In a flurry of headline-grabbing events involving Bank of America last Thursday, the SEC announced the renewed settlement of its enforcement suit against the company, while at the same time New York Attorney General Andrew Cuomo announced his office’s initiation of a separate fraud action against the company and two former company officials. These high-profile developments pose a series of questions, not the least of which are the questions concerning the claims raised — or not raised — against the company officials, which in turn underscore some basic issues concerning the liability of individuals under the federal securities laws.

 

The first and most fundamental question is whether Southern District of New York Jed Rakoff will approve the current $150 million settlement, after previously rejecting the prior $33 million deal.

 

In his harshly worded September 14, 2009 opinion (here), Judge Rakoff rejected the prior settlement, finding that it was "neither fair, nor reasonable, nor adequate." He challenged the very premise of the deal, which he said "proposes that shareholders who were the victims of the Bank’s alleged misconduct must now pay the penalty for the misconduct."

 

Judge Rakoff further criticized the deal because the SEC did not explain why "it did not pursue charges against the Bank management or the lawyers who allegedly were responsible for the false and misleading proxy statements."

 

As Susan Beck of the AmLaw Litigation Daily points out in her February 4, 2010 article about the settlement (here, registration required), the renewed settlement seemingly does not address either of Judge Rakoff’s principal concerns. That is, the company is still proposing to settle the case at the expense of current shareholders. And the settlement does not address Rakoff’s earlier criticism of the SEC for failing to hold any individuals accountable.

 

Along the same lines, the WSJ.com Law Blog quotes (here) Duke Law Professor James Cox as saying "Either I’m hopelessly ignorant or this doesn’t address Rakoff’s concerns at all. Maybe they think Rakoff is getting senile in his old age. But I wouldn’t count on that."

 

The lack of SEC action against individual company officials is all the more evident because of the separate action the NYAG initiated virtually simultaneously with the SEC’s announcement of the renewed settlement. Cuomo’s lawsuit (here) not only names the company, but also names as defendants former BofA CEO Ken Lewis and former CFO Joseph Price. The New York action seemingly begs the question of why the SEC did not pursue claims against individuals, especially in light of Rakoff’s concerns.

 

There are some important considerations that need to be taken into account in contrasting the SEC’s and the NYAG’s respective actions. First of all, the SEC has said all along that the reason it did not pursue enforcement claims against individuals is because of concerns with its ability to satisfy scienter requirements. Indeed, in his September 14 opinion, Judge Rakoff expressly noted that the SEC had contended at that time that it had not pursued claims against individuals as "culpable intent was lacking because the lawyers made all the relevant decisions."

 

Thought the NYAG’s action asserts claims against two former executives, the legal basis of the claim is New York’s Martin Act. Unlike the liability provisions of the federal securities laws, the Martin Act does not require a finding that the individuals acted intentionally. The NYAG’s claims simply do not face the same pleading barriers as the SEC would if it were to pursue claims under the federal securities laws against company executives.

 

The challenge in substantiating claims under the federal securities laws against senior company officials even when their company was engaged in fraudulent misconduct was underscored in the recent Vivendi securities class action trial, where the jury found the company liable on all 57 counts, yet at the same time found the individual defendants not liable. In a post trial interview (here), the individual defendants’ trial counsel explained that this seemingly split verdict can be understood in part by the fact that the jury (defense counsel contend) was persuaded by the individuals’ testimony that they had not intended to mislead anyone.

 

The SEC’s reluctance to pursue the BofA executives and the odd split verdict in the Vivendi trial raise some interesting questions to ponder about the susceptibility of individuals to the imposition of liability under the federal securities law, although the lack of traction against the individual executives in those two cases may simply be a reflection of situation specific circumstances.

 

But in any event, the seeming contradiction between the SEC’s inaction against any individuals and the NYAG’s pursuit of the two executives may not be quite as first appears. Among other things, the SEC settlement and the NYAG’s lawsuit announcement were not in isolation from each other. To the contrary, Cuomo’s press release expressly references the SEC’s settlement and quotes him as saying that he support the SEC’s settlement.

 

The suggestion is that the two developments should not be viewed as in disjunction but rather as complementary. Perhaps the SEC will refer to the NYAG’s suit in response to Rakoff’s likely concerns with the settlement about the SEC’s inaction against individuals.

 

The most important differences between the SEC’s renewed settlement and the earlier version Rakoff rejected are that the latest deal represents significantly larger dollar amounts, and it also includes the company’s agreement to adopt certain corporate governance reforms.

 

The governance reforms arguably provide real value to the current shareholders. But even if the value to shareholders is substantial, the renewed deal still does not avoid Judge Rakoff’s earlier concerns that BofA’s shareholders are being forced to bear the cost for having been misled about the Merrill Lynch transaction. Indeed, the significantly larger dollar value of the renewed settlement seemingly exacerbates this very problem.

 

Given these concerns, it will be very interesting to see what Judge Rakoff does with the renewed settlement. It is very hard to read his September 14 opinion now and to think that this renewed settlement will fare any better than the prior version. It will be particularly interesting to see what Judge Rakoff’s response says about the fundamental notion of holding individuals accountable under the federal securities laws.

 

Broc Romanek’s post about the SEC’s renewed settlement on his CorporateCounsel.net blog (here) has some interesting observations about the role of corporate governance reforms within the resolution of SEC enforcement actions.

 

"Bump-Up" Claims Surge: Much ink has been spilled concerning the supposed decline in the number of securities class action lawsuit filings in 2009. But whether or not the class suits are in fact declining, another form of corporate litigation apparently is on the rise.

 

According to a February 4, 2010 Law.com article (here), there has been an "uptick in shareholder lawsuits over mergers and acquisitions." One source quoted in the article states that filings of those types of claims – referred to as "bump up" actions because they seek to increase the sale price – are up "at least 50 percent" over a few years ago.

 

The article also quotes Boris Feldman of the Wilson Sonsini law firm as saying that "plaintiffs lawyers are trying to replenish their inventory, because traditional securities suits have fallen." He goes on to say that "nature abhors a vacuum, so more and more plaintiff firms have been filing merger suits instead."

 

Many D&O insurance policies have express exclusions precluding coverage for the amount of any additional consideration paid to settle a bump up claim. Moreover, as I discussed at length in a prior post (here), some courts have held that there is no coverage for the additional consideration, even without respect to the exclusion. In many circumstances, however, defense costs at least may be covered.

 

Lehman Subprime-Related ERISA Suit Dismissed: In an earlier post (here), I noted that Judge Lewis Kaplan had dismissed liability claims filed against the rating agencies that had provided ratings opinions in connection certain Lehman Brothers securities offerings. In a separate opinion relating to the Lehman collapse, on February 2, 2010 Judge Lewis Kaplan also dismissed the subprime-related ERISA class action that beneficiaries had filed against former company officials. A copy of Judge Kaplan’s opinion can be found here.

 

In dismissing the case, Judge Kaplan held that the complaint failed to allege that the misconduct alleged against the eleven director defendants violated any fiduciary duties that the individuals had to plan beneficiaries. He further held that the complaint failed to allege that the sole remaining defendant (a member of the plan administrative committee) had any responsibility for or involvement with the company’s supposedly misleading disclosures, or any prior awareness of the company’s imminent collapse.

 

A February 3, 2010 AmLaw article discussing the opinion can be found here (registration required). I have in any event added the opinion to my list of subprime-related lawsuit dismissal motion rulings, which can be accessed here.

 

Lost Generation: If you have not yet seen it, you may want to take a couple of minutes to view the Lost Generation "mirror image" video. It is pretty bare bones, but is still makes an interesting statement. Hat tip to the CorporateCounsel.net blog for the link.

 

https://youtube.com/watch?v=42E2fAWM6rA%26hl%3Den_US%26fs%3D1%26

On February 5, 2010, BAE Systems announced (here) that it has entered separate settlements with the U.S. Department of Justice and the U.S. Serious Frauds Office, pursuant to which the company will pay a total of nearly $450 million to settle long-standing investigations of improper payments.

　

Under the U.S. plea deal, the company will pay $400 million to settle one charge of conspiring to make false statements and under the U.K. deal the company will pay a penalty of £30 and plead guilty to one charge of breach of duty to keep accounting stemming from a payment to a former consultant in Tanzania. A February 6, 2010 Wall Street Journal article discussing BAE’s entry into these deals can be found here.

 

The investigations surrounding BAE’s improper payments have been both very high-profile and very controversial. As discussed at length in a prior post (here), the most sensational aspects of the investigation have involved allegations involving the Al-Yamamah Saudi Arms deal, which allegedly involved improper payments to Prince Bandar bin Sultan, a member of the Saudi royal family. The propriety of the Serious Fraud Office’s decision to terminate that aspect of the BAE investigation was particularly controversial and eventually made its way to the House of Lords, which, as noted here, concluded that the SFO had properly exercised its authority to terminate the investigation, after a lower court had previously ruled that the SFO must reconsider its decision to terminate the investigation. The DoJ continued its investigation of the controverisal arms deal, however.

 

Given the controversy surrounding the BAE investigation, it is hardly surprising that, notwithstanding the sheer size of BAE’s deals resolving the investigation, questions about the resolution of the investigation have arisen.

 

Among others concerns that have been noted, it is very difficult to discern from BAE’s press release and from the SFO’s release (which can be found here) which exactly the company is admitting to having done. Neither document contains words or phrases you might, under the circumstances, expect to see, including, for example, "bribery" "corruption" or even "improper payments" or "improper influence." As the FCPA Professor blog notes here, "can the enforcement agencies on both sides of the Atlantic say with a straight face that this case was merely about improper record keeping, making false statements to the government, and export licenses?"

 

The criminal information that the Department of Justice filed in the District Court for the District of Columbia is a little more specific, as it as least refers to improper payments that the company made in connection with military aircraft transactions involving the governments of the Czech Republic and Hungary. The criminal information also specifically references "undisclosed payments associate with the sale of Tornado Aircraft and other defense materials to the Kingdom of Saudi Arabia." The criminal information also specifically references "substantial benefits" provided to one unnamed Saudi official "who was in a position of influence" regarding the aircraft deals.

 

According to the FCPA Blog (here), the Al-Yamamah arms deal, about which the blog has additional information (including a link to video footage) is "at the heart" of the criminal information, though the details are slight.

 

The paucity of detail almost ensures that controversy will continue to surround the investigation. The tenor of the controversy is succinctly captured by the FCPA Professor blog’s comment in connection with the BAE deals that "transparency, corporate accountability, and indeed a criminal justice system all suffered setbacks today."

 

But though questions will continue to be raised, the sheer size of the payments BAE has agreed to make in order to resolve these investigations should not be overlooked. Along with the staggering amounts to which Siemens agreed to pay in connection with its own separate corrupt practices investigation, these payments demonstrate that corrupt practices investigations represent a very significant risk exposure. It should also not be overlooked that in the case of Siemens and BAE, as well as a number of other companies that U.S. authorities have targeted, these corrupt practices investigations often involved companies domiciled outside of the United States.

 

As I have previously noted (here), one parallel threat accompanying threat of regulatory investigations concerning corrupt payments is the possibility of follow-on civil litigation in U.S. courts. BAE systems was itself the target of a shareholders’ derivative suit regarding the corrupt payments investigation, although as noted here (scroll down after linking), the BAE Systems derivative suit was later dismissed due to the claimants lack of appropriate standing to bring the action.

 

Other foreign targets of FCPA investigations have also been subject to civil litigation in U.S. courts, as demonstrated by the recent securities lawsuit filed against Panalpina and certain of its directors and officers concerning its disclosures and accounting for certain alleged improper payments.

 

The point is that not only does the threat of an improper payments investigation represent a significant risk exposure for companies active in the global economy but that threat includes the risk of civil litigation in U.S. courts. This litigation threat all of these issues important considerations for purposes of D&O insurance, as I discussed in a prior post, here.

 

On February 2, 2010, the SEC published its interpretive release providing guidance to public companies on the SEC’s existing disclosure requirements as they apply to climate change. The release can be found here. A February 4, 2010 memo from the Gibson Dunn law firm analyzing the SEC’s release can be found here.

 

While the interpretive release take pains to emphasize that it only clarifies existing obligations, the release nevertheless represents the Commission’s clearest statement about expectations for public company’s climate change disclosures. The release’s specificity and its reliance on requirements that have themselves previously been cited in suits pertaining to more traditional environmental disclosures raise the question whether suits pertaining to climate change-related disclosure may be next.

 

The release cites several existing disclosure rules that it says required public companies to provide disclosures regarding climate change, including Items 101, 103 and 303 (among others) in Regulation S-K.

 

The release also identifies four topics that could require climate change-related disclosures, including: the impact of climate change legislation and regulation; the impact of international climate change accords; indirect consequences of climate change regulation or business trends; and the physical impacts of climate change.

 

Public companies will now have to accommodate their disclosure practices to the SEC’s guidance. While the SEC claimed only to be clarifying existing requirements, the practical reality is that many companies will now have to reconsider their disclosure process and practices, and, in many cases, alter the content of their disclosures.

 

With the SEC’s clarification of the disclosure requirements comes the opportunity for claimants or even for the SEC itself to later allege that a company’s climate change disclosures fell short of requirements. By way of illustration of how these claims might arise, it is worth considering that the very disclosure provisions with respect to which the SEC provided its climate change guidance have previously served as reference points in claims alleging misrepresentations or omissions of more traditional environmental liabilities and exposures.

 

For example, as I noted in a prior post (here), the SEC has in the recent past brought disclosure-related enforcement actions against reporting companies for alleged failures to observe existing environmental reporting requirements.

 

Nor are these types of claims limited solely to regulatory enforcement actions; investors have also brought damages actions relating to alleged misrepresentations or omissions regarding environmental issues. For example, as I noted in a recent post here, shareholders of Tronox Corporations recently filed a securities class action lawsuit against the company and certain of its directors and offices, as well as the company’s corporate predecessors in interest, based upon the company’s alleged failure to disclose the true nature of its environmental and tort liabilities.

 

There may be a temptation to view climate change related considerations as remote and distant future concerns, but as I noted in a recent post here, climate change related issues are already a practical component of current business conduct, for example, in the M&A context.

 

Just as disclosure obligations regarding traditional environmental concerns have given rise to disclosure-related enforcement actions and even shareholder litigation, the newly clarified expectations regarding climate change disclosures seem likely to create a context out of which similar actions may arise in the future.

 

Rating agencies are not susceptible to ’33 Act liability as "underwriters," even if they helped structure the mortgage backed securities at issue, according to February 1, 2010 ruling (here) by Southern District of New York Judge Lewis Kaplan in which he dismissed Moody’s and McGraw-Hill (S&P’s parent) from the Lehman Brothers Mortgage-Backed Securities Litigation.

 

Plaintiffs had purchased the mortgage back securities that Lehman Brothers had issued in two offerings in August 2005 and August 2006. The plaintiffs allege that the originators of the loans that backed the securities failed to comply with the general loan underwriting guidelines described in the offering documents. The plaintiffs allege that the rating agencies determined the composition of the loans in the mortgage pool that the instruments securitized. The plaintiffs also allege that the credit enhancements supporting the loans were insufficient to support the investment ratings the rating agencies gave the securities.

 

The plaintiffs premised their securities liability claims against the rating agencies based on their argument that the rating agencies were "underwriters" within the meaning of Section 11 of the ’33 Act. The plaintiffs based their theory that the rating agencies were "underwriters" within the meaning of Section 11 on the argument that the "underwriter" liability extends to those "who engaged in steps necessary for the distribution."
 

 

Judge Kaplan found this argument "unpersuasive," noting that

 

The Rating Agencies’ alleged activities may well have had a good deal to do with the composition and characteristics of the pools of mortgage loans and the credit enhancements of the Certificates that ultimately were sold. But there is nothing in the complaint to suggest that they participated in the relevant "undertaking" – that of purchasing the securities here at issue, the Certificates – "from the issuer with a view to their resale." The Section 11 claim is insufficient in law.

 

Judge Kaplan also rejected plaintiffs’ arguments that the rating agencies had "seller" liability under Section 12(a)(2) or control person liability under Section 15.

 

The rating agencies dismissal from this subprime-related securities class action lawsuit is not as significant as it would have been if it had based on the rating agencies’ claims that their ratings opinions are proteced by the First Amendment. Though Judge Scheindlin rejected that argument on narrow grounds in the Cheyne Financial case (refer here), the First Amendment defense undoubtedly will play a crucial role in many of the subprime-related securities cases that have been filed against the rating agencies, and the litigants in the many cases that have been filed against the rating agencies will have to await a later date to get a clearer sense of how those arguments will fare in these cases.

 

But though Judge Kaplan did not reach the first amendment issue, his ruling nevertheless is significant. As the subprime litigation wave unfolded, there were a number of complaints filed against the rating agencies asserting ’33 Act claims against them in which the plaintiffs in those cases had argued that the rating agencies were susceptible to "underwriter" liability under Section 11. Judge Kaplan’s rejection of that theory undoubtedly will be influential in those other cases where the plaintiffs have attempted to assert Section 11 "underwriter" liability against the rating agencies.

 

I have in any event added Judge Kaplan’s ruling to my list of subprime and credit crisis-related lawsuit resolutions, which can be accessed here.

 

SEC Issues Climate Change Interpretive Guidance: The SEC decided recently to issue interpretive guidance on climate change disclosure. The SEC has now issued the interpretive guidance, which can be found here. I think this is a significant development, and not just because the SEC has now formally put climate change disclosure on the list of things to do for reporting companies.

 

It is clearly a topic worthy of much longer treatment than I am able to give it while I am in New York attending the PLUS D&O Symposium, but the danger is that the disclosure requirement establishes the predicate for a plaintiff to later claim that a public company failed to meet its climate change-related disclosure obligations. In my view, the SEC’s issuance of the interpretive guidance brings us that much closer to the day when we may start to see D&O claims arising out of misrepresentations or omissions concerning climate change related disclosures.

 

The End of the World: In response to my recent statement that I was tired and could use a nap, one of my much younger colleagues replied "O.K, first we take zee nap, ZEN WE DEESTROY ZEE WORLD!" She undoubtedly saw from the puzzled look on my face that I didn’t have a clue what she was talking about, so she immediately sat down and showed me this YouTube video, which she described as "the original viral Internet video." Readers should be forewarned that  the video uses vulgar language and contains humor that some may find crude or offensive. It is also seriously funny. Viewer discretion is, however, strongly advised.

https://youtube.com/watch?v=kCpjgl2baLs%26hl%3Den_US%26fs%3D1%26

In a 90-page January 27, 2010 opinion (here) District of New Mexico Judge James Browning granted substantial parts of the defendants’ motions to dismiss in the Thornburgh Mortgage subprime securities suit, while also denying the motions to dismiss in connection with certain claims against Larry Goldstone, who served as the company’s President and COO, and after December 2007, as its CEO.

 

Judge Browning’s rulings dismiss all of the plaintiffs’ claims under the ’33 Act as well as many of the plaintiffs’ claims under the ’34 Act, except for the claims against Goldstone, which will go forward. Judge Browning reserved any ruling on the claims against the company itself, which is in bankruptcy, as well as to allegations of control person liability against three individual defendants, as those claims depend first upon the possibility of the company’s liability.

 

In a separate 38-page January 27, 2010 opinion (here), Judge Browning also granted the dismissal motions of the offering underwriter defendants, ruling that the plaintiffs’ consolidated complaint failed to allege sufficiently any material misrepresentations or omissions in the relevant offering documents.

 

Background

Thornburg was a publicly traded residential-mortgage lender focused on the market for "jumbo" and "super jumbo" adjustable rate mortgages. Beginning in 2006, real estate values around the country began to falter, but Thornburgh denied that it was affected, claiming its superior underwriting standards insulated the company from the deteriorating conditions. Thornburg’s executives also denied that it originated "subprime" or Alt-A mortgages.

 

Thornburg’s business model depended on a variety of borrowing and capital mechanisms to fund its lending activities. Thornburg maintained an investment portfolio as collateral for its borrowing. Plaintiffs allege that the portfolio consisted in part of securities backed by Alt-A mortgages, and that these securities were both illiquid and, in 2007, declining in value, which in turn triggered certain margin calls.

 

Specifically, in August 2007, Thornburg was forced to sell 35% of the highest-rated assets in its portfolio to meet margin calls, which in turn triggered both a stock price decline and the filing of the first of several securities class action suits against the company.

 

During 2007 and 2008, the company completed several securities offerings. However, Thornburgh also continued to face additional margin calls, and on February 28, 2008, J.P. Morgan notified the company of its failure to meet margin call requirements, triggering cross default provisions in other short term borrowing arrangements.

 

On March 4, 2008, the company’s auditor withdrew its unqualified audit opinion "due to conditions and events that were known or that should have been known to the company." On March 11, 2008, Thornburg filed a restatement of its prior financials. On March 19, 2008, Thornburg announced it had entered a "bailout" agreement with its remaining lenders that resulted in a substantial dilution of shareholders’ interests.

 

On May 1, 2009, Thornburg filed a petition for voluntary Chapter 11 bankruptcy.

 

The plaintiffs filed their consolidated amended class action complaint on May 27, 2008, on behalf of persons who purchased Thornburg shares between April 19, 2007 and March 19, 2008. The plaintiffs allege that the defendants had failed to disclose that the company was facing increasing margin calls and that its financial condition had deteriorated to the point where it was forced to sell assets. The plaintiffs further alleged that the company failed to disclose that it originated Alt-A mortgages and possessed a multi-million dollar portfolio backed by Alt-A loans.

 

The defendants moved to dismiss, arguing that Thornburg’s losses were the result of market forces beyond defendants’ control.

 

The January 27, 2010 Order

In his January 27 order, Judge Browning first focused on the plaintiffs allegations under Section 10(b). He found with respect to many of the statements or omissions that most of them were not false or misleading or related to matters that the company had no duty to disclose. He also found that the plaintiffs had not specifically attributed any wrongful conduct or statements to any of the individual defendants other than Goldstone, and therefore he granted the motion to dismiss the Section 10(b) claims as to all individual defendants other than Goldstone.

 

However, Judge Browning found that Goldstone had in several public statements sought to attribute the downturn to problems with Alt-A lenders, from which he sought to differentiate Thornburg. Judge Browning found that "on at least two occasions" in June and July 2007, Goldstone made statements that "could be construed and reasonably understood as asserting that [Thornburg} did not engage in Alt-A lending or purchase Alt-A assets," statements which Judge Browning found were false and misleading, taking the plaintiffs’ allegations to be true.

 

Judge Browning also found that statements in the company’s 2007 10-K (which Goldstone signed) about the presence of cross-default provisions in the company’s borrowing agreements also to be false and misleading.

 

On the issue of scienter, Judge Browning rejected the defendants’ suggestion that the absence of insider selling and the presence of insider buying negated the inference of scienter, finding rather that the financial crisis itself "provides another motive that adequately fills the gap left by the lack of suspicious insider-trading activity: survival." Judge Browning said that it was a plausible inference that the defendants were motivated by a desire to help the company survive the crisis, although this allegation alone is not sufficient to establish an inference of scienter.

 

Rather, Judge Browning held that Goldstone’s repeated efforts to distance the company from the mortgage crisis by differentiating the company from Alt-A mortgage originators, "gives rise to a strong inference that Goldstone was attempting to hide from the market that [Thornburg] engaged in Alt-A or subprime lending, and knew, or recklessly disregarded that withholding this information would mislead investors." Thornburg’s omission from its 2007 10-K of its failure to meet the J.P. Morgan margin call, and of the consequent triggering of cross-defaults in other agreements, suggests that Thornburg was "concealing information."

 

The most plausible inference, Judge Browning found, was that Thornburg was "a sinking ship," but that the defendants "tried to stay positive" and that Goldstone "made some statements that crossed the line between optimistic and false and/or misleading."

 

Judge Browning granted the motions to dismiss all of the plaintiffs’ claims based on Sections 11 and 12(a)(2) of the ’33 Act, finding that the plaintiffs had failed to allege any false or misleading statements in the relevant offering documents.

 

Due to its pending bankruptcy proceeding, Judge Browning reserved any ruling on the claims against Thornburg itself, as well as on the control person liability allegations under the ’34 Act that are predicated on the sufficiency of claims against the company.

 

Finally, as noted above, in a separate order, Judge Browning granted the dismissal motions of the offering underwriter defendants, based on his finding that the plaintiffs had failed to allege any false or misleading statements in the relevant offering documents.

 

Discussion

Judge Browning’s exhaustive analysis and his rulings are significant on several levels. First, his order present another example where a court has been willing to dismiss ’33 Act claims in a subprime-related securities class action lawsuit. As I noted in my recent post discussing the ACA Capital Holdings case, where ’33 Act claims were also dismissed, it previously had been the case that courts appeared reluctant to dismiss ’33 Act claims in subprime-related securities lawsuits. But with the ACA Capital Holdings rulings, and now with the rulings in the Thornburg case, the suggestion that Section 11 claims are likelier to survive dismissal motions seems to be less certain, if not entirely unsubstantiated.

 

Judge Browning’s analysis of the scienter issue is also significant. His willingness to overlook the defendants’ insider buying is interesting and noteworthy, particularly in light of his willingness to draw an inference that the defendants were motivated – and perhaps motivated enough to make misleading statements – by a desire to help the company survive the downturn.

 

Many defendants in many other subprime and credit crisis-related cases were similarly motivated to try to help their companies ride out the crisis. To be sure, not all companies or their officials made statements that plaintiffs in those cases will be able to allege diverged from actual circumstances at their companies. But the fact that the plaintiffs in the Thornburg Mortgage case were able to survive the dismissal motion, and to overcome the absence of any insider trading and the presence of insider buying, suggests one possible way that other plaintiffs may overcome initial pleading hurdles.

 

Judge Browning granted the dismissal motions in very substantial part, eliminating almost all of the defendants and many of the plaintiffs’ claims. But the plaintiffs were able to survive the dismissal motions at least as to certain substantial allegations against at least one defendant. Large swaths of their case were cut away, but enough made it through to give them a chance to live for another day and to try to salvage something from the case.

 

Because what remains is substantial, even if only a small part of what was initially alleged, I have placed these rulings on my list of dismissal motion denials, in my running tally of dismissal motion rulings in subprime and credit crisis-related securities suits. My table of dismissal motion rulings can be accessed here.

 

More Failed Banks: On January 29, 2010, the FDIC took control of six more banks, bringing the year to date number of bank failures already this year to 15. By contrast, at this same point in 2009, there had only been a total of six bank failures. The bank failure closure rate is on pace for a total of 180 bank failures in 2010, compared to the 140 banks that failed in 2009.

 

The 15 bank failures so far this year have been spread across ten different states, with three bank failures already this year in the state of Washington, and two each in Georgia, Minnesota, and Florida.

 

This Week: I will be attending the PLUS D&O Symposium at the Marriott Marquis in New York this week. I know many readers will also be there. I hope that if you see me at the Symposium that you will say hello, particularly if we have not met before. While I am away for the Symposium, The D&O Diary may run a reduced publication schedule. "Normal" publication will resume next week. See you in New York.

 

In recent posts (here and here), I have discussed the issues surrounding coverage under D&O insurance policies for investigative costs and special litigation committee expenses. In response to these posts, readers Jeff Kiburtz and Cindy Forman of the Santa Monica law firm of Shapiro Rodarte & Forman have submitted the following guest blog post. This guest post of course reflects the views of the post’s authors, and not necessarily those of the author of The D&O Diary. Cindy and Jeff’s guest post is as follows:  

 

Having recently ended an unusual week straight of rain in normally sunny Los Angeles, the saying "when it rains it pours" comes to mind. This phrase aptly describes the situation in which many companies find themselves when revelations of accounting irregularities or other alleged misconduct surface – first there is a story in the press, then a letter indicating the SEC opened an informal investigation, next a DOJ subpoena, and, sometime during this period, the company’s stock drops and a shareholder makes a demand for an investigation or forgoes the demand and files a derivative suit.

 

The response to this downpour is immediate and expensive. Typically, at least three sets of law firms are retained – one to handle the government investigations and private litigation, a second to conduct an internal investigation and report to a special committee established by the company, and a third, which usually consists of several different firms, to defend the implicated directors and officers.

 

Recognizing the potential to spend large amounts of money very quickly, in-house counsel and the company’s outside lawyers move to create a division of labor between the various firms to coordinate the overall effort. Central projects such as the review, coding and scanning for privilege of all of the documents potentially relevant to the underlying issue are assigned to a specific firm, frequently the internal investigation counsel. Work specific or unique to the various groups is, however, done by the respective group’s own counsel.

 

Although each firm represents the unique interests of their clients, and potential or actual conflicts are therefore implicit, in many circumstances the various interests are largely aligned and the attorneys can and do work together for the mutual benefit of all. If, for example, the company needs to respond to a DOJ document subpoena, there is no reason their theoretically diverging interests should prevent the company’s defense counsel from tapping into the document review work done by the internal investigation counsel to locate responsive documents.

 

The single greatest beneficiary of this collaboration is the company, which in many circumstances is required to pay the bill for all of the various lawyers. We would think that, by extension, the company’s D&O insurers would also see and appreciate the extent to which collaboration between the various groups reduces the overall legal spend. It seems, however, that many D&O insurers are quite restrained in their enthusiasm, often declining coverage for various categories of fees incurred by the company under numerous theories. One fee category that is almost uniformly declined is fees incurred by internal investigation counsel, which, perhaps coincidentally, also happens to be the largest single line-item in many situations.

 

When declining coverage for internal investigation fees, insurers often argue that because the definition of "Claim" does not specifically reference internal investigations, fees incurred by internal investigation counsel were not incurred "in connection with a Claim." Insurers also argue that the internal investigation counsel represents only the special committee, which typically is not one of the enumerated categories of "Insureds" under most D&O policies. A related argument is that internal investigation counsel is supposed to be neutral and objective, such that their work cannot be described as defensive in nature and, therefore, cannot be considered "defense costs."

 

Most policyholders regard these arguments as formalistic and compartmentalized, divorced from the business realities of these "when it rains it pours" situations. For one, the carriers do not give adequate consideration to the fact that much of the internal investigation work (e.g., construction of an electronic document database and obtaining witness statements) is relevant and necessary to defending any securities claim or government investigation, and would need to be performed even in the absence of any internal investigation. In this sense, the insurer’s objection is one of form not substance, as the nature of the substantive work is less relevant to the insurer than the designation of the firm who handled that work (e.g., document review conducted by defense counsel is admittedly covered, but that same work is allegedly not covered merely because it was performed by internal investigation counsel).

 

Further, the insurers’ arguments tend to disregard the direct and obvious connection between the allegations of and investigation into potential wrongdoing and the coordinated effort taken and paid for by the company to investigate and respond in an appropriate manner. When the allegations surface, all of the attorneys involved, whether they represent the company, the special committee or the individual insureds. need to review documents and interview witnesses to determine the relevant underlying facts that impact their respective clients’ interests. It often is not until much later, if at all, that facts surface which demonstrate that the various parties’ interests are in fact adverse. That the information gained during the earlier investigation phases might be used by the special committee in a manner inconsistent with coverage (e.g., advising the board to pursue litigation against directors and officers) does not justify a wholesale declination of all fees incurred by the special committee.

 

A few of these issues came up in the recent MBIA v. Federal Ins. Co. coverage action Kevin has addressed (here and here), where the court seemed not to have been overly warm to the legal principles underlying the insurer’s arguments.

 

 

Federal argued that the firm which handled the internal investigation, Dickstein Shapiro, represented only the special committee, not the company or any of the other insureds. Although the court dismissed this argument on a factual basis (finding that Dickstein made an appearance on behalf of the company in the securities litigation), it also noted that, independent of this fact, the special committee was comprised of members of the board of directors who were expressly charged with acting in the best interest of the company and who "could readily reach independent decisions without being independent of [the company]." While this portion of the opinion could have been more clear, the court’s decision cuts against both the notion that special committees are necessarily separate "entities" from the company and that their required independence precludes characterizing as "defense costs" the work done on their behalf.

 

Another aspect of the court’s decision in MBIA is also worth noting. Insurers frequently argue that internal investigation counsel’s work was not performed "in connection with a Claim," but rather was performed "in connection with" something other than a "Claim," e.g., an internal investigation. This argument makes relevant the causal nexus implied by the "in connection with" language. Policyholders often argue that the implied nexus in this non-exclusionary term is very broad, something akin to an incidental or minimal causal connection; for example, the fees are covered if they bear some reasonable relationship to a covered claim. In our experience, insurers appear reluctant to characterize the allegedly required nexus, but by implication seem to suggest something like predominant causation; for example, the fees are covered only if the predominant reason for doing the work was to defend against the covered claim. While it does not appear that the parties in the MBIA case briefed this issue, by finding coverage for the internal investigation fees related to the derivative suits the court arguably recognized that "in connection with" implies only a minimal causal connection in this context.

 

The insurance bar is likely concerned by the MBIA decision, as it could have widespread implications. It will be interesting to see whether Federal seeks appellate review or whether insurers in the future will simply seek to downplay the significance of a district court decision and attempt to confine it to the facts before the court. 

 

The D&O Diary would like to thank Cindy and Jeff again for their submission of this guest post. The D&O Diary accepts appropriate guest posts from responsible commentators on topics relevant to this blog. My goal in hosting guest posts is to encourage discussion of important topics and to facilitate the exchange of contrasting points of view. Readers who are interested in submitting guest posts should feel free to let me know using the "Contact" function on this blog. 

 

 

According to January 29, 2010 reports in the New York Times (here) and on Bloomberg (here), the jury in the long-running securities class action lawsuit against Vivendi has resulted in a verdict against the company on all 57 of the plaintiffs’ claims. However, the jury also found that the two individual defendants, former Vivendi CEO Jean Marie Messier and former Vivendi CFO, were not liable. According to published reports, damages (with prejudgment interest) could be as much as $9 billion.  

This case involved the financial impact on the company from the $46 billion December 2000 merger between Vivendi, Seagram’s entertainment businesses, and Canal Plus. The plaintiffs contended that as a result of this and other debt-financed transactions, Vivendi experienced growing liquidity problems throughout 2001 that culminated in a liquidity crisis in mid-2002, as a result of which, the plaintiffs contend, Vivendi’s CEO Jean-Marie Messier and CFO Guillaume Hannezo were sacked.

 

The plaintiffs contended that the between October 2000 and July 2002, the defendants misled investors by causing the company to issue a series of public statements "falsely stating that Vivendi did not face an immediate and severe cash shortage that threatened the Company’s viability going forward absent an asset fire sale. It was only after Vivendi’s Board dislodged Mr. Messier that the Company’s new management disclosed the severity of the crisis and that the Company would have to secure immediately both bridge and long-term financing or default on its largest credit obligations." 

 

Additional background regarding the case and the plaintiffs’ allegations can be found here.

 

As reflected in data compiled by Adam Savett on the Securities Litigation Watch (here) since the enactment of the PSLRA in 1995, a total of nine securities class action lawsuits (counting Vivendi) have been tried to verdict. Of those nine, and after all post verdict motions and appeals, defendants have prevailed in five and plaintiffs have prevailed in four. Among the cases in which plaintiffs have prevailed is the Household International securities class action trial, which on May 7, 2009  resulted in a plaintiff’s verdict on the issue of liability (about which refer here.). Damages are also to be determined later in that case.

 

Though plaintiffs have prevailed in the Vivendi trial, at least as to their claims regarding the company, this case undoubtedly has much further to go. Not only will there be post-verdict motions and further proceedings regarding damages, but there almost certainly will be subsequent appeals. Indeed, Vivendi has already indicated that it would appeal if the verdict were unfavorable. Among other things, the case presents significant jurisdictional issues, particularly with respect to the claims of certain foreign domiciled investors. These issues are now pending before the Supreme Court in the National Australia Bank case.

 

But the bottom line is that the two securities class action cases that have gone to the jury in the last 12 months have resulted in verdicts in plaintiffs’ favor, a development the plaintiffs’ bar will certainly tout as significant .

 

On January 27, 2010, NERA Economic Consulting released its updated annual review of Canadian securities class litigation entitled "Trends in Canadian Securities Class Actions: 2009 Update" (here). The report presents an interesting study of the evolution of class action litigation in a jurisdiction outside the U.S.

 

According to the report, there were eight new securities class action lawsuits filed in 2009, which is fewer that the ten filed in 2008 "but still greater than filings in previous years." With the addition of the eight new cases, there are now 23 pending securities class actions, representing more than $14.7 billion in claims. Most of these cases were filed in the last three years although some of the pending cases were filed almost 10 years ago.

 

Though the number of new filings is noteworthy, the more significant developments may be the class certifications in three cases and the ruling allowing the IMAX securities class action plaintiffs leave to proceed under the new Ontario securities laws. (My prior detailed discussion of the rulings in the IMAX case can be found here.). The NERA report comments that these rulings "may ultimately prove to be an inflection point" for securities class action litigation in Canada.

 

Though there were significant new filings in 2009, one noteworthy feature of the cases that were filed is the "absence in Canada of class actions filings relating to the credit crisis." This absence may be due in part to the relatively smaller impact of the credit crisis in Canada compared to the U.S. and the negotiated $32 billion restructuring of the Canadian Asset Backed Commercial Paper market, which may have preempted further litigation.

 

Six cases settled in 2009 for a total of approximately $51 million, for an average of approximately $8.5 million and a median of approximately $9 million (which is roughly comparable to the median settlement of U.S. securities class action lawsuits). 2009 settlements averaged 13.7% of the amount of claimed damages. Cases with cross-border litigation counterparts in the U.S. tended to settle for larger amounts both in terms of absolute dollars and as a percentage of claimed damages.

 

According to a January 27, 2010 article in the Vancouver Sun (here), the number of filings and the procedural developments (including the rulings in the IMAX case) are "a wake up call for publicly traded companies." Law firms are "advising their clients to revisit their compliance and corporate-governance procedures to protect against similar suits."

 

One lawyer quoted in the article says that he is also advising his clients to review their corporate insurance, as well. He goes on to state that "We’ve seen over the years there are a lot of problems in terms of clients don’t really have the type of coverage they need."

 

Yet, as for the question of whether there may be a flood of litigation, one plaintiffs’ attorney quoted in the article sounds a note of caution. The attorney, Dimitri Lascaris, who is one of the lead attorneys in the IMAX case, notes that that the Canadian system still provides for adverse costs, and even the liberalized standard under the new Ontario law are time consuming and expensive. So, he says, "we’re never going to achieve the level of activity in securities class actions that we see in the United States."

 

In light of these developments and their potential significance regarding insurance coverage, the session planned for the upcoming PLUS D&O Symposium (scheduled next Wednesday and Thursday in New York) on the topic of Canadian Securities Class Action Litigation is quite timely. The panel will be moderated by my friend Dave Williams from Chubb (Canada) and planned speakers include a number of prominent players in the area in Canada, including Dimitri Lascaris. Information about the Symposium can be found here.

 

The Securities Litigation Watch blog has a post about the NERA study here.

 

Excess Side A Carrier Contributes to Options Backdating Settlement: On January 25, 2010, a judge in the Western District of Pennsylvania preliminarily approved the settlement of the options backdating lawsuit that had been filed against Black Box, as nominal defendant and certain of its directors and officers. As part of the settlement, the company agreed to pay plaintiffs’ counsel $1.6 million and the company agreed to adopt certain corporate governance measures.

 

As reflected in the parties’ stipulation of settlement (here), as part of the settlement, the company is to receive a payment of $1.5 million from its Excess Side A carrier as well as another $500,000 from its EPL carrier.

 

According to a January 25, 2010 article about the settlement in the Pittsburgh Tribune-Review (here), the company also separately settled a claim against the company by its former CEO, who left the company in connection with the options backdating related matters. At the time he left, the CEO claimed, the company took away over $19.6 million in options related compensation. The company settled these claims for its agreement to pay $4 million.

 

The Black Box settlement marks the second instance of which I am aware in which an Excess Side A carrier contributed toward an options backdating related derivative lawsuit settlement. (The first instance is the Broadcom settlement, about which refer here.) This is yet another instance where Excess Side A insurance is being called on to provide protection outside of the insolvency context. As I have previously noted, the Excess Side A carrier’s contribution to these settlements may be a significant development for the carriers, who have offered the product in a largely low loss environment, at least outside the insolvency context.

 

The settlement with the CEO is an odd component of this settlement. There aren’t many of these cases where the former CEO who left as a result of backdating related issues walked away with a cash payment.

 

I have in any event added the Black Box settlement to my table of options backdating related lawsuit settlements and dismissal motion rulings, which can be accessed here.

 

SEC Will Issue Guidance on Climate Change Disclosure: On January 27, 2010, the SEC voted 3-2 to provide interpretive guidance on existing dislosure requirements to require climate change related disclosure under certain circumstances. The SEC’s January 27 release can be found here. The SEC’s release states that the interpretive release will be posted on the SEC web site as soon as possible. The news release identifies several examples of situations that might trigger disclosure requirements, including: impact of legislation and regulation; impact of international accords; indirect consequences of regulation or business trends; and physical impacts of climate change.

 

Suit Against Rating Agencies Dismissed, But Without Reaching First Amendment Issues: According to a January 27, 2010 Am Law Litigation Daily article by Andrew Longstreth (here), Judge Lewis Kaplan has granted the motions of Moody’s and S&P to be dismissed from a securities lawsuit filed by certain investors who had invested in certain mortgage-backed securities underrwitten by Lehman Brothers. Judge Kaplan has not yet issued a written opinion but according to the article his opinion was based solely on the fact that the rating agencies didn’t have anything to do with the offering documents at issue in the case. HIs ruling reportedly did not reach the rating agencies first amendment defenses (about which refer here.)  

　

The problems facing many banks in the current economic environment are well-documented. For troubled banks’ directors and officers, the banks’ D&O insurance may represent a last line of protection. But what if the insurers could just cancel the policies? Surprisingly, many bank D&O insurers have that right under their policies, and while cancellation is rare, it is not unprecedented, and some insurers are now invoking that right to shed the risks associated with failing or problem institutions.

 

As reflected in a January 24, 2010 FinCri Advisor article entitled "Your D&O Insurer Might Be Scouring Your Call Report Looking to Cancel Coverage" (here), the policy forms of many bank D&O insurers have cancellation clauses that permit the insurer to cancel the policies mid-term, either because there is a "material change in the risk" or for any reason at all.

 

Many of these clauses are found only in policies that were issued on a multiyear basis, but even some single-year bank D&O insurance policies contain cancellation clauses. While many policies also specify that the insurer must give the policyholder 60 days (or more) notice so that the policyholder can try to replace coverage, the fact is that if something serious enough to cause the insurer to cancel coverage has occurred, it likely will be a very difficult time for the policyholder to try to find replacement coverage.

 

For D&O insurance practitioners who don’t venture into the Financial Institutions arena (or FI as it is known), the very existence of these clauses in bank D&O policies may come as a surprise, since these clauses do not appear in most mainstream commercial D&O insurance policies.

 

The obvious question is how did a cancellation clause get into bank D&O policies when it is rarely if ever seen in other kinds of D&O insurance policies? Part of the answer is that, particularly with respect to community banks, the D&O insurance marketplace has over the years become both very specialized and intensely competitive.

 

Before the current troubled bank era began, D&O insurance for community banks became increasingly less expensive. But as buyers became increasingly (or even exclusively) focused on price, some carriers looked for ways to trim coverage. And so a term such as the cancellation clause that isn’t seen in other D&O insurance policies found its way into the basic forms of several community bank D&O insurance carriers.

 

A neutral observer might question the value of a contract that one party can simply cancel unilaterally. The promise to provide insurance seems tenuous indeed if the insurer can walk away because problems have emerged – which is of course the very circumstance for which buyers purchase insurance in the first place.

 

All of this does raise the question of why any buyer would agree in the first place to accept a policy that has a cancellation clause. The answer is either that the buyer is unaware the clause is there or the buyer has no other choice.

 

Given the number of bank D&O insurers that have cancellation clauses in the policy forms, there undoubtedly are many banks whose policies have these clauses. I am guessing only a very small number of these banks (many of whom may have purchased their insurance on a direct basis) have any idea the clauses are there.

 

The problem is that the market for D&O insurance for banking institutions is in turmoil now due to the number of failed and troubled banks. For banks that are struggling, it may be challenging in the current environment to obtain a policy without a cancellation clause. Or, if they can a policy without a cancellation clause, the coverage afforded may otherwise be restricted (as for example, by the inclusion of a regulatory exclusion or the absence of past acts coverage).

 

Healthy financial institutions in many instances can still get coverage on a relatively attractive basis. Healthier banks should not have to accept a policy with a cancellation clause. However, even the healthy banks can only avoid the cancellation clause and other undesirable policy features if their advisor is well-informed and knows what to look and ask for.

 

One added note is that even some bank D&O policies that do not have cancellation clauses have other undesirable features that are almost as bad. For example, the policy form of at least one D&O insurer that is active with community banks does not allow the policyholder the option of purchasing extended reporting period coverage, even in the event of nonrenewal, which could have a similarly negative impact on a bank whose D&O insurance is not renewed. Again the presence or absence of an extended reporting period option is a term that the bank’s D&O insurance advisor will, if well-informed and knowledgeable, be looking for.

 

For the banks whose D&O insurers hit them with a notice of cancellation, the only recourse may be for the banks to provide their insurers with a "laundry list" notice of circumstances that may give rise to a claim – always a challenging proposition because of the uncertainty of knowing what claims may arise later. But the laundry list may be the only chance the bank has to lock in coverage before it is unilaterally taken away.

 

All of this underscores the critical importance for banks and for all insurance buyers of involving a knowledgeable and experience advisor in the acquisition of D&O insurance. Without informed advice, policyholders can be left with inadequate insurance protection when problems arise.

 

The individual defendants in the various Stanford Financial-related SEC enforcement and criminal proceedings have been engaged in a long-running and procedurally complicated battle over whether the firm’s D&O insurers must advance the individuals defense expenses. In a sweeping January 26, 2010 opinion (here), Southern District of Texas Judge David Hittner rejected the grounds on which the insurers sought to avoid coverage and ruled that the insurers must advance the individuals’ defense costs.

 

Background and the January 26 Opinion

The defense fee dispute has a complex procedural history but for purposes of the January 26 opinion the critical fact is that on November 16, 2009, the insurers sent the individuals letters "retroactively declining to extend coverage for costs." The insurers contended that coverage was precluded by the Policy’s "money laundering" exclusion. The exclusion precludes coverage for loss "arising directly or indirectly as a result of or in connection with any act or acts (or alleged act or acts) of Money Laundering," as that term is defined in the policy.

 

In his opinion, Judge Hittner noted that the carrier’s were not seeking to avoid coverage based on the exclusion precluding coverage for fraud or criminal misconduct, because that exclusion has a requirement of an "adjudication" that the precluded conduct had occurred. The money laundering exclusion has no "adjudication" requirement, leaving, the insurers’ argued, the determination that money laundering has in fact occurred, to the insurers.

 

Judge Hittner also noted parenthetically that the insurers urged this position even though only one of the twenty-one counts in the criminal action alleges money laundering or conspiracy to commit money laundering. (The insurers argued that the policy’s definition of money laundering was broad enough to encompass all of the allegations.)

 

The plaintiffs first opposed the insurers’ position based on the "eight corners" rule, arguing under Texas law that in determining an insurer’s defense obligations, a court may not consider anything beyond the four corners of the policy and the four corners of the complaint. Judge Hittner found that despite the insurers’ arguments to the contrary, the Supreme Court of Texas "never has recognized an exception to the eight corners rule."

 

Judge Hittner was in any event strongly against a broader view of what a court properly might consider in determining the insurers’ obligations.

 

If a contemporaneous duty to advance or reimburse defense costs were judge on an "actual facts" basis, an insurer’s contractual obligation to pay defense costs could change on a daily basis as additional "facts" are developed. Essentially, coverage that directors and officers relied upon and expected when the Policies were purchased on their behalf could be withdrawn at the insurer’s whim. If, as Underwriters suggest, the Policies afford Underwriters absolute discretion to withhold payments whenever charges of intentional dishonesty are leveled against directors and officers, then insurers will be able to withhold payment in virtually every case at their discretion. That would leave directors and officers in an extremely vulnerable postion , as any allegation of dishonesty, not matter how groundless, could bring financial ruin on a director or officer. Essentially an insurer could act as judge and jury and convict its own insureds, thus avoiding any further financial responsibility for the insureds’ defense. This simply cannot be the case. (Citations omitted.)

 

The court found in applying the eight corners rule that the allegations were insufficient to establish that the precluded conduct had occurred. The insurers nevertheless sought to argue that the individuals refusal to testify in support of the application for a preliminary injunction is proof enough that the allegations against the individuals are true. The insurers sought to argue that the refusal to testify supported an inference that money laundering did in fact occur.

 

Judge Hittner held that the "given the magnitude, complexity and nature of the charges," he declined to draw the inference, and that in any event, because of the eight corners rule, the insurers’ reliance on the supposed inference from the individuals refusal to testify is "misplaced."

 

Judge Hittner, applying the standard required for a preliminary injunction motions ruled that though the money laundering exclusion does not require a judicial determination to apply, the exclusion’s requirements "also may mean much more than an insurer’s own determination." He said that he need not decide what level of factual determination must be made, and instead ruled only that plaintiffs have a substantial likelihood of succeeding on the merits at trial, satisfying the standard for awarding preliminary injunctive relief.

 

The court, in further consideration of the preliminary injunction standard, noted that the plaintiffs would suffer "irreparable harm" if the relief they sought was withheld. He noted that it is "unmistakable and cannot be seriously disputed" that the harm the individuals will suffer is "real, immediate and irreparable." He rejected the insurers contrary position that, he said, would "essentially require [the individuals] to prove their innocence." Judge Hittner commented that
 

 

Underwriters’ position is absurd because these circumstances are precisely why corporations procure D&O insurance on behalf of their directors and officers. Indeed, it would contravene the very purpose of the Policies – as well as the policy language itself – to require Plaintiffs to prove their innocence before being entitled to funds for their defense.

 

Judge Hittner found the harm to the insurers from granting the preliminary injunction was relatively slight and that public interest also weighed in favor of granting the preliminary injunction. He finally held that the individuals did not have to post a bond.

 

Discussion

Given the nature of the allegations against the individuals and the notoriety of the circumstances, as well as the number of people who lost money as a result of the collapse of Stanford Financial, the tone and temperature of Judge Hittner’s words are a little surprising. If nothing else is clear, Judge Hittner was certain that individuals needed to be able to defend themselves, and the insurers were obliged to provide the defense. The depth of Judge Hittner’s discussion of these defense cost issues are such that his words may prove useful for other individuals who are seeking to have their defense expenses paid under their policies.

 

You do get the sense that Judge Hittner ducked the hard issue – that is, if the money laundering exclusion, unlike the fraud exclusion, doesn’t have an "adjudication" requirement, then an adjudication can’t be required, so what is sufficient? Given Judge Hittner’s certainty that the eight corner rule is absolute under Texas law, there might be no way to meet the requirement. It does make you wonder whether it matters from a practical perspective whether or not there is an "adjudication" requirement.

 

Even though the usefulness of Judge Hittner’s determinations for others seeking insurance coverage arguably might be limited to those jurisdictions that also absolutely enforce the eight corners rule, the breadth of his pronouncements about the limitations on insurers’ ability to make preclusive coverage determinations virtually guarantees that his phrases will appear in the legal briefs of other individuals who are seeking defense cost coverage. His unwillingness to allow the individuals’ refusal to testify on their own behalf in the preliminary injunction proceeding may also prove helpful to other policyholders.

 

Because of the tone of Judge Hittner’s rhetoric and the high profile nature of the case, I suspect there may be some strong views about this decision. I invite readers who have thoughts about this decision to add their views to this post using the blog’s comments feature.

 

A January 26, 2010 Bloomberg article about Judge Hittner’s ruling can be found here.

 

Special thanks to Bill Schreiner of the Zuckerman Spaeder law firm for providing me with a copy of the decision.

 

Vivendi Watch: The Vivendi securities class action case went to the jury on January 11, 2010, but still no verdict. The parties are anxiously awaiting the verdict and in the meantime debating what the length of the jury deliberations may mean, according to a January 26, 2010 article by Andrew Longstreth on AmLaw Litigation Daily (here). The article also reports that almost regardless of the verdict, there will likely be an appeal, if for no reason that because of the potential jurisdictional implications of the National Australia Bank case now pending before the Supreme Court. Stay tuned (to the second power, apparently).