I am pleased to present below an article submitted by John Iole, a partner in the Insurance Recovery Practice of the Jones Day law firm. John notes with respect to his guest post that “the views expressed in this post are those of the author and not necessarily those of the firm or any of its clients.”

 

I welcome proposed guest post submissions from responsible persons on topics relevant to this blog or its readership. Please contact me if you think you might be interested in submitting a guest post.

 

 

I note that John’s post addresses conflicts of interest that may arise in connection with the D&O insurance policy. In addition to the conflicts John discusses in his post, an additional conflict that can arise under the D&O policy is a conflict between the interests of the non-officer directors and other persons insured under the policy. I discussed these conflicts involving non-officer directors in a prior post, here.

 

 

Here is John’s post.

 

 

D&O insurance rightfully attracts the scrutiny of highly-placed personnel at purchasing companies. Likewise, the placing brokers are specialists with broad and deep experience in this line of cover. Nevertheless, a recurring issue that is infrequently addressed is the balance of interests that must be struck each year at the time of D&O renewal. This issue can arise again at the point of a claim.[1]

 

 

            Several characteristics combine to create divergent interests among the parties involved in D&O coverage. First, standard D&O insurance is sold on an aggregate limits basis, meaning that the program limits in any given policy period are available for any and all claims made against the policy. With exceptions that are essentially immaterial, any claim made against a D&O policy will, to the extent it is paid, result in an erosion of the limits available to pay all other claims that are made during (or allocated to) that same policy period. This means that a claim that is paid today necessarily reduces the insurance limits available to pay another claim tomorrow.[2]

 

 

            The second — and for present purposes the most significant — characteristic of D&O insurance is the fact that there are multiple insured persons who stand to receive the benefit of the insurance limits available. Each insured person has a separate interest in maximizing the limits available to pay a claim that might be asserted against that individual (or entity). Because insurance is protection purchased today against the financial consequences of events that might take place tomorrow, each insured person has an interest in guarding against erosion of limits – this holds true even when no claim has been asserted or is expected. Of course, if claims are known to be likely (known risks, not known losses, which would be excluded), then each insured person has an even greater interest in making sure that expenditures are kept to a minimum in order to protect the availability of funds. In addition, some individuals might have a particularly acute sensitivity to the potential for claims. For example, a member of the audit or compensation committee might expect a higher incidence of claims than non-member insureds. Although many insurance contexts represent the situation in which payment of claims results in a consumption of limits, the multiple insured persons that exist in the D&O context creates a potential for conflict.

 

 

            A third complicating consideration is the interest of the entity in the case of a company that has cover under Side-B (reimbursement of the entity for claims paid on behalf of directors and officers) or Side-C (which provides coverage to the entity itself, generally for securities claims). Take the case of a claim asserted against a director or officer that falls within the Side-B cover, and the entity not only is permitted to indemnify the individual, but also is required as a matter of corporate by-laws and/or indemnification agreement to do so. In such a case, the entity will pay the individual’s legal expenses as they become due, and these can be significant. In addition, the entity will stand ready to pay any judgment (or settlement) that results on the merits of the claim. In turn, the entity can expect to be reimbursed by the D&O insurance proceeds for the amount outlaid on behalf of the individual.[3] The individual’s interests are protected by the entity’s funds, and the individual has no direct concern as to whether the entity is reimbursed. Thus, a Side-B claim presents a conflict situation that is similar to the straightforward competition for limits (or preservation of limits) that exists between any two directors or officers. In a Side-B context, however, the competition is between the individuals (as a whole) and the entity.

 

 

            The conflict is essentially the same when a Side-C claim is asserted, in that the entity’s consumption of limits in the defense or resolution of a covered claim likewise reduces the limits available for other purposes (such as payment of Side-A claims). One significant difference in Side-C claims is that, unlike Side-B claims, a Side-C claim does not present any retirement of individual liability, but only pays for the elimination of corporate liability. In the case of a Side-B claim, the entity is reimbursed only after the individual claims already have been paid, whereas Side C claims potentially put the entity at the front of the claims line.

 

 

            Additional conflicts arise when a D&O program is laden with coverage “enhancements” that branch out from the core purpose of D&O cover. These enhancements sometimes are offered as a way to add value to an expensive line of insurance. In this respect, it can be an alluring prospect to equip the D&O program with optional coverages with the idea that the entity is saving premium dollars that otherwise would be spent on separate policies. For example, some D&O programs include special coverages (or combined limits) for employment-related claims or fiduciary claims. This type of cover might take the place of separate Employment Practices Liability or Fiduciary coverage.[4] Similarly, some D&O programs provide Employed Lawyers coverage for in-house counsel when acting as a lawyer (as opposed to coverage for counsel acting as an officer of the company).[5] As with securities claims against Side-C cover, these coverage grants can result in claims that compete for limits with “standard” D&O claims. Moreover, these coverages can extend the scope of insured persons to a broad swath of employees.

 

 

            These conflicts are not necessarily insurmountable problems, but should be adequately recognized and harmonized within the overall D&O program. There are many ways to deal with these issues, both at the point of policy placement, and also at the point of a claim. For example, a potential solution to invoke at the time of placement is to purchase substantial limits so that the risk of complete exhaustion is minimized, but of course this will bring extra cost. Another time-of-placement solution is to purchase Side-A only coverage (either excess, or excess difference in conditions) that sits above the Side A/B/C cover and comes into play if the A/B/C cover is exhausted (but of course this does not eliminate the potential for conflicts among insured persons). Another option is to purchase stand-alone individual Side-A-only cover for particular directors and officers.

 

 

            So long as the policy language provides sufficient flexibility, different solutions can be used at the point of a claim in order to reduce competition for limits. If it appears that the program limits could be compromised by pending and expected claims, the potentially competing demands can be harmonized by an automatic or discretionary deferral of payments to the entity through an order of payments clause.[6] A problem with an automatic order of payments clause (e.g., a clause stating that side A claims shall be paid before side-B or side-C claims), however, is that it can only operate with respect to known and ripe claims.  If the policy also combines a discretionary feature that allows the designated person to direct when and how payments will be made, then a deferral can be invoked to preserve limits for pending claims that are not yet ripe for payment, or for potential unasserted claims.[7] Because of the delicate interests that must be balanced in such a situation, the designated decision-maker will play a critical role.

 

 

            Given the inherent conflicts facing the directors and officers (both inter se and as between the entity), an additional consideration confronts each lawyer or other professional involved in policy placement and negotiation — namely, the interests that he or she is protecting, and the extent to which he or she is charged with representing conflicting interests. It is basic black-letter legal ethics law that a lawyer representing a corporation represents “the organization acting through its duly authorized constituents.”[8]

 

 

            In the context of D&O insurance, however, the representation analysis is complicated by the fact that the entity is providing coverage for the benefit of the individuals, and potentially also for its own benefit. In that setting, there are multiple potential clients – or at least acutely interested parties – who do not share identical interests. Furthermore, because the actual or potential conflicts of interest might not be fully appreciated by each of the affected persons, and the role of counsel might not be clearly understood, some statement of role clarification ordinarily will be prudent.[9] Nevertheless, a potential adversity of interests does not necessarily require separate legal representation. In the case of divergent interests among clients, the basic ethics rules still permit a multiple representation, so long as the lawyer reasonably believes that each client can be competently represented and each provides informed consent.[10] Although conflicts of interest at the time of placement have not generated reported disputes or case decisions, similar conflicts that arise at the point of a claim can produce major difficulties if the rules are not carefully observed.[11] 

 

 

            Therefore, when embarking on a representation involving D&O insurance that might affect multiple constituencies, the most prudent course to follow is to clearly define and limit (if necessary) the scope of the representation, and to obtain informed consent of each affected client if representation of more than one party is undertaken.[12] Another option is to make clear that some constituencies are being represented as clients and others are not being represented. In cases of particular risks or sensitivities, there is always the option to retain separate counsel to represent one or more constituents who are adverse to the others. Depending on the interests and jurisdiction involved, this potentially could be accomplished through separate lawyers from the same organization, or might require separate outside counsel.[13] In the end, there is no certain decision that is foolproof, but a consideration of these items, along with thoughtful guidance when appropriate, hopefully will yield the most prudent decisions that properly accommodate the different interests involved.

 

 

[1]This post does not address the obvious conflicts that occur when it becomes apparent that competing claims to limited insurance proceeds will eclipse the available limits, as discussed in Tittle v. Enron Corp., 463 F.3d 410 (5th Cir. 2006). In that situation, jurisdictions develop rules to determine whether claimants will be treated on a "first in time, first in right" basis or an equitable apportionment basis.

 

[2] There are some ancillary coverages that do not significantly affect the analysis, in that they either are subject to defined sub-limits or allowances, or are likely to be so small as to be an inconsequential impairment of limits. For example, a D&O policy might provide coverage for “crisis management” or “crisis communications,” or for responding to a subpoena for documents or testimony. Except in extraordinary situations, these claims will not seriously erode the limits, and these claims might be subject to a stated maximum amount. For example, the Chartis Executive Edge form provides: “This policy shall pay the Crisis Loss of an Organization, up to the $100,000 CrisisFund®. . . . .” A crisis under this form includes delisting events and events that cause or are reasonably likely to cause a material effect on stock price.

 

 

[3]Functionally, the insurance could pay instead of the entity in order to discharge the entity’s indemnity obligation, or alternatively could reimburse the entity after it has made payments on behalf of the individual. For example, the Chubb Asset Management Protector form pays on behalf of the entity: “The Company shall pay, on behalf of an Organization, Loss for which such Organization grants indemnification to an Insured Person, and which the Insured Person becomes legally obligated to pay on account of any Claim first made against the Insured Person, during the Policy Period . . . for a Wrongful Act by such Insured Person before or during the Policy Period.” The Chartis Executive Edge form provides reimbursement to the entity:  “This policy shall pay the Loss of an Organization that arises from any: . . . . Claim . . . made against any Insured Person . . . for any Wrongful Act of such Insured Person . . . but only to the extent that such Organization has indemnified such Loss of, or paid such Loss on behalf of, the Insured Person.”

 

 

[4]Towers Perrin reports that, for 2008 (the most recent year for which data is available), 57% of the surveyed companies purchased EPL coverage with their D&O insurance policy, whereas 33% purchased a stand-alone EPL policy (10% purchased no EPL coverage). Towers Perrin, Directors and Officers Liability: 2008 Survey of Insurance Purchasing Trends (Sept. 2009), at 7. Of those surveyed companies that purchased any fiduciary coverage, Towers Perrin reports that roughly half bought combined limits for D&O and fiduciary cover. Id.

 

 

[5]Additional coverages might include cover for shareholder derivative demand investigations or cover for participation as a member of the board of other organizations.

 

 

[6] The Chubb Asset Manager Protector form directs that Side-A claims, and covered loss to be paid on behalf of a benefits plan (if such coverage is purchased), be paid first before all other claims. The form specifically permits the insurance to pay claims without regard to whether there is a “potential for other future payment obligations” (i.e., future claims). The Chartis Executive Edge form provides:

 

In the event of Loss arising from a covered Claim(s) and/or Pre-Claim Inquiry(ies) for which payment is due under the provisions of this policy, the Insurer shall in all events:

 

(1) First, pay all Loss covered under Insuring Agreement A. Insured Person Coverage;

 

(2) Second, only after payment of Loss has been made pursuant to subparagraph (1) above and to the extent that any amount of the Limit of Liability shall remain available, at the written request of the chief executive officer of the Named Entity, either pay or withhold payment of Loss covered under Insuring Agreement B. Indemnification Of Insured Person Coverage; and

 

(3) Lastly, only after payment of Loss has been made pursuant to subparagraphs (1) and (2) above and to the extent that any amount of the Limit of Liability shall remain available, at the written request of the chief executive officer of the Named Entity, either pay or withhold payment of Loss covered under Insuring Agreement C. Organization Coverage and Insuring Agreement D. Crisisfund® Coverage.

 

In the event the Insurer withholds payment pursuant to subparagraphs (2) and/or (3) above, then the Insurer shall, at such time and in such manner as shall be set forth in instructions of the chief executive officer of the Named Entity, remit such payment to an Organization or directly to or on behalf of an Insured Person.

 

 

[7]Even though D&O insurance is sold on a claims-made basis (i.e., it pays covered claims made against the insureds during the policy period), it is not true that all payable claims will be made before the end of the policy period. For example, if a later claim (made after the policy period) is sufficiently related to a claim made during the policy period, then the limits of the first policy will respond to the claim and it will be excluded from later policies.

 

 

[8]See, e.g., ABA Model Rule 1.13, Organization as Client. This rule is emphasized by the Corporate Governance Recommendations adopted by ABA House of Delegates in 2003, which include the following statement: “A lawyer representing a public corporation shall serve the interests of the entity, independent of the personal interests of any particular director, officer, employee or shareholder.” Report of the American Bar Association Task Force on Corporate Responsibility, at p.32 (March 31, 2003).

 

9] For example, ABA Model Rule 1.13(f) provides: “In dealing with an organization’s directors, officers, employees, members, shareholders or other constituents, a lawyer shall explain the identity of the client when the lawyer knows or reasonably should know that the organization’s interests are adverse to those of the constituents with whom the lawyer is dealing.”

 

 

[10] ABA Model Rule 1.7(b) provides: “Notwithstanding the existence of a concurrent conflict of interest under paragraph (a), a lawyer may represent a client if: (1) the lawyer reasonably believes that the lawyer will be able to provide competent and diligent representation to each affected client; . . .and (4) each affected client gives informed consent, confirmed in writing." Each state has a different formulation of the rule, and some are dramatically different, so the relevant rule must be verified. For example, some states require consent to be confirmed in writing, whereas others do not. It is also clear that in-house counsel are treated essentially the same as outside counsel, and thus company counsel must be mindful of the conflicts presented by intra-corporate representations. See, e.g., ABA Model Rule 1.0(c) ("Firm" or "law firm" denotes . . . the legal department of a corporation or other organization.”); see also Association of the Bar of the City of New York, Committee On Professional And Judicial Ethics, Formal Opinion 2008-2, “Corporate Legal Departments And Conflicts Of Interest Between Represented Corporate Affiliates” (Sept. 2008) (discussing responsibilities of in-house counsel in the conflicts context).

 

[11] See, e.g., U.S. v. Ruehle, 606 F. Supp.2d 1109 (C.D. Cal.) (law firm referred for discipline for failure to properly advise and/or document warning to officer that firm represented corporate entity and not individual officer), rev’d on other grounds, 583 F.3d 600 (9th Cir., Sept. 30, 2009) (indictment dismissed on remand).

 

 

[12] See, e.g., ABA Model Rule 1.13(g) (“A lawyer representing an organization may also represent any of its directors, officers, employees, members, shareholders or other constituents, subject to the provisions of Rule 1.7.  If the organization’s consent to the dual representation is required by Rule 1.7, the consent shall be given by an appropriate official of the organization other than the individual who is to be represented, or by the shareholders.”).

 

 

[13] The lawyer ethics rules have not completely caught up with the realities of corporate law departments. The Model Rules define a “firm” to include a corporate legal department. The trouble arises when the imputation rule applicable to law firms is applied indiscriminately to corporate law departments. In that setting, no two lawyers in the law department are permitted to represent adverse interests unless two lawyers within a private firm would be permitted to do so. See, e.g., The Association of the Bar of the City of New York Committee on Professional and Judicial Ethics, Formal Opinion 2008-2, “Corporate Legal Departments And Conflicts Of Interest Between Represented Corporate Affiliates” (Sept. 2008). Some accommodation of corporate realities to permit ethical screens in this context to take the place of separate "firms" would appear to be appropriate in most cases.

 

The amount of damages awarded in 2009 Japanese securities cases exceeded "the aggregate amount of securities litigation damages determined by court decisions in Japan for the entire previous decade," according to a new study of Japanese securities litigation from NERA Economic Consulting. The report, dated August 2, 2010 and entitled "Trends in Japanese Securities Litigation: 2009 Update," and which can be found here, updates the NERA report released last year that surveyed Japanese securities litigation from 1998-2008.

 

According to the report, there were 39 total cases filed in 2009, of which 14 related to misstatements, the same number of misstatement cases as in 2008. The balance of the filings largely involve broker-dealer cases, of which there were 23 in 2009, 12 of which related to unlisted stock trading.

 

The most significant trend noted in the report has to do with damages awards. The total value of all 2009 securities lawsuit judgments was about 47.2 billion yen (just under $550 million), which is four times the 2008 total and the highest annual level ever. The average damage aware per judgment amount was also a record high of 1.9 billion yen, or about $22 million.

 

Both the 2009 filings and damage awards reflected matters involving two notable companies, Livedoor and Seibu Railway. Thus, of the 14 new disclosure cases filed in 2009, five each related to Seibu Railway and Livedoor. New cases "involving other companies and/or allegations were limited." Similarly, much of the damages awarded "were related to the Livedoor and Seibu Railway cases." The report specifically notes awards that approximately 25 billion yen in damages is attributable to just two awards involving those two companies in 2009.

 

The report acknowledges that as the Seibu Railway and Livedoor cases are resolved, there is like to be a decrease in the number of judgments and damages related to misstatements, but the report suggests that any such downturn will be "short-term."

 

The report attributes the historical trends of increased number of disclosure related lawsuits and increased damages to changes that were introduced in Japanese law in 2004. Among other things, these changes the plaintiffs’ burden for proving damages was decreased and the powers of the Japanese Securities and Exchange Surveillance Commission were increased. Increased disclosure burdens on companies and heightened institutional investor expectations "may lead to an increase in the number of misstatement cases in the [the] future."

 

Though the reasons for the phenomenon in Japan may have uniquely Japanese attributes, Japan is only one of several countries that has seen an increase in the number and severity of securities related lawsuits in recent years, largely as a result of relatively recent legal reforms. Prior NERA reports have detailed these trends in Australia (about which refer here) and Canada (about which refer here).

 

These trends, which are also emerging in other counties as well, seem likely to continue, both because of the evolving impact of legal reforms as well as because of increased expectations of institutional and other investors. Other factors, including the increasing availability of litigation funding, which has proved to be a significant factor in the growth of securities litigation in Australia and elsewhere, could also contribute to these developments.

 

Another factor that at least potentially could encourage these trends is legal developments in the United States, particularly the U.S. Supreme Court’s June 2010 decision in Morrison v. National Australia Bank (about which refer here and here). As a result of this decision aggrieved investors who purchased securities on non-U.S. exchanges will be unable to pursue remedies under the U.S. securities laws in U.S. courts. As a result, some foreign-domiciled investors who might have attempted to pursue claims in the U.S. may now seek to pursue claims in their own country – and even, to the extent they find the remedies or procedures in their own country to be unsatisfactory, to seek legislative.

 

In any event, as the authors of the recent study suggest, the developments in Japan seem to represent longer term trends, which seems to be true in other countries as well. Even though there are still many more securities lawsuits in the U.S. than elsewhere, the number and significance of the lawsuits outside the U.S. appear to be increasing.

 

In a prior post, I published the first in what I intend to be an occasional series of articles on the nuts and bolts of Directors’ and Officers’ Liability Insurance. I continue the series here with the second post in the series. In this post, I take a look at the most basic component of the D&O insurance policy – the insuring agreement. This basic policy clause contains the most critical terms, the definitions of which often determine whether or not a claim will be covered under the policy.

 

The Insuring Clause

Though the precise formulations may (and often do) vary from policy to policy, all D&O insurance policies more or less provide coverage for Loss arising from Claims first made during the policy period alleging Wrongful Acts against Insured Persons.

 

Each one of these nouns or noun clauses in the insuring agreement – Loss, Claims, Wrongful Acts, Insured Persons – are defined terms in the policy, and the specifics of the definitions of each of these terms may be among the most coverage-determinative provisions in a D&O insurance policy.

 

I briefly discuss below each of these terms and the claims issues that can arise in connection with each of the terms. I should emphasize at the outset that the precise contours of these terms have been the subject of extensive litigation over the years. Within the constraints of this blog format, I could not hope to summarize this litigation or all of the issues that have arisen. Moreover, it is important to note that the specific terms and definitions in any particular policy will determine the claims outcome in specific claims circumstances.

 

Here are the key insuring clause terms, addressed in a slightly different order than they typically appear in the D&O policy.

 

"Claims Made"

Many liability insurance policies are what are known as "occurrence" policies – that is, the policies provide coverage for accidents or mishaps that occur during the policy period, regardless of when the lawsuit is actually filed. However, D&O insurance policies are not "occurrence" policies, they are "claims made" policies. That is, D&O insurance policies provide coverage for claims made during the policy period, regardless of when the underlying conduct may have occurred.

 

(Actually, that last statement is not always literally true, as many D&O policies have "past acts" dates which specify the date after which the allegedly wrongful conduct must have occurred. In connection with policies that have past acts dates, claims based on conduct that occurred prior to the date would not be covered, even if the claim is made during the policy period.)

 

"Claim"

Obviously, in order to determine whether a claim was made during the policy period, one critical question is going to be, what is a "Claim"? Answering that question may be relatively straightforward in the context of civil litigation, as the service of the complaint is relatively easily recognizable as a claim.

 

The typical D&O policy’s definition of the term "Claim" extends much more broadly beyond civil litigation. Most policies’ definitions of the term encompass any type of demand for monetary or non-monetary relief, whether or not in the form of a complaint. A letter demand for redress of grievances, for example, though less formal than a civil complaint, typically constitutes a claim under a D&O policy.

 

In addition, the term "Claim" typically extends well beyond civil litigation to many other types of proceedings. For example, many policies extend the definition to include criminal proceedings, usually with a narrowing provision requiring the service of an indictment or an equivalent document. Many policies also extend to regulatory or administrative proceedings, although these clauses often include a requirement that these proceedings be "formal."

 

The term "Claim" also increasingly is defined to extend to arbitration and mediation and other types of alternative dispute resolution proceedings.

 

One of the perennial claims battlefields is the question whether investigative proceedings constitute a "Claim" within the meaning of a D&O policy. The question usually depends critically on the precise wording of the policy definition and the specifics of the investigation involved. Among other frequently recurring questions is whether grand jury subpoenas, informal document requests or other informal inquiries represent claims.

 

"Loss"

The term "Loss" specifies the things for which the policy will pay. The term usually encompasses specified indemnity amounts (settlements and judgments) as well as attorneys’ fees and other defense costs. (And, it should be noted, the policy’s payment of defense fees reduces the amount of insurance remaining under the policy, as payment of defense expenses erodes the limit of liability under the policy). The policy definition also typically excludes payment of certain items, including fines, penalties and matters deemed uninsurable under applicable law.

 

Among the recurring issues in relation to the definition of "Loss" are questions of coverage under the policy for amounts paid as disgorgement or restitution. These amounts generally are not regarded as "Loss," since they typically represent a defendant’s restoration of funds that were never his or hers in the first place. The battleground on these questions, though, is usually over whether or not a specific payment or kind of payment actually represents restitution or disgorgement.

 

Another recurring D&O insurance question arises in connection with lawsuits filed in the M&A context, particularly where the claim is that the transaction price is unfair to shareholders. These claims often are settled with an adjustment of the sales price. The question is whether the additional consideration paid is covered under the policy. These kinds of claims, often referred to as "bump up" claims, frequently recur and often depend on the specific circumstances presented and the policy wording involved. (Many policies today actually have specific "bump up" exclusions.)

 

"Wrongful Act"

The term "Wrongful Act" is usually defined as an actual or alleged act, error or omission, misleading statement or breach of duty. D&O policies are liability policies, so in order for coverage to attach, the insured person must have done something (or be alleged to have done something) for which they are liable to third parties. Although that might seem pretty straightforward, it can often become tricky in a variety of contexts.

 

One frequently recurring set of circumstances where the question whether or not a wrongful act has been alleged is in connection with the investigative proceedings. As noted above, the question whether or not subpoenas or informal document requests are claims often comes up. However, even if the specific investigative proceedings are claims under the definition of a specific policy, there may still be questions of coverage (again, depending on the specific circumstances and policy language involved) because the subpoena or informal document request does not allege a wrongful act. Or, if they allege a wrongful act, whether or not it is alleged against an insured person.

 

"Insured Person"

Many D&O policies provide coverage for both natural persons and for corporate entities. Whether or not a person or entity is or is not an insured person under the policy will often depend both on the person’s status and on the capacity in which they were acting.

 

For individuals, the status entitling them as insured persons under the policy is usually their service as a duly elected or appointed officer or director of the company. Whether or not a person is duly elected or appointed will often depend on the insured company’s own organizing documents or corporate charter. Questions can sometimes arise about whether or not middle or lower level personnel are insured; these questions are usually best addressed at the time the policy is formed, by endorsing the policy to specify that persons holding specific offices – or even specify particular named persons—are insured persons under the policy.

 

A frequent concern is whether individuals have coverage after they have completed their board service or officer duties. Most D&O policies include current, past and future director and officers within the definition of insured persons, so a former director or officer should continue to have protection for acts undertaken during their service, at least as long as the company continues to have D&O insurance in place.

 

Beyond the questions whether an individual’s status entitles him or her to be an insured person under the policy are questions concerning the capacity in which an individual was acting at the time of the alleged wrongful conduct. The individuals are insured only for actions in an insured capacity – that is, in connection with their service as a director or officer of the company.

 

These questions can be difficult when the individual has multiple connections with the insured company – as an investor, for example, or as a representative of a private equity or venture capital firm, or where the individual’s actions were in connection with a joint venture or other related but separate entity. The capacity in which the person was acting at the time may be a critical issue.

 

As for entities insured under the D&O policy, the typical policy provides coverage both for the insured entity (usually the first named insured) and its subsidiaries. Questions can arise whether or not an entity is a subsidiary (depending on the corporate parent’s ownership percentage). Questions can also arise about organizations formed or acquired after the policy’s inception. Most policies have very specific policy provisions addressing these subsequent formations or acquisitions.

 

More complex organizational structures can pose particular challenges. Organizational vehicles such as joint ventures or limited partnerships can pose particularly troublesome concerns if not addressed in the policy. Full exploration of these entity organizational issues are well beyond the scope of this blog post, but the critical issue is that these organizational questions should be addressed during the insurance acquisition process.

 

Future Posts in This Series: Based on the response I received to my initial post in the series, I intend to continue to write and publish posts on the nuts and bolts of D&O insurance in the weeks ahead. I am interested to hear from readers on topics they are particularly interested in seeing this series address. I can’t promise that I will address every issue – that are so many issues that I might possibly address, some of which are well beyond the "nuts and bolts" scope of this project.

 

However, with a better understanding of the issues in which readers are interested I can at least try to shape future posts to the issues that appear to be of greatest interest or concern. As always, I welcome readers’ thoughts and comments on the posts I publish as part of this series, as well as any other issues relating to this blog or its content.

　

Earlier this week, I hosted a guest post from the counsel for the plaintiffs in the Vivendi securities class action lawsuit, in which plaintiffs’ counsel summarized their position on the impact that the U.S. Supreme Court’s decision in Morrison v. National Australia Bank had on their case.

 

In response to their post, University of Minnesota Law Professor Richard Painter prepared the following commentary and submitted it to me for publication here. By way of background, Professor Painter’s opening reference is to George Conway of the Wachtell Lipton firm, who, as reported in the prior post on this topic, briefed and argued the Morrison case for National Australia Bank, and who has been quoted as characterizing the position of the Vivendi plaintiffs on this issue as “Completely nuts, N-U-T-S.” 

 

 

Here are Professor Painter’s comments:

 

 

Actually, Conway has to be right. The argument that Section 10(b) applies to foreign transactions in securities merely because those securities are listed in the United States is absurd.

 

 

First, a reading of the entire Morrison opinion leads to the conclusion that the Court did not extend the reach of Section 10(b) to foreign transactions in securities listed on an American exchange. The Court’s unequivocal holding is that Section 10(b) does not apply “extraterritorially.” The Court repeatedly emphasizes that the “focus” of American securities laws is on “domestic transactions” and on “purchases and sales of securities in the United States.”

 

 

An extremely large hole would be driven through that holding if the mere listing of a stock or an ADR on an American exchange were enough to justify application of U.S. law to a foreign purchase of the stock on a foreign exchange, as there are hundreds if not thousands of foreign issuers that list their home-country shares or ADRs on a U.S. exchange.

 

 

Second, the Court was well aware that NAB had ADRs listed in New York. In order for a foreign issuer to sponsor and list ADRs on a U.S. exchange, it must register the underlying, deposited shares with the SEC and, at least for the NYSE, actually list the underlying shares (though not for trading). NAB’s registration statement in the United States, for example, pertained to “ordinary shares” (At page 58 of the Supplemental Joint Appendix in Morrison v. NAB, the 20-F cover says NAB’s ordinary shares were “registered on the NYSE.” This cover looks exactly like the 20-F cover for Vivendi that the plaintiffs there are relying on.)

 

 

The Court nonetheless held that Section 10(b) did not apply to NAB’s ordinary shares traded in Australia. This holding is inconsistent with a theory that the Court would apply Section 10(b) to any security listed on a U.S. exchange even if the transaction in that security is outside the United States.

 

 

Many companies have ADRs trading in the United States. It cannot possibly be the case that the Court intended Section 10(b) to apply not only to the ADR itself but also to a foreign purchase of the underlying stock on a foreign exchange simply because the underlying shares are registered in the United States to enable the company to issue the ADR.

 

 

Indeed, if the Vivendi plaintiff’s counsel were correct, Section 10(b) after Morrison would have a broader extraterritorial reach than ever before. Think of the many foreign-cubed claims dismissed under the Second Circuit’s conduct test before the Supreme Court ruled: many – if not most – of the defendant issuers in those cases had sponsored ADRs that traded on American exchanges, just like NAB, and just like Vivendi. On plaintiffs’ reading of Morrison, those cases were wrongly dismissed. Section 10(b) – which the Supreme Court said did not have any extraterritorial application “at all” – according to Vivendi plaintiffs’ counsel would apply more extraterritorially than ever before.

 

 

This is the exact opposite of what the Court clearly intended. And it would mean that the Court got the result wrong in Morrison itself.

 

 

There are other points to make against the plaintiffs’ contention, such as the significance of Section 30 of the Exchange Act, whose territorial limitations would be rendered meaningless if plaintiffs’ reading of Morrison were correct. The bottom line is: it is quite clear that plaintiffs who transacted in securities outside the United States have no cause of action under Section 10(b) merely because these securities or related ADRs are listed on a U.S. securities exchange.

 

 

Nice try plaintiffs, but if you want a different rule, ask the SEC to recommend one in its study of extraterritorial private rights of action that Congress mandated in Dodd-Frank. Don’t waste your time with a meritless interpretation of Morrison.

 

 

I encourage reader to respond to Professor Painter’s commentary or to the Vivendi plaintiffs’ prior column using this blog’s comment function.

 

 

I welcome guest blog posts from responsible commentators on topics of interests to readers of this blog. Please contact me (using the Contact function in the right hand column) if you are interested in submitting a guest column.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

　

　

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

 

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

 

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

 

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

 

　

 

 

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

 

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

 

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

 

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

 

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

 

　

 

 

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

 

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

　

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

　

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Background

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

 

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

 

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

 

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

 

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

 

The July 27 Decision

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Discussion

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

 

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

 

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

　

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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