On April 6, 2010, PricewaterhouseCoopers issued this year’s version of its annual study of securities class action litigation (here). The PwC report differs in certain particulars from previously released studies of the 2009 securities lawsuit filings, but the overall findings are directionally consistent with the prior reports. PwC’s April 1. 2010 press release about its 2010 study can be found here.　

 

My own analysis of the 2009 securities lawsuit filings can be found here. Cornerstone’s previously released study of 2009 filings can be found here and Cornerstone’s study of the 2009 securities lawsuit settlements can be found here. NERA’s 2009 study can be found here and Advisen’s can be found here.

 

According to the PwC study, there were only 155 securities class action lawsuits in 2009. As discussed below, PwC’s lawsuit count differs materially from all other published account. Consistent with the other studies, however, PwC reports that the number of 2009 filings represented a significant decline from 2008, when, according to PwC, there were 210 filings.

 

With respect to the 2009 filings, PwC notes a "noteworthy trend" involving "the incidence of long delays between the end of the class period and the filing date of the case." The study notes that the 2009 average time lag of 219 days is almost double the average number of 114 days since the PSLRA was enacted.

 

The study also reports that a total of 34 cases were filed one year or more after proposed class period cutoff date, and also notes that most of these delayed cases were not related to the financial crisis. The study suggests that "plaintiffs’ attorneys may now be returning to where they left off before the financial crisis began." (My own most recent post concerning the belated lawsuit filings can be found here.)

 

For the second consecutive year, financial services companies were the most frequent securities lawsuit targets. Financial services companies were named in 41 percent of all filings, compared to 48 percent in 2008.

 

The concentration on financial services companies has meant a "two-year reprieve" for companies in the high-technology sectors. Traditionally these companies have been a favored target, representing, for example, 55 percent of all companies sued in 2001. By contrast, in 2009, high-tech companies were named in only 12 percent of all 2009 filings.

 

Filings against pharmaceutical companies have remained consistent. Since the enactment of the PSLRA, pharmaceutical companies have represented an annual average of eight percent of all filings, and since 2002, the average percentage of filings against pharmaceutical companies has represented double digit percentages. In 2009, new filings against pharmaceutical companies presented 14 percent of total filings.

 

New lawsuit filings against Fortune 500 companies represented 20 percent of all 2009 filings. Almost half of the Fortune 500 companies named in new securities suits in 2009 were financial services companies.

 

The average securities class action settlement in 2009 was $34.6 milllion, which is 20 percent lower than the $43.4 million settlement average in 2008, is above both the ten-year average of $31.5 million and the $30.7 million average since the enactment of the PSLRA. The average settlement value of cases that settled for $1 million or more and up to $50 million is $10.8 million, up slightly from $11.2 million in 2008. The median 2009 settlement was $9.5 million, up from $8.5 million in 2008.

 

(The settlement values, averages and medians exclude "outliers" but the study does not specify how outliers are defined. The PwC study assigns settlements to the year in which they were announced, by contrast to other studies which assign settlements to the year in which they are approved.)

 

The PwC study ends with the observation that though the number of securities class action lawsuits declined, companies should by no means "relax their guard." The study comments that the 2009 decline "may simply be a lull as the plaintiffs’ bar refocuses following two years of intense financial-crisis related filings."

 

Discussion

PwC is one of several organizations providing a substantial public service by making its annual securities litigation surveys publicly available, for free. The firm’s willingness to share its analysis and insights is a boon for which the rest of us should be very grateful.

 

There is a certain audience that is very keenly interested in these reports. Virtually every member of this audience reads all of these reports as they are published. For example, the typical reader of the PwC report has already read all of the other annual reports that I listed and linked to above.

 

Because of this general audience familiarity with all of these published reports, it is probable that most readers are fully aware of the material difference between the lawsuit count published in PwC’s report and those that appeared in the other published versions. By way of example and by contrast to the 2009 lawsuit count of 155 that PwC reported, my own count was 189. Cornerstone’s latest updated 2009 lawsuit count is 178. NERA’s projected number (released before year end) was 235.

 

In the absence of explanation, these differences can vexing and frustrating for the readers of these reports, who, as I mentioned, will typically read all of these reports.

 

There is absolutely no reason why the counts should agree. I know from maintaining my own count that reasonable minds can differ about how to count and whether or not to include certain kinds of cases. But though the counts almost as a matter of course will differ, the authors of the various counts owe it to their audience – which, again is going to be reading all of the various studies – to at least say why their counts differ from other published accounts.

 

One explanation for the difference between the PwC count and some other published counts is that PwC (as explained on the study’s "methodology" page) counts "multiple filings against he same defendant with similar allegations" as one case. Some other studies, for example, the NERA study, will count separate filings against the same defendant as separate lawsuits. But that distinction does not account for the difference between the PwC study and, for example, the Cornerstone study and my own count, both of which count related filings only once.

 

The PwC 2009 lawsuit count comes in at some 20 to 30 cases lower than Cornerstone’s and my count. Obviously, PwC counted something differently or left some things out. Obviously, PwC knows its counts are different and they know why, or could easily determine why, because Cornerstone publishes on the web the identities each of the cases that it counts. Given how easy it is for PwC to identify these differences and how easy it would have been to tell its audience of readers, it would have been far preferable if they could have acknowledged and explained these differences.

 

As I said before, the rest of us should be grateful that PwC and other firms are willing to share their data and analysis. But it doesn’t seem too much to suggest that these various publications could do a little bit more for their audience and acknowledge that their publication does not appear in a vacuum. Its audience is going to read each report in the context of the other reports.

 

The firms publishing these reports would substantially enhance the value of their annual studies to their intended audience if they would simply explain their counting methodology in greater detail and in particular how that methodology may explain differences from other published reports.

 

Again, there is absolutely no reason why the reports should be the same. There is absolutely no reason why the reports should use the same or even similar methodologies. But the reports’ audience would be grateful if they might better understand why they differ.

 

These various publishers would significantly enhance the value of their publications to their intended audience if they would simply acknowledge that each other exists.

 

Note to Subscribers: I recently changed the service I use for delivery of email notifications to subscribers. If you have not been receiving email notifications, the most expeditious thing to do at this point may be to resubscribe by entering your email address in the Subscribe dialog box in the right hand column, clicking Go, and then clicking on the subscription confirmation link. It is my hope the new service will be more reliable and more timely. I apologize for any inconvenience the change may cause.

 

I was only away from the office for a few days last week, but while I was away, an absolute cascade of dismissal motion rulings in subprime and credit crisis-related securities cases arrived. A number of the rulings were sufficiently favorable to the defendants that Alison Frankel commented in an April 1, 2010 article in the AmLaw Litigation Daily that "it’s been a truly lousy week for plaintiffs’ lawyers in the securities bar."

 

But while the defendants did indeed prevail in there motions to dismiss in a number of very high profile subprime and credit crisis-related securities lawsuits, not all of the rulings were favorable to the defendants. In several cases, the dismissal motions were denied, and in other cases enough of the case survived the dismissal motion rulings that the plaintiffs probably consider themselves to have been successful. As discussed further below, there arguably are certain discernable trends amongst all of these rulings.

 

Dismissal Motions Granted

The dismissal motion rulings that are most favorable to the defendants undoubtedly are the highest profile cases amongst the latest rulings. Here is a brief summary of the defense friendly rulings:

 

American International Group Derivative Litigation: In a March 30, 2010 opinion (here), Southern District of New York Judge Laura Taylor Swain granted the motion to dismiss the shareholders’ derivative suit that had been filed against American International Group and certain of its individual officers and directors. The plaintiffs claimed that the defendants had failed to properly oversee the company’s credit default contracts and had made certain material misstatements and omissions regarding the company’s financial health and risk management. The plaintiffs also allege waste and breach of fiduciary duty with regard to the company’s dividend increase and share buybacks instituted in the month’s preceding the company’s near collapse and government rescue.

 

The defendants moved to dismiss on the grounds that the plaintiffs failed to make presuit demand. The plaintiffs contended that because it would have been futile, demand was excused.

 

Judge Swain granted the defendants’ motion, concluding that because at least of five of the company’s nine June 2009 directors were sufficiently disinterested and independent, demand was not excused.

 

Of particular interest, in granting the defendants’ motion with respect to plaintiffs’ allegations concerning the alleged failure to oversee the company’s credit default swap exposures, the court specifically observed (in reliance on the Delaware Chancery Court’s February 2009 dismissal of the subprime-related derivative suit filed against Citigroup) that a plaintiff "may not support a claim based on the duty of oversight…merely by identifying signs of general difficulty in the market in which the company participates and asserting that the defendants should be held liable for exercising their business judgment in a manner that appears to have been inconsistent with those indications." Rather a plaintiff must allege that the directors "knew they were not discharging their fiduciary obligations" or "demonstrated a conscious disregard for their obligations."

 

Merrill Lynch Auction Rate Securities Litigation: In a March 31, 2010 ruling (here), Judge Loretta Preska granted the motion of defendants to dismiss the auction rate securities litigation that had been filed against Merrill Lynch and related entities. Judge Preska’s ruling is the latest in a series of auction rate securities lawsuit dismissals. However unlike many of the dismissals (for example, the dismissal of the UBS auction rate securities lawsuit), the dismissal did not depend alone on the Merrill Lynch’s entry into a regulatory settlement. The dismissal was, rather, on the merits.

 

Specifically, Judge Preska held, citing the recent ruling in the Raymond James auction rate securities litigation (refer here), that the plaintiffs had failed to allege with sufficient specificity, with respect to the allegedly misleading statements about the securities, "which financial advisors made such statements or when, where and to whom the statements were made."

 

Judge Preska also rejected the plaintiffs’ arguments that the defendants had engaged in manipulative conduct, holding that as a result of the defendants’ 2006 auction rate securities settlement with the SEC and related disclosures, the defendants’ market-related conduct was fully disclosed. Judge Preska also found that the plaintiffs had not sufficiently pled reliance.

 

In addition to the ruling in the Merrill Lynch case, in a March 30, 2010 order (here), Southern District of New York Judge Robert Patterson granted the motion of defendant Morgan Stanley to dismiss the individual action Ashland Inc. and related entities had filed against the company, alleging securities violations in connection with the plaintiffs’ purchase of over $66 million of auction rate securities. Judge Patterson found that certain allegations do not involve the "purchase or sale of securities," as they involved only the alleged inducement to hold securities. Judge Patterson also found that the plaintiffs’ allegations failed to support a strong inference of scienter. He also held that the plaintiffs had failed to establish that they had reasonably relied on the supposedly misleading statements.

 

Fremont General Corporation: In a March 29, 2010 order (here), Central District of California Judge Jacqueline Nguyen granted with prejudice the motion of defendants to dismiss the subprime related securities class action lawsuit that had been filed against Fremont General Corporation.

 

As noted here and here (scroll down), the court had previously granted the defendants’ motions to dismiss in the Fremont General case. In granting the renewed motion to dismiss, Judge Nguyen noted that renewed pleading "still fails to allege the causes of action with sufficient specificity," observing further that the plaintiffs’ third amended complaint "sets forth virtually no new facts, disregards [the court’s] order not to include certain allegations, and constitutes ‘puzzle pleading’ that made the [prior complaints] so difficult to decipher."

 

BankUnited Financial Corporation: On March 30, 2010, Southern District of Florida Judge Marcia Cooke entered an order (here), granting the motion of the individual defendants to dismiss the subprime related securities lawsuit that had been filed in connection with the events leading up to the May 21, 2009 closure of BankUnited FSB (for more about which refer here).

 

In granting the motion, Judge Cooke held that that certain of the statements on which plaintiffs sought to rely were "general, vague, unverifiable statements of corporate puffery." She found that other statements on which plaintiffs sought to rely were forward looking and protected by the safe harbor. She also found that various statements about the bank’s loan underwriting practices on which the plaintiffs sought to rely were not false and misleading. Judge Cooke also concluded that the plaintiffs had not sufficiently pled scienter, holding that the "generalized allegations" on which the plaintiffs sought to rely "do not support a strong inference of scienter, let along a strong one. "

 

Security Capital Assurance: In a March 31, 2010 order (here), Southern District of New York Judge Deborah A. Batts entered an order granting without prejudice the defendants’ motions to dismiss in the subprime-related securities class action lawsuit that had been filed against Security Capital Assurance, its Corporate parent XL Capital, certain of its individual directors and officers and its offering underwriters.

 

SCA is a holding company for financial guaranty insurance and reinsurance. SCA was formed by and was still partially owned by XL. As reflected here, the plaintiffs alleged that the defendants had misled investors about SCA’s exposure, through its insurance operations, to securities backed by subprime residential mortgages.

 

In her 84-page March 31 order, Judge Batts granted defendants’ motion on the grounds that plaintiffs had not sufficiently alleged either scienter or loss causation. In concluding that plaintiffs scienter allegations were insufficient, Judge Batts stated that "plaintiffs’ broad allegations that Defendants received and were aware of information contradicting their public statements because they held management roles is not enough to allege scienter." Judge Batts also noted, based on plaintiffs’ own allegations, "defendants, like so many other institutions floored by the housing market crisis, could not have been expected to anticipate the crisis with the accuracy plaintiffs enjoy in hindsight."

 

In finding that plaintiffs had not adequately alleged loss causation, Judge Batts stated that "Plaintiffs have not with this Complaint effectively shown that it was the incremental revelation of Defendants’ fraudulent misrepresentations, and not the actions of third parties or other circumstances of the market that caused the decline in SCA’s share price over the Class Period." She adds that "Plaintiffs leave wide periods unaccounted for, and select inconsistent date spreads and wide event windows that permit market noise, and suggest Plaintiffs may be cherrypicking dates that suit their argument."

 

With respect to whether or not she should allow plaintiffs leave to amend, she noted that "it is not likely that Plaintiffs will be able to establish loss causation." But because "amendment might not be futile," the court allowed plaintiffs leave to amend their complaint.

 

Dismissal Motion Granted in Part and Denied in Part

In addition to the dismissal motion rulings described above in which the defendants’ motions prevailed, there were also a group of rulings in which the defendants prevailed in part. In some cases, the defendants were successful in having substantial parts of the plaintiffs’ cases dismissed. Nevertheless, in each of the following cases, the plaintiffs were able to preserve at least a part of their case, at least as to some defendants.

 

Harborview Mortgage Loan Trusts: In a March 26, 2010 order (here), Southern District of New York Judge Harold Baer, Jr. granted in part and denied in part the defendants’ motions to dismiss in the subprime related securities class action lawsuit involving the Harborview Mortgage Loan Trusts. The Trusts had issued certain mortgage backed securities, of which defendant Royal Bank of Scotland was the primary issuer and underwriter. Certain rating agencies that provided ratings of the securities were also named as defendants.

 

Judge Baer granted the rating agencies’ motions to dismiss on the grounds that they could not, as the plaintiffs’ sought to allege, be held liable under the Securities Act, as underwriters. Judge Baer also dismissed, on the basis of lack of standing, plaintiffs claims based on offerings in which the plaintiffs had not purchased securities. Judge Baer also dismissed plaintiffs’ claims that the RBS defendants had not disclosed conflicts of interest with the rating agencies or the dependence of the ratings on outdated ratings models.

 

However, while as a result of the rulings described in the preceding paragraph, substantial parts of plaintiffs’ claims did not survive the motion to dismiss, Judge Baer denied defendants motions to dismiss related to "misstatements and nondisclosure of mortgage originators’ ‘disregard’ for loan underwriting standards."

 

The loan originators in question included certain mortgage lenders whose names "are now synonymous with sub-prime lending and the housing market collapse," including Countrywide, American Home Mortgage Corporation, IndyMac, BankUnited, and Downey Savings. Judge Baer concluded that "plaintiffs have pled sufficient factual allegations to plausibly infer that the underwriting guidelines were disregarded by mortgage originators, and in conflict with the disclosures made in the Offering Documents." Judge Baer found the plaintiffs had alleged that the originators "systematically ignored their stated underwriting practices" and that "plaintiffs have also sufficiently, albeit just barely, connected these allegations to the offerings in question."

 

Credit-Based Asset Servicing & Securitization, LLC: In a terse, two-page March 31, 2010 order (here), Southern District of New York Judge Jed Rakoff granted in part and denied in part the defendants’ motion to dismiss that had been filed in the C-BASS subprime related securities lawsuit. Background regarding the lawsuit can be found here. The plaintiffs had alleged that the defendants had made material misrepresentations and omissions in the offering documents related to the sale of certain mortgage pass-through certificates.

 

For reasons that Judge Rakoff will elaborate upon in a forthcoming order, Judge Rakoff granted in part and denied in part the defendants’ dismissal motions. Judge Rakoff granted the dismissal motion as to claims involving offerings in which the plaintiffs had not purchased securities. Judge Rakoff also granted with prejudice the dismissal motions of the underwriter defendants, C-Bass itself and certain mortgage originator defendants. Judge Rakoff also granted without prejudice the dismissal motions of the offering underwriter defendants, as well as the Section 15 claims against certain individual defendants.

 

Though these rulings resulted in the elimination from the case of a substantial part of plaintiffs’ case, Judge Rakoff went on to rule that, other than the parts dismissed, "all other claims survive." According to an AmLaw Litigation Daily article discussing the decision (here), though Judge Rakoff’s ruling dismissed with prejudice plaintiffs claims on 65 offerings, his ruling also "keeps Merrill and other defendants exposed to liability on 19 mortgage-backed securities offerings."

 

MBIA: In a March 31, 2010 order (here), Southern District of New York Judge Kenneth Karas granted in part and denied in part the dismissal motions that had been filed in the subprime related securities class action lawsuit that had been filed against MBIA and certain of its directors and officers. MBIA provides insurance to traditional bond and structured finance issuers. As discussed at greater length here, the plaintiffs allege that the defendants misrepresented MBIA’s risk exposure to certain collateralized debt obligations containing residential mortgage-backed securities.

 

In his March 31 order, Judge Karas granted without prejudice the motions to dismiss of the two individual defendants, finding that the plaintiff had failed to "allege particularized facts sufficient to state a claim based on recklessness against" the two individuals. Judge Karas also dismissed without prejudice plaintiffs’ allegations against MBIA as to claims based on the company’s alleged failure to disclose the lack of certain structural protections for in the insurer in certain of the CDO transactions.

 

However, Judge Karas otherwise denied MBIA’s motion to dismiss, holding that even though the plaintiff had failed sufficiently to allege scienter as to the two individual defendants, the plaintiff "has alleged particularized facts supporting a strong inference of recklessness as to MBIA." He went on to find that "the inference that MBIA’s officers knew or likely knew that their statements were materially misleading" is "at least as plausible an inference that they were not aware of the potential importance of CDOs-squared to investors."

 

Dismissal Motions Substantially Denied

In addition to the motions described above in which a least a portion of plaintiffs claims survived the motions to dismiss, there were at least a couple recent dismissal motion rulings in which the plaintiffs’ claims substantially survived the dismissal motions rulings.

 

iStar Financial, Inc.: In a March 26, 2010 order (here), Southern District of New York Judge Richard Sullivan substantially denied the defendants’ motion to dismiss in the subprime-related securities lawsuit that filed against iStar Financial, certain of its directors and officers, and its offering underwriters. iStar is a real estate investment trut providing commercial real estate loans. The plaintiffs alleged that iStar had failed to disclose losses on certain investments, losses in its loan portfolio, and had misrepresented the carrying value of certain nonperforming loans.

 

Judge Sullivan denied the defendants motions to dismiss, other than with respect to the Section 12 claims against the individual defendants and the Section 11 claims as to one individual defendant.

 

In otherwise denying the motion to dismiss plaintiffs’ ’33 Act claims, Judge Sullivan rejected the defendants’ arguments that the quarterly reports and earnings calls preceding the company’s secondary offering put the market on notice of deteriorating loan performance. He stated that the Court is "unable to hold that there was sufficient information in the marketplace to render iStar’s nondisclosures in the registration statement immaterial as a matter of law." Judge Sullivan specifically rejected the underwriter defendants’ motions to dismiss.

 

Judge Sullivan also found that the plaintiffs had adequately alleged a claim under the ’34 act, specifically finding that the plaintiffs had adequately pleaded scienter, relying on plaintiffs’ allegations that defendants needed to conceal iStar’s deteriorating performance "to secure financing and mating an investment-grade rating."

 

Evergreen Ultra Short Opportunities Fund: In a March 31, 2010 ruling (here), District of Massachusetts Judge Nathaniel Gorton substantially denied the defendants’ motions to dismiss in the subprime-related securities class action lawsuit filed on behalf of investors who purchased shares of Evergreen Ultra Short Opportunities Fund. The plaintiffs sued the trust that issued the fund’s shares, the fund’s investment manager and its corporate parent, as well as individual members of the trust’s board of trustees. The plaintiffs alleged that the defendants had violated the securities laws by representing the fund as a "safe, liquid and stable investment" when, it was alleged, "it was comprised of illiquid, risky and volatile" mortgage-backed securities.

 

Judge Gorton denied the defendants’ motions to dismiss, except that he granted the trustees’ motion to dismiss the Section 12 claims that had been filed against them. Judge Gorton specifically found as sufficient plaintiffs’ allegations concerning the offering documents’ statements about the fund’s objectives; the offering documents’ statements about the fund’s limited holdings of illiquid assets; and the offering documents’ statements comparing the fund to certain indices which reflected longer average portfolio durations than the fund.

 

Discussion

There is little doubt that this line up of dismissal motion rulings reflects some significant defeats for the plaintiffs. The impact of these decisions undoubtedly is magnified by the high-profile nature of several of the cases in which the dismissals were granted.

 

But while the plaintiffs in some of these cases took some substantial hits, the overall outcome of this long list of dismissal motion rulings is far from just one-sided. There are of course the cases noted above in which the dismissal motions were substantially denied. Moreover, in the cases in which the dismissal motions were denied at least in part, the plaintiffs at least preserved the right to live for another day. Since the name of the game for the plaintiffs’ attorneys in these kinds of cases is just to get past the dismissal motion, the plaintiffs in these cases have preserved at least enough of their case to press on.

 

Though the plaintiffs did not come away empty handed in all of these cases and won some other motions more or less outright, the balance of these cases still do seem to be running in the defendants’ favor. As I noted in my recent status update on the subprime and credit crisis related securities litigation, the dismissal motion rate on these cases is running far higher than the 33-40% dismissal rate that generally applies to securities class action litigation.

 

To be sure, as I have frequently noted in the past, there are still many of these cases in which dismissal motions have not yet been heard. But with this recent wave of dismissal motion ruling described above, a significantly greater number of dismissal motions have been addressed, and the rulings do still seem to be running in defendants’ favor, disproportionately to historical norms.

 

Of course, it should be noted that there have been cases in which plaintiffs have managed to survive renewed dismissal motions based on amended pleadings filed after initial motions have been granted (as noted, for example, here, in connection with the Credit Suisse case).

 

I have in any event added all of these recent rulings to my now substantially updated register of subprime and credit crisis-related securities class action lawsuit dismissal motion rulings, which can be accessed here.

 

Very special thanks to the several readers who sent along copies of one or more of the above referenced decisions.

 

Subscription Update: As I have tried to let everyone know, I recently changed the service that I use for email subscription notices. It is my hope that the new service will afford more timely and more reliable service. Readers who subscribed in the past to receive email notices should have received during the past week a reminder to reconfirm their subscription. If you did not receive a notice, or if you deleted it without reconfirming, the most expeditious thing to do is to resubscribe by entering your email address in the Subscribe box in the right hand column and click Go. As an antispam measure, you will then be asked to confirm your subscription.

 

As I said, it is my hope that by switching services, I will be able to provide more reliable email notifications. I apologize for any inconvenience that the change may cause.

 

Last week (of March 29, 2010), I changed the service I use to distribute my email notifications. My hope is that this new email distribution service will provide subscribers with more timely and more reliable email notifications. In order to ensure continued receipt of email notification, subscribers will need to reconfirm their subscription.

On Monday, March 29, 2010, or within a day or two thereafter, all subscribers should have received an email from me at The D&O Diary, with instructions on how to resubscribe. This process should be relatively simple and should involve little more than clicking on al link and entering your email address. Again, all subscribers will need to resubscribe in order to continue to receive email notifications.

As you have probably noticed, I didn’t add any new content last week, while these changes were taking place, so the first email notifications from the new service will not appear until this week, of April 5, 2010.

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Oral argument in the Morrison v. National Australia Bank case, now before the U.S. Supreme Court on a petition for writ of certiorari, is scheduled to take place next week, on Monday March 29, 2010. The case presents questions about the extraterritorial application of the U.S. securities laws, questions of growing importance in light of increasing globalization of financial activity. My prior discussion of the Second Circuit’s ruling in the case can be found here.

 

While the NAB case represents the first time the U.S. Supreme Court will directly address these issues in the context of the U.S. securities laws, this is far from the first time the Court has been called on to address the extraterritorial application of U.S. law.

 

For example, the court has previously addressed the extraterritorial application of the U.S. antitrust laws. Most recently in the Court’s 2004 decision in Hoffman-LaRoche Ltd. v. Empagran S.A. (here), the Court held that it was unreasonable to apply U.S. antitrust laws to foreign conduct where the resulting foreign injury was independent of any domestic injury.

 

However, thought the Empagran case does address questions of extraterritorial application of U.S. laws, it may provide relatively little insight into how the Court might address the issues in the NAB case, since the Court in the Empagran case was interpreting an express statutory provision addressing the extraterritorial application of the U.S. antitrust laws, the Foreign Trade Antitrust Improvement Act of 1982. There is no equivalent statutory provision with respect to the securities laws – at least not yet. A brief overview of the extraterritorial application of the U.S. antitrust laws can be found here.

 

The question of extraterritorial application of U.S. laws comes up in a variety of contexts. Stetson Law Professor Ellen Podgor points out on her White Collar Crime Prof Law Blog (here) that a February 2010 petition for a writ of certiorari in the British American Tobacco case raises the question of the extraterritorial application of RICO. A copy of the cert petition can be found here.

 

In addition, according to a March 2010 paper by the Hughes Hubbard law firm (here), the question of extraterritoriality also comes up in the bankruptcy context. Just as there are practical advantages that would lead a foreign investor to pursue securities claim in U.S. courts under U.S. laws, there are reasons why a foreign domiciled debtor might decide to "enjoy the shelter of chapter 11 of the U.S. bankruptcy code," which the foreign debtor apparently can do if it has assets in the U.S. and a U.S. bankruptcy court accepts jurisdiction.

 

The fact is that in a complex global economy where cross-border business transactions are an integral part of financial activity, questions involving the extraterritorial application of law are inevitable.

 

Because of these fundamental considerations, the NAB case is both an important case and a closely watched case. The case has attracted fifteen amicus briefs, including briefs filed, among others, on behalf of the governments of Australia and of France. The United Kingdom and Northern Ireland also filed an amicus brief, here. The foreign governments urge that principles of comity and respect for the sovereign rights of nations to govern their internal affairs militate against the exercise of jurisdiction by U.S. court over the claims non-U.S. claimants against non- U.S. companies. All of the Supreme Court briefs in the NAB case can be found here.

 

Among the briefs is an amicus brief filed by the U.S. Solicitor General. The SG has urged that a transnational securities fraud violates the U.S. securities laws if "significant conduct material to its success" occurs in the United States and if the U.S.-based component of the fraud directly causes the claimant’s injury. (The SG’s brief also argues that the questions before the court are not jurisdictional at all, but rather simply the plaintiffs are entitled to relief under the relevant statutory scheme.)

 

I am going to go out on a limb here and make a prediction that the test that emerges from the Supreme Court is going to look a lot like that urged by the Solicitor General. That is, it will not be enough for claimant to allege merely that the U.S. conduct to be "a substantial component of the fraud," but rather the U.S. conduct must have directly caused the claimant’s injury. That is, the court will look at some sort of nexus to the injury test.

 

By way of illustration, in the NAB case itself, the alleged underlying financial fraud took place in Florida but the allegedly misleading disclosures were issued in Australia. Under the test urged by the SG, the misleading disclosures caused the claimant’s injury, not the underlying financial misconduct, and therefore the case should not go forward in U.S. courts.

 

Hiatus: The D&O Diary will be taking a break from its usual publication schedule for the next few days. Normal publication activities will resume the week of April 5, 2010.

 

Service Announcement: I just wanted to remind readers that I will be changing the service that I use for email notifications. The change will take place during the week of March 29, 2010.

 

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If all goes according to plan, on March 29, readers will received an email message from me at The D&O Diary. The email message will require you to resubscribe in order to continue to receive email notifications from The D&O Diary. Please follow the links in the resubscription email in order to continue to receive email notifications.

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On March 24, 2010, Cornerstone Research released its annual study of securities class action lawsuit settlements. The most recent study, which is entitled "Securities Class Action Settlements: 2009 Review and Analysis" and is written by Ellen M. Ryan and Laura E. Simmons, can be found here. Cornerstone’s March 24, 2010 press release concerning the study can be found here.

 

The study reflects a number of interesting observations about median and average securities class action lawsuit settlements that were approved during 2009. The study also includes a useful analysis of the factors that affect settlement size, and concludes with some commentary about likely future settlement trends.

 

First, the median 2009 settlement of $8.0 million is unchanged from 2008, although slightly up from the $7.4 median of all settlements during the years 1996 through 2008.

 

Second, the 2009 average settlement amount of $37.2 million is up from the 2009 average of $28.4 million. The 2009 average of $37.2 million is well below the $55.4 million average of all settlements during the period 1996 through 2009. However, if the largest four settlements during the period 1996 through 2008 are removed from the analysis, the average 2009 settlement of $37.2 million is slightly higher than the adjusted $34.4 million average for the 1996 to 2008 period.

 

(This analysis of average settlements excludes the settlements associated with the IPO Laddering cases, which given the number of cases resolved in that settlement has the effect of distorting the average settlement values.)

 

Third, the distribution of 2009 settlements also is comparable to prior years. Almost 60% of all settlements during the period 1996 through 2009 are below $10 million, and more than 80 percent settled for less than $25 million. Settlements in excess of $100 million remain relatively infrequent, occurring in approximately 7 percent of all cases.

 

Fourth, according to the study, the largest single most important factor is the amount of so-called plaintiffs’ style damages (that is, "damages" calculated using the methodology most often urged by securities class action plaintiffs). However, settlements as a percentage of plaintiffs’ style damages generally decrease as damages increase, and this observation is particularly valid for very large cases.

 

Fifth, the Cornerstone also assesses settlement values relative to what it calls Disclosure Dollar Loss, which compares the defendants company’s stock prices on the days before and the days after the corrective disclosure. The study reports that settlements as a percentage of the disclosure dollar loss generally decline as the loss increases.

 

The study also identified a number of other factors that affect overall settlement size:

 

1. GAAP Violations: Approximately 65% of 2009 settlements involved cases included alleged violations of GAAP. These cases "continued to be resolved for larger settlements that for cases not involving accounting allegations.

 

2. Auditor Defendants: Cases in which auditors are defendants settle for a relatively higher percentage of estimated plaintiffs’ style damages even when compared to the broader set of all cases in which improper accounting allegations were made. Since the cases filed in 2009 involve an increased number of auditor defendants even while the overall number of filings declined compared to the prior year, the presence of auditor defendants could become an increasingly significant factor in future settlements.

 

3. Financial Restatements: Approximately 45 percent of 2009 settlements involved financial restatements, which contrasts with reports of declining numbers of financial restatements. However, given the general lag between filing and settlement, the 2009 settlements generally involve cases filed during the 2004 to 2006 period, which was when the most significant numbers of restatements occurred.

 

4. ’33 Act Allegations: After controlling for the presence of underwriter defendants and controlling for other factors, the inclusion of ’33 Act claims does not result in a statistically significant increase in settlement amounts.

 

5. Institutional Investors Plaintiffs: Cases involving institutional investors as lead plaintiffs are associated with significantly higher settlements. The higher settlements are associated with cases involving public pension plans as lead plaintiffs as opposed to union funds or other institutional investors. These larger settlements may be due to the fact that the sophisticated investors get involved in the stronger cases and the larger cases. However, even when controlling for case size and other factors the presence of a public pension plan as lead plaintiff is still associated with a statistically significant increase in settlement size.

 

6. Companion Derivative Suits: Securities class action lawsuits associated with companion derivative cases are associated with statistically significant higher settlement amounts.

 

7. SEC Enforcement Actions: Cases that involve SEC actions are associated with significantly higher settlements, as well as higher settlements as a percentage of estimated "plaintiffs’ style" damages.

 

The study concludes with the observation that the economic environment during 2009 "did not have a distinguishable effect either on the number of settled cases or on the total value of securities case settlements approved during the year.’

 

The study also notes that as a general matter the securities class action lawsuits associated with credit crisis largely have not yet settled. Looking ahead, the study’s authors "anticipate that as these cases are resolved, settlements are likely to increase both in number and in value."

 

Discussion

As has been the case in prior years, Cornerstone’s analysis of the 2009 settlements is interesting and full of useful information. There are a number of important considerations to keep in mind in assessing the information in the study.

 

The first is that the Cornerstone analysis is limited exclusively to aggregate amounts paid in settlement of securities class action lawsuits. It does not reflect, or even provide any indication of, settlement amounts that were or were not paid for out of D&O insurance.

 

Second, the settlement values do not reflect costs incurred in connection with the defending the securities class action lawsuits, or any related proceedings (for example, derivative suits or SEC enforcement proceedings). In considering the Cornerstone data for purposes of assessing D&O limits adequacy, appropriate adjustment would have to made for associated defense expense. Given the incredible escalation of defense expenses in recent years, the adjustment required to accommodate likely defense expense is substantial.

 

Third, the data set upon which the Cornerstone analysis is based is limited exclusively to class action settlements. In recent years, however, there has been the increased incidence of claimants opting out of the class settlement and reaching their own separate settlements. This phenomenon potentially increases the aggregate dollar costs required to resolve all related securities litigation, which is an additional factor that needs to be taken into account in connection with the overall question of D&O limits adequacy.

 

　

In a March 23, 2010 Summary Order (here), the Second Circuit affirmed the March 2, 2009 ruling of Southern District of New York Judge Gerald Lynch, in which he held that the excess insurers’ prior knowledge exclusion precluded coverage under their policies for claims brought against former Refco directors and officers.

 

Background

As detailed in a prior post about Judge Lynch’s district court order (here), at the time that the Refco scandal emerged, Refco had $70 million of D&O insurance arranged in multiple layers. The primary and first level excess insurers advanced their entire combined $17.5 million limits of liability in payment of defense expenses. In a separate ruling not involved in this appeal, Judge Lynch ruled that the second level excess insurer also must advance its defense expense.

 

In his March 2, 2009 ruling (here), Judge Lynch granted summary judgment for the third and fourth level excess insurers, based on exclusions in those policies (not found in the underlying policies) precluding coverage for claims arising from any facts or circumstances of which "any insured" had knowledge at policy inception and that might reasonably be expected to give rise to the claim. (In a portion of his opinion not relevant to this appeal, Judge Lynch denied summary judgment as to the fifth level excess insurer.)

 

The critical question before Judge Lynch was whether the knowledge of the fraudulent scheme of Refco’s CEO Phillip Bennett could be imputed to the other directors and officers. These individual had sought to rely on so-called severability provisions in the primary policy, to which the excess policies were "follow form," and from which they sought to argue that the prior knowledge exclusion was not applicable to them. Their argument was that Bennett’s knowledge could not be imputed to them due to the non-imputation language in the primary policy’s severability provision.

 

Judge Lynch rejected their argument that the severability provision in the primary policy precluded the operation of the prior knowledge exclusion in the excess policy.

 

The Second Circuit’s March 23 Summary Order

In its March 23 Summary Order, the Second Circuit expressly adopted Judge Lynch’s "comprehensive and well-reasoned analysis." The Court quoted Judge Lynch’s language that "in the context of the [prior knowledge exclusion] the words ‘any insured’ unambiguously precludes coverage for innocent coinsureds."

 

The Second Circuit also expressly affirmed that because the exclusionary language in the excess policy "cannot be reconciled with the severability language provision of the underlying policy, the language in the excess policy controls." The Second Circuit also affirmed that the claims against the individuals come within the "arising out of" preamble of the exclusion.

 

Discussion

As I detailed in my prior discussion of Judge Lynch’s opinion, this case illustrates the complicated ways that the various components of a single D&O insurance program can operate in unanticipated ways to produce unexpected results. The case also demonstrates the extent to which supposed "follow form" excess coverage is not always truly "follow form."

 

The outcome also underscores the importance of application and exclusion severability issues not just at the primary levels but all the way up the insurance tower.

 

My other ruminations about this outcome are set forth at length in my prior post about Judge Lynch’s opinion.

 

The Second Circuit’s Summary Order states on its face that it has no precedential effect. However, the practical effect of the Summary Order is the validation of Judge Lynch’s analysis, to which future litigants undoubtedly will refer.

 

It is probably worth noting that while Judge Lynch was a district court judge in March 2009 when he wrote his coverage opinion in the Refco case, by the time the Second Circuit got around to reviewing the case, Judge Lynch had become a member of the Second Circuit bench, where his new Circuit Court colleagues found his prior work as a district court judge to be "comprehensive and well reasoned." Perhaps the preservation of domestic tranquility around the courthouse water-cooler requires no less.

 

Special thanks to Neil McCarthy of Lawyer Links for providing me with a copy of the Second Circuit’s Summary Order.

　

In the largest weekly collection of bank failure so far this year, the FDIC took control of seven banks this past Friday evening, bringing the 2010 year to date total of failed banks to 37. The YTD total already far exceeds the 2008 annual total of 25 failed banks and the pace of the 2010 closures is well ahead of last year’s pace, when a total of 140 banks closed by year end.

 

The closures this past Friday night included three more banks in Georgia, bringing the 2010 year to date total in that state to five, and the total since January 1, 2008 to 35, by far the highest number for any state during that period.

 

The only other state with as many as 2010 closures as Georgia is Florida, which also has five failed banks in 2010. Since January 1, 2008, Florida has had a total of 21 failed banks, which ranks the state fourth overall during that period, behind Georgia, Illinois (25), and California (24). During 2010, Illinois has three failed banks and California has two.

 

Two other states that have significant numbers of 2010 bank closures are Minnesota and Washington State. Minnesota has four 2010 YTD bank failures and eleven total since January 1, 2008, Washington has four failed banks this year and seven total since January 1, 2008.

 

Overall 17 states have had at least one bank failure in 2010. Although there is a perceptible concentration of bank failures in Georgia and Florida, the 2010 failed banks have been widely dispersed geographically.

 

This overall geographic spread has characterized the current wave of bank failures since its beginning. Indeed, since January 1, 2008, 36 different states have each had at least one failed bank. There has, however, been some concentration in certain states, particularly Georgia, Illinois, California and Florida.

 

The pace of bank closures so far in 2010 is well ahead of the pace during 2009. At this same point a year ago, there had only been 20 failed banks, compare to 37 so far this year. The 37th bank closure last year did not take place until June 5, 2009.

 

The pace of bank failures definitely has quickened in recent months. During the 27 month period since January 1, 2008, here have been 202 bank closures. However, of those 202, 132 (or roughly two-thirds) have failed just in the nine months since July 1, 2009.

 

Although there has been no single month that has come close to the July 2009 total of 24 failed banks, the 15 so far this month is tied with the third highest monthly total since the early 90’s.

 

The 2010 bank closures continue to be concentrated among the smaller banks. 29 of the 37 bank failures so far this year have involved institutions with assets under $1 billion. (Of course, there are many more institutions with assets under $1 billion, so in that sense this distribution may not be surprising.)

 

The pace of bank failures has remained at elevated levels over the past nine months. Given that in its last Quarterly Banking Profile, the FDIC identified 702 banks as "problem institutions" as of December 31, 2009, the heightened pace of bank failures seems likely to continue for some time to come.

 

But while the number of failed banks continues to grow, there has not yet been an equivalent wave of failed bank litigation. Indeed, at least one lawsuit brought by a failed bank’s investors has been withdrawn.

 

As I noted in an earlier post (here), in December 2009, nearly 60 investors in New Frontier Bank had brought suit against certain former directors and officers of the failed bank. However, the Greeley (Colo.) Tribune reported on March 17, 2010 (here), that the investors are withdrawing their lawsuit out of concerns about insurance coverage and out of recognition of the FDIC’s priority rights as receiver to the bank’s claims. Based on the article, I am no entirely sure what the investors’ insurance coverage concerns are, but I have previously written about the FDIC’s priority rights here.

 

The New Frontier Bank’s investors’ expectation is that the FDIC will pursue claims against the former directors and officers of that bank. Indeed, the expectation in general has been that the FDIC will pursue these kinds of claims with respect to many of the banks that have failed during the current round of bank closures. Certainly during the S&L crisis, the FDIC pursued claims against former directors and officers of roughly a quarter of the banks that failed (as detailed here). There no reason to assume that the FDIC will not be similarly litigious this time around. But at least so far lawsuits brought by the FDIC as receiver against the directors and officers of failed banks have yet to materialize in significant number.

 

Travel Hell: On Saturday March 13, 2010, I was scheduled to catch a flight from Cleveland to Newark at 5:55 pm, where I was to catch an 8:45 pm flight to London. At around 3 pm on Saturday, I received an email from Continental Airlines advising me that my flight to Newark was delayed due to weather and that it would not arrive in Newark until 8:30 pm.

 

Because of concern that I would miss my connection in Newark, I called Continental. They advised me that the 2:00 pm flight from Cleveland to Newark was also delayed and had not yet left Cleveland, and perhaps I could catch that flight and still make my connection.

 

I sprinted to the airport and managed to get a seat on the delayed 2:00 pm flight. However, as the afternoon turned into evening, all of the Newark bound flights were pushed back further and further. (There were huge storms in the New York area that night.) Eventually, the delayed flights were scheduled to leave Cleveland after the scheduled departure time of the London flight. I threw in the towel and booked myself on the first flight to Newark in the morning, and then I went home.

 

The 8:45 am flight from Newark to London, meanwhile, left Newark right on time. I suspect it was the only flight that entire weekend that was on schedule.

 

The next morning, I was up at 4:00 am (which felt like 3:00, due to the daylight savings time change), and I went to the Cleveland airport to start all over again. My 6:25 am flight to Newark was also delayed somewhat, but I made it to Newark by about 8:30 am, in plenty of time for the 10:00 am connection to London.

 

However, the airplane that was to be used for the London flight had been delayed coming out of Lima, Peru the prior evening, and it did not actually arrive in London until about 11:30 am.

 

After the plane from Peru arrived, there was a long delay, and finally about 12:45 pm, there was an announcement that while en route from Lima, the plane had been hit by lightening, and it was being taken out of service. A new plane would have to be brought to the gate.

 

We finally started to board the new plane at around 2:00 pm. The plane was entirely full and the boarding process took a long time. Finally, after everyone had boarded, the captain came on the P.A. and announced that the crew had timed out, and there would have to be a delay while the crew rested. So – everyone off the plane. The new departure time announced was 12:45 am.

 

After several lonely lifetimes haunting the concourse at Newark, we finally boarded the plane at 2:00 am. After everyone had boarded, the captain came on the P.A. and announced that the plane had a flat tire, and so we would have to get a new plane. So—everyone off the plane.

 

After everyone was off the plane, it was discovered that everyone’s boarding passes had expired. So everyone had to get new boarding passes.

 

After everyone had their new boarding passes, we boarded yet another new plane at around 4 am. Astonishingly, at about 4:45 am, the plane finally departed.

 

About three hours later, while the plane was approximately over the middle of the Atlantic Ocean, a flight attendant came on the P.A. and said, "If there is a doctor on the plane, could you please ring your flight attendant call button." About ten minutes later, the flight attendant came back on the P.A. again and said, "If there is anyone on the plane who is qualified to read vital signs, could you please ring your flight attendant call button."

 

For the rest of the flight, the flight attendants rushed back and forth with worried faces. When we finally reached the gate at Heathrow, a crew of EMTs boarded the plane and they removed a very grave looking older man from the plane.

 

After I took a taxi into London, I finally arrived at my hotel around 5 pm local time on Monday – about 46 hours after I first left my house on Saturday. I had missed all of my Monday meetings.

 

I left my hotel to return home at about 5 am on Wednesday morning, about 36 hours after I had finally arrived. In other words, I spent ten hours less in London than I had spent trying to get there.

 

On the other hand, though it was pretty bad for me, it was worse for the guy they carried off the plane on stretcher.

 

Service Announcement: Readers may have experienced a variety of different problems with the email notifications for this blog. There have been duplicate notifications, late notifications, missing notifications — and the problems have been getting worse.

 

As a result of these problems, I will be switching to a different service provider for delivery of email notifications. I am still not 100% sure when the switchover will take place, but probably some time in the next few days.

 

When the change does occur, every current email subscriber will receive an email requiring them to confirm their subscription. This is important – if you wish to continue to receive email notifications, you will need to reconfirm in order to reactive your subscription, so that you will receive email notifications from the new service provider.

 

I apologize for any inconvenience this change may cause, but in light of the recurring problems with my existing email notification service, I had to take corrective action. Please let me know if you have any difficulties with the change.

 

In recent decisions in separate subprime-related securities class action lawsuits reflecting a common unwillingness to engage in "backward looking assessments," two different Southern District of New York judges granted defendants’ motions to dismiss. In each of the cases, the judge’s recognition of the extent of the financial crisis played into their rulings, and in the absence of specific allegations showing how internal information or knowledge differed from the defendant companies’ public statements, both judges were unwilling to allow the cases to go forward.

 

The State Street Case　

In a February 22, 2010 opinion (here), Southern District of New York Judge Richard Holwell granted with prejudice the motion of defendants to dismiss the subprime-related securities class action lawsuit that had been filed against State Street Corporation, its management arm, and two executives and eight trustees of the management arm and one of the funds it managed, the Yield Plus Fund.

 

According to the complaint, the Fund’s value declined 34% during the class period of July 1, 2005 and June 30, 2008. This decline was alleged to have reflected the write-downs of the value of the Fund’s mortgage-related holdings. The Fund was liquidated on May 30, 2008.

 

The plaintiffs claimed that the Fund’s offering documents reflected three categories of misrepresentations: (1) a misleading description of the Fund’s investment strategy; (2) misrepresentations of the extent of Fund’s exposure to mortgage-related securities; and (3) inflated valuations of the Fun’s mortgage-related holdings. Based on these alleged misrepresentations, the plaintiffs sought to recover damages under the liability provisions of the Securities Act of 1933.

 

With respect to the plaintiffs’ allegations that the defendants’ misrepresented the Fund’s investment strategy, by misrepresenting its goal to invest in "high-quality debt securities," Judge Holwell found the plaintiffs had insufficiently pled falsity. He noted that though the phrase "high quality" is "somewhat vague when read in isolation," it "surely cannot be understood as a guarantee that investors would not suffer losses."

 

Judge Holwell also observed that the plaintiffs cannot allege that it was false for defendants to describe the Fund’s investments as high quality "without averring facts showing that the investments’ actual quality …was in fact otherwise." Judge Holwell went on to observe that:

 

Of course, from our vantage point on the other side of the financial crisis, it is conventional wisdom that highly rated, investment grade securities were exposed to risks that the rating agencies did not perceive….And not surprisingly, the Fund sustained most it is calamitous losses on securities with high investment ratings. …In hindsight then, it could be alleged that investments were viewed by defendants – and the marketplace – to be "high quality"…in fact stood on shaky foundations. But the accuracy of the offering documents must be assessed in light of information available at the time they were published…A backward-looking assessment of the infirmities of mortgage-related securities, therefore cannot help plaintiffs’ case.

 

As to the plaintiffs’ allegation that the offering documents misrepresented the Fund’s exposure to mortgage-related securities, Judge Holwell concluded that the plaintiffs had not alleged sufficient to plead that the Fund’s investment categorizations were materially misleading.

 

Finally, Judge Holwell held that plaintiffs’ allegations that the Fund overstated the value of its mortgage-related holdings "fail" because the Complaint "does not aver a single concrete fact to suggest that defendants deviated from the prescribed valuation methods." Judge Holwell noted that other financial entities, including even other mutual funds, have been accused of carrying mortgage-related securities on their books at inflated values, but in light of these other accusations, "the Complaint’s failure to identify information about how State Street overvalued its holdings is telling."

 

The CIBC Case　

In a March 17, 2010 opinion (here), Southern District of New York Judge William H. Pauley III granted the motions to dismiss the subprime related securities class action lawsuit filed against defendants Canadian Imperial Bank of Commerce (CIBC) and four of its officers and directors.

 

CIBC is a Canadian bank whose shares are traded on the New York and Toronto stock exchanges. The plaintiffs allege that the defendants misled investors about CIBC’s exposures to mortgage-backed securities.

 

In granting the motions to dismiss, Judge Pauley noted that not only had none of the defendants benefited from the alleged fraud, but in fact both CIBC and three of the four individuals bought CIBC shares during the class period. Judge Pauley noted that "it is nonsensical to impute dishonest motives to the Individual Defendants when each of them suffered significant losses in their stock holdings and executive compensation."

 

Judge Pauley also noted that the complaint "makes no reference to internal CIBC documents or confidential sources discrediting Defendants’ assertion that they were only adapting to a ‘rapidly changing economic environment’ during a ‘once-in-a-century credit tsunami’." He added that the plaintiffs "should, but do not, provide specific instances in which Defendants received information that was contrary to their public declarations."

 

Judge Pauley also noted a "compelling" alternative explanation for CIBC’s statements:

 

The Complaint describes an unprecedented paralysis of the credit market and a global recession. Major financial institutions like Bear Stearns, Merrill Lynch, and Lehman Brothers imploded as a consequence of the financial dislocation. Looking back, a full turn of the wheel would have been appropriate. That CIBC chose an incremental measured response, while erroneous in hindsight, is as plausible an explanation for the losses as an inference of fraud. …CIBC, like so may other institutions, could not have been expected to anticipate the crisis with the accuracy Plaintiff enjoys in hindsight.

　

Judge Pauley also found that the complaint "is bereft of factual allegations from which a reader could infer Defendants intentionally or recklessly failed to take write-downs on U.S. mortgage backed securities."

 

Judge Pauley’s dismissal order is not expressly without prejudice; however, he does close his opinion with the observation that "any request for leave to file an amended consolidated class action complaint should conform to this Court’s Individual Practices."

 

CIBC was represented by Jay Kasner and Scott Musoff of Skadden Arps. Andrew Longstreth’s March 18, 2010 AmLaw Litigation Daily article about the CIBC decision can be found here. Special thanks to the several readers who sent me copies of the CIBC ruling.

 

Discussion

These two opinions, both out of the Southern District of New York, where so many of the subprime and credit crisis-related securities class action lawsuits were filed, share a number of similar and significant features.

 

First and foremost, in both instances, the judges were reluctant to subject the defendant company’s pre-credit crisis disclosures to hindsight judgment. The courts were simply unwilling judge as fraudulent the defendants’ failure to anticipate the crisis that arose later.

 

Nor were the courts receptive to the arguments in both cases that the defendants knew their companies were vulnerable or knew that things were already going wrong. That is, without more specific details about what the defendants supposedly knew and how that differed from public statements, the courts were unwilling to let the cases go forward.

 

These two judges’ unwillingness, in light of the magnitude of the financial calamity, to engage in "backward-looking assessments," is a judicial predisposition that plaintiffs in many of these cases will have to struggle to overcome. Absent internal documents or confidential witness testimony showing internal company knowledge or information different from public statements, many other subprime and credit crisis cases may face the same fate as did the complaints in these two cases.

 

These ruling underscore how critical confidential witness testimony is. Indeed, as I noted here, in cases in which renewed motions to dismiss were denied after initial motions to dismiss had been granted, the critical additional detail that convinced the courts to allow the amended complaints to go forward was the addition of allegations supported by confidential witness testimony. In the absence of that corroborative support, courts seemingly are much more likely to follow their predisposition to avoid backward looking assessments.

 

In any event, I have added these two rulings to my register of subprime and credit crisis related dismissal motion rulings, which can be found here. The interim scoreboard continues to show that motions to dismiss in these cases are continuing to be granted in disproportionate numbers, at least so far than is the case for the universe of all securities class action cases. My recent status update of the subprime and credit crisis related litigation can be found here.

 

And Finally: "Outside of a dog, a book is man’s best friend. Inside a dog it’s too dark to read." Groucho Marx

Within the space of just a few days, two federal appellate courts – the Fifth and Sixth Circuits – issued separate opinions consider D&O insurers’ obligations to advance defense expenses. The Fifth Circuit entered its March 15, 2010 decision in the high-profile Stanford Financial insurance coverage dispute. The Sixth Circuit’s March 11, 2010 opinion was entered in an insurance coverage dispute involving Abercrombie & Fitch and a rather unusual set of circumstances surrounding the company’s D&O insurance policies. The Sixth Circuit’s opinion was also accompanied by a rather spirited dissent. Both decisions are interesting and provide illuminating perspective on D&O policy interpretation.

The Fifth Circuit’s Stanford Financial Decision

The March 15 Opinion

The Fifth Circuit’s March 15, 2010 opinion (here) arises out of the expedited appeal of Stanford Financial’s D&O insurers to the January 26, 2010 opinion of Southern District of Texas Judge David Hittner entering a preliminary injunction prohibiting the insurers from "withholding payment" of defense expenses from four individuals (including Allan Stanford) who face SEC and criminal actions in connection with the Stanford Financial scandal. My prior discussion of Judge Hittner’s ruling can be found here. 

Stanford Financial had $100 million D&O insurance. The primary policy contained a fraud exclusion which does not apply absent a "final adjudication" that the prohibited conduct had occurred. The policy also contains a "money laundering" exclusion, which the insurers contend precludes coverage. The money laundering exclusion specifies that it does not apply "until such time as it is determined that the alleged act or acts did in fact occur."

In its March 15 opinion, the Fifth Circuit considered whose determination of the facts this exclusionary provision requires. The court emphasized that the provision does not specify that the insurer was to make this determination. The court commented that "while there is nothing remarkable about an insurer reserving the right to make a unilateral coverage decision, it is equally unremarkable to require an insurer to be explicit when doing so, rather than leaving the reader to ponder the word ‘it’."

The Fifth Circuit also considered the wording contrast between the fraud exclusion, which requires a "final adjudication," and the money laundering exclusions "in fact" wording, and observed that the difference between the two exclusions’ wordings boils down to the judicial proceeding in which the determination is to be made. The "final adjudication" provision, the Fifth Circuit reasoned, requires the determination to be made in the underlying proceeding, but the money laundering exclusion’s "in fact" determination wording requires a judicial determination but allows that determination to be made in a separate proceeding such as a coverage action.

The Fifth Circuit also held, in contrast to Judge Hittner’s ruling at the district court level, that the evidence relevant to this determination is not limited to the "eight corners" of the insurance policy and the underlying complaint; rather, the policy’s terms expressly contemplate the consideration of "extrinsic evidence" in the determination of policy coverage.

The Fifth Circuit remanded the case to the district court, with the added proviso that a judge not involved in the underlying criminal proceedings should consider the insurance coverage issues. The remanded case will be the "collateral vehicle" in which coverage is to be determined.

In the interim, until the determination, the insurers are obligated to advance defense costs until the merits are resolved. To that extent, the Fifth Circuit affirmed the district court’s preliminary injunction enjoining the insurers from withholding payment of defense expenses until the judicial determination.

　

However, the determination cannot be "final" until the underlying proceeding is resolved, because "a determination of the facts on remand unfavorable to the executives would have to be reconsidered should the executives be cleared of all charges."

Discussion

The money laundering exclusion in the Stanford Financial D&O insurance policy is an unusual provision not found in many D&O insurance policies, and the wording arguably also reflects an unusual and awkward formulation. As the Fifth Circuit said of its own work and of the policy, its construction "is a sensible construction of an awkwardly drafted instrument."

But the Fifth Circuit’s analysis represents more than just a detailed exposition of an awkwardly worded and atypical clause. Most D&O policies have conduct exclusions requiring "determinations" as a prerequisite to the exclusions’ application to a particular set of circumstances. The Fifth Circuit’s orderly analysis of the determination processes implied by various policy formulations will undoubtedly inform future judicial consideration of the "determination" language found in the more typical D&O policy exclusions.

In particular, the Fifth Circuit’s analysis implying a requirement of a judicial determination in the first instance, and precluding unilateral insurer determinations unless expressly provided for, will illuminate coverage analysis whenever these types of conduct exclusions are at issue.

And in the underlying cases, the individual defendants will have their defense expenses advanced, for now, on an interim basis, until there is a determination in the collateral coverage case, and subject to the outcome of the underlying proceedings. Depending on how all of these circumstances unfold, the coverage dispute could go on for a considerable time. For now at least the individuals will be able to fund their defenses.

The Sixth Circuit’s Abercrombie Opinion

The March 11 Decision

In its March 11, 2010 opinion in the Abercrombie & Fitch coverage action, the Sixth Circuit affirmed the district court’s determination that Abercrombie’s D&O insurer must advance defense expense incurred in connection with the underlying claim. The Sixth Circuit’s opinion can be found here.

The coverage dispute arose out of an unusual sequence of events. Abercrombie had been insured by a $10 million D&O insurance policy that expired on September 1, 2005 (hereafter, the predecessor policy). On September 2, 2005, Abercrombie and certain of its directors and officers were sued in a securities class action lawsuit. Subsequently derivative suits were also filed and an SEC investigation ensued. On September 30, 2005, Abercrombie exercised its right under the predecessor policy to purchase one-year extended reporting period coverage.

Abercrombie also purchased a successor D&O insurance policy with a different insurer with a policy period incepting on September 1, 2005. The successor policy was amended to specify that the successor policy is expressly excess to the predecessor policy for any claims made regarding acts occurring prior to September 1, 2005. The parties to the coverage dispute agree that if the successor policy lacked this excess provision, the predecessor and successor policies would both be primary and would pay loss for the claim (including defense expense) on a pro rata basis.

The predecessor insurer contended that in this deal shifting the burden to provide primary coverage exclusively to the predecessor insurer, Abercrombie violated the policy’s cooperation clause, which specifies that "in the event of a claim," the policyholder "will do nothing that will prejudice [the insurer’s] position or its potential or actual rights of recovery."

The Sixth Circuit rejected the predecessor insurer’s argument, holding that the "purpose" of the cooperation clause, including its "no prejudice" provision, was to "enumerate the parties’ respective rights and obligations when a claim was made against an insured," but it "does not address the parties’ rights and obligations when a policy has elapsed, a claim has been made against a (formerly) insured, and the insured is deciding whether to elect – and how to structure – extended insurance coverage."

The Sixth Circuit added that "there is nothing about" the cooperation clause that "prevents Abercrombie from making fiscally driven business decisions, even if such a decision is unanticipated by an existing or past insurer." The Sixth Circuit also adopted the district court’s statement that it is an "unreasonable interpretation" of the cooperation clause "to find that it requires Abercrombie to structure its insurance needs based not on its own needs and its own best interests, but rather to minimize the insurers’ potential exposure."

Judge Kethledge’s Dissent

Circuit Judge Raymond Kethledge dissented. He emphaszied that the successor policy incepted on September 1 and as originally written was primary, and in fact, Abercrombie first reported the September 2 claim to the successor insurer. Then on September 29, Abercrombie elected discovery coverage, which Judge Kethledge noted "seemed a strange thing to do," since the $820,000 extended reporting period coverage was seemingly duplicative of the coverage in place under the successor policy.

Abercrombie was, Judge Kethledge wrote, "behind the scenes" negotiating with the successor insurer, for the successor insurance to be excess to the predecessor insurer’s coverage. It was not until November 22, 2005 that the successor policy was endorsed to make the successor policy expressly excess.

The effect of these changes, Judge Kethledge noted, was "retroactively to foist" on the predecessor insurer "the entire burden of coverage for the claim up to the $10 million policy limit." The reason Abercrombie did that, and was willing to pay the $820,000 premium for the extended reporting period coverage, was that in exchange the successor insurer waived its $2 million retention for the securities claims and promised not to increase Abercrombie’s premium for the following renewal.

Judge Kethledge viewed these events as having "prejudiced" the predecessor insurer in violation of the "no prejudice" provision in the cooperation clause, because it extinguished the predecessor insurer’s right to collect half of the claims costs from the successor insurer. Judge Rutledge noted that the "very purpose" of Abercrombie’s post claim action was to "increase [the predecessor’s] liability by $5 million and to extinguish its contribution claim for that amount." Judge Rutledge found the no prejudice clause’s requirement that the policyholder "do nothing" to prejudice that predecessor to be unambiguous and to clearly govern these circumstances.

Discussion

What makes this situation so awkward is that Abercrombie’s negotiations with the successor insurer took place after the claim arrived. The opinion is not sufficiently clear on this point, but it seems as if at the time of the September 1, 2005 renewal the successor insurer competed to move onto the account and then got smacked by a claim airmailed in the second day it was on the policy.

It isn’t clear who initiated the negotiations, but the successor insurer was bargaining to reduce its exposure to the walk in claim. Reading between the lines, the predecessor insurer’s gripe is not with Abercrombie but with the successor insurer, for (as Judge Kethledge put it) "foisting" the claim on the predecessor insurer.

The deal Abercrombie and the successor insurer struck clearly benefited both of them – the successor insurer reduced its claim expense (for a claim that was clearly made during its policy period), and Abercrombie was able to obtain valuable concessions.

I can certainly see why the predecessor insurer objected under these circumstances. The question is whether as a matter of contractual rights and duties (as opposed to more basic notions of fair play) the detrimental impact of the successor insurer’s deal with Abercrombie represents the kind of "prejudice" that violates the provisions of the cooperation clause.

On the one hand, as a result of the deal, the predecessor insurer was obligated to do nothing more than it was otherwise obligated to do under the extended reporting period coverage, which all agree that Abercrombie was entitled to purchase, even if it did so after the claim came in.

On the other hand, the predecessor insurer’s rights and obligations under its policy also include the right to proceed against alternative sources of recovery. Abercrombie’s entry into the deal with the successor insurer compromised the predecessor insurer’s rights and it did so after the claim had come in. You can certainly see the predecessor insurer’s argument that this violated the requirement that the policy "do nothing" after a claim to prejudice the predecessor insurer’s right of recovery.

The majority found that there is nothing in the policy to prevent Abercrombie from structuring its insurance according to its own interests. There is certainly nothing here to suggest that Abercrombie did anything to prejudice the underlying claim. Moreover, there is nothing about the "no prejudice" provision that requires a policyholder to subordinate its interests to those of the insurer, and that consideration seems particularly relevant after a policy’s expiration.

In the end we may all nod sympathetically in response to the plight of the predecessor insurer here. Our sympathetic nods, however, reflect the sentiment expressed in the words of Judge Keithridge’s dissent: "What is legal is sometimes different than what is right."

And Finally: "Cigarettes are very like weasels – perfectly harmless unless you put one in your mouth and try to set fire to it." Boothby Graffoe.

Data security and privacy could be the "stealth issue of 2010," according to a recent report. Despite the intense focus on financial and related issues during the current economic crisis, a variety of legislative and regulatory initiatives suggest that data privacy and security issues necessarily will become a top corporate priority. These developments have important risk management consequences, among which are the increasing importance of privacy breach and network security liability insurance within a company’s overall insurance program.

 

Recent Regulatory and Legislative Action

A March 12, 2010 Law Technology News article entitled "The Evolving Landscape of Data Privacy" (here), takes a comprehensive look at the various recent regulatory and legislative developments raising the importance of data security and privacy issues.

 

As the article emphasizes, several new federal and state privacy regimes go into effect this year. In particular, the FTC’s long-delayed Red Flag rules will become effective on June 1, 2010. These rules will require "financial institutions" and "creditors" (as those terms are defined in the rules) to implement a written identity theft protection program designed to detect the warning signs of identify theft, to prevent the crime, and to anticipated the damage it inflicts. The FTC’s guide to the new rules can be found here.

 

In addition, the Massachusetts Office of Consumer Affairs and Business Regulation has promulgated its "Standards for the Protection of Personal Information of Residents of the Commonwealth" (here), which applies to persons who "own, license, store or maintain personal information about a resident of the Commonwealth of Massachusetts."

 

The regulation requires all affected persons to "develop, implement, maintain and monitor a comprehensive, written information security program applicable to any records containing such personal information." The regulations include the requirement that the affected persons must "adopt comprehensive security programs that include technical administrative and physical safeguards for both electronic and paper records."

 

The state level action in Massachusetts suggests the possibility of similar actions in other states, which raises the specter of a confusing patchwork of different regulatory requirements, a situation that cries out for uniform regulation at the federal level. In that context it is hardly surprising that there are Congressional initiatives in this area as well.

 

On December 8, 2009, the House passed the Data Accountability and Trust Act (H.R. 2221), about which refer here. The legislation would, among other things, require all businesses to implement safeguards to protect reasonably foreseeable data vulnerabilities and to notify customers if their personal information is breached. Similar initiatives are receiving Senate consideration. Though the Senate has a great deal of other things on its plate right now, it is possible this legislation could still get through, perhaps as part of another larger bill (for example, a financial reform bill).

 

Practical Steps, Including Insurance Solutions

It seems probable that these kinds of regulatory and legislative initiatives will continue to emerge in the months and years ahead. In light of these concerns, the article cited above suggests that companies adopt compliance strategies, including: reviewing how their firms safeguard non-public customer and employee data; adopting risk-based safeguards and controls that encompass industry best practices and make use of available technology; and reviewing their firms’ data privacy policies and notices.

 

In addition to these practical steps, every company’s data privacy and security risk management should also include the acquisition of a privacy breach and network security liability insurance policy. These policies have been available for some time, but in recent years, both their availability and their scope of coverage have improved significantly. There are now a variety of commercially attractive insurance products available in this area.

 

Because this insurance product is relatively new, there still is some skepticism over the need for this type of insurance protection. Some of this resistance is simply due to the lack of familiarity with the numerous and growing sources of exposure in this area. As time goes by and the extent of corporate vulnerabilities becomes increasingly apparent, this reluctance will eventually fade, a process that will undoubtedly be accelerated by the increasing amount and extent of the growing regulatory requirements.

 

Another source of skepticism about his product arises from the view that the consumer actions that have been filed so far have not fared particularly well. Some of the consumer cases have indeed been unsuccessful (refer for example here), in part because consumers have a difficult time showing proximately caused damages. In light of consumer concerns when data breaches occur, however, it seems likely that consumers affected by data breaches will continue to bring these kinds of actions, which at a minimum means a continuing defense costs exposure.

 

Companies that suffer data breaches will continue to have both notification and remediation requirements, which even in relatively modest breaches can entail an enormous expense. A recent study relating to data security breaches in the United States (link unavailable) shows that the average 2009 per-incident costs were $6.75 million. The costs included an average cost of $204 per customer with a potentially compromised data record.

 

In addition, companies sustaining data breaches are subject to the costs of regulatory investigations, as well as penalties and fines. While not all of these costs will be insured in every instance, remediation costs and legal expense will be covered in many instances. Many policies offer fines and penalties coverage on a sub-limited basis under certain circumstances.

 

Finally, because of the likelihood that plaintiffs’ lawyers will continue to press these issues when data breaches occur, there is a continuing danger that plaintiffs lawyers will succeed in imposing liability on persons they contend are responsible for the data breach. The policies cover negligence or failure to protect or safeguard confidential data, even for acts of rogue employees or vendor employees. Some policies will apply in instances of employee negligence such as lost or stolen laptops.

 

Some of the insurance products also provide protection in the event of cyber extortion, for example in connection with the threat of a disclosure of a security breach or a denial of service attack. Some policies also provide first party coverage in the event of electronic business interruption or reimbursement coverage for the cost to replace or reconstruct digital assets.

 

Insurance for privacy liability and network security is still a developing product area, but with the passage of time, more and more companies are recognizing that their insurance programs are incomplete without this kind of protection. The evolution of this product very similar to where we were several years ago when Employment Practices Liability insurance came along. At first, takeup of the product was slow. But over time the product improved and the need for the insurance became more self-evident, and now pretty much every company has EPL insurance. Within a very short time, the same will also be true of privacy liability and network security insurance.

 

The fact is that, particularly in the current regulatory and legislative environment, every company is susceptible to these kinds of problems and so every kind of company should consider this insurance as an important part of a complete corporate insurance program.