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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

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

 

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

 

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

Introduction

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

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

Indemnification

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

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

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

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

D&O Insurance

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

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

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

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

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

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

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

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

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

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

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

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

When Ohio Attorney General Richard Cordray announced this past Friday that he had entered a massive $725 million settlement on behalf of three Ohio pension funds in the long standing securities class action lawsuit against AIG, he definitely accomplished his objective –his announcement made the front pages of all the newspapers in Ohio (it was the lead story in Saturday’s Cleveland Plain Dealer).

 

There is only one problem. AIG doesn’t have the money to pay for the settlement. The plan, such as it is, is that AIG is going to fund the first $175 million following the settlement’s preliminary approval. Then, AIG is going to try to conduct a stock offering to raise the remaining $550 million.

 

As Susan Beck put it on the Am Law Litigation Daily, there have been lots of settlement over the years, but "we’ve never seen one quite like this."

 

As reflected in greater detail here, the plaintiffs first sued AIG, certain of its directors and officers, its auditor and certain third parties in October 2004, shortly after then-New York Attorney General Eliot Spitzer first announced his investigation of a "scheme" in connection with commercial insurance transactions involving bid-rigging and the payment of contingent commissions. Further allegations made their way into the complaint following additional revelations.

 

The plaintiffs’ 497-page consolidated third amended complaint filed in March 2006 included  the bid-rigging and contingent commission allegations, as well as allegations that AIG falsified its financial statements, among other things, by entry into a finite reinsurance transaction with General Reinsurance Corporation, as well as of reinsurance transactions with other offshore entities. In May 2005 AIG restated five years of earnings, reducing shareholders’ equity by more than $2.7 billion.

 

Even before the $725 million AIG settlement announced Friday, the Ohio AG’s office had already entered settlements totaling $284.5 million in the case. First, on October 3, 2008, the Ohio AG entered a $97.5 million settlement with PricewaterhouseCoopers, as reflected here.

 

Second, on February 2, 2009, the Ohio AG announced that Gen Re had agreed to a $72 million settlement.

 

Third, on August 13, 2009, the Ohio AG announced that he had entered a $115 million settlement with former AIG CEO Maurice Greenberg, and several other former AIG executives, as well as certain corporate entities affiliated with Greenberg. (Several of these same individuals and entities also separately settled a related derivative lawsuit for $115 million, largely funded by insurance, as discussed here.)

 

The sum of these settlements in the securities class action case, including the recently announced settlement with AIG, is $1.0095 billion, which, according to data from Risk Metrics (here), would rank as the tenth largest securities class action settlement amount. Indeed, the AIG settlement by itself would rank twelfth on the list.

 

There is the small problem of how AIG’s is going to pay for the $725 million settlement. The company, you will recall, has received over $130 billion in U.S government bailout support and is now 80 percent owned by the U.S. taxpayers. The company is struggling to sell assets to repay the bailout money.

 

According to AIG’s July 16, 2010 filing on Form 8-K, the settlement is "conditioned on its having consummated one or more common stock offerings raising net proceeds of at least $550 million prior to final court approval." The decision whether "market conditions or pending or contemplated corporate transactions make it commercially reasonable to proceed with such an offering will be within AIG’s unilateral discretion."

 

The intent is for AIG to register a secondary offering of common stock on behalf of the U.S. Treasury. AIG also has the option to fund the $550 million from other sources. If AIG fails to fund the $550 million, the plaintiffs have several options. They can terminate the agreement; they can "elect to acquire freely transferable shares of AIG common stock with a market value of $550 million provided AIG is able to obtain the necessary approvals"; or they can  extend the period for AIG to complete the offering.

 

A securities offering conducted for the sole purpose of funding past litigation is not exactly the most attractive investment opportunity, even under the best of circumstances. But these are not the best of circumstances for AIG. Indeed, the settlement’s announcement comes at a time when the company’s leadership seems in disarray, after the company’s board chair resigned following a "board battle" with the current CEO. The company faces a daunting array of challenges as it seeks to repay the bailout money, as reflected in a July 17, 2010 Wall Street Journal article here unrelated to the settlement and the projected stock offering,

 

A July 16, 2010 New York Times article about the settlement quotes one commentator as saying, "There’s still a lot of question marks hanging over AIG. How would you write the prospectus for it? The document would be quite appalling when it described the risks."

 

The offering would, according to the article, be "rife with uncertainties" given the fact that the offering would be dilutive of the government’s ownership interest. On the other hand, as the article also points out, "taxpayers and legislators would cry foul" if the lawsuit were funded out of the $22 billion that remains available to the company.

 

Along with the questions of how the company will fund the $550 million settlement chunk is the question of how the company is paying for the first $175 million. Given the U.S. taxpayers’ interest in the company, it seems like there should be some explanation somewhere about the source of that money, but none of the publicly available information provides any explanation. It is possible that insurance will fund that portion, although none of the disclosure documents make any suggestion of that possibility, and in addition, significant insurance funds were previously paid to fund the derivative lawsuit settlement identified above. The settlement agreement itself might answer the question, but it is not yet available on PACER.

 

The lawsuit itself is a vestige of a different time and place. Though the events involved are only a half dozen years in the past, the complaint reflects a lengthy roster of individuals whose roles have long-since changed in ways that no one could possibly have imagined at the time. The alleged wrongdoing , while involving some fairly egregious circumstances, pales by comparison with the cataclysmic events that followed. Given this antediluvian aspect of this case, it does seem high time that it settled. However, only time will tell if the parties have in fact succeeded in driving a stake into the heart of this beast.

 

Somehow it seems fitting that just this past week there were news reports that during a recent lunch at the Four Seasons Hotel in New York, where Greenberg was having lunch with former Citigroup CEO Sandy Weill, Spitzer approached Greenberg, stuck his hand out, and asked Greenberg if he would appear on Spitzer’s CNN show. Unsurprisingly, Greenberg declined. Can you imagine the look on Greenberg’s face? The world is a very strange place sometimes. Or, at least there are some strange inhabitants.

 

It is also entirely fitting that Cordray’s and Spitzer’s names should be linked in connection with this story. Cordray has definitely borrowed several key pages out of Spitzer’s political play book. Playing the role of Wall Street Scourge definitely worked for Spitzer, at least until his extracurricular activities earned him some extended gardening leave followed by his current rehabilitation assignment on CNN. It also seemed like it was working for Connecticut AG Richard Blumenthal until it turned out he had oversold his credentials as a veteran.

 

Cordray is playing the angle for all it is worth. His website has a separate page devoted to securities class action litigation activities, including a June 1, 2010 summary of the current cases. (The document is headed "Holding Wall Street Accountable.") However, it is probably worth noting that many of the cases on Cordray’s list were actually launched by his predecessors, although Cordray did demonstrate his own initiative with the action he recently filed against the rating agencies, about which refer here.

 

The New Homogeneity: If, as seems likely, Elena Kagan’s nomination to the Supreme Court is confirmed, the Court’s make-up will, at least in certain respects, reflect unprecedented levels of diversity. Three women will be served on the Court for the first time. The Court includes a Hispanic and an African-American. There will be six Catholics and three jews, although, curiously, no Protestants.

 

But in another respect, Kagan’s arrival will make the Court even less diverse. As detailed on a July 16, 2010 post on the Economix blog (here), with Kagan’s addition, eight out of the nine justices will have attended one of two elite East Coast, Ivy League law schools. The only exception, Justice Ginsberg, graduated from Columbia Law School, but she started at Harvard and transferred after her first year to be in New York with her husband. According to data cited in the blog post, for the first time in the Court’s history, every sitting justice will have a law degree from the Ivy League.

 

The immediate question is whether this matters. There has always been a healthy representation of Ivy League graduates on the Court. Such luminaries as Oliver Wendell Holmes and Louis Brandeis immediately come to mind.

 

But even if the Ivy League has always been well represented on the Court, it has never been quite so dominant, and a wider diversity of educational backgrounds was always present. William Rehquist and Sandra Day O’Connor were classmates at Stanford Law School. Earl Warren attended Boalt Hall at the University of California. Warren Berger attended the William Mitchell College of Law. Indeed, Robert Jackson, usually cited as one of the Court’s finest writers, did not even graduate from law school, but rather apprenticed for a lawyer in Jamestown, New York.

 

Nor is the Court is the only branch of government that has been captured by these same two schools. The last four occupants of the White House, including the current President, all have at least one educational degree from one of these same two schools. (George W. Bush had one of each.)

 

When and how did this very peculiar form of elitism get instituted?

 

To be sure, no one could claim that the current justices or the recent Presidents are cookie cutter copies of each other. But the concentration of power and authority in the hands of a few persons sharing the same elite background seems highly antithetical to some of the most basic notions of American self-government. Or to put it another way, if ethnic and gender diversity are desirable goals, at the same time shouldn’t we be taking care that we are not undermining the benefits of diversity by concentrating power and authority in the hands of a small elite?

 

The Court’s peculiar narrowness actually takes several forms. Not only do the current justices share a common background of higher education, their careers have all followed similar and similarly narrow paths. Their individual resumes consist largely of service in the judiciary and academia, with the occasional service as a government lawyer or prosecutor thrown in. None of the current justices has ever had to make payroll or struggled to try to make a profit. None has ever had to establish a political coalition or get themselves elected. None has served in the military. Even their legal experience is narrow – none has been a criminal defense attorney, for instance.

 

Some may argue that I am making too much of the necessarily limited demography of a very small population. But I do think the slender reach of the Court’s collective education and experience has practical consequences. For example, the Court has recently shown a predilection to take up securities cases, but none of the justices seem particularly motivated by a concern for the financial markets or to have a vital appreciation of the importance of the financial markets for the country’s well being. Instead, the cases seem to represent challenging intellectual problems, detached from their deeper significance.

 

All I am saying is that before everyone puts their arms out of joint congratulating each other about the increasing diversity on the Court, perhaps the question should be asked whether one kind of uniformity is simply being replaced with a different kind of homogeneity.

 

I Will Assume She Was Not Referring to Me: In her July 17, 2010 column in the Wall Street Journal entitled "Youth Has Outlived Its Usefulness," Peggy Noonan said:

 

Why do so many young bloggers sound like hyenas laughing in the dark? Maybe it’s because there’s no old hand at the next desk to turn to and say, "Son, being an enraged, profane, unmoderated, unmediated, hit-loving, trash-talking rage money is no way to go through life."

 

Poor old Peggy, her memory must be going. Clearly she has forgotten that the surest way to show that your sell by date has passed is to start fulminating about "young people these days" and the things that somebody ought to tell them. On the other hand, she could use somebody to tell her that attempting in a single paragraph to portray her bêtes noires as both laughing hyenas and rage monkeys hardly sets an example of restraint. Perhaps the rage she detects is her own.

 

In a striking series of developments late yesterday afternoon, the Senate passed the financial reform bill and the SEC announced its record-setting settlement of the enforcement action it filed against Goldman Sachs last April. The Goldman settlement drew extensive coverage in the mainstream media, primarily focused on the sheer size of the $550 million settlement and on Goldman’s concessions that, according to the SEC’s press release, "its marketing materials for the subprime product contained incomplete information."

 

Goldman Sachs’ July 15, 2010 statement about the settlement can be found here.

 

There are many other interesting details about the settlement, some of which have not received widespread attention in the media.

 

First, the settlement resolves only the charges against Goldman Sachs itself. According to the SEC’s July 15, 2010 press release, "the SEC’s litigation continues against Fabrice Tourre," who seems to have left to fend for himself. Things don’t appear quite so "fabulous" for Mr. Tourre just now.

 

Second, as reflected in Goldman’s July 14, 2010 "Consent" (a copy of which can be found here), the $550 million settlement amount consists of a disgorgement of $15 million and a civil penalty of $535 million.

 

Goldman acknowledged in the Consent that the settlement funds may be distributed under the Fair Funds provisions of Section 308 of the Sarbanes Oxley Act. In its press release, the SEC states that of the $550 million settlement, $250 million would be paid to "harmed investors" through a Fair Funds distribution and $300 million will be paid to the Treasury.

 

Third, the Consent also reflects the specifics of Goldman’s admissions regarding the Abacus transaction. In paragraph 3 of the Consent, Goldman "acknowledges" that the Abacus marketing materials "contained incomplete information" and that it was "a mistake" for the materials to state that the Abacus reference portfolio was selected by ACA Management without disclosing the role of Paulson & Co or that Paulson’s economic interests were adverse to those of the CDO investors. The consent states that Goldman "regrets" the omission of this information.

 

Fourth, Goldman agrees in the Consent that, other than with respect to the amount of the disgorgement, it will not argue that it is entitled to any offset or reduction of a compensatory damages award in any Related Investor Action by any amount of any part of the company’s payment of a civil penalty in the SEC enforcement action. If a court nevertheless grants an offset, the Goldman has to pay the amount of the offset either to the Treasure or the Fair Fund, within 30 days.

 

Fifth, Goldman agrees both that "it shall not seek or accept, directly or indirectly, reimbursement or indemnification form any source, including but not limited ot payment may to any insurance policy, with regard to any civil penalty" and also agrees that it "shall note claim, assert or apply for a tax deduction or tax credit with regard to any federal state or local tax for any penalty amounts."

 

Sixth, Goldman acknowledges in the Consent that the Commission has not made any promises or representations "with regard to any criminal liability that may have arisen or may arise from the facts underlying this action or immunity from any such criminal liability."

 

Finally, in the Consent, Goldman agrees that it will not make any public statements "denying, directly or indirectly, any allegation in the complaint or creating the impression that the complaint is without factual basis." However, this agreement does not affect Goldman’s "right to take legal or factual positions in litigation or other legal proceedings in which the Commission is not a party."

 

All told, the Consent is a really striking document that — together with the massive size of the settlement itself — bespeaks a compelling need on Goldman’s part to resolve this matter as quickly as possible.

 

An interesting question is the effect that Goldman’s "acknowledgement" in the Consent will have on the various shareholder lawsuits that sprang up in the wake of the SEC enforcement action.

 

On the one hand, the omissions that Goldman acknowledged in the Consent were made in the marketing materials for the Abacus document, not in the public statements to Goldman’s shareholders.

 

On the other hand, Goldman’s acknowledgement that it made a "mistake" when it omitted information from the Abacus marketing materials clearly will be useful for the plaintiffs’ lawyers in the shareholder lawsuits. But, as Duke Law Professor James Cox commented on the WSJ.com Law Blog, even though Goldman admitted to a "mistake," it did not admit to fraud.

 

In any event, the plaintiffs’ lawyers can at least be reassured that Goldman cannot attempt to offset its liability in the shareholder lawsuits by the amount of its massive penalty in this settlement.

 

Andrew Longstreth’s July 15, 2010 Am Law Litigation Daily article with his thoughts about the effect of the Goldman SEC settlement on other litigation pending against Goldman can be found here.

 

Goldman’s undertaking that it would not seek reimbursement or insurance for the amounts of the penalty seems largely symbolic, since it is highly unlikely that any insurance policy would provide coverage for the disgorgement amounts and penalties that the company has agreed to pay. However, the significance of the undertaking may be what it portends for other settlements in other matters. This kind of requirement that enforcement action defendants will not seek indemnification or insurance for amounts paid in SEC enforcement action settlements represents a substantial (and chilling) threat to other persons the SEC may target.

 

The exclusion of Tourre from the settlement is interesting. It is possible that Mr. Tourre himself may have declined to participate, either because he believes he did nothing wrong or because he was unwilling to make the type of acknowledgment the SEC might require as a condition of settlement. It is also possible that the SEC expected Tourre to agree to some type of ban that would undermine his ability to continue to work as an investor banker in the United States. Whatever the reason, it does seem noteworthy that Tourre is not a part of this settlement.

 

Another question about the settlement relates to the proposed Fair Funds distribution. Why does the Treasury get $300 million but "harmed investors" only get $250 million? (I guess that is one way to reduce the deficit.)

 

The other question about the propose Fair Funds distribution is, who are the "harmed investors" who will get these funds? It seems that it would be the two investors in the Abacus transaction, IKB and ACA– except that ACA’s interests have been passed along to Royal Bank of Scotland, as a result of other transactions that ACA entered attendant to the Abacus deal.

 

I suppose the Fair Funds administrator will have to sort all of that out, but it does seem like SEC went to an awful lot of trouble for the benefit of non-U.S. institutional investors that have plenty of problems of their own – and that is setting aside the question whether the institutional investors who entered this transaction are either entirely blameless or merit this type active regulatory protection.

 

As Professor Cox commented (quite appropriately I might add) on the WSJ.com Law Blog, the investors "made out like bandits." (He added that the investors are "not necessarily saints here.") The Los Angeles Times takes a look here at where the settlement money is going and also summarizes the various sordid background details on the Abacus transaction investors.

 

It is interesting to reflect that, according to media reports, the SEC was divided 3-2 on whether to bring the Goldman Sachs enforcement action. The settlement seems to make the decision to bring the case look pretty good. But what is even more curious is that, at least according to yet other media reports, the SEC also split 3-2 on whether to settle with Goldman.

 

I can understand the split vote on whether to bring the action, because the SEC did not, shall we say, have the strongest case in the world against Goldman. But once you have a chance to snag a half a billion dollars, don’t you declare victory and go home for a nice dinner and a glass of wine with your spouse? Geez, seems like a good day’s work to me.

 

Finally, can I just say that while the SEC has touted this settlement as some kind of record, the fact is that there have been larger SEC enforcement action settlements. As reflected in data from NERA Economic Consulting (here), there have been at least two larger SEC enforcement action settlements, including AIG’s February 2006 $800 million settlement and WorldCom’s July 2003 $750 million settlement. The Goldman Sachs settlement is, as the SEC pointed out, the largest settlement against a Wall Street firm. I guess we can all agree that more than half a billion dollars is a lot of money, even for Goldman Sachs.

 

UPDATE: The morning press coverage provided some added perspective on some of the points raised above. First, with respect to the size of the settlement, the Wall Street Journal notes that the $550 million settlement "is equivalent to just 14 days of profits at Goldman in the first quarter."  (Maybe half a billion isn’t a lot of money for Goldman Sachs.) As for whether the amount represents some kind of record, the Journal notes that in 1988 Drexel Burnham Lambert agreed to pay $650 million in fines and restitution. The Drexel settlement included amounts paid to satisfy investors’ civil claims. in 2003, ten Wall Street firms collectively paid $1.4 billion to settle analyst conflict cases. Finally, as for Mr. Tourre, the Journal reports the he plans to "continue trying to clear his name accoding to a person familiar with the matter."

 

Let the Games Begin: The Senate may now have approved the financial reform bill and all 2,319 pages of the bill will now be headed to the White House for President Obama’s signature. But this is not the end, it is the beginning.

 

As Broc Romanek points out on the CorporateCounsel.net blog (here), under the Dodd-Frank Act, "a total of 11 regulators are committed to make 243 rulemakings, 67 studies and 22 new periodic reports under the Act. The SEC itself will be required to conduct 95 of those rulemakings, 17 studies and 5 new periodic reports."

 

Over at the SEC Actions blog, Tom Gorman has a detailed list, here, of several categories of the more significant rule making processes that lie ahead.

 

To those who want to know the meaning and significance of the financial reform bill’s passage, the only honest answer is – stay tuned.

 

As The Joker Said, "Why So Serious?": All of this seems way too serious to me, so it is about time to roll out The Egg Trick. If you have never seen this footage of Dom DeLuise’s unforgettable turn on the Johnny Carson Show, drop everything and watch this right now. With all of this other stressful stuff going on, you need a "break." Enjoy.

 

https://youtube.com/watch?v=gRduPZvIm08%26hl%3Den_US%26fs%3D1

Overall levels of corporate and securities litigation increased during the second quarter of 2010, according to a new study released on July 15, 2010 by the insurance information firm Advisen. A copy of the report can be found here.

 

Preliminary Notes

The litigation analyzed in the Advisen report includes not only securities class action litigation, but a broad collection of other types of suits as well, including regulatory and enforcement actions, individual actions, derivative actions, collective actions filed outside the U.S. and allegations of breach of fiduciary duty.

 

In considering the Advisen report, it is critically important to recognize that the report uses its own unique vocabulary to describe certain of the litigation categories.

 

For example, the report uses the phrase "securities fraud" lawsuits to describe a combination of both regulatory and enforcement actions, on the one hand, and private securities lawsuits brought as individual actions, on the other hand; however, the category of "securities fraud" lawsuits does NOT include private securities class action lawsuits, which is its own separate category (SCAS").

 

In addition, both "securities fraud" lawsuits and securities class action lawsuits, as well as all of the other categories of lawsuits described in the report, are subparts of the aggregate group of corporate and securities litigation the report refers to as "securities suits."

 

Due to these unfamiliar usages and the similarity of category names, considerable care is required in reading the report.

 

The Report’s Analysis

Even though subprime and credit crisis case filings during the second quarter were well below 2009 levels, overall corporate and securities litigation activity was up in the quarter – "nearly 30 percent higher than the first quarter and about 19 percent above the very active second quarter."

 

The report also notes that securities class action litigation activity was up in the quarter as well, largely as a result of litigation relating to the government investigation of Goldman Sachs and the Deepwater Horizon oil spill.

 

However, in what may be the report’s most significant observation, securities class action litigation is becoming an increasingly smaller percentage of all corporate and securities litigation. The report notes that this percentage has been trending downward for several years; securities class action lawsuits, which represented more than half of all corporate and securities lawsuits before 2006, represented only 23 percent of these suits in 2009 and only 19 percent in the first half of 2010.

 

In addition to the relative number of securities class action lawsuits, the absolute number of securities class action suits also declined in the first half of the year. According to the Advisen report, there were 85 securities class action lawsuits in the first half of 2010, which annualizes to 170 cases. The average annual number of securities class action filings during the period 2005-2009, according to the report, is 213. The 2010 decline "is due substantially to a sharp drop in subprime/credit crisis cases."

 

The report also notes that the average time between the end of the class period and the date the lawsuit was filed is lengthening, from 126 days in 2008 to 228 days in the first half of 2010.

 

Though new subprime and credit crisis cases continue to decline, companies in the financial sector remain the most frequent corporate and securities litigation target. According to the report, financial firms were named in about 34 percent of all corporate and securities lawsuits in the second quarter.

 

Though securities class action lawsuit filings as a percentage of all corporate and securities lawsuits have declined, lawsuits alleging breach of fiduciary duty are becoming an increasingly larger percentage of all corporate and securities lawsuits, primarily in connection with merger and acquisition activity. Breach of fiduciary duty cases represented only eight percent of all corporate and securities lawsuits in 2004, but 32 percent of all such litigation in 2009.

 

Discussion

The public dialog about securities litigation tends to concentrate on securities class action lawsuit filings. Though securities class action litigation remains the most costly type of corporate and securities litigation, from a frequency standpoint, securities class action litigation is becoming increasingly less important. According to the Advisen report, more than 80 percent of all corporate and securities litigation in the first half of 2010 involved types of litigation other than class action securities litigation.

 

Moreover this movement of litigation activity away from securities class action litigation is now well-established, having persisted (and indeed accelerated) for well over five years now.

 

The fact is that companies and their senior managers face an increasingly diverse range of potential litigation exposures. The changing landscape of corporate and securities litigation may have important implications for companies’ management liability insurance decisions. At a minimum, the changing mix of litigation suggests that companies should carefully consider potential liability exposures beyond just those involved with possible securities class action litigation.

 

The changing mix of litigation also provides an important context within which to interpret apparent declines in securities class action litigation activity. Even if fewer class action lawsuits are being filed (at least lately, anyway), that does not mean the overall threat of litigation has declined. To the contrary, the Advisen report shows that the threat of corporate and securities litigation generally continues to increase. The litigation threat is not declining, it is simply changing.

 

The more interesting question is what the future may hold for securities class action litigation. In all likelihood the apparent recent decline in new securities class action lawsuits is merely cyclical – there have certainly been prior periods where new securities class action lawsuits fell below historical levels (for example, during the period from mid-2005 to mid-2007). On the other hand, some recent activity – for example, the increase in the number of belated lawsuit filings – suggests that a variety of forces and factors are at work.

 

My own view is that, as has always been the case in the past, the litigation cycle will eventually turn and filing activity levels will revert to the mean. There is an entrenched industry of highly entrepreneurial plaintiffs’ securities class action lawyers who have every incentive to continue to file lawsuits. I suspect strongly that one factor in the current relative downturn in new securities class action filings is that the plaintiffs’ lawyers are simply swamped trying to keep up with the massive wave of complex lawsuits they filed in the wake of the subprime meltdown and the credit crisis. Eventually the decks will clear and they will resume their normal activities, particularly if there are headline-grabbing events that provide litigation fodder.

 

My own prior analysis of first half 2010 securities class action litigation filing activity can be found here. The Advisen report’s analysis of securities class action lawsuit filings in the year’s first half is directionally consistent with my own observations.

 

Advisen Securities Litigation Webinar: At 11:00 am EDT on Friday July 16, 2010, I will be participating in a free, one-hour Advisen webinar to discuss the firm’s Second Quarter Securities Litigation Report. Joining me for the webinar panel discussion will be Carl Metzger from the Goodwin Proctor firm; Carol Zacharias from ACE, and Louise Pennington of Integro. Information about and registration instructions for the webinar can be found here.

　

Corporate Scienter: One of the recurring issues in securities litigation is the question of what is required to establish that the corporate defendant acted with scienter. The question was squarely presented by the Vivendi trial verdict, where, as discussed here, the jury found that the corporation was liable, even though the two individual defendants were exonerated. Judge Rakoff also posed the issue in his notorious initial critique of the SEC’s settlement of the Bank of America enforcement action (about which refer here), where he questioned why the SEC was proceeding solely against the corporation without also pursuing the company’s senior managers.

 

An interesting July 12, 2010 memo from the Arnold & Porter law firm entitled "Whose Mind is It? Pleading and Proving Corporate Scienter" (here) take a detailed look at the appellate case law addressing the questions of what is required to establish that the corporation acted with the requisite state of mind to establish a corporate securities violation.

 

The memo surveys the various recent corporate appellate decisions, including, among others, the Ninth Circuits’s decision in the Glazer Capital Management case (refer here) and the Seventh Circuit’s decision on remand from the Supreme Court in the Tellabs case (refer here). The memo states that "the courts consistently have … considered whether plaintiff pleaded or proved scienter on the part of one or more members of senior management who bore sufficient responsibility for issuing the challenged statements, which could then be attributed to the corporation."

 

The authors suggest that none of the appellate cases have endorsed a "collective scienter" approach whereby plaintiffs may establish a claim against a corporation without naming any corporate officer or employee who acted with scienter – although the authors do labor to reconcile the dicta in Judge Posner’s opinion in the Seventh Circuit’s consideration of Tellabs with this overall analysis.

 

Finally, the authors conclude by suggesting that one of the recurring issues in this area is the fundamental question of what it means to "make" a statement, because it goes to the heart of the question of who made a statement for issue of potential securities liability. The authors suggest that the Supreme Court may well provide necessary guidance in its upcoming term on this issue in the Janus Capital Case, in which the Court recently granted a writ of certiorari (about which refer here).

 

European Corporate and Securities Developments: In light of the U.S. Supreme Court’s recent decision in the Morrison v. National Australia Bank case (about which refer here), narrowing the availability of U.S. courts to claimants who did not purchase their shares on U.S-based exchanges, there may be increased interest the regulatory and legal regimes outside the U.S. There are certainly relevant developments outside the U.S., particularly in Europe.

 

A July 2010 memorandum from the Sherman & Sterling law firm entitled "Governance & Securities Law Focus: Europe Edition" (here) takes a detailed look at corporate and securities developments at the EU level as well as at the level of certain individual countries (particularly Germany and the U.K.) The memo also includes a brief summary of key U.S. developments as well.

 

U.K. Bribery Bill: Regular readers know that a recurring theme on this blog is consideration of the question of the increasing liability exposure that companies may face under the Foreign Corrupt Practices Act. But the U.S. authorities’ enforcement of this statute is far from the sole regulatory effort to enforce anticorruption measures, as the German authorities’ pursuit of the Siemens case demonstrates.

 

In addition the U.K. recently substantially increased regulators’ statutory antibribery authority, and these changes have important implications, even for U.S.-based companies, according to a July 7, 2010 memo from the Reed Smith law firm entitled "What the U.K. Bribery Act Means for U.S. Companies" (here).

 

According to the memo’s authors, the Bribery Act 2010 , which has not yet come into force, "introduces important new offences which will apply to any business either based in the U.K. or which has some part of its operation in the U.K." and in "some important respects" will be "more far reaching than the FCPA."

 

Among other things, the FCPA requires at least one actor in the alleged bribery to have a role in the public sector, whereas the Bribery Act will "apply to acts of bribery which take place between two entirely private entities." The FCPA also has a statutory safe harbor for small "grease payments," but the Bribery Act has no such carve out. The Bribery Act also provide for significantly greater criminal penalties.

 

Pertinent to the question of corporate state of mind discussed above, the Bribery Act gets around the challenging question of corporate intent by making the new corporate offense described into a strict liability offense. Guilt can be a result of attempted or actual bribery a corporation’s "associated person." which seemingly includes not only employees and agents but anyone who provides services for the company.

 

As a result of this corporate strict liability, the activities of a U.S. company in any part of the world "could make it liable to a prosecution in the U.K. for this corporate offence if that U.S. company carries on some part of its business in the U.K. or for a principal bribery offence if some part of it is committed in the U.K."

 

The memo also addresses the question of the procedures that the Act requires, noting that "to avoid U.K criminal liability under the corporate offence introduced in the Bribery Act, it will be essential for U.S. companies which operate in the U.K. to put in place and to maintain clear and effective anti-bribery procedures over both their own staff and those who provide services to them."

 

Advisen Quarterly Securities Litigation Seminar: At 11:00 EDT on Friday, July 16, 2010, I will be participating in a free, one-hour webinar sponsored by Advisen to discuss 2Q2010 securities litigation trends. The panel will include my good friends Carl Metzger of the Goodwin Proctor law firm, Carol Zacharias of ACE, Louise Pennington of Integro and David Bradford of Advisen. Information about and registration instructions for the webinar can be found here.

 

On July 12, 2010, in one of the more high-profile investor actions filed as part of the subprime securities litigation wave, Southern District of New York Judge Sidney Stein substantially denied in part the defendants’ motions to dismiss in the Citigroup Bond Litigation. A copy of the opinion can be found here.

 

As detailed in greater detail here, Citigroup bondholders first filed their suits in September 2008 in connection with 48 different Citigroup bond offerings in which Citigroup raised over $71 billion between May 2006 and August 2008. (The first of these cases was filed in New York state court but later removed to federal court.) The defendants include the company itself and related corporate entities, as well 28 current or former Citigroup directors and officers and nearly eighty investment banks that served as offering underwriters in the bond offerings.

 

The plaintiffs, who purchased bonds in some of the offerings, alleged that the defendants had violated sections 11, 12 and 15 of the Securities Act of 1933 by failed to truthfully and fully disclose in the bond offering documents information concerning the company’s exposure to "toxic mortgage-linked documents."

 

Specifically, the plaintiffs alleged that Citigroup had failed to disclose Citigroup’s exposure to $66 billion worth of CDOs backed by subprime mortgage assets; Citigroup’s exposure to $100 billion in structured investment vehicles backed by subprime mortgage assets; that Citigroup "materially understated reserves" held for residential loan losses; Citigroup’s exposure to $11 billion of auction rate securities; that as result of these exposures, Citigroup was not, contrary to its representations, "well capitalized" and in fact required a massive government bailout.

 

In his July 12 order, Judge Stein first held that the plaintiffs had standing to assert claims in connection with all of the 48 offerings, even though plaintiffs had not purchased bonds in all offerings. Because the offerings were based common shelf registration document containing at least some common information, he found that the plaintiffs have standing to assert claims common to all purchasers.

 

But while he found that the plaintiffs has standing to assert Section 11 claims, he granted the defendants’ motions to dismiss the plaintiffs’ Section 12 for lack of standing, based on the insufficiency of plaintiffs’ allegations about whom the plaintiffs bought their investments from.

 

The centerpiece of the defendants’ dismissal motions was their argument that the plaintiffs had failed to allege any actionable misstatement or omission. Judge Stein found that that the plaintiffs’ had adequately alleged misrepresentation or omission as to Citigroup’s CDO exposure; with respect to plaintiffs’ allegations about Citigroup’s SIV exposure, at least with respect to statements made after those exposures were consolidated on Citigroup’s balance sheet; plaintiffs’ allegations about the adequacy of Citigroup’s residential mortgage loan loss reserves; with respect to Citigroup’s statements about the adequacy of its capitalization; and with respect to Citigroup’s statements that its financials were GAAP compliant.

 

However, Judge Stein also found that the plaintiffs had not sufficiently alleged misrepresentation or omission in connection with their allegations concerning Citigroup’s SIV exposure, at least those made prior to the consolidation of the SIV assets onto Citigroup’s financial statements; and about Citigroup’s exposure to auction rate securities.

 

Thus while a portion of plaintiffs’ claims did not survive defendants’ dismissal motions, a substantial portion of plaintiffs’ case will be going forward.

 

Both because of Citigroup’s prominence and because of the sheer magnitude of dollars involved in this case, this is a high profile decision. Though there is definitely a school of thought that defendants are faring better on the subprime securities cases in general, the plaintiffs are still managing to get some cases past the initial pleading hurdles, particularly in many of the highest profile cases (e.g., Countrywide, New Century, Washington Mutual, etc.).

 

In addition, Judge Stein’s decision in the Citigroup Bondholders case is the latest of several recent rulings in subprime related securities cases in the Southern District of New York that have favored the plaintiffs, including the recent decisions in the Ambac Financial subprime related case (about which refer here) and in the CIT Group subprime related securities case (about which refer here).

 

I have in any event added the July 12 decision in the Citigroup Bondholders’ suit to my running tally of subprime related securities class action lawsuit dismissal motion ruling, which can be accessed here.

 

Andrew Longstreth’s July 12, 2010 Am Law Litigation Daily article about the decision can be found here. A July 12, 2010 Bloomberg article about the decision can be found here.

 

Special thanks to a loyal reader for providing a copy of the opinion.

 

On July 2, 2010, in what is as far as I am aware the first suit by the FDIC against former directors and officers of a failed bank as part of the current wave of bank failures, the FDIC as receiver of IndyMac filed a lawsuit in the Central District of California against four former officers of IndyMac’s Homebuilder Division (HBD). 

 

Very special thanks to Peter Christensen of the Appraiser Law blog for providing links to the complaint.

 

The FDIC took control of IndyMac on July 11, 2008. At the time, the outstanding balance on HBD’s portfolio of homebuilder loans was nearly $900 million. The FDIC alleges in its complaint that IndyMac’s losses "are estimated to exceed $500 million."

 

The lawsuit is filed against Scott Van Dellen, HBD’s former President and CEO, who is alleged to have approved all of the loans that are the subject of the FDIC’s suit; Richard Koon, who was HBD’s Chief Lending Officer until mid-2006 and who is alleged to have approved at least 40 of the loans at issue; Kenneth Shellem, who served as HBD’s Chief Compliance Officer until late 2006, and who is alleged to have approved at least 57 of the loans at issue; ;and William Rothman, who served as HBD’s Chief Lending Officer from mid-2006 and who is alleged to have approved at least 34 of the loans at issue.

 

The lawsuit seeks to recover damages from the four individual defendants for "negligence and breach of fiduciary duties." The lawsuit alleges "two significant departures from safe and sound banking practices."

 

First, the complaint alleges that HBD’s management "repeatedly disregarded HBD’s credit policies and approved loans to borrowers who were not creditworthy and/or for projects that provided insufficient collateral." The complaint further alleges that HBD’s compensation plans encouraged HBD’s management to "push for growth in loan production volume with little regard for credit quality."

 

Second, HBD’s management is alleged to have "continued to follow a strategy for growth at the tail-end of the longest appreciating real estate market in over four decades," despite management’s alleged "awareness that a significant downturn in the market was imminent and despite warnings from IndyMac’s upper management about the likelihood of a market decline." HBD’s management allegedly "unwisely continued operations in homebuilder lending in deteriorating markets even after becoming aware of the market decline.

 

The FDIC’s complaint, which sprawls to some 309 pages, details a litany of allegedly negligent lending practices, including approving loans where repayment sources were not likely to be sufficient; where the loans violated applicable laws and the Bank’s own internal policies; where the loans were made to borrowers who "were or should have been known to be not creditworthy and/or in financial distress; based on inadequate or inaccurate financial information; without taking proper and reasonable steps to insure that the loan proceeds would be used in accordance with the loan application.

 

The complaint is very detailed and reflects painstaking preparation. A lot of time and effort went into the preparation of this complaint, which may in and of itself explain why the FDIC has not up until this point filed other complaints against directors and officers of failed banks. If the FDIC is taking similar measures in connection with other claims that it might be considering, it is little wonder that there have been no claims up until this point. Complaints containing this level of specificity and painstaking detail will take a significant amount of time to prepare.

 

There are some particular reason why IndyMac attracted one of the first claims. First, the FDIC took control of IndyMac relatively early in the current round of bank failures – it has been almost exactly two years since IndyMac closed, meaning the FDIC has had a greater amount of time to review the circumstances that led up to IndyMac’s failure and consider potential claims. When the FDIC took control of IndyMac, it was only the fifth bank failure that year, meaning that IndyMac was among the earliest of the current bank failures.

 

But perhaps even more important that its timing was the sheer size of IndyMac’s failure. At the time of its closure, IndyMac had assets of about $32 billion, making its closure the second largest bank failure during the current wave of bank failures (exceeded only by the closure of Washington Mutual, which had assets of $307 billion).

 

More to the point, IndyMac’s failure triggered losses to the FDIC’s insurance fund of $8 billion, by far the largest amount of any bank failure during the current round. The magnitude of these losses suggests possible motivations for the FDIC to give priority to claims relating to IndyMac.

 

While the recently filed IndyMac claim may be the first claim the FDIC has filed against former directors and officers of a failed bank as part of the current bank failure wave, it is surely not the last. (Indeed, it may not even be the last filed against former IndyMac officials.) Statistics reported by the Alston & Bird firm suggest that during the last wave of bank failures in the S&L crisis, the FDIC filed claims in connection with about 24% of all bank failures.

 

The fact that the FDIC appears poised to pursue many additional claims against bank officials represents a threat both to the individuals themselves and to the bank’s D&O liability insurers. The extent to which the FDIC’s efforts result in significant recoveries will depend on a wide variety of factors, the most important of which is the extent to which the FDIC can successfully allege individual liability. But beyond that, the FDIC’s ability to actually recover money will depend on identifying and accessing funding sources.

 

The extent to which the FDIC will succeed in recovering substantial amounts of D&O insurance will depend on a host of factors, including in particular the terms and conditions of the applicable policies. Claims made and notice of claims issues will be highly relevant, as will potential policy exclusions, such as, for example, the regulatory exclusion, which insurers added to many policies in recent years. These insurance coverage questions suggest the likelihood that in addition to a round of claims against former officials of failed banks, we are also likely to see a parallel round of insurance coverage litigation.

 

In addition to the FDIC’s recent action, there has also been extensive litigation involving IndyMac’s shareholders, as detailed here. Most recently, on March 29, 2010, Central District of California Judge George Wu certified an interlocutory appeal to the Ninth Circuit of his denial of the defendants’ motion to dismiss the plaintiffs’ sixth amended complaint.

 

Bank Failure Wave Continues: Meanwhile, while the FDIC cranks up its litigation efforts, it is continuing to take control of additional banking institutions. This past Friday evening, July 9, 2010, the FDIC took control of four additional banks, bringing the 2010 total number of failed banks to 90.

 

Through June 30, 2010, the FDIC had closed 86 banks, which put the FDIC on pace to close 172 banks this year, compared to 140 in 2009 and only 25 in 2008. Indeed, by way of comparison, as of June 30, 2009, the FDIC had closed only 40 banks, as the pace of bank failures quickened substantially in the second half of 2009 and continued into 2010.