On May 20, 2010, the U.S. Senate passed the Restoring American Financial Stability Act of 2010 (S. 3217) by a vote of 59 to 39. The Senate websites latest version of the Bill can be found here, and the Senate Banking, Housing and Urban Affairs Committee’s link to the most current version can be found here. Though these may be the most current versions available they do not necessariliy represent the final text of the bill, which was substantially amended and is not yet publicly available.

 

The Senate Bill must now be reconciled with the financial reform legislation the House passed last December (about which refer here). The reconciliation committee will be selected this upcoming week, and the plan is to have the reconciled version available for President Obama’s signature before July 4.

 

The massive Senate bill weighs in a 1566 pages. It is in many important ways substantially similar to the House bill, although there are also critical differences. Among the differences is the Senate bill’s controversial provision, sponsored by Sen. Blanche Lincoln, requiring financial firms to separate derivatives trading from banking operations and even spin them off under certain circumstances.

 

Among other measures that were not included in the Senate bill is the amendment proposed by Senator Arlen Specter that would have legislatively overturned Stoneridge and created a private right of action for aiding and abetting securities fraud. Theoretically, the measure could be included during the reconciliation process, but that seems highly unlikely at this point. Susan Beck’s May 21, 2010 Am Law Litigation Daily article reporting on the amendment’s defeat can be found here.

 

Another provision not included in the Senate bill is the measure incorporated in the House version (Section 7216) to provide extraterritorial jurisdiction for securities cases involving conduct within the U.S. constituting significant steps in furtherance of the securities violation, even if the transaction occurs outside the U.S. and involves only foreign investors. This provision, if incorporated in the reconciled version of the legislation, would legislatively address the "f-cubed" securities suit raised in many cases, included the National Australia Bank case now before the U.S. Supreme Court.

 

On the other hand, the Senate bill, like the House version, does incorporate a number of statutory corporate governance reforms. Among other things, the Senate version provides for non-binding shareholder votes on executive compensation (Section 951). The Senate bill also includes a measure requiring clawbacks from "any current or former officer" of incentive compensation awarded in the three year period prior to a financial restatement (Section 954). The Senate bill also adds additional disclosure requirements regarding compensation and regarding employee and director hedging (Sections 952 and 955)

 

In addition the Senate bill also specifies rules governing director elections (Section 971), among other things mandating that in uncontested elections, directors receiving a majority of votes are deemed elected. The measure further provides that directors receiving less than a majority in an uncontested election shall resign, with the board to consider whether or not to accept the resignation.

 

The Senate bill also requires companies to disclose the reasons why they have or have not chosen to have the same person serve both as board chair and CEO (Section 973)

 

The Senate bill also adopts a number of measures under the heading of "Investor Protection and Improvements to the Regulation of Securities." Among other things, the Senate bill, like the House version, includes measures providing protection and rewards for whistleblowers who report securities law violations to the SEC (Sections 922-24). The Senate bill also creates an Investor Advisory Committee that would consult with the SEC on matters pertaining to protecting investor interests (Section 911). The Senate bill also creates an Office of Investor Advocate within the SEC (Section 914).

 

Of particular interest to readers of this blog, the Senate bill, like the House bill, has a number of provisions relating specifically to insurance. The Senate Bill creates an Office of National Insurance (Section 502), which is in form substantially similar to the Federal Insurance Office in the House version. Like the agency created in the House version the agency created in the Senate bill would be housed within the Treasury Department. Neither the House nor the Senate version envisions that that the new federal agency would replace state insurance regulation. Instead, the new agency would monitor the industry in order to identify systemic risks; oversee TRIA; and coordinate international insurance regulatory efforts, among other things.

 

The Senate bill also contains a number of other insurance-related provisions, including a section addressing reporting, payment and allocation of premium taxes (Section 521); and another section relation to the regulation of non-admitted insurance (Section 522). Yet another measure specifies streamlined non-admitted insurance procedures for certain commercial insurance buyers (Section 525)

 

There are many other measures of more general interest in the massive Senate bill, including "improvements" to the regulation of rating agencies (Section 931 et seq.); increased disclosure requirements in connection with municipal securities (Section 975 et seq.); the creation of a Bureau of Consumer Financial Protection (Section 1001 et seq.); provision for the regulation of hedge fund advisors and others (Section 401 et seq.); and the institution of regulation for swap markets (Section 721 et seq.).

 

Though the ultimate shape of the legislation that will be presented to President Obama remains to be seen, the likely scope of many measures is already relatively clear, as both versions of the legislation include numerous substantially similar provisions. Whether or not the provisions ultimately enacted into law will suffice to prevent future financial crisis is a separate question but there can be little doubt that the financial system is about to face some enormous changes.

 

It is probably worth emphasizing here, as it may be overlooked elsewhere given the other high-profile issues the legislation involves, that the reform legislation, when enacted, will entail significant federal government involvement in areas previously viewed as the province of state regulation. Specifically, both insurance and corporate governance have until recently been regarded as matters with respect to which state interests should control.

 

Though significant levels of regulatory responsibility will remain at the state level both for insurance and corporate governance, this reform legislation significantly increases the federal government involvement. It doesn’t seem too suspicious to conjecture that these measures represent significant milestones in what is likely to be continued growth of federal responsibility in these areas.

 

The bill’s provisions relating to insurance could be of practical significance for insurance professionals. I did not review the provisions at length in this post, but if they survive in some form in the final bill, I will undertake a detailed review at that time.

 

Rating Agencies in the Crosshairs: The financial reform bill’s provisions relating to the rating agencies represent only one of a variety of developments that is raising the heat for those firms. David Segal’s May 23, 2010 New York Times article entitled "Suddenly, the Rating Agencies Don’t Look Untouchable" (here) takes a look at the assaults the rating agencies are facing on a variety of directions, including on the litigation front.

 

The article makes the point that though the rating agencies are prevailing in most of the credit crisis related cases in which they have been involved, there have also been a small handful of cases that have survived initial motions to dismiss. The article makes the point that as the litigation evolves, the plaintiffs’ lawyers are learning from every decision, including the dismissals, and are refining their arguments in subsequent cases.

 

The author of The D&O Diary is quoted briefly toward the end of the article.

 

More Deepwater Horizon Securities Litigation: As I have previously noted, the Deepwater Horizon disaster has already produced significant corporate and securities litigation, including the BP shareholders derivative suit (about which refer here) and the Transocean securities class action lawsuit (refer here). Now this litigation also includes a securities class action lawsuit filed against BP and certain of its directors and officers.

 

On May 21, 2010, plaintiffs’ lawyers filed a securities class action lawsuit in the Western District of Louisiana against BP and nine of its directors and officers. A copy of the complaint can be found here. The case is brought on behalf of purchasers of BP’s American Depositary Receipts "based on Defendants’ repeatedassurances of BP’s safe operations, reflected in the ADR price, have seen the value of their shares plummet 20% overnight – representing about $30 billion in market capitalization – as the truth about BP’s operations has emerged."

 

The complaint alleges that "by touting the growth potential of its Gulf of Mexico operations… and highlighting the safety of the operations, BP convinced investors, including Plaintiffs, that BP would be able to generate tremendous growth with minimal risk." However, the plaintiffs allege, "The truth was that BP was cutting comers and reducing its spending on safety measures in an effort to maximize profits in the Gulf of Mexico."

 

Interestingly, the plaintiffs’ Louisiana counsel is the law firm of Domengeuax, Wright, Roy & Edwards, a Lafayette, Louisiana firm that has already been very active in pursuing Deepwater Horizon claims on behalf of commercial fisherman, shrimpers, oystermen, and charter boat operators, as well as on behalf of families of persons suffering injuries or death in the initial platform explosion, as reflected here.

 

Special thanks to Adam Savett of the Securities Litigation Watch blog for providing a copy of the BP complaint.

 

O.K., Who Invited the Actuary?: In his rambling biography of Pablo Picasso, Norman Mailer describes an opium-laced party at Le Bateau-Lavoir, Picasso’s Montmartre rooming house, where the guests included such luminaries as Guillaume Apollinaire and numerous avant- garde sculptors, painters and poets. Mailer also reports that the guests included "Maurice Princet, the actuarial mathematician for insurance companies, who would give them his own popular introduction to Einstein’s work before long."

 

Say what?

 

I mean no disrespect to my many insurance actuary friends, but even were I to have access to Picasso’s opium, I don’t think I could imagine how an actuary wound up in this particular scene. I mean, can you picture Princet trying to bring down the house with the old story about the guy "who couldn’t disprove the null hypothesis"?

 

In fairness, I should acknowledge that Princet was to play in important role in the later development of "cubism," and indeed has been described by one of the principal actors in the drama as the "godfather" of cubism, for having introduced Picasso to certain mathematical concepts. I don’t think I would be alone, however, in finding it startling that the cast of characters in this particular production includes an insurance actuary.　

 

According to the FDIC’s Quarterly Banking Profile for the 1st Quarter of 2010, released on May 20, 2010 (here), results for reporting banks "contained positive signs of recovery for the industry," reflecting "clear improvement in certain performance indicators." Nevertheless, the number of "problem" institutions at quarter end increased to 775, up from 702 at the end of 2009 and representing 10% of all reporting institutions.

　

The positive signs include such things as lower provisions for loan loss reserves and reduced expenses for goodwill impairment. These and other factors contributed to reported earnings at FDIC-insured institutions of $18 billion, the highest quarterly total since the first quarter of 2008.

 

However, some of these positive sign look somewhat less reassuring on closer scrutiny. Thus, for example, though the reporting institutions reported $10.2 less in loan loss reserve increases than they had in the first quarter of 2009, only about one-third of all institutions reported year-over-year declines, with most of the overall reduction concentrated among a few of the largest banks.

 

In addition, there are indicators that some concerns have not yet started to improve. For example, the total number of loans at least three months past due climbed for the 16th consecutive quarter. The Wall Street Journal quotes FDIC chairman Sheila Bair as saying that "The banking system still has many problems to work through, and we cannot ignore the possibility of more financial market volatility,"

 

This uneven distribution of the positive signs and the continuing concerns in some areas helps explain at least in part how the number of "problem" institutions continues to grow despite the positive signs in the industry.

 

The FDIC defines "problem" institutions as those with "financial, operations or managerial weaknesses that threaten continued financial viability." These institutions are rated as "4" or "5" on the FDIC’s 1-to-5 scale of financial and operational criteria.

 

As of March 31, 2010, there were 725 "problem" institutions, which is the highest number since 1993. The 775 institutions represent total assets of $431,189 million. These figures also represent increases in the number of "problem" institutions and total assets of 154% and 96% respectively over the equivalent figures as of March 31, 2009, when there were 305 "problem" institutions representing $220,047 million in assets.

 

This increase over that period is all the more striking given that during the same 12 month period, the number of "problem" institutions was being reduced as some of those institutions changed their status from "problem" to "failed." During the period March 31, 2009 to March 31, 2010, the FDIC took control of 160 banks, which makes the growth in the number of "problem" institutions during that period all the more striking.

 

The March 31, 2010 "problem" institution figures also represent increases of 10% and 7%, respectively, in the number of institutions and total assets since December 31, 2009, when there were 702 "problem institutions" representing $402,782 in total assets.

 

Though the number of "problem" institutions continues to grow, the pressure on the FDIC may be beginning to ease. According to a May 19, 2010 New York Times article (here), the growing willingness of private investors to step in with financial investments in some trouble institutions is a positive sign that may mean fewer failed banks.

 

Interestingly, among the specific institutions the Times article mentions as having attracted private investment capital are banks that have also recently attracted securities class action lawsuits, including Synovus Financial, Sterling Financial, and Pacific Capital Corporation. (Perhaps the investment explains in part why the class action plaintiffs voluntarily dismissed their suit against Pacific Capital Bancorp, about which refer here.)

 

Once consequence of the improving banking industry conditions and the increasing willingness of private investors to step in is that there may be few total number of bank failures than some observers had previously projected. Thus, even those who had predicted 1,000 bank failures (a figure I questioned at the time they were first pronounced), now, according to the Times article, "foresee perhaps 500 to 750 bank failures."

 

If the continued pace of bank failures continues unabated through the end of 2011, we could perhaps reach a total number of bank failures of as many as 500 to 750 banks. (There have been 357 bank failures since January 1, 2008.) However, the positive signs indicating improvements in the banking sector and the return of private investors offers some hope that at some point the number of bank failures may begin to decline. Indeed, the Journal article quotes FDIC officials as saying that the bank failures will probably peak in 2010.

 

But for now, with the most current FDIC figures indicating an increase in the number of "problem" institutions, signs are that bank failures will continue to accumulate, at least for the near term.

 

"Beyond Tone Deaf": Though the $250 million punitive damages award in the Novartis class action gender discrimination case is outside of The D&O Diary’s usual bailiwick, it still caught our attention. There undoubtedly will be further proceedings in the case, but for eye-popping jury verdict is attracting scrutiny.

 

Those interested in trying to understand what the company may have done to get his with a punitive damages award of that magnitude will want to read Susan Beck’s scathing May 19, 2010 Am Law Litigation Daily column (here).

 

According to Beck, referring to the company’s trial counsel Richard Schnadig of the Vedder Price firm, "this was a company – and a lawyer – that simply didn’t know how to deal with the plaintiffs’ accusations. Their response to the women’s testimony was beyond tone deaf. It was, to put it bluntly, insulting and stupid."

 

As support for this statement, Beck cites Schnadig’s characterization in his closing arguments of the testimony of one the named plaintiffs, who testified that her manager had pressured her not to have children. Schnadig dismissed the plaintiff as hysterical, stating "I’ve never seen anybody cry so much on the witness stand in my life…She didn’t have very much to cry about…It’s like she had been knifed. Honestly, what’s wrong with this woman? She was so fragile." Her manager, Schnadig argued, was more credible because according to Schnadig, he was "a nice Southern guy."

 

Beck cites numerous other statements in closing arguments very much in the same vein.

 

Novartis may have had many other things to say in its defense, but these kinds of statements apparently did not play well with the jury. Jurors are scary enough as it is, but trying to convince a jury that the plaintiffs are just a bunch of crazy hysterics seems like a particularly ill-advised strategy.

 

　

As the subprime litigation wave evolved in late 2008, among the many cases arising were cases I described at the time as "new wave" subprime-related cases, where the target company’s financial problems were due not to the company’s own exposure to subprime-related assets, but rather due to the company’s exposure to other companies that suffered reverses because of the subprime meltdown.

 

One particular type of these new wave cases involved companies that were sued because of the target companies’ exposure to Lehman Brothers. In a May 17, 2010 order (here), Southern District of New York Judge John G. Koeltl ruled on the motion to dismiss in a case pending against JA Solar Holdings and certain of its directors and offices, in which it was alleged that the company had misrepresented its exposure to Lehman Brothers. In what is as far as I know the first ruling in one of the Lehman exposure cases, Judge Koetltl denied the defendants’ motion to dismiss.

 

As discussed at greater length here, JA Solar was sued in December 2008, after the company announced on November 12, 2008 that it was recording an impairment for the entire principal value of a Note the company had purchased from Lehman Treasury, a Netherlands-based affiliate of Lehman Brothers.

 

In July 2008, JA Solar completed a $400 million financing, following which it purchased a $100 million note from Lehman Treasury with an October 9, 2008 maturity date. The note was supposed to have 100% principal protection and was guaranteed by Lehman Brothers.

 

The plaintiffs alleged that the company made two sets of misrepresentations or omissions about the Note. First, in an August 12, 2008 press release and subsequent conference call, the company and its CFO mentioned that Lehman brothers was managing its cash but did not mention the purchase of the Note, or the nature of the company’s relationship to Lehman as a result of the company’s investment in the Note.

 

Second in a September 16, 2008 press release and conference call, on the day following the Lehman bankruptcy, the company disclosed the $100 million Note for the first time, but stressed that the Lehman unit that had issued the Note had not filed for bankruptcy and emphasized that the note was "principal protected." In the subsequent conference call, the company’s CFO stated that the company expected that at the end of the Note’s term "there will be principal and interest returned to us."

 

In the same call, but only in response to analysts’ questioning, the CFO acknowledged that the only recourse if the Lehman affiliate company does not repay the Note was a guarantee by Lehman, which was in bankruptcy.

 

On November 12, 2008, the company recorded a $100 million impairment charge for the value of the Note.

 

The defendants moved to dismiss the complaint, arguing that the company had no duty to disclose the Note in the August communications and that the total information in the September call adequately disclosed the information about the Note and the Lehman guarantee.

 

Judge Koeltl found that the plaintiffs had adequately alleged that in the August conference call the company’s CEO had made a misleading statement about Lehman’s role with the company. He found that the statements misrepresented "how JA Solar’s cash was invested and the truthful nature of JA’s Solar’s relationship with Lehman Brothers."

 

Judge Koeltl also found that the plaintiff had adequately alleged misrepresentations in connection with the September statements. Among other things, the company’s CEO had stressed that the Note has "100% principal protection" without stating that "any possible protection was provided solely by the bankrupt Lehman Brothers." Judge Koeltl added that "it is difficult to understand how JA Solar could have assured investors that the Note was fully protected when the only protection was provided by a company in bankruptcy."

 

Judge Koeltl rejected the defendants’ arguments that, in response to the analysts’ questions, the CFO had clarified the full effect of the Lehman Brothers bankruptcy. Judge Koeltl said that whether the statements effectively counterbalanced the prior statements is a factual question "that cannot be resolved in a motion to dismiss," adding that the plaintiffs "have pleaded sufficient facts at this stage to call in to question whether Mr. Lui’s statements cleansed the allegedly misleading statements. "

 

Finally Judge Koeltl found that the plaintiffs had adequately alleged scienter, finding that the plaintiffs had adequately alleged that the defendants knew in August that "JA Solar had not simply engaged Lehman Brothers to manage its cash, but rather than JA Solar had purchased the $100 million Note" which was guaranteed by Lehman from a Lehman affiliate. He also found the defendants knew "in spite of their statements in September 2008 that the Note had 100% principal protection and that they expected the principal and interest to be returned, that Lehman Brothers was the only guarantor of the Note and that Lehman Brothers was, in fact, in bankruptcy."

 

Judge Koeltl found that the defendants’ knowledge of these facts, in contradiction of their public statements, "satisfies the scienter requirement."

 

While a lot might be said about this decision, the overall impression is that Judge Koeltl was persuaded that the company had simply not been candid about its exposure to Lehman Brothers. Of course, it is hard now to recall how tumultuous and uncertain things were in the days in early fall 2008, but alleged facts create the impression that the company was straining to avoid disclosing how exposed it was to Lehman Brothers. Whether the defendants actually believed they would be able to redeem the Note at maturity, notwithstanding Lehman’s bankruptcy, is one issue that will have to be sorted out in this case as it goes forward.

 

I have in any event added the ruling in the JA Solar case to my running tally of subprime-related dismissal motions rulings, which can be accessed here.

 

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

 

Apologies: My apologies that this blog site was unavailable almost the entire day on May 17, 2010. Once again my hosting service, LexBlog, experienced server problems that managed to take the entire site offline for an extended period of time. I apologize to anyone inconvenienced by this hosting service failure.

 

 

Though some observers have reported a downturn in 2010 securities class action lawsuits compared to prior years, at least very recently there has been a flurry of filing activity, with six new securities suits in the past week, by my count. With these latest filings coming in, it seemed worthwhile to take a look at the most recent cases, to try to get a handle on where these latest suits are coming from. It does in fact appear that certain discernable factors are driving the recent filings.

 

1. The Headline Hit Parade: It is a truth universally acknowledged that a public company facing a public relations crisis must be in want of a securities class action lawsuit – or at least that seems to be the perspective of the plaintiffs’ bar. This pattern started earlier this year when Toyota’s sudden acceleration debacle led to a host of securities class action lawsuit filings (refer here). The pattern has been perpetuated in connection with the most recent public relations disasters.

 

Massey Energy sustains a coal mining disaster? Wham, in comes the securities class action lawsuit.

 

Goldman Sachs is target in a high profile SEC enforcement action: Pow, in comes the securities class action lawsuit.

 

Transocean is prominently involved in what may be the worst oil spill in U.S. history? Of course, a securities class action lawsuit filing followed closely behind. (The Transocean securities class action lawsuit filing follows closely on the heels of the shareholders’ derivative lawsuit filed against BP in connection with the Deepwater Horizon disaster, which I previously noted here.)

 

To find out which company will be next in line for one of these insult-to-injury lawsuits, just keep a close eye on the headlines – that seems to be what the plaintiffs’ lawyers are doing.

 

2. The Delayed Reaction Phenomenon: Another category of recent lawsuits look completely opposite from the headline driven lawsuits described above. Beginning around the middle of 2009, one phenomenon that developed was the emergence of belated lawsuits, where the filing date was as much as a year or more after the proposed class period cutoff date. Several of the most recent filings reflect this belated filing pattern.

 

For example, on May 11, 2010, plaintiffs’ lawyers initiated a securities class action lawsuit in the Southern District of New York against Pfizer and certain of its directors and officers. The proposed class period cutoff date is January 23, 2009, nearly 16 months prior to the initial filing date.

 

Similarly on May 12, 2010, plaintiffs’ lawyers initiated a securities class action lawsuit in the Western District of North Carolina against CommScope and certain of its directors and officers. The proposed class period cutoff date is October 30, 2008, more than 18 months before the initial filing date.

 

And on May 6, 2010, plaintiffs’ lawyers filed a complaint in the District of Delaware against Heckmann Corporation and certain of its directors and officers, in which the proposed class period cutoff date is May 8, 2009, just short of one year before the filing date.

 

Similarly belated filings have been an important aspect of the 2010 YTD securities class action lawsuit filings. Of the approximately 60 securities class action lawsuit filings this year, eleven (or about 18%) have been first filed at least one year after the proposed class period cutoff date. Perhaps more significantly, many of the most recent filing in May 2010 have been among these belated cases.

 

An interesting question related to these belated filings is whether the U.S. Supreme Court’s recent statute of limitations decision in the Merck case (about which refer here) will lead to the filing of even more superannuated suits. Reliable sources have suggested to me that it will.

 

3. Because That’s Where the Money Is: Since the beginning of the subprime-related litigation wave in 2007, lawsuits against financial services companies have predominated all filings. Though the proportion of filings against financial firms began to diminish around mid-2009, lawsuits against financial companies still represent the largest proportion of securities class action filings so far in 2010.

 

Thus, while the roughly 60 entities against which securities class action lawsuits have been filed so far this year represent 29 different Standard Industrial Classification (SIC) Code categories (and ten of the 60 lack any SIC Code classification), 17 of the 60 (or about 28%) involve companies in the 6000 SIC Code series (Finance, Insurance and Real Estate). Indeed, most of the entities lacking SIC Code designations are also financially related, and lawsuits filed against these two groups (that is, the 6000 SIC Code series entities and the entities without SIC Code designations) represent about 45% of all 2010 lawsuits.

 

The most noteworthy difference among the 2010 lawsuit filings involving financial companies compared to the most recent prior years’ filings is the number of commercial banks among the financial companies that have been sued. Indeed, several of the most recent filings have targeted failed or troubled banks, including, for example, the May 12, 2010 lawsuit filed against BancorpSouth (here), the May 7, 2010 lawsuit against First Regional Bancorp (here), and the April 15, 2010 lawsuit against Frontier Financial (here).

 

As I have recently noted, this lawsuit trend involving failed and troubled banks is likely to continue in the months ahead.

 

4. When All Else Fails: Though lawsuit filings against financial companies have continued to predominate among all securities suit filings, lawsuits against life sciences remain a familiar and important accompanying theme. With six lawsuits so far this year in the 283 SIC Code series (Drugs) and four more in the 384 SIC Code series (Surgical, Medical and Dental Instruments), lawsuits against life sciences companies remain an important part of 2010 lawsuit filings, as they have been in the past.

 

Several of the most recent lawsuit filings have involved life sciences companies, including the May 11, 2010 filing against Pfizer noted above, and the May 11, 2010 filing against NBTY. Indeed, 2010 filings that don’t involve either a financial services company or a life sciences company are in the distinct minority.

 

NERA Updates Options Backdating Securities Settlement Study: Earlier on in the evolution of the Options Backdating litigation, NERA Economic Consulting had reported (refer here), based on the handful of settlements at that time, that the options backdating cases were settling for lesser amounts than NERA’s analysis of all securities class action lawsuit settlements would predict. At the time, NERA proposed two possible alternative explanations – either the weaker backdating cases were settling first or suits alleging backdating were weaker than securities cases as a whole.

 

With many more of the options backdating securities class action lawsuits having settled (including the recent $173 million Maxim Integrated Product options backdating securities suit settlement), NERA has updated its analysis. In a May 12, 2010 report entitled "Do Options Backdating Class Actions Settle for Less – May 2010 Update" (here), NERA has taken a look at the 31 options backdating settlements and compared them to what their database model would predict.

 

Based on their analysis, NERA concluded that actual settlements were about 71% of predicted settlements. As a statistical matter they are unable based on the data to reject the hypothesis that "settlements in backdating class actions are, on average, no different than settlements in other shareholder class actions." This conclusion supports the corollary hypothesis that the "early settlements were relatively low because the weakest backdating class actions tended to settle most quickly."

 

The report includes a detailed list of each of the 31 options backdating related securities class action settlements to date.

 

Special thanks to Branko Jovanovic of NERA for permission to cite and link to the NERA backdating article.

 

SEC Settlements Update: And speaking of NERA updates, on May 14, 2010, NERA released its latest update on SEC settlement trends (here). In it last semiannual report, NERA reported that the SEC settled with 354 defendants in the first half of fiscal 2010, compared to 328 defendants in the second half of fiscal 2009 and 290 in the first half of 2009.

 

The first half of fiscal 2010 included two particularly noteworthy SEC settlements, the $314 million State Street settlement and the $150 million Bank of America settlement. The State Street settlement is the seventh largest SEC settlement since the passage of the Sarbanes Oxley Act.

 

Who’s On First/ In Whose Possession is First Base?: When I first conceived the title for this blog post, I recognized that I must construct the caption carefully or I would earn the scorn of vigilant grammarians. After careful review of the vast literature addressing the who’s/whose conundrum, I believe the caption is correct. It is always hard to tell who’s right and who’s wrong on these issues. But after all, whose blog is this? Who’s to tell? Whose views should prevail?

　

In prior posts (most recently here), I have noted the growing numbers of lawsuits brought against the former directors and officers of failed or troubled banks. If the complaint recently filed in New York state court is any indication, the "dead bank" lawsuits apparently will also include claims against the directors and offices of failed banks from outside the U.S., too. As it turns out, the fallout from the Icelandic banking explosion includes claims filed in New York against former directors and officers of one of the largest Icelandic bank failures.

 

On May 11, 2010, the U.S. representative of the resolution committee of Glitnir Bank filed an action in New York (New York County) Supreme Court seeking to recover $2 billion in damages from Glintir’s controlling shareholder and his wife; two former directors and the former CEO of Glitnir; several of the controlling shareholder’s business associates, and the bank’s auditor, the Icelandic affiliate of PricewaterhouseCoopers. A copy of the complaint can be found here.

 

Though based in tiny Iceland (total population substantially smaller than that of Cleveland), Glitnir, which ultimately was one of Iceland’s three largest banks, grew to have over 1,900 employees in ten countries, with a market capitalization of over $7 billion and total assets of over $40 billion.

 

In October 2008, in the midst of the global financial crisis, Iceland’s Financial Services Authority took control of Glitner. Glitner ultimately filed a petition for bankruptcy in the U.S. under Chapter 15 of the Bankruptcy Code. According to the May 11 complaint, creditors have filed claims exceeding $26 billion.

 

Michael Lewis’s outstanding April 2009 Vanity Fair article, "Wall Street on the Tundra" (here) chronicles the astonishing and even inexplicable rise and spectacular collapse of the Icelandic banking bubble. ("Iceland instantly became the only nation on earth that Americans could point to and say, ‘Well, at least we didn’t do that.’ In the end, Icelanders amassed debts amounting to 850 percent of their GDP.")

 

The May 11 complaint alleges that Jon Asgeir Johannesson (typographical markings omitted) and his wife, Ingibjorg Stefania Palmadottir (typographical markings omitted), and businesses they owned or controlled, used improper means to "wrest control" of Glitnir and to "fraudulently drain over $2 billion out of the Bank to fill their pockets and prop up their own failing companies."

 

According to the complaint, beginning in 2006, Johannesson "engaged in a scheme" using his "web of companies" to take control of Glitnir in violation of Icelandic law. By April 2007, Johannesson and his companies owned about 39% of Glitnir’s stock. As a result, Johanneson was able to "stack" Glitnir’s board "with individuals who had connections with companies he controlled," and he also "had his inexperienced hand-selected candidate" replace the existing CEO.

 

Having taken control of the Bank, its board and its management, Johannesson and the other individual defendants "used their control over the Bank and funds raised in U.S. financial markets to issue massive ‘loans’ to, and a series of equity transactions with, companies Johannesson controlled, in an effort to stave off their eventual collapse," which "placed the Bank in extreme financial peril."

 

The complaint specifically alleges that the defendants "concealed the truth about their risk they had created for Glitnir when they turned to the United States markets to raise funds." The complaint specifically references a September 2007 transaction in which Glitnir issued $1 billion in medium term notes (MTN), alleging that the offering documents "understated Glitnir’s exposure to related and connected parties by $800 million."

 

The complaint also alleges that the individual defendants "could not have succeeded in their conspiracy to loot Glitnir without the complicity of Glitnir’s outside auditors at PricewaterhouseCoopers." (Jim Peterson has a particularly interesting commentary on the Glitnir bank claims against PwC on his Re:Balance blog, here.)

 

The complaint asserts nine separate claims against the individual defendants alleging violation of Icelandic statutory laws governing corporations. The complaint also asserts common law claims against the individual defendants for tort, conversion, and unjust enrichment. In addition, the complaint asserts negligence and breach of contract claims against PwC. The complaint seeks damages of $2 billion against the individual defendants and $1 billion against PwC.

 

The complaint’s allegations are fascinating, in the way that it is interesting to find out what events and actions preceded a train wreck or plane crash. In many critical ways, the events (allegedly) preceding Glitnir’s collapse precisely recapitulate the sequence Micheal Lewis described in summarizing what happened in Iceland; Lewis wrote in his Vanity Fair article that "a handful of guys in Iceland, who had no experience in finance, were taking out billions of dollars in short-term loans from abroad. They were then re-lending this money to themselves and their friends to buy assets – the banks, soccer teams, etc."

 

Though this lawsuit has its own peculiar Icelandic flavor, the lawsuit resembles in many ways any lawsuit that might be filed in the wake of a U.S. bank’s collapse. The specific U.S. variety of lawsuit this case most resembles is a claim brought by a bankruptcy trustee, as opposed to an investor lawsuit or a lawsuit brought by regulators.

 

But the resemblance to a variety of U.S. lawsuit notwithstanding, the obvious question about this case is: what the heck is it doing in state court in New York? We’ve got an Icelandic bank, Icelandic defendants, and even claims under Icelandic statutory law. The plaintiffs knew you were going to ask that question. The complaint helpfully points out that Johannesson and his wife reside in New York; that many of the acts in furtherance of the conspiracy took place in New York (including the September 2007 MTN financing); many of the transaction documents had New York choice of law provisions; and the bank and its key officials "had substantial interaction with New York."

 

The plaintiffs do their earnest best to justify their resort to a New York court for this case. They even try to exploit New York’s vain self-regard, asserting that the case belongs in New York because it is "the financial center of the world," and it not only has "a general interest in maintaining and fostering its undisputed status as the preeminent commercial and financial nerve center" but it also has "a keen interest in making sure its financial markets are not abused to facilitate massive illegal activity."

 

The plaintiffs do not mention, but we can assume, that they prefer New York over Iceland because U.S. courts offer a host of advantages over the courts of just about any other jurisdiction, including jury trials, pre-trial discovery, and contingent attorneys’ fees.

 

For all of the reasons the plaintiffs acknowledge, and perhaps even more so for the reasons the plaintiffs don’t explicitly mention, litigants from around the world may seek to access U.S. courts for redress of grievances in the wake of bank failures. I have long felt that the current wave of U.S. bank failures is going to produce a wave of lawsuits. The Glitnir case suggests that the litigation wave may well encompass claims relating to failed banks from around the world, not just failed U.S. banks.

 

One question I wondered while reading this complaint is whether or not Glitnir carried D&O insurance. The reckless way business was conducted in Iceland (at least as portrayed in Lewis’s Vanity Fair article) suggests the Icelandic financiers might not have slowed down long enough to consider any type of risk mitigation, much less anything as conventional as insurance. And even if Glitnir had insurance, it has likely long since lapsed, and so unless this new complaint relates back to some timely filed claim or notice, insurance might not be available anyway.

 

But whether or not there is D&O insurance available, this complaint, for all of its peculiar Icelandic features (including typographical symbols I am unable to reproduce here), in many ways represents the classic type of D&O claim that can follow a bank’s collapse, at least to extent it names two former directors and the former CEO as defendants. I had not anticipated that claims involving Icelandic banks would corroborate my position, but I will say that this case is at least consistent with my long-standing projection for litigation arising from the growing number of failed banks.

 

There are of course many more conventional cases also corroborating my position, including the investor lawsuit filed on May 7, 2010 involving First Regional Bancorp (about which refer here) and the lawsuit filed on May 12, 2010 involving BancorpSouth (refer here) – both of which involving U.S.-based banks.

 

The bottom line is that it is no longer quite accurate for me to continue to say that failed bank litigation is coming – it is here.

 

A Literary Interlude: The reference above to Michael Lewis’s Vanity Fair article reminded me that a copy of his latest book, The Big Short, is languishing unread on my bookshelf. Rather than reading yet another account of our dysfunctional financial system, I have been distracted by Maurice Lever’s excellent biography of Pierre-Augustin Caron de Beaumarchais.

 

Beaumarchais is now remembered mostly for having written The Barber of Seville and The Marriage of Figaro, though ironically he wrote those works essentially as a diversion from his many other hyperkinetic activities. Beaumarchais was a watchmaker’s son who managed to leverage music lessons provided to the French King’s daughters into court contacts and business opportunities from which he achieved wealth, notoriety and a life so full it almost can’t be summarized.

 

Variously an entrepreneur, inventor, author, royal agent, diplomat, spy, labor organizer, publisher and printer, arms merchant, and revolutionary, and throughout it all a tireless and effective self-promoter and compulsive litigant, Beaumarchais was at the center of many of the critical events in the events leading up to the French Revolution.

 

The vast sweep of Beaumarchais’s life encompasses enough to have filled several lifetimes. If we now remember him most for his plays, we should at least recognize how provocative and even seditious his plays were at the time. One excerpt from Figaro is particularly illustrative in that regard, and worth reproducing here. Though Figaro speaks the words, it is not too hard to imagine these same sentiments come from the mouth of one as talented and ambitious as Beaumarchais, chaffing against the unfairness of a system of aristocracy that delimited the upward range of his achievement:

 

Just because you’re a great nobleman, you think you’re a great genius! Being an aristocrat, having money, a position in society, holding public office – all that makes a man so arrogant! What have you ever done for all this wealth? You took the trouble to be born and nothing else! Apart from that you’re rather an ordinary man. And me, God damn it, a nobody, one of the crowd, and I’ve had to use more skill and ingenuity simply to stay alive than they’ve expended in a hundred years governing the whole of Spain! And you dare challenge me!

 

　

　

As the various subprime-related securities lawsuits have reached the motion to dismiss stage, some of the rulings have gone for the defendants and other have gone for plaintiff. Regions Financial Corporation experienced one of each kind of ruling in two separate cases involving allegations about the goodwill the company carried on its balance sheet as a result of its November 2006 acquisition of AmSouth.

 

As discussed below, the motion to dismiss was denied in the Alabama state court derivative suit, but the motion to dismiss was granted in the securities class action lawsuit pending in the Southern District of New York.

 

Regions Shareholders’ Derivative Lawsuit (Alabama)

Background

Plaintiffs filed their shareholders’ derivative complaint in May 2009 in Alabama (Jefferson County) Circuit Court against Regions, as nominal defendant, and certain current and former members of Regions’ board of directors. The complaint asserts claims against the company defendants for breach of fiduciary duty, corporate waste, and abuse of control. (The complaint asserts separate claims against the company’s offering underwriters and auditing firm for aiding and abetting and breach of professional duties).

 

The complaint’s allegations pertain to the company’s November 2006 $10 billion purchase of AmSouth and the alleged falsification of the company’s public statements and disclosure documents both during and following the transaction. The complaint principally focuses on the company’s disclosures between the time of the merger and the company’s January 2009 write down of over $6 billion of goodwill. Throughout that period, and despite the deteriorating real estate market, the merger allegedly was touted as a success, notwithstanding Regions’ acquisition of AmSouth’s exposure to the Florida real estate market.

 

According to the complaint in June 2008 the SEC questioned the company’s determination in its 2007 10-K that its goodwill balance was not impaired. Analysts also began to question this issue as well, but it was not until January 2009 that the company, as the Alabama court later put it "wrote down its goodwill and admitted that the value of its loan portfolio was billions less that [sic] what had been reported." The plaintiff alleges that the defendants knew of the true financial situation and misrepresented or concealed those facts.

 

The company defendants moved to dismiss on the grounds that the plaintiff had failed to make a pre-suit demand that the company itself bring the claims. The plaintiff countered that demand was excused.

 

The May 6 Ruling

In a May 6, 2010 order (here), Circuit Court Judge Robert S. Vance, Jr., applying Delaware substantive law and Alabama procedural requirements largely denied the defendants’ motions to dismiss, finding that the plaintiffs "have met their burden, at least at to the extent needed to establish demand futility at this point."

 

Judge Vance noted the widespread deterioration of the Florida real estate market, and also reviewed the duties of the board, particularly its audit committee, to consider critical financial issues such as goodwill impairment. Judge Vance noted that:

 

Given these duties along with the well-known and heavily publicized deterioration of the real estate market (especially in Florida) and the corresponding collapse in the credit market, and the letter received from the S.E.C. in June 2008, the members of the audit committee can fairly be said to confront a substantial likelihood of liability as a result of Regions’ failure to advise its shareholders prior to January 2009 that its financial situation was threatened.

 

Judge Vance also denied (in reliance on the Citigroup derivative lawsuit case) defendants’ motions to dismiss the plaintiffs claims for waste "to the extent that corporate waste allegations pertain to compensation issues specifically authorized by the directors."

 

However, Judge Vance found that the plaintiffs had failed to show enough to maintain claims based on an alleged failure to oversee Regions’ subsidiary, Morgan Keegan, holding that the plaintiffs "fail to show in what particular ways the Regions’ board has consciously failed to oversee the operations of its subsidiary."

 

Southern District of New York Securities Class Action Lawsuit

Background

As reflected in greater detail here, the plaintiffs first filed a securities class action lawsuit in the Southern District of New York against Regions on April 1, 2009. The plaintiffs represented investors that had purchased securities in the company’s $345 million April 2008 trust preferred securities offering. The defendants included the company, certain of its directors and officers, its offering underwriters, and its auditor.

 

The plaintiffs alleged that the April 2008 offering documents were false and misleading because they incorporated by reference financial statements that overstated goodwill and underestimated loan loss reserves. Among the financial statements incorporated into the offering documents was the company’s 2007 Form 10-K.

 

The complaint alleged that the company "did not write down any of the massive goodwill" it recorded in its 2007 10-K "despite growing evidence indicating that serious problems existed at the time of the acquisition." The complaint also alleges that Regions "only marginally increased its loan loss reserves" despite "the high risk of loss inherent in its mortgage loan portfolio."

 

The defendants moved to dismiss on the grounds that the plaintiffs had failed to allege any actionable misstatements or omissions.

 

The May 10 Ruling.

In his May 10, 2010 opinion (here), Southern District of New York Judge Lewis Kaplan granted the defendants’ motions to dismiss.

 

With respect to the plaintiff’s allegations regarding goodwill, Judge Kaplan concluded that "in the absence of particularized allegations that management believed that the goodwill figure was materially overstated, the amended complaint is insufficient as a matter of law."

 

In reaching this conclusion, Judge Kaplan noted that the goodwill was intended to reflect the excess of the acquisition price over the fair value of AmSouth’s assets at the time of the acquisition. He noted that the value of AmSouth’s loan portfolio "was not a matter of objective fact," as its loan assets were not traded on an efficient market, adding "nor has plaintiff pointed to any other objective standard of value." Given the lack of "any objective or readily determinable value," the question of the falsity of the goodwill presented in the offering documents is not a question of whether or not the value was wrong in some empirical sense, but whether or not the offering documents actually reflected management’s "honest opinion." Because the complaint did not allege that the goodwill did not reflect management’s opinion, the complaint’s allegations regarding goodwill were insufficient as a matter of law.

 

Even though the SEC’s June 2008 inquiry letter came two months after the April 2008 securities offering, Judge Kaplan expressly addressed the letter’ implications He noted that the SEC did not question the validity of Regions’ goodwill balance, but rather asked only for Regions to disclose how it determined that the goodwill balance was not impaired. Regions had responded that the goodwill reflected the fact that a potential buyer would offer a control premium for the business franchise. The SEC had replied that it had no further comments. Judge Kaplan concluded that the exchange with the SEC did not support an inference that Regions was aware that its goodwill was impaired at the time its alleged misstatements.

 

Judge Kaplan reached a similar conclusion with respect to the alleged insufficiency of Regions’ loan loss reserves, noting that the loan loss reserves are not a matter of objective fact, but rather were statements of opinion. He noted that the complaint is "devoid of any allegation that the defendants did not truly hold those opinions at the time they were made public."

 

Discussion

The difference in outcome of these two dismissal motion rulings is largely a reflection of the fact that the two courts were engaged in significantly different exercises. The Alabama court was determining only whether or not the requirement for pre-suit demand was excused based on the circumstances alleged.

 

Judge Kaplan was not only examining the legal sufficiency of the allegations, but he was also considering whether or not the complaint met the specific legal requirements for the specific claims alleged.

 

But the difference between these two opinions reflects more than the difference in the precise questions before the respective courts.

 

The two opinions also reflect strongly different starting points. Judge Vance in the Alabama case took it as a given that the residential real estate marketplace was rapidly deteriorating during the relevant time period, and that the deterioration was a relevant consideration. Judge Vance also considered the SEC’s letter relevant to whether or not the company’s financial statements were misleading due to the company’s delay in recognizing the impairment of the goodwill.

 

Judge Kaplan’s analysis seems to suggest that that these external considerations were irrelevant, and the only consideration was whether or not the offering documents accurately reflected management’s opinion about goodwill.

 

Judge Vance was, of course, concerned with a broader period of time and a broader range of communications than was Judge Kaplan. And unlike the plaintiffs in the securities fraud lawsuit before Judge Kaplan, the plaintiffs in the derivative lawsuit had expressly alleged knowing or reckless misrepresentation. Because the claims before Judge Kaplan were asserted under the ’33 Act, the plaintiffs in that case had not alleged knowing or reckless misrepresentation.

 

Accordingly, it might be asserted that the differences between the two opinions are simply a reflection of the differences in the facts alleged and the substantive difference in the claims asserted. That assertion might even be true. However, I find it very hard in reading these two opinions not to conclude that these opinions are best explained by the differences in the two Judge’s starting points. For Judge Vance, it was all about the external context. For Judge Kaplan, the context is irrelevant.

 

Just to round out the picture here, it is worth noting that in a March 9, 2010 order (here), Western District of Tennessee Judge Samuel H. Mays, Jr. denied the motion to dismiss in the Regions Financial subprime-related ERISA class action lawsuit. On the one hand you might say that this is yet another decision relating to the same set of circumstances, but it could also be argued that the ERISA plaintiffs have alleged a substantially broader array of misrepresentations. At a minimum, you can say that the dismissal motion rulings in the subprime-related cases involving Regions Financial Corp. are basically all over the map.

 

Once final note is that Judge Vance’s ruling may be significant due to the fact that it is a higher-profile subprime related derivative suit in which the complaint survived the initial motions to dismiss. This outcome stands in contrast to prior rulings in subprime-related derivative suits – for example, in the Citigroup derivative lawsuit (about which refer here) and AIG derivative lawsuit (refer here). Based on these rulings, a perception has been growing the plaintiffs are struggling in these cases.

 

Judge Vance’s holding that demand in this case is excused is a potentially significant holding, although its impact is likely to be limited both due to the somewhat case specific facts (including in particular the SEC’s June 2008 letter inquiry), and due to the fact that the ruling is the product of an Alabama state court applying Delaware law. These factors may restrict the impact of the case.

 

Nevertheless the May 6 order does represent an example where plaintiffs were able to overcome the challenging initial hurdles involved in shareholders’ derivative litigation.

 

I have in any event added the two Regions-related rulings to my running tally of subprime-related dismissal motions rulings, which can be accessed here.

 

Special thanks to several loyal readers for providing me with copies of the various Regions Financial rulings. .

 

E*Trade Subprime Securities Suit Dismissal Motion Ruling Denied: And speaking of subprime-related securities lawsuits in which the dismissal motions were denied, in another order dated May 10, 2010 (here), Southern District of New York Judge Robert Sweet denied the defendants’ motion to dismiss in the subprime related securities suit pending against E*Trade and certain of its directors and officers.

 

As reflected in greater detail here, the plaintiffs had first filed their securities actions against E*Trade in October 2007, alleging that the company had failed to disclose deterioration in its mortgage and home equity loan portfolio. The defendants moved to dismiss, arguing among other things that the company’s losses were the result of a "worldwide economic catastrophe" and the plaintiffs’ claims were nothing more than "fraud by hindsight."

 

In denying the defendants’ arguments, Judge Sweet rejected this "global meltdown" arguments saying that "because the issue in this action is what the Defendants knew and when they knew it, a securities violation has been adequately alleged." 

 

Andrew Longstreth’s May 12, 2010 Am Law Litigation Daily article about the dismisal motion ruling in the E*Trade case can be found here. I have also added the E*Trade ruling to my running tally of subprime lawsuit dismissal motion rulings.

 

 

 

Reflection: Judge Vance is the eldest son of Robert Smith Vance, who served as a United States District Circuit Judge, first in the Fifth Circuit and later in the Eleventh Circuit. The elder Judge Vance is one of the few federal judges to be assassinated as a result of his judicial service. Judge Vance was killed by a mail bomb in 1989. Prosecutors later concluded that the bomb had been sent by a convicted criminal upset because the Eleventh Circuit had refused to expunge the conviction.

 

In memory of Judge Vance, the name of federal building and courthouse in Birmingham, Alabama as been changed to the Robert S. Vance Federal Building and United States Courthouse.

 

One side-effect from the oil slick spreading across the Gulf of Mexico following the blowout of the Deepwater Horizon oil rig, and a direct result of the massive economic and environmental damage it has caused, is the efflorescence of lawsuits from persons whose property or livelihood have been threatened or damaged by the spill. Given the magnitude of the damage and the extent of the ensuing litigation, it was perhaps only a matter of time before the expanding litigation wave came to include D&O claims too.

 

On May 7, 2010, a BP shareholder filed a shareholders’ derivative lawsuit (complaint here) against BP PLC, as nominal defendant, and 15 individual directors and officers, including Tony Hayward, BP’s CEO. The defendants also include Transocean Ltd. and related entities, the Deepwater Horizon’s rig owner; Cameron International Corp., which manufactured the blowout prevention devices that allegedly failed; and Halliburton Energy Services, which was installing cement casing on the well-head at the time of the explosion. The complaint also purports to name as defendants the third-party defendants’ insurers.

 

The complaint seeks recovery against the BP defendants for breach of fiduciary duty and corporate waste. The complaint alleges that despite numerous other prior safety and environmental concerns at BP the defendants "elected to cut costs, including safety and manufacturing expenditures in pursuit of profitable results, even lobbying regulatory authorities to "remove or decrease the extent of safety and maintenance regulation."

 

The complaint also asserts claims against the third-party defendants for contribution and constructive trust alleging that their misconduct was a "substantial factor in the disaster" and therefore they "should be held responsible for the effects of the disaster."

 

Among the damages to BP that the plaintiff alleges are the costs of $6 million per day that BP is spending to try to stop the leak and remediate its effects; BP’s required cleanup costs under federal and state statutory mandates; its exposure to lawsuits; as well as damage to BP’s reputation and good will, which as already resulted in a drop in BP’s share price.

 

There are a number of very interesting things about this lawsuit, particularly with respect to the claims against BP’s directors and officers.

 

The is that, in arguing that the BP board cannot objectively evaluate whether to bring the claims alleged in the complaint, the complaint explicitly references BP’s prior disasters, including the infamous 2005 Texas City, Texas refinery explosion and fire and the 2006 Prudhoe Bay oil spill. In particular this most recent complaint references the Prudhoe Bay shareholders’ derivative lawsuit filed against BP’s directors and officers, in which the defendants had (according to the latest complaint) agreed to "certain corporate governance changes at BP designed in part to prevent a recurrence of safety and maintenance problems at the company." (General background regarding the Prudhoe Bay lawsuit and its outcome can be found here.)

 

The Deepwater Horizon lawsuit complaint alleges that notwithstanding the commitment in the Prudhoe Bay litigation settlement agreement BP has "merely gone through the motions" to make the agreed upon changes, as a result of which the company has "not experienced one iota of improvement in its workplace and environmental safety." Elsewhere the complaint alleges that notwithstanding the severity of the safety concerns that led to this prior settlement that company has been "making purely cosmetic changes at the corporate level while ignoring the substance of the safety violations and the threat to" the environment as well as to "the Company’s own survival as a going concern."

 

Second, as another argument why demand on the current board should be excused, the complaint also cites the massive wave of litigation that has already been filed against BP in the wake of the Deepwater Horizon disaster. The complaint argues that the BP defendants "cannot reasonably be expected to defend BP itself against allegations of misconduct in [the other lawsuits] while simultaneously pursuing these claims" in the derivative suit "for the very same or very substantially related misconduct." Given the vast number of claims, the complaint contends, "it is not possible for the Director Defendants in this case…to impartially consider whether to bring these claims."

 

Third, the complaint, though filed in Louisiana, expressly references the standards identified in the British Companies Act of 2006, particularly the Act’s requirement in Section 172 that corporate boards ensure that their companies conduct operations with due regard for "the impact of the company’s operations on the community and the environment." This express reference to U.K. law is interesting given that the case is filed in Louisiana and highlights what may be one fundamental problem the plaintiff may face, as discussed further below.

 

Fourth the plaintiffs’ bid to join the third-party defendants’ insurers seemingly represents an attempt to take advantage of the fact that Louisiana is one of the few jurisdictions permitting tort claimants to bring so-called "direct actions" against their tortfeasor’s liability insurers.

 

Though the plaintiff’s complaint invokes the full-throated rhetoric of righteous outrage, it nevertheless faces certain hurdles that could shut the case down before it gets started.

 

The first of course is that the plaintiffs have not made the requisite demand on BP’s board to bring these claims directly on the company’s behalf. As noted above, the plaintiff has argued that due to prior litigation against BP and current Deepwater Horizon-related litigation now emerging, demand should be excused.

 

Setting aside the question whether or not demand is excused, there are other potential threshold hurdles. One that is amply illustrated in the complaint’s reference to the U.K. law noted above which is that BP is a U.K. corporation organized under the U.K.’s laws. BP will undoubtedly attempt to argue that the "internal affairs doctrine" dictates that the U.S. court should decline jurisdiction, so that these claims involving a U.K. corporation and U.K. law may be heard in U.K. courts.

 

The "internal affairs doctrine" was argued successfully by another U.K. corporation, BAE Systems, which successfully had derivative litigation in the U.S. arising from the company’s bribery scandal dismissed in reliance on the "internal affairs doctrine." Indeed, BP itself unsuccessfully raised similar arguments in the Prudhoe Bay derivative litigation.

 

The plaintiffs’ complaint attempts to anticipate these arguments. The complaint is full of explicit references to the myriad vital contacts between BP and the U.S. Among other things the complaint emphasizes that 39% of BP’s shareholders are located in the U.S. and that its energy production and capital expenditures are larger in the U.S. than in any other country. The plaintiff is clearly cueing up an argument that the circumstances uniquely affect the U.S. and its interests and therefore the case comes within an exception to the doctrine.

 

Where the BP derivative litigation may ultimately head remains to be seen. At a minimum, BPs directors and officers face the prospect of enormous expense defending against this litigation, and significant potential liability.

 

It should not be overlooked that this lawsuit represents yet another example of a company domiciled outside the United States facing a D&O claim in the U.S. courts. The susceptibility of non-U.S. companies to U.S.-based D&O litigation is a topic of recurring interest, among other reasons because of the securities law issues regarding the extraterritorial jurisdiction of the U.S. securities laws, of the kind raised in the National Australia Bank case now pending before the U.S. Supreme Court.

 

These questions of non-U.S. companies’ exposure to U.S. claims are also a topic of recurring interest to D&O insurers. The most obvious concern to insurers is the extent to which non-U.S. companies face threats of D&O litigation in the U.S. and therefore should be paying D&O premiums commensurate with the existence of the U.S.-based litigation exposure.

 

My final observation about the new BP lawsuit is that while I was reading the complaint I had the premonition that the BP derivative complaint may represent the precursor of the as-yet-unfiled but undoubtedly soon-to-arrive first D&O lawsuit based on global climate change related allegations.

 

The BP complaint’s allegations about the extent of the environmental and economic damage from the Deepwater Horizon oil spill, as well as the reputational harm to the company, and about management’s failure to anticipate and prevent the alleged harm, both to the spill victims and to the company, may prefigure the way the first global climate change lawsuit will be written (up to and including the tone of unrestrained moral outrage). The only thing missing is some event – or perhaps some alleged disclosure violation – and the existing environmental disaster derivative lawsuit template will be adapted for new global climate change derivative litigation.

 

Whether or not the litigation template is adapted to global climate change, the threat of environmentally-related D&O litigation undoubtedly will persist. Indeed, heightened concern and anxiety in the wake of the Deepwater Horizon disaster will only make this type of litigation more likely in the future.

 

A good overview of the litigation environment surrounding the oil spill and the general implications for the insurance industry can be found in a May 7, 2010 memo from Laura Foggen and Benjamin Theisman of the Wiley Rein law firm entitled "The Gulf Oil Spill: Considerations for Insurers" (here).

 

A May 10, 2010 Bloomberg article about the new BP derivative lawsuit can be found here.

 

Let Us Remember Justice Stevens – and The Bee, Don’t Forget the Bee: Everyone here at The D&O Diary is very interested in President Obama’s nomination of Solicitor General Elena Kagan to the U.S. Supreme Court. Press coverage in coming months undoubtedly will be filled with stories concerning her nomination and the confirmation process. Though attention is appropriately focused on the nominee, we think it is also appropriate to pause and consider the Justice she hopes to replace, John Paul Stevens.

We can think of no better place to being that in Ian Frazier’s piece, "Remember Justice Stevens" in this week’s issue of the New Yorker (here). Be forewarned, you may start to suspect that the article is going off the tracks right about the point where the author states: "A few minutes passed before Justice Stevens became aware of the bee under his shirt, just at the base of his neck."

 

It remains to be seen whether the FDIC will pursue civil actions against former directors and officers of failed banks, but it has made it clear that it will file criminal actions in cases where it suspects fraud. According to news reports, on May 7, 2010, the U.S. Attorney of the Northern District of Georgia unsealed indictments against two former officers of the failed Integrity Bank as well as against a real estate developer whom the officials said obtained $80 million in improper loans from the bank.

 

Douglas Ballard, the bank’s former Executive Vice President in charge of client relationships and a member of the bank’s board of directors, and Joseph Todd Foster, the bank’s former Executive Vice President for Risk Management, are charged with conspiracy, insider trading and bank fraud. The developer, Guy Mitchell, is charged with conspiracy and bribery.

 

The indictment alleges that Mitchell and companies he controlled obtained more than $80 million in business loans from Integrity Bank. He allegedly obtained the loans under false pretenses and deposited nearly $20 million in a checking account used for personal expenses, included over $1.5 million spent on a private island in the Bahamas. Later loans were used to pay interest on earlier loans.

 

The indictment also alleges that Mitchell paid Ballard, who authorized the loans, over $290,000 over a nine month period (half in cash and half in a cashier’s check) as a reward for Ballard’s assistance.

 

Ballard and Foster are also alleged to have committed securities fraud by engaging in insider trading. They are alleged to have sold all of their shares based on inside information (specifically, with knowledge of the bank’s problems with Mitchell’s loans).

 

Many of the news reports about the indictment have highlighted the fact that Integrity Bank had been founded with a faith-based theme. According to the Atlanta Journal Constitution (here), bank employees regularly prayed before meetings and in bank lobbies with customers.

 

The FDIC took control of the bank in August 2008. The Atlanta Journal Constitution article quotes the U.S. Attorney for the Northern District of Georgia as saying that the alleged fraud "was substantial contributing factor to the collapse," adding that "more than $80 million was given away from a dirty insider who was taking payoffs from the developer. That’s more that the average bank has had to deal with."

 

The Wall Street Journal (here) also quotes the U.S. Attorney as saying that "We are continuing to investigate and potentially other officials could be charged."

 

Statements by agency officials suggest that this prosecution may not be an isolated event. The indictment reportedly was the result of an interagency collaboration that included the FDIC’s Office of Inspector General. News reports quote the FDIC’s Inspector General as saying that "we are particularly concerned when senior bank officials, who are in positions of trust within their institutions, are alleged to be involved in unlawful activity. Prosecutions of individuals and entities involved in criminal misconduct maintain the safety and soundness of the Nation’s financial institutions."

 

The FDIC had already demonstrated substantial interest in claims involving Integrity Bank. As I discussed in a prior post (here), the FDIC intervened in the derivative lawsuit that had been brought by the bankruptcy trustee of the bank’s holding company against four former directors and officers of the holding company and the bank. The court granted the FDIC’s motion to intervene and also granted the FDIC’s motion to have the trustee’s claims dismissed, holding that under FIRREA the agency had the exclusive right to pursue claims on behalf of the bank. Basically, the FDIC made it clear that if anybody is going to pursue claims against the former officers, it is going to be the FDIC.

 

I had interpreted the FDIC’s moves in the bankruptcy trustee’s lawsuit as evidence that the FDIC intended to pursue its own claims against the former officials of Integrity Bank. But I was expecting civil claims; I certainly did not forsee this criminal prosecution. The FDIC may yet pursue civil claims as well. But it is nevertheless interesting that the FDIC is going ahead with criminal prosecutions but not yet pursuing its own civil actions, either in connection with Integrity or really any other failed banks.

 

Special thanks to the several readers who sent me links to news articles about the Integrity indictment.

　

Meanwhile the Investor Lawsuits Continue to Emerge: While we all wait to see that whether the FDIC will unleash a flood of failed bank claims as it did during the S&L crisis, the failed banks’ aggrieved investors are continuing to file their own claims against the directors and officers of the failed institutions.

 

The latest of these investor lawsuits is the securities class action lawsuit filed on May 7, 2010 in the Central District of California against certain former directors and officers of First Regional Bancorp, the holding company for First Regional Bank, a Los Angeles based bank that regulators closed on January 29, 2010. According the plaintiffs’ attorneys’ May 7 press release (here), the defendants "caused the Company to disseminate financial statements that were not fairly presented in conformity with Generally Accepted Accounting Principles and were materially false and misleading, and failed to make complete and timely disclosures concerning certain actions taken by regulators."

 

The First Regional lawsuit follows several other recent securities lawsuits that have involved failed banks. For example, on April 15, 2010, investors filed a securities lawsuit in the Western District of Washington against Frontier Financial Corp., the holding company of Frontier Bank, and certain of its directors and officers. Regulators closed Frontier Bank on April 30, 2010.

 

There have also been a number of securities lawsuits filed against other troubled banks, including Sterling Financial, Smithtown Bancorp and Haven Trust Bancorp.

 

In addition to securities class action lawsuits, investors are pursuing a variety of other kinds of claims against former directors and officers of failed banks, as illustrated, for example, by the recent action for negligent misrepresentation filed against the former officials of the failed Alpha Bank and Trust, about which refer here.

 

At this point, it seems well-established that failed bank investors intend to pursue these kinds of claims, although whether they will succeed and produce value for the claimants remains to be seen. My recent post discussing plaintiffs’ dismissal motion record in these kinds of cases can be found here.

 

As a result of series of legal developments, securities class action lawsuits in Australia have become have become increasingly common in recent years, and signs are that these trends will continue, according to a comprehensive study of Australian securities class action litigation issued on May 7, 2010 by NERA Economic Consulting.

 

The report can be found here, and NERA’s May 7 press release can be found here. (Hat Tip to Adam Savett of the Securities Litigation Watch blog, who has a post about the NERA study here).

 

Although the Australian laws permitting securities class action litigation have been in place since 1992, there were only two cases filed prior to 2000. There were a total of five cases filed during the years 2000 to 2003, and the filings began to increase steadily during 2004 and thereafter. There were a record number of cases filed in 2009, when six securities class action lawsuits were filed. There were a total of 22 securities class action lawsuits filed during the period 2004 to 2009.

 

A number of factors have contributed to the growing numbers of lawsuits. The first is that, according to the NERA study, "following the high-profile collapse of a number of companies in the early 2000s … shareholders have demonstrated that they are increasingly willing to use class actions as a tool to protect themselves from harmful conduct, and to punish offenders."

 

In addition, there have been several key case law developments that have removed some impediments, including decisions clarifying that shareholders can seek damages when their loss is distinct from any loss suffered by the company, and other decisions clarifying the rights of shareholders suing for damages against companies that are under administration.

 

However, perhaps the most significant development behind the increase in securities class action litigation in Australia is the "emergence of commercial litigation funding." Because of the prohibition against contingency fees, as well as the risks of costs awards against unsuccessful litigants, there were substantial financial barriers against pursuing this type of litigation.

 

Seventeen out of the 24 Australian securities class action lawsuits that have been filed since 2004 have been financed by a commercial litigation funder. The Australian commercial litigation funding business is dominated by IMF (Australia) Ltd., the first publicly listed litigation funder in Australia. IMF has financed 14 securities class action lawsuits and has proposed financing in an additional three suits that have not yet been filed. Though IMF dominates, according to the NERA study, a number of new firms have recently entered the market.

 

(Readers who, like me, are fascinated by this concept of litigation funding may want to have a look at IMF’s website, linked above.)

 

The two primary causes of action in Australian securities class action lawsuits are "contraventions of the continuous disclosure rules" and alleged violations of the laws prohibiting misleading and deceptive conduct. A number of suits also allege breaches of fiduciary trust. The two most common allegations, asserted in 52% of cases, are inaccurate earnings guidance and improper accounting.

 

Despite the dominance of the materials industry in the Australian economy, suits against mining or other companies represent only 14% of all cases filed. Actions brought against issuers in the diversified financial, insurance and real estate industries account for slightly more than half of all filings.

 

Because so many of the securities lawsuits have been filed in recent years, only a small number of all suits have been resolved. Of the 12 that were resolved as of December 2009, eight were settled, although all five of the resolved cases that were filed after 2003 were settled. The NERA report suggests that the litigation funding arrangements may have contributed to this trend toward negotiated resolutions, as the litigation funders are likely to "promote the selection and subsequent filing of actions that are stronger and for which a greater proportion of potential class members have signed a funding agreement."

 

Though Australian securities class action lawsuit filings have increased in recent years, they are many fewer securities lawsuit filed there than in the United States even allowing for the differences in size of the two countries’ economies. The NERA report comments that the class action filing levels in the Australia are "broadly similar to the level seen in Canada, once adjusted for the respective size of each economy."

 

The report concludes with the observation about Australian securities class action lawsuits that "with a number of recent common law developments having resolved many areas of uncertainty, it is likely that the rate of growth of filings evident since 2004 wil continue into the future."

 

NERA is of course well known for its periodic studies of U.S. securities class action lawsuits. Their new study of Australian class action lawsuits is the third in a series of studies concerning securities class action lawsuit litigation outside the U.S., following on its studies concerning securities litigation in Canada (refer here) and Japan (refer here).

 

More About the Schwab YieldPlus Securities Class Action Lawsuit Settlement: In an earlier post (here), I reviewed the $200 million settlement in the Schwab YieldPlus subprime related securities class action lawsuit. As noted at the time, the settlement did not resolved the related state law claims that the plaintiffs had filed.

 

On May 5, 2010, the Charles Schwab Company announced (here) that it had resolved the remaining state law claims as well, in exchange for an agreement to pay an additional $35 million, brining the total value of the Schwab YieldPlus settlement to $235 million. I have adjusted my table of subprime-related securities lawsuit case resolutions accordingly.

 

Farewell Ernie Harwell: Everyone here at The D&O Diary was saddened by the news earlier this week of the death of Hall of Fame baseball announcer for the Detroit Tigers, Ernie Harwell. One of my fondest memories from my three years at University of Michigan Law School is of listening to radio broadcasts of Tiger games, and of Harwell’s friendly, welcoming voice bringing the games alive. Harwell is perhaps better known for his signature home run calls ("That one is long gone!), but I will always remember the way he began games by saying "Its another great day for Tiger baseball." It was always a great day for Tiger baseball when Harwell was in the booth.

 

Ernie, we will miss you.

 

Although some noteworthy settlements from the subprime-related securities class action litigation wave have started to accumulate (refer for example here), there are still some impressive settlements coming in from the prior scandal.

 

In the third largest options backdating-related securities class action lawsuit settlement, Maxim Integrated Products has agreed to settle the claims against all defendants in the options-related securities suit pending against the company for a payment of $173 million. According to the company’s May 5, 2010 press release (here), the after tax cost to the company from the settlement, which is still subject to documentation and court approval, would be $110 million.

 

As detailed in a prior post (here), on February 6, 2008, plaintiffs’ lawyers announced (here) that they had initiated a securities class action lawsuit in the United States District Court for the Northern District of California against Maxim Integrated Products and certain of its directors and officers. The lawsuit relates to Maxim’s January 17, 2008 announcement (here) that, as a result of its Board’s special committee’s investigation of the company’s stock option practices, the company would be restating its financial statements to record non-cash, pre-tax charges of between $550 and $650 million for additional stock-based compensation expense. The company also announced that investors should not rely on the company’s financial statements for the fiscal years 1997 through 2005 and corresponding interim reporting periods through March 25, 2006.

 

In order dated July 16, 2009 (here), the court denied in part the defendants’ motions to dismiss, but perhaps more telling with respect to the timing and size of the securities lawsuit settlement, on April 23, 2010, following an eightday criminal trial, Maxim’s CFO Carl Jasper was found liable for securities fraud related to the backdating, as noted in this April 26, 2010 article by Zusha Elinson in The Recorder, here.

 

The SEC had previously sued the company and its CEO in an options backdating enforcement action (about which refer here). The CEO, Jack Gifford, who settled the SEC charges for a payment of $800,000 has since passed away.

 

The $173 million Maxim Integrated Product settlement is exceeded in dollar value among options backdating related securities lawsuit settlements only the $925.5 million total settlement of the UnitedHealth Group options-related securities lawsuit and the $225 million Comverse settlement. My complete tally of options related settlements and other case resolutions can be accessed here.

 

Adam Savett of the Securities Litigation Watch has also been tracking the options backdating related securities lawsuit settlements, and in his most recently updated tally (here), he reported that of the 39 total options backdating related securities class action lawsuits, 35 (not counting Maxim) have been resolved, with 8 dismissed and 27 settled (again, not including Maxim). Prior to the Maxim settlement, the 27 options backdating related securities class action lawsuits that had settled had been settled for an aggregate total of $2.15 billion and an average settlement of $79.7 million.

 

With the Maxim settlement, the aggregate is now $2.325 billion, and the average has also increased, as Savett’s forthcoming revised calculations undoubtedly will show. UPDATE: Savett has indeed updates his analysis, here. The updated average is $79.7 million, but if the outsized UnitedHealth Group settlement is excluded from the calculation, the average drops to $51.88 million. The median settlement is $16 million, and $14 million if the United Health Group settlement is excluded.