bankruptcy filing data by the American Bankruptcy Institute, business filings decreased 4 percent for the six-month period ending June 30, 2010, to 29,059 from the first-half 2009 total of 30,333.

 

Despite this quarter by quarter decrease in business-related bankruptcy filings, the overall number of filings (including non-business related filings) actually increased during the three months ending June 30, 2010, to 422,061, which is the highest for any quarter during fiscal 2010 (which runs October 1, 2009 to September 30, 2010), and the highest for any April-June quarter since the 2005 third quarter filings.

 

Though the news about bankruptcy filings overall is discouraging, the news related to business related bankruptcy filings may be slightly encouraging as there appears to be some suggestion that the worst may be past. However, that positive note should not obscure the fact that, even if the number of filings may be declining on a quarter to quarter basis, the number of business filings still remain at elevated levels compared to periods preceding the current economic crisis.

 

In a recent post, I discussed several recent decisions in which securities cases involving failed or troubled banking institutions survived dismissal motions. By contrast, however, in an August 16, 2010 ruling (here), Southern District of New York Judge Robert Patterson, Jr. granted the defendants’ motion to dismiss without prejudice in the securities class action lawsuit filed against Raymond James Financial and certain of its directors and officers alleging inadequate disclosures regarding the company’s banking subsidiary’s loan loss reserves.

 

As discussed in greater detail here, plaintiffs first filed their action against Raymond James Financial in June 2009. The plaintiffs’ allegations center on the loan portfolio and loan loss reserves at the company’s banking subsidiary, Raymond James Bank. Judge Patterson stated in his August 16 opinion that, despite the length of the complaint (which "extreme length," Judge Patterson noted, provides "an independent ground for dismissal"), the plaintiff’s allegations "boil down to one proposition: that the Defendants purposefully underfunded their loan loss reserves and then made material misrepresentations about het adequacy of those loan loss reserves during the class period."

 

With one small exception, Judge Patterson concluded that the misrepresentations and omissions on which plaintiff seeks to rely are not actionable. For example, he concluded that the alleged misrepresentations about the bank’s loan loss reserves "are, without exception, general statements of optimism" which "in and of itself renders these statements inactionable."

 

Similarly, Judge Patterson concluded that the statements about the quality of the bank’s loan portfolio "were, similarly, very general and not sufficiently detailed to have misled investors" and "for the most part" represent "classic puffery."

 

The one exception to his conclusion that the statements on which the plaintiff sought to rely are not actionable were two paragraphs in the Amended Complaint relating to the quality of the loan portfolio. These statements included representations that the bank "independently underwrote" all loans, including loans "sourced from agent or syndicate banks." The Amended Complaint reference the testimony of a confidential witness who avers that many loans that were later charged off were not independently underwritten.

 

However, Judge Patterson also concluded that the plaintiff had not sufficiently alleged scienter. He concluded with respect to the plaintiffs’ scienter allegations that:

 

None of the allegations of scienter are sufficiently specific that they allow the Court to determine whether the Defendants knew (or even likely knew) that their statements were false when made. For the most part, the scienter allegations are of the sort that could be made about nearly any company operating in the United States, namely that the executives were motivated to create profit, that the executives received a near-constant stream of information about economic trends, and that the executives made mistakes in some of their forward-looking projections.

 

These allegations, Judge Patterson concluded, were insufficient to give rise to a strong inference that the defendants acted with the requisite state of mind.

 

Accordingly, Judge Patterson granted the defendants’ motions to dismiss, but he did so without prejudice.

 

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

 

Among the very, very latest trends in securities class action lawsuit filings are suits against for-profit educational companies. Just since the middle of last week, at least five companies in this sector have been tagged with new lawsuits, four of which were securities class actions.

 

These lawsuits have been accumulating in the wake of an August 3, 2010 Government Accountability Office report (here) which alleged that several companies in the for-profit education industry encouraged fraud and engaged in deceptive advertising. The report was prepared in connection with the August 4, 2010 hearing before the Senate Committee on Health, Education, Labor and Pensions.

 

The GAO report said that undercover tests revealed that at least four schools encouraged fraudulent practices and all 15 tested made deceptive or questionable statements to the GAO’s undercover applicants. The fraud involved encouraging falsified financial aid applications. A summary of the report can be found here. A statement of the report’s highlights can be found here.

 

Though no specific companies are named in the report (or perhaps because no specific companies are named in the report), the share prices of many of the publicly traded for-profit education companies fell after the news about the GAO report circulated. And, perhaps inevitably, the lawsuits started coming in.

 

As far as I am aware, at least four for-profit education companies have been named in securities class action lawsuits just since the end of last week. These companies include the following:

 

Education Management Corp., against which the first suit was filed on August 11, 2010. A copy of the complaint filed in the Western District of Pennsylvania can be found here.

 

American Public Education, against which the first suit was filed on August 12, 2010. A copy of the complaint filed in the Northern District of West Virginia can be found here.

 

Lincoln Educational Services, against which the first suit apparently was filed on August 13, 2010. A copy of the complaint can be found here.

 

Apollo Group, Inc., against which the first suit apparently was filed on or about August 16, 2010. A copy of complaint can be found here.

 

In addition to these securities class action lawsuits, a separate class action lawsuit against Alta Colleges, Inc. (parent of Westwood College) and related entities and persons was filed on August 11, 2010 in the District of Colorado alleging violations of the Colorado Consumer Protection Act. A copy of the Alta/Westwood complaint can be found here.

 

With five suits in already, it seems safe to predict that other publicly-traded for-profit education companies could also get hit with one of these suits. This seems to be one of those classic contagion events that produces an epidemic of similar lawsuits that comes up every now and then. Last year it was ETFs (refer here); this year it seems to be for-profit educational companies.

 

The name Apollo Group may be familiar to many readers, as the company was the target of a prior securities class action lawsuit that has achieved a certain amount of notoriety because it is one of the few securities cases that has actually gone to trial. The trial resulted in a plaintiffs’ verdict, although the presiding judge later set the verdict aside in a response to a post-trial motion. More recently, the Ninth Circuit reversed the trial court’s ruling and remanded the case to the district court for further proceedings, a development that has sparked significant interest and discussion.

 

Unfortunately for Apollo Group, all of the long-running drama in the prior case was no shield against another case being filed.

 

It remains to be seen how these cases will fare. But this industry-specific litigation outbreak 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.

 

New Securities Suit Based on FCPA-Related Allegations: Regular readers know that I have frequently commented that one result of increased Foreign Corrupt Practices Act enforcement has been the growth in the number of follow-on private civil lawsuits based on the underlying corruption allegations.

 

The latest example of this phenomenon is the lawsuit filed against SciClone Pharmaceuticals and certain of its directors and officers. According to the plaintiffs’ lawyers’ August 16, 2010 press release (here), the complaint they filed in the Northern District of California alleges that:

 

defendants were engaged in illegal and improper sales and marketing activities in China and abroad regarding its products. This ultimately caused the Company to become the focus of a joint investigation by the Securities and Exchange Commission ("SEC") and the Department of Justice ("DOJ") for possible violations of the Foreign Corrupt Practices Act ("FCPA"). It was only at the end of the Class Period, however, that investors ultimately learned the truth about the Company’s operations after it was reported that the SEC and DOJ were investigating the Company for violations of the FCPA. At that time, shares of the Company declined almost 40% in the single trading day.

 

This case presents further support for the proposition that increased anticorruption enforcement activity represents a growing area of liability exposure for company executives.

 

Thought for the Day: "Time flies like an arrow. Fruit flies like a banana." (Often attributed to Groucho Marx, but although it seems as if he would have said it, he apparently did not.)

Though we are in the midst of the dog days of summer (at least in the northern hemisphere), the federal courts, at least, have been busy. In the last several days alone, several courts have issued dismissal motion rulings in lawsuits arising out of the subprime meltdown and the credit crisis.

 

As noted below, several of these decisions involve failed or troubled banks, and therefore may be of particular interest in relation to the many banks have failed in recent months or that are continuing to struggle now. Though investor plaintiffs in other cases involving failed or troubled banks have sometimes struggled to survive the initial pleading stages, in the cases discussed below, the plaintiffs managed to survive the dismissal motions, at least in part.

 

PFF Bancorp: In an August 9, 2010 opinion (here), Central District of California Judge Andrew Guilford denied the defendants’ motions to dismiss in the securities class action lawsuit against two former directors and officers of PFF Bancorp, the corporate parent for PFF Bank & Trust, which failed on November 21, 2008.

 

As reflected here, in January 2009, shareholders of the holding company filed a securities lawsuit alleging that the company’s President and CEO and its CFO contending that they concealed the Bank’s unsafe lending practices and made misleading statements about the bank’s loan loss reserves and capital levels.

 

In his August 9 order, Judge Guilford found that while the plaintiffs’ allegations that defendants made misleading statements about the banks’ "cautious" and "conservative" lending practices were insufficient to state a claim, the plaintiffs’ allegations that defendants had falsely characterized the bank’s loan loss reserves as "adequate" were sufficient to state a claim.

 

Judge Guilford also found that plaintiffs had adequately alleged scienter, finding that plaintiffs’ allegations "permit the inference that Defendants knew PFF’s loan practices were risky and that PFF had inadequate loan loss reserves, yet told investors that the loan loss reserves were adequate."

 

Interestingly, Judge Guilford found plaintiffs’ scienter allegations to be adequate despite the defendants’ contention that they had actually purchased PFF shares at the supposedly inflated prices. Judge Guilford declined, at the motion to dismiss state, to take judicial notice of the SEC forms on which defendants sought to rely in order to establish their share purchases.

 

Popular, Inc. (Securities Claim): In an August 2, 2010 order (here), District of Puerto Rico Judge Gustavo Gelpí granted in part and denied in part the defendants motion to dismiss the securities class action lawsuit that had been filed against Popular, Inc., certain of its directors and officers, its auditor and its offering underwriters.

 

The plaintiffs’ complaint focused on the company’s accounting for a deferred tax asset. In the three years preceding the beginning of the class period (which went from January 24, 2009 to February 2009), the company had recorded tax loss carry forwards that totaled over $1 billion, largely as a result of the company’s U.S. subprime and other lending operations. The benefit of these deferred tax assets could only be realized if the company experienced sufficient U.S.-based gains within 20 years.

 

To offset the possibility the company might not fully realize the value of the deferred tax assets, accounting rules required reporting companies to take a valuation allowance, but the company recorded no material valuation allowance of this asset until late 2008. The company ultimately recorded an allowance for the full value of the asset. Following the announcement of this action, the company’s share price fell substantially.

 

The plaintiffs allege that the increasing, multiyear U.S.-based operating losses prevented it from anticipating sufficient taxable income to realize the full value of the deferred tax asset prior to the expiration of the 20-year period, yet failed to take a valuation reserve because doing so would have lowered the bank’s risk-based capital ratio below regulatory requirements. The financial picture the company’s treatment of the asset portrayed allowed the company to raise over $300 million in a May 2008 offering.

 

The Court found that the plaintiffs allegations adequately alleged material misrepresentations, given that "Popular’s three-year cumulative loss position, combined with the Company’s significant downsizing of its U.S. mainland operations and the worsening market conditions, constituted strong evidence that at the beginning of the class period it was more likely than not that the Company would not be able to realize the benefit of its [deferred tax asset] in full."

 

The Court also concluded that the complaint adequately alleged scienter, concluding that the defendants’ decision "not to take an earlier valuation allowance was ‘highly unreasonable’ and an ‘extreme departure from the standards of ordinary care’ to the extend that the danger was either know to the defendants or so obvious that they must have been aware of it."

 

The Court also concluded that the ’33 Act allegations against the officer defendants were also sufficient. However, because the Court found that the amended complaint in which the plaintiffs added as defendants the outside directors, the company’s auditor and its offering underwriters had been filed more than a year after there were sufficient "storm warnings" to put the plaintiffs on inquiry notice, the ’33 Act claims against those defendants were untimely and were therefore dismissed.

 

Popular, Inc. (Derivative Suit): In an August 11, 2010 opinion (here), applying Puerto Rico law, in the shareholders’ derivative lawsuit filed against Popular, Inc, as nominal defendant, certain of its directors and officers, and its outside auditor, Judge Jay Garcia-Gregory denied in part and granted in part the defendants’ motions to dismiss. The allegations in the derivative suit largely mirror those alleged in the securities class action lawsuit.

 

The officer and director defendants had moved to dismiss on the ground that the plaintiff had not presented a demand to the company’s board to pursue the lawsuit. The plaintiff argued that demand was futile, and the Court agreed. The Court found that the plaintiffs’ allegations and of the requirements of SFAS 109 "provide ‘reason to doubt’ the legality of declining to record a valuation allowance until 2009" and therefore "demand is excused" because the presumption that the board took a valid business judgment had been rebutted by the alleged lack of "legal fidelity."

 

The Court did, however, dismiss the plaintiff’s gross mismanagement claim as duplicative of the breach of fiduciary duty claim. The Court also found that the plaintiff had not adequately alleged corporate waste. Finally, the Court found that the plaintiff’s claim against the company’s auditor should also be dismissed, on the grounds that the plaintiff had not made a demand on the company’s board to pursue the claim and had not established demand futility.

 

Discussion

Plaintiffs have had some difficult surviving initial dismissal motions in many of the securities class action lawsuits that have been filed against the directors and officers of banks that have failed during the current failed bank wave. For example, the securities class action lawsuit arising out the failure of Downey Financial Corp. (whose operating bank failed the same day as PFF Bank & Trust) was dismissed with prejudice.

 

Similarly, the motion to dismiss in the Fremont General case was also ultimately dismissed with prejudice. Similarly, the motion to dismiss was granted in the BankUnited securities case, albeit without prejudice.

 

More recently, however, the motion to dismiss was denied in the securities class action lawsuit arising out of the failure of Corus Bankshares. With the above decisions, it seems as if the plaintiffs in these cases have managed to overcome the initial pleading hurdle at least in several cases now.

　

To be sure, the reasoning the Popular case is based on circumstances that may be unique to that case. The allegations in the PFF Bancorp case, however, arguably are more typical. But while the PFF Bancorp case survived the dismissal motions, it remains to be seen whether the case will survive additional proceedings in the case, if defendants are able to establish that the purchased company shares at the allegedly inflated prices.

 

Ultimately, the fundamental question about the failed banks is whether the FDIC will lower the litigation boom on directors and officers of the failed banks. So far, the FDIC’s litigation activity has been limited to a single lawsuit it filed against officers of a subsidiary of IndyMac (about which refer here). Whether and to what extent the FDIC will pursue other claims will be revealed in the weeks and months ahead.

 

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

 

Very special thanks to the loyal readers who provided me with copies of these decisions.

　

Another Banking Institution Dismissal Motion Ruling: Though the financial institution involved has neither failed nor is seriously troubled, it should be noted here at least briefly that in an August 10, 2010 order (here), Southern District of Ohio Judge Sandra Beckwith denied in part and granted in part the defendants’ motion to dismiss in the securities class action lawsuit that had been filed against Fifth Third Bancorp and certain of its directors by former shareholders of First Charter, which Fifth Third acquired in a deal announced in August 2007.

 

As discussed here, the former First Charter shareholders alleged that in connection with the merger, Fifth Third and certain of its directors and officers had materially misrepresented Fifth Third’s exposure to poorly performing residential real estate markets, and had not fully represented how seriously its mortgage portfolio was deteriorating.

 

Judge Beckwith’s detailed and painstaking August 10 opinion denied the motion to dismiss as to the claims of certain classes of First Charter shareholders, but granted the motion to dismiss as to all other claims and claimants.

 

Another Credit-Crisis Related Securities Suit Dismissal Motion Ruling: In an August 13, 2010 order (here), District of Maryland Judge Catherine Blake denied in part and granted in part defendants’ motions to dismiss the securities class action lawsuit that had been filed against Constellation Energy.

 

As discussed here, Constellation Energy was one of the many nonfinancial companies that suffered credit crisis related financial reverses in late 2008 and early 2009 and attracted securities litigation arising out the companies’ financial woes.

 

In September 2008, Constellation shareholders and subordinated debenture holders filed a securities class action lawsuit against the company, certain of its directors and officers and offering underwriters. Their complaint asserts claims under Section 11, 12(a)(2) and 15 of the ’33 Act and under Section 10(b) of the ’34 Act.

 

Essentially, the plaintiffs alleged that the defendants had misrepresented the additional collateral the company would have to post in connection with its merchant energy business in the event of a company credit downgrade. (As the company itself later disclosed, the collateral requirements for a one-notch credit downgrade were less than had been disclosed; the collateral requirements for a two or three notch downgrade were significantly greater than disclosed.)

 

The plaintiffs also alleged that the defendants had not sufficiently disclosed the company’s exposure to Lehman Brothers. The plaintiffs also alleged that the defendants’ misrepresented the company’s future earnings, business outlook, risk management and internal controls.

 

In fall 2008, after the company suffered a several notch ratings downgrade and after Lehman collapsed, the company’s share price fell and investors’ sued. The company ultimately sold a substantial portion of its assets.

 

In her August 13 order, Judge Blake found that the plaintiffs’ ’33 Act allegations regarding the company’s downgrade collateral obligations were sufficient to state a claim. Interestingly, Judge Blake reached her conclusion even though the company’s debenture prices dropped only slightly immediately after the disclosure of the company’s revised collateral obligation and in fact rose thereafter for several weeks. These facts "ultimately may counsel against materiality" but are "not dispositive at this stage of the litigation.

 

Judge Blake found that the plaintiffs’ remaining ’33 Act allegations were insufficient to state a claim.

 

As for plaintiffs ’34 Act allegations, Judge Blake found that the plaintiffs had not adequately alleged scienter in connection with the downgrade collateral obligations. She noted that "without additional factual allegations that the defendants were somehow aware that the downgrade collateral requirements were miscalculated …neither Constellation nor its officers can be presumed to have known of a faulty computer calculation."

 

Judge Blake also found that the plaintiffs’ remaining ’34 Act allegations were inadequate.

 

I have also added the Fifth Third and Constellation Energy rulings to my running tally of credit crisis lawsuit dismissal motion rulings, which again can be accessed here.

 

Special thanks to a loyal reader for providing a copy of the Constellation Energy decision.

　

The September 2008 collapse of Lehman Brothers resulted in the largest bankruptcy filing in U.S. history, as well as an explosion of litigation and regulatory actions and investigations. In the pending bankruptcy proceedings a recent motion by the debtor’s counsel details the massive legal costs accumulating in the various legal proceedings and also raises some interesting D&O insurance implications.

 

Special thanks to Wayne State University Law Professor Peter Henning, who provided me with copies of the bankruptcy-related documents and who previously these issues on the Dealbook blog, here.

 

On July 27, 2010, counsel for the debtor filed a motion in the Lehman Brothers bankruptcy proceeding under Bankruptcy Code Section 362 for relief from the automatic stay in order to allow certain of Lehman’s excess D&O insurers to advance defense expenses.

 

According to the motion papers, for the policy period May 16, 2007 to May 16, 2008, Lehman carried an aggregate of $250 million in D&O insurance, consisting of a $20 million primary policy and sixteen layers of excess insurance. A copy of the Lehman primary policy, which is included in the bankruptcy pleadings, can be found here.

 

In March and November 2009, respectively, the bankruptcy court previously entered orders granting relief from the stay to allow defense fees to be paid first from the $20 million primary policy and then from the $15 million first excess policy.

 

However, the motion papers note, submitted defense fee statements already exceed the limits of liability of the first excess policy (i.e., the aggregate fees already exceed $35 million). The motion seeks relief from the stay to allow the second excess insurer, whose policy provides limits of $10 million in excess of $35 million, to advance defense expenses.

 

The motion goes on to state that the second excess policy’s $10 million excess of $35 million limits are likely to be exhausted "by August of this year." (That is, fees apparently already have or are about to top $45 million.) Accordingly the motion asks for relief from the stay for third excess policy, which provides limits of liability of $10 million excess of $45 million.

 

The third excess policy may also soon be exhausted. The motion suggests that the third excess policy may be exhausted by October. So the motion also asks for relief from the stay for the fourth excess policy, which provides limits of $15 million in excess of $55 million.

 

In answer to the obvious question of how so much defense expense could be accumulating so rapidly, the motion provides a brief recitation of the various proceedings in which the company’s former directors and officers are involved. First, there are the various securities class action lawsuit which have been brought by Lehman security holders. Then there are the various securities lawsuits which have been brought against former directors and officers in connection with the plaintiffs’ purchases of mortgage-backed securities. There are also additional actions or arbitrations which have been brought against certain individuals in connection with Lehman-issued securities, auction rate-securities and other alleged conduct.

 

In addition, the U.S. Department of Justice as well as the SEC and the New Jersey Bureau of Securities have "commenced formal grand jury and regulator investigations concerning the circumstances surrounding the collapse of the Lehman enterprise and have issued various requests and subpoenas," according to the motion papers.

 

All of these various proceedings undoubtedly took on a heightened sense of urgency after the March 11, 2010 release of the report of the bankruptcy examiner, Anthon Valukas, in which he referred, among many other things, to what he regarded as "actionable balance sheet manipulation."

 

In light of all of these various proceedings and given the fact that each of the individuals undoubtedly has their own counsel, it may be unsurprising that defense fees are accumulating so rapidly. Indeed, as Professor Henning notes in his Dealbook post, the fees seem to have been accumulating more rapidly in recent months, to the point that the fees now seem to be running at about $5 million a month. At that rate, even the fourth excess policy is likely to be exhausted before year’s end.

 

Given the size of Lehman’s insurance tower, there may be no immediate reason for the individual defendants to be alarmed. Even were the fourth excess policy to be soon exhausted, that would still leave $180 million in insurance available to cover the defense expenses.

 

But even if there may be no immediate cause for alarm for the individuals, the events so far and that likely lie ahead do present some noteworthy issues.

 

First, the sheer volume of defense expense so far dramatically underscores the enormous potential for a catastrophic claim to produce astonishing levels of defense expenses. To be sure, the Lehman collapse, as the largest bankruptcy in U.S. history, may represent an extreme case. But it is not as if the Lehman situation is the only case where enormous defense expenses have rapidly accumulated. To cite just two examples, in prior posts I have detailed the huge defense expenses that accumulated in the Broadcom options backdating lawsuit (refer here) and in connection with the Collins & Aikman bankruptcy (refer here).

 

In that regard, it should noted that not only has the pace of defense fee accumulation in the Lehman case accelerated in recent months, but the fees seem likely to accumulate even more quickly if the SEC were to file an enforcement action or the DoJ were to file criminal charges. As astonishing as are the fees that have accumulated already, it seems possible (arguably, probable) that even more astonishing fees could lie ahead. Professor Henning’s blog post, linked above, discusses these possibilities in greater detail.

 

While it is still only the catastrophic claims circumstances that produce these kinds of enormous fees, these cases do raise some very serious questions about traditional notions of limits adequacy. The fact is that the most important purpose of D&O insurance is to ensure that the individual directors and officers are protected in the event that the corporate entity is unable to indemnify them. These catastrophic claims scenarios demonstrate how challenging it may be to ensure that the D&O insurance can provide sufficient protection at the point where it is most needed.

 

One answer to this challenge may be the one that Lehman itself apparently followed, which is to buy very significant amounts of D&O insurance. Of course, not every company can afford to purchase anywhere near the amount of insurance that Lehman did. (To put the Lehman insurance program into perspective, the primary policy alone – which was written over a $10 million corporate reimbursement retention – cost Lehman more than $2 million. Clearly Lehman was willing to invest very substantial sums for its executives’ protection.)

 

For that matter, it remains to be seen if even the huge amount of insurance that Lehman put in place will be sufficient to protect the individuals from all of the defense expenses that may lie ahead. If the SEC were to file an enforcement action and the DoJ were to pursue criminal charges, it is not impossible that the accumulating defense expenses could test even the remaining limits

 

(And that is without even allowing for the possibility, raised by Professor Henning in his blog post, that one or more of the excess insurers might seek to disclaim coverage – "You know how insurance companies can be," he comments.)

 

There are no easy solutions to these kinds of concerns, although one consideration that should be taken into account is D&O insurance program structure. That is, in addition to considering the question of how much insurance is enough, the question of what structure of insurance should be put into place should also be considered. Among other things, one particular question is whether specific parts of the program should be designated solely for the protection of specific individuals (for example, outside directors) as one way to ensure that no matter what happens there is always a specific pot of money available for the protection of those individuals.

 

In any event, the consequences following the Lehman collapse are continuing to unfold and undoubtedly have much further to run. The astonishing accumulation of defense expense seems likely to continue if not accelerate. Whether or to what extent any of the D&O insurance might be available to pay settlements or judgments remains to be seen.

 

This last point, about possible funds for settlements or judgments, does underscore an issue that could well become critically important later on. That is, the D&O insurance tower that is responding to these various proceedings is the one that was in place for the period May 2007 to May 2008. However, Lehman filed for bankruptcy in September 2008. There is in fact, according to footnote 6 of the debtor’s memorandum in support of the motion for relief from the stay, a separate $250 million insurance tower that was in place for the period May 16, 2008 to May 16, 2009.

 

The 2007-2008 tower presumably is the one that is responding to these various proceedings because the first of the shareholder lawsuits apparently was filed in February 2008, during the policy period of the earlier tower, and later filed proceedings apparently have been treated as interrelated with the first filed claim, and therefore relate back to the date the first claim was made.

 

Given the huge amount of money at stake and in light of the fact that the 2007-2008 tower is being substantially eroded, it seems probable that someone will find it worthwhile to try to establish that one or more of the various claims triggered the 2008-2009 tower. (Indeed, it may well be that this type of effort is already well underway in one or more disputes or proceedings.) Before all is said and done in connection with the fallout from the Lehman collapse, there could be many twists and turns.

 

With as many as 17 different D&O insurers involved in this claim, there undoubtedly are quite a number of professionals in the D&O insurance industry involved in this matter. With a situation like this, there could be some pretty good scuttlebutt. I encourage anyone involved in this matter who is willing to share to post a comment using this blog’s comment function (anonymously if necessary). I am certain there is a lot more going on in this claim than can be discerned from the bare face of the pleadings.

 

Finally, for those practitioners who would appreciate insight into how the D&O insurance policy operates in the bankruptcy context, the debtor’s motion makes some pretty interesting reading. The motion not only shows how the the policy proceeds are administered and monitored in light of bankruptcy procedures, but it also illustrates how various key policy provisions (for example, the priority of payments clause) are intended to operate.

 

In the latest development in the long-running lawsuit that is among the very few securities cases to actually have gone to trial, the Ninth Circuit – in its second crack at the case – affirmed the district court’s dismissal. The Ninth Circuit’s August 9, 2010 opinion (here) in the Thane International securities class action lawsuit affirmed the district court’s entry of judgment for the defendants on the issue of loss causation.

 

Background

Reliant Interactive Media Corp. was acquired by Thane International in September 2001. Reliant shareholders received Thane shares in the merger. Thane’s shares had not been publicly traded, but the merger prospectus stated that Thane’s shares had been "approved for quotation and trading on the NASDAQ National Market" upon completion of the merger.

 

However, when the merger was consummated, Thane’s shares commenced trading not on the NASDAQ National Market System by on the NASDAQ Over-the-Counter Bulletin Board. For nineteen days, the shares traded above the merger price. However, when the company then reported disappointing earnings, the share price fell, and it continued to decline until Thane ultimately bought back the shares at a fraction of the merger price.

 

In September 2002, a class of former Reliant shareholders sue Thane and four of its directors and officers under Sections 12(a)(2) and 15 of the ’33 Act, alleging that the pre-merger prospectus had been misleading because it implied that Thane Shares would list on the NASDAQ National Market System.

 

Following a three-day bench trial, the district court concluded that Thane did not violate Section 12(a)(2), finding that the prospectus was not misleading, and that in any event the misrepresentations were not material because Thane’s share price did not depreciate below the merger price after the market became aware of the market on which the company’s shares were trading.

 

As discussed here, in a prior appeal, the Ninth Circuit reversed the district court’s trial ruling, holding that the statements in the prospectus, even if literally true, contained misleading statements regarding where Thane shares would be listed and trade, and that the information was material, because a reasonable investor would have wanted to know where the shares would trade. However, the Ninth Circuit recognized that the defendants could still prevail by establishing the affirmative defense of lack of causation.

 

On remand, the district court held that the defendants had carried their burden of establishing lack of loss causation, holding that there could be no loss as long as Thane’s share price remained above the merger price, and there could be no loss causation since the stock price didn’t fall below the merger price after "impounding" the information about the nonlisting on the National Market System. The plaintiffs’ appealed.

 

The August 9 Opinion

In its latest opinion, the Ninth Circuit quickly rejected the plaintiffs’ argument that the appellate court’s prior ruling that the prospectus misrepresentation "foreclosed" the defendants’ reliance on the loss causation defense. The Ninth Circuit found that materiality and loss causation are separate issues, and the question whether investors would find information important (materiality) is different than the question whether a particular misstatement actually resulted in a loss (loss causation). Even if the "two inquiries are related" that "does not mean they are the same."

 

The Ninth Circuit also rejected the plaintiffs’ argument that, due to the inefficiency of the market in which Thane’s shares traded, the share price could not be used in a loss causation assessment. The Court said the absence of efficiency "does not mean that prices are unreliable." The Court rejected the theory urged by the plaintiffs that it is inappropriate to rely on stock prices in an inefficient market to determine loss causation.

 

Finally, the Ninth Circuit held that the district court did not err when it found that Thane’s share price had "impounded" (absorbed) the failure to list on the National Market System before it fell below the merger price.

 

Discussion

The decision is likely to be of greatest interest to the parties involved, although it also has some value for its analysis of the relation between materiality the loss causation issue. The Court’s analysis of the role in the loss causation analysis of prices for shares that trade on an inefficient market is also interesting.

 

However, the thing that makes this decision most noteworthy is that it involves one of the very rare securities class action lawsuits that actually went to trial. Yes, the trial was a three-day bench trial, and yes the case’s lengthy post-trial procedural history essentially reduces the fact that there was a trial to just one event in the long history of the case.

 

Nevertheless, the process of tracking securities cases that have gone to trial has taken on an importance of its own, so for purposes of maintaining the running scorecard of securities cases that have gone to trial, this Ninth Circuit’s decision upholding the lower court’s dismissal is noteworthy.

 

According to data compiled by Adam Savett, the Director of Securities Class Actions at Claims Compensation Bureau, there have been nine securities class action lawsuits that have gone to trial post-PSLRA involving post-PSLRA conduct, including the Thane International case. Taking the Ninth Circuit’s recent ruling in the Thane case into account (as well as other recent developments, including the Ninth Circuit’s recent action in the Apollo Group case), the scoreboard in those nine post-PSLRA cases currently stands at five for the plaintiffs and four for the defendants.