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

 

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

 

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

 

Background

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

 

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

 

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

 

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

 

The Settlement

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

 

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

 

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

 

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

 

Discussion

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Discussion

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

 

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

 

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

 

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

 

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

 

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

　

In recent months, I have documented on this blog the rising tide of failed banks as well as the ensuing failed bank related litigation. An August 16, 2010 report by Paul Hinton of NERA Economic Consulting entitled "Failed Bank Litigation" (here) takes a comprehensive view of the economics and causes of recent bank failures, compares the recent bank failure wave to the S&L crisis, and analyses the implications for litigation against the directors and offices of the failed institutions. The report contains a wide variety of different kind of information that readers will find interesting and useful.

 

Bank Failures to Date

The report begins with an analysis of the causes of the bank failures to date. The report notes that the earliest failures in the current wave derived from "losses in residential real estate and their structured finance businesses," but more recently the bank failures have been "characterized by smaller institutions that are more specialized in financing local businesses, commercial mortgages and real-estate development."

 

The report specifically notes that banks that went on to fail were held worse performing loans in each loan category than banks overall. These banks were also "less well prepared to deal with expected losses," since their allowance for loan losses at the beginning of the credit crisis were "not correspondingly higher," but instead were "lower than for all other banks."

 

Possible Future Bank Failures

Looking ahead, though the economy has improved and banks overall are showing signs of recover, the number of problem banks continues to rise and loan performance has yet to turn around. Many community banks may be burdened as a result of their issuance of trust preferred securities, the holders of which have priority rights in the event of bank failure, which could deter prospective investors. A wider concern for community banks is "the risk posed by continuing financial distress in commercial real estate markets," an issue I explored at length in a prior report here.

 

The report notes that one group of banks particularly at risk are "community banks with high [construction and development, or C&D] loan concentrations and the smallest allowances for loan losses compared to their level of non-performing loans." Another high-risk group of institutions are banks that are "under-provisioned and that have relatively high levels of non-performing loans."

 

Comparison to the S&L Crisis

Though the number of failed banks so far in the current wave is lower than the number that failed during the S&L crisis, "the losses incurred in 2009 are larger than all but one year of losses during the S&L crisis (expressed in 2010 dollars)," because the average size of banking institutions and savings institutions has increased since the time of the S&L Crisis. The average per failed bank loss in the current crisis ($303 million) is more than three times larger in 2010 dollars than for banks in the S&L crisis and were attributable to banks that were about two and a half times as big.

 

The factors contributing to bank failures in the current failed bank wave appear similar to the factors the FDIC identified as having caused bank failures during the S&L crisis. That is, economic conditions were "secondary to poor management and other internal problems."

 

Many readers will find the reports analyses of the banking regulators’ S&L crisis-related litigation track record particularly interesting. Among other things, the report documents (in Figure 14) that the FDIC pursued D&O claims with respect to about one-quarter of failed institutions. The report also shows (in Figure 15) that the FDIC’s peak recoveries lagged peak bank failures by about three years, which may be suggestive of the likely recovery track for the current bank failures.

 

Of particular interest is the detail (in Figure 16) regarding the FDIC’s professional liability claims recoveries during the period 1990-1995 (when most, but not all, of the FDIC’s S&L Crisis-related recoveries took place.). The chart shows that overall, excluding recoveries related to Drexel Burnham and excluding further criminal restitutions, the FDIC recovered $3.2 billion, $1.3 billion of which was from D&O claims, $1.15 billion of which was from accounting claims, and $500 million of which was from attorney malpractice claims. Another $300 million was from fidelity bond claims.

 

Failed Bank Litigation

The report details the FDIC’s special litigation authority under FIREEA (about which refer here), while noting that the FDIC’s special standing may not entirely preclude the claims of private litigants. Though the FDIC has to date filed only one action against former directors and officers of failed banks, all signs are that the FDIC is readying itself to bring more claims, as the report details.

 

Among other things, the report notes that many of the failed and troubled banks in the current wave are publicly traded, by comparison to the S&L crisis, when almost none of the failed institutions are publicly traded. As a result, there is much more investor related litigation this time around than there was during the prior crisis.

 

The report notes that of the roughly 240 credit crisis-related securities class action lawsuits, there were 45 against depository institutions (after excluding auction-rate securities cases). Eleven were filed against failed banks. Of the 20 banks that failed prior to 2010 and that produced the largest losses. 13 were publicly traded, of which eight have been sued in securities class action lawsuits as of the end of 2009.

 

The report notes that the private litigants will compete with the FDIC for D&O insurance, and while the FDIC is generally first in line to recover assets, private litigants may be able to recover against insurance assets even when the FDIC is not (for example, where the D&O policy has a regulatory exclusion that would preclude coverage for the FDIC’s claim but not for the investors’ claims).

 

Though there is already extensive litigation and more seems likely to come, all claimants, including even the FDIC, will face a basic causation problem; as the report concludes, "distinguishing the effects of underwriting practices from the effects of a deteriorating economy will be one of the important elements of this litigation." These cases "will require careful case-by-case economic analysis."

 

Conclusion

Overall, this report is useful and informative. Readers will undoubtedly find the report’s distillation of important background information and analysis in a single source to be particularly helpful.

 

Many D&O insurance professionals in particular will find this report to be helpful, particularly those involved with either the placement of D&O insurance for banking institutions or those involved in claims arising under those policies. Underwriters and brokers will find the report’s analysis of the causes of bank failures and the likely causes of future failures informative. Those involved in claims and claims administration will find the aggregate date from the S&L crisis claims particularly useful.

 

Special thanks to the report’s author, Paul Hinton, for providing me with a copy of the report. I would also like to thank Paul for his numerous citations to this blog in his report.

 

The question of insurance coverage for the attorneys’ fees of Allen Stanford and his co-defendants is at issue in a three-day bench trial before Southern District of Texas Judge Nancy Atlas that began on Tuesday, August 23, 2010 in Houston.

 

Stanford and several other individuals have been criminally charged with financial fraud in connection with the collapse of the Stanford Financial Group. The criminal trial is set to commence in January 2011. Stanford and several of the other individuals are also defendants in an SEC enforcement action as well as numerous other civil proceedings.

 

Stanford Financial had $100 million in D&O insurance. The primary policy contains a money laundering exclusion that the insurers contend precludes coverage under the policies. The money laundering exclusion specifies that it does not apply "until such time as it is determined that the alleged act or acts did in fact occur."

 

In a January 26, 2010 opinion, Southern District of Texas Judge David Hittner entered a preliminary injunction prohibiting the insurers from "withholding payment" of defense expenses from four individuals (including Allan Stanford), as discussed here.　

 

In a March 15, 2010 opinion (about which refer here), the Fifth Circuit reversed and remanded the case to the district court, concluding that the money laundering exclusion’s "in fact" wording required a judicial determination to establish whether or not the exclusion had been triggered, but also concluding that this determination can be made in a separate proceeding such as a coverage action.

 

Based upon the trial that began on Tuesday in Houston, the court will determine whether or not the money laundering exclusion has been triggered, and therefore whether the insurers have any obligations to pay the defendants’ attorneys fees or other amounts on the defendants’ behalf under the policies.

 

According to news reports, there were a number of interesting developments in the first day of trial.

 

First, the lawyer for Laura Pendergest-Holt, Stanford Financial’s former Chief Investment Officer, told the court that Pendergest-Holt had entered a settlement with the insurers. The details of the settlement were not disclosured.

 

Second, in response to a question from Judge Atlas as to where the policy’s unusual definition of "money laundering" had originated, the lawyer for the insurers told the court that the language had been in prior policies through several renewals, but the language originally "been brought to the contract negotiation …by Stanford’s insurance broker." The insurers’ lawyer said that the insurer did not plan to offer a witness on the origins of the language.

 

Judge Atlas commented: "All I can say, it’s turning out not to be such a bargain."

 

Third, the witnesses are unlikely to testify during the coverage trial, given the risks that would entail for the criminal case. Judge Atlas said she will not determine yet whether she will draw an adverse inference about the individuals’ guilt from the individuals’ decision not to testify during the coverage case.

 

Finally, the insurers revealed that to date the insurers had advanced over $15 million dollars to pay for attorneys’ fees on behalf of the individuals and other insured persons under the policy.

 

Think Your Commute is Bad?: According to an August 24, 2010 Wall Street Journal article, a 60-mile traffic jam near Beijing "could last until mid-September." Traffic has been backing up since earlier this month due to construction on the Beijing-Tibet highway. Traffic is now backed up "almost all the way to Inner Mongolia."

　

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.