On December 7, 2009, NERA released its most recent update on trends in the numbers and values of settlements of SEC enforcement actions. The latest study, which is as of September 30, 2009 and complete through the end of the SEC’s 2009 fiscal year, shows that the number of settlements during the year declined for the second straight year, but the average settlement amount increased, and the median settlement amount held steady. NERA’s December 7 press release regarding the study can be found here.

 

As the report notes, because the 2009 settlements largely relate actions initiated in earlier periods, they may or may not be indicative of what reasonably may be expected in the SEC’s current heightened enforcement environment.

 

In addition, the reports observations about the high frequency of individual participation in the settlement of SEC enforcement actions may provide important additional context for Judge Rakoff’s recent high profile rejection of the proposed settlement of the SEC’s enforcement action involving the Merrill Lynch bonuses.

 

First, with respect to the numbers of settlements, the report shows that there were 626 settlements in fiscal 2009, compared to 673 in fiscal and 717 in fiscal 2007. Among other things, the report notes that fiscal 2009 was a year characterized by staff turnover and transition for the agency’s top leadership, which may be relevant to understanding the relative decline in the numbers of settlements.

 

Monetary payments were a component of 58.6% of company settlements and 58.9% of individual settlements for FY 2009. The average monetary SEC settlement during fiscal 2009 was $10.7 million, compared to only $4.7 million in fiscal 2008, but the increased 2009 average is largely a reflection of several very large settlements during fiscal 2009, including, for example, the $350 million Siemens paid in settlement of the FCPA enforcement action the agency filed against the company. Removing the settlements in excess of $100 million reduces the FY 2009 average to $4.4 million.

 

By contrast to the average, the median SEC enforcement settlement was about $1.0 million, about equal to the prior fiscal year’s median.

 

Among largest source of SEC enforcement actions are cases involving alleged misstatements. In an interesting analysis of the relationship between individual and corporate settlements in misstatement cases, the report notes that between the enactment of SOX and the end of FY 2009, the SEC had reached settlements in 353 cases involving alleged misstatements by corporate companies. Of these 353 settlements, 62 involved only the company, 99 cases involve only individual directors or employees, but the remaining 192 cases involved both the company and individuals.

 

In other words, individuals participate to a greater or lesser extent in the vast majority of SEC enforcement actions involving misstatements. As the report points, this pattern presents interesting additional context for Judge Rakoff’s high profile rejection of the SEC’s proposed settlement of the Merrill Lynch bonus enforcement action. Judge Rakoff faulted the proposed settlement because it fined the company (and its shareholders) but not the supposedly blameworthy individuals.

 

The report notes that this outcome is likely to spur the SEC to pursue individuals with "renewed vigor" and indeed SEC officials have made statements to that effect. The SEC’s own settlement patterns show that in general it is the agency’s practice to involve individuals in settlement of restatement cases.

 

The report reflects a number of different interesting findings, and also contains some helpful and interesting tables, including lists of the ten largest corporate and individual post-SOX settlements, as well as interesting data showing relating to the number of insider trading settlements – somewhat unexpectedly, the number of inside trading settlements hit a post-SOX low during fiscal 2009.

 

The report concludes with the observation that the full impact of the reforms that the SEC has only just begun to initiate "is likely yet to be seen." The report suggests that the trends observed in the most recent report are likely to change in the periods ahead.

 

SEC Files Enforcement Action Against Former New Century Officials: Perhaps as a reflection of the newly more active SEC, on December 7, 2009, the SEC filed an enforcement action in the Central District of California against three former New Century Financial Corporation officials.

 

The SEC’s complaint, which can be found here, alleges that the three defendants violated the securities laws failed to disclose important negative information, including dramatic increases in early loan defaults, loan repurchases, and pending loan repurchase requests. Defendants knew this negative information from numerous internal reports they regularly received, including weekly reports ominously referred to internally as "Storm Watch." The SEC’s December 7 litigation release about the action can be found here. 

 

The timing of the SEC’s enforcement action against the three New Century officials stands in interesting contrast to the private securities class action lawsuit filed against certain former New Century officials. The private securities, which was the first of the subprime related securities class action lawsuits when it was first filed in February 2007, is nearly three years old. The court denied the defendants’ motion to dismiss almost exactly a year ago.

 

 

 The more interesting question is whether the filing of the New Century action represents the first in a series of enforcement actions related to the subprime meltdown and credit crisis. In light of the new environment at the agency and the pressure it is under to reestablish its regulatory credentials, there may well be further actions yet to come.

More than three years have passed since the first blockbuster revelations about corrupt payments at Siemens, yet litigation arising from the scandal continues to emerge. On December 4, 2009, plaintiffs’ lawyers filed a securities class action lawsuit in the Eastern District of New York against Siemens, based on alleged misrepresentations following initial revelations of the improper payments. The complaint, which can be found here, has a number of interesting features and it potentially raises complicated issues.

 

As reflected in a prior post (here), the bribery scandal at Siemens hit the front pages of the world’s financial papers in late 2006 after more than 200 German police raided the offices and homes of over 30 current and former Siemens employees. The ensuing investigation and enforcement action culminated in the December 15, 2008 announcement (here), that Siemens had agreed to pay a total of $350 million in disgorgement to the SEC, a criminal fine of $450 million to the U.S., and a fine of 395 euros to the office of the Prosecutor General in Germany.

 

The recently filed securities suit refers extensively to the SEC’s enforcement complaint against the company. But though the class action complaint is inextricably linked to the company’s bribery revelations, the complaint is not about the bribery disclosures as such. Rather, the complaint purports to be based on company statements about its business prospects and its ability to compete without making improper payments.

 

That is, the complaint alleges that the company claimed that it "had cleaned up [the] corporate-wide scandal and that it would meet its publicly announced revenue and earning projections" – but, the complaint further alleges, "Siemens ability to generate revenues and achieve earnings expectations was clearly dependent on its corporate-wide bribery activities."

 

Consistent with the theory that the complaint is not about the bribery itself but about the company’s claims about how it would fare as a bribery-free competitor, the proposed class period does not commence at some time prior to the bribery revelations. Instead, the proposed class period begins more than a year after the scandal first emerged, in November 2007, when new management projected significant growth for the company.

 

During the class period, the complaint alleges, management sought to dispel concerns that the lingering bribery investigation would have an adverse impact on the company’s ability to meet its earnings projections. The proposed class period ends at the end of the company’s 2008 second fiscal quarter, when the company announced a sharp drop in second quarter profits.

 

So while the plaintiff’s complaint consists almost exclusively of a detailed recounting of the bribery scandal and its regulatory aftermath, the complaint isn’t about the bribery or even the revelations about the bribery at all; instead, the plaintiffs seek damages based on what the company allegedly said about whether it could meet its goals now that it was no longer getting business by paying bribes.

 

Plaintiffs will obviously face certain challenges demonstrating that their claimed damages are due to these statements about Siemens’ prospects without bribing officials, as opposed to ongoing revelations concerning the bribery investigation – which continued both during and after the proposed class period. Indeed, the class period ends at the same time as the company disclosed certain findings of the law firm the company had hired to investigate the bribery allegations.

 

In one sense it seems as if the plaintiffs arguably are trying to have it both ways with respect to damages. They do not allege what harm was due to the company’s supposedly misleading projections; rather they allege only that "as a result of defendant’s fraud and misconduct, Siemens’ shareholders have suffered, and will continue to suffer, billion of dollars of damages." These broad damages claims are arguably at odds with the complaint’s relatively narrow class period and narrow range of alleged misrepresentations.

 

The complaint may also be susceptible to challenges that it does not sufficiently allege scienter. In that regard, it is interesting to note that the sole defendant named is the company. No individuals are named as defendants. Without any individual defendants, the possibility for the complaint to survive a dismissal motion will depend on some kind of "collective scienter," based on the supposed knowledge or recklessness of responsible corporate officials.

 

Critically, for the plaintiff’s complaint to succeed, they will have to show that during the class period, senior company officials knew (or were reckless in disregarding) that the company could not make its earnings targets without resorting to bribery. To put it as neutrally as I can, it is unclear from the complaint what allegations the plaintiffs intend to rely upon to show that the company’s senior officials knew during the class period that without improper payments Siemens could not meet its earnings projections.

 

The complaint could also face certain hurdles with respect to the claims of so-called "f-cubed" claimants. The proposed class period is not limited solely to the claims of investors who purchased their Siemens securities on the NYSE. To the extent the class purports to include the claims of foreign-domiciled investors who bought their shares in Siemens on a foreign exchange, the complaint could present the same kinds of jurisdictional issues as were raised in the National Australia Bank case, in which the U.S. Supreme Court recently granted a petition for writ of certiorari.

 

Perhaps in anticipation of these kinds of concerns, the new class complaint quotes liberally from the SEC’s allegations concerning the "nexus" between the improper payments and the U.S. However, the misleading statements that are the basis of the new class action complaint clearly appear from the face of the complaint to have been made in Germany. It is therefore possible that the claims of "f-cubed" class members could be susceptible to jurisdictional challenge.

 

In any event, and at a minimum, this case presents yet another concrete example of the way in which regulatory or enforcement investigations into corrupt payments can lead to civil litigation, which many readers will recognize as a recurring theme on this blog.

 

The fact that no individuals are named as defendants in the lawsuit is unusual, and could generate any number of interesting D&O coverage issues. For example, at least in the early days when company coverage first began to be added to insurance policies that previously only protected individuals, the company’s coverage was only available if there were also claims against individuals. These co-defendant requirements largely have fallen by the wayside over time, but the policy’s bias towards protecting individuals in preference to the company still survive in a various respects.

 

A related question about the company’s coverage is whether or not the company’s various admissions in connection with the prior regulatory or other settlements would trigger the conduct exclusions found in most D&O policies. I suppose that if the exclusion is sufficiently narrow, the company could argue that whatever else the company may have admitted, it did not make any admissions about the statements alleged in this complaint to be fraudulent. However, if the exclusion has a broader preamble, a carrier might well argue that the wrongful acts alleged in this complaint arise out of, related to or are based upon improper conduct to which the company as admitted.

 

In its December 3, 2009 filing on Form-10-Q (here), Dell disclosed that on November 20, 2009, it had entered a written agreement to pay $40 million to settle the consolidated securities class action lawsuit pending against the company and certain of its directors and officers.

 

What makes the $40 million Dell settlement noteworthy is not its amount but its timing – the settlement comes not only after the securities lawsuit had been dismissed with prejudice at the district court level, but following oral argument on the plaintiffs’ subsequent appeal to the Fifth Circuit.

 

On September 13, 2006, the first of four securities class action lawsuits were filed in the Western District of Texas against Dell and four individual defendants, as well as against the company’s outside auditor. The plaintiffs’ 340-page Consolidated Amended Complaint (here) alleges that the company had a "culture of deception" and that it had used "fraudulent accounting" to inflate its revenues by $463 million for fiscal years 2003 through the 2006.

 

The plaintiffs further alleges that the individual defendants took advantage of the company’s inflated share price to unload millions of dollars of their personal holdings in the company stock – indeed, in the case of company founder, Michael Dell, the plaintiffs alleged that he had sold billions of dollars of company stock.

 

In an opinion dated October 6, 2008, Judge Sam Sparks granted the defendants’ motions to dismiss, with prejudice. The plaintiffs appealed to the Fifth Circuit. According to Dell’s most recent 10-Q, oral argument on the appeal took place before the Fifth Circuit on September 1, 2009. Thereafter, and while the appeal was still pending, the parties reached the settlement agreement described above. The parties jointly request that the Fifth Circuit remand the case so that the district court could consider the proposed class settlement.

 

As surprising as it is for a case to have settled following dismissal and while appeal was pending, this peculiar settlement timing is not entirely unprecedented. Most notably, the parties to the Bristol- Myers Squibb securities class action lawsuit agreed to settle that case for $300 million while the case was on appeal to the Third Circuit following the district court’s dismissal.

 

But even though it may have happened before for a securities case to be settled while on appeal following dismissal, the timing of the $40 million Dell settlement – coming as it did shortly after oral argument – does leave you wondering why the case settled when it did.

 

In her blog Footnoted (here), Michelle Leder, who was the first to note and report on the Dell settlement disclosure, speculates that the appeal "had to have gone really poorly" for the company to settle after securing dismissal in the court below. To a certain extent, Leder’s speculation seems plausible. Why else would the company agree to pay $40 million to settle a case that it had already managed to get dismissed?

 

There are some other possibilities. The first is that the company just wanted the case gone. Old cases, even those that are going reasonably well, don’t get better with age. More that one litigant has thrown money at a case just to get rid of it, and for a company with annual revenues of $12.9 billion and third quarter earnings of $337 million, the $40 million settlement (to the extent not funded by insurance) could represent a regrettable but relatively small cost of doing business.

 

Another possibility is that the plaintiffs are the ones for whom oral argument had gone poorly, and that thereafter for the first time they were willing to negotiate in a range that Dell was willing to consider.

 

Whatever the reason for the odd settlement timing, the fact that the parties were able to settle a case while on appeal and after oral argument shows that in a securities lawsuit, the possibility for a deal is always somewhere on the table.

 

Very few securities suits go to trial – in general, the cases either are dismissed or they settle. And, as the Dell case shows, sometimes a case can be both dismissed and settled.

 

Readers who have insight they can share about why the Dell case settled when it did are cordially invited to pass that information along. If I learn anything interesting from readers, I will add it to this post. Anonymity for those who need it will be scrupulously protected.

 

UPDATE: Alison Frankel has a very interesting December 7, 2009 post on the Am Law Litigation Daily (here) about the Dell settlement, including additional procedural history and statements from the plaintiffs’ counsel about the settlement.

 

In closing, I should add a note of appreciation for the Footnoted blog. Michelle Leder consistently reports nuggets she has unearthed by digging through companies’ SEC filings. As a result of her diligence, she regularly reports perceptive and interesting things that no one else has noticed. Her site demonstrates the incredible value and power of a really good blog. Footnoted, everyone here at The D&O Diary salutes you.

 

With 124 failed banks so far in 2009, and more likely to come in the weeks and months ahead, one recurring question has been whether the FDIC will be as aggressive in pursuing claims against directors and officers of failed lenders as it was during the S&L crisis. While we are awaiting the arrival of the seemingly inevitable regulator lawsuits, it is worth reviewing what the FDIC’s receivership litigation rights look like.

 

A recent decision out of the Northern District of Georgia arising from the 2008 failure of Integrity Bank and citing the body of case law the FDIC developed during the last failed bank era examines the FDIC’s litigation rights and also strongly reinforces the impression that the FDIC has D&O claims on its agenda.

 

Background

Integrity Bancshares is the parent holding company of Integrity Bank of Alpharetta, Georgia. On August 29, 2008, Georgia banking regulators closed Integrity Bank and the FDIC was appointed as receiver. On October 13, 2008, the holding company filed for Chapter 7 bankruptcy.

 

In February 2009, the bankruptcy trustee filed a damages action against four individual directors and officers for breach of fiduciary duties and negligence. Though some of the individual defendants were directors and officers of both the holding company and of the bank, the trustee’s claims are based solely on the individual defendants’ capacities as officers of the holding company and the bank. The trustee also filed an action against the bank’s D&O insurer seeking a judicial declaration of coverage for the damages action.

 

The trustee’s damages action alleges that the individual defendants harmed the now-bankrupt holding company and imperiled the capital that the holding company raised for and provided to the bank, by negligently managing the bank’s operations. Among other things, the trustee alleges that the bank’s lending practices, for which the individual defendants were responsible, were deeply flawed and were characterized by loans to speculative developments made at substantial variance to the bank’s putative lending requirements.

 

The FDIC intervened in the trustee’s damages action to assert that the trustee lacks standing to bring the damages claims, because the essentially derivative claims the trustee has brought belong to the FDIC as receiver of Integrity Bank. The individual defendants and their D&O insurer also moved to dismiss the declaratory judgment action based on the absence of an actual case or controversy.

 

The Court’s Opinion

In a November 30, 2009 opinion (here), Judge Richard W. Story granted the FDIC’s motion to dismiss, holding that under the Financial Institution Reform, Recovery and Enforcement Act of 1989 (FIRREA) all derivative claims against the officers and directors of Integrity Bank belong to the FDIC.

 

Judge Story observed that to have standing, the trustee would have to allege that the defendants caused direct and unique harm to the bankrupt holding company. But, Judge Story found, all of the alleged misconduct took place at the bank level. The allegations relate "only to actions taken in the Defendants’ roles as Bank officers." The harm to the holding company alleged is in its capacity "as a shareholder to the Bank," and the alleged harm is "secondary and predicated upon injury to the Bank."

 

Judge Story found that

 

Once the FDIC-R became the receiver of the Bank, the Debtor [i.e, the bank’s parent holding company] no longer had the ability to bring derivative claims against the officers of the Bank, because the FDIC-R succeeded to those claims. The fact that the Debtor subsequently declared bankruptcy did not create in the Trustee any standing that the Debtor did not already possess. Therefore, the Trustee does not have standing to bring the derivative claims alleged in the Damages Complaint.

 

Judge Story also found that though the complaint stated that the Trustee alleged "direct and unique harm," these allegations represent mere conclusory allegations insufficient to satisfy threshold pleading requirements under Iqbal.

 

Finally, Judge Story granted the motion to dismiss the declaratory judgment action as moot, essentially ruling that the court cannot rule on coverage issues until the underlying claims have been addressed.

 

Discussion

I literally have not had occasion to write or type the acronym "FIRREA" for over 15 years. Reading Judge Story’s opinion really is like déjà vu all over again. All of the key cases Judge Story cites are over 15 years old. This all has an uncannily familiar feel.

 

But there’s no nostalgia here.

 

No one should miss the obvious implication from the FDIC’s intervention in the Integrity case that if anybody is going to sue the directors and officers, it is going to be the FDIC. The FDIC’s assertion of its successor rights to derivative claims is not a mere academic exercise. The FDIC’s intervention looks like a blocking tactic calculated to preserve its ability to pursue its own claims as receiver.

 

All of this makes me feel like Harry Potter revealing the awful truth to his fellow students at Hogwarts – Voldemort is back, after a 14 year absence. (We still bear the scars from our last encounter, which quite nearly killed us, too.)

 

So it may be time to retrieve all those old files out of storage, because it looks like its dead bank litigation time again. Indeed, with the return of the regulatory exclusion on many financial institutions D&O policies, this may well and truly be déjà vu all over again.

 

To end where I began, with 124 failed banks this year, I think it is only a matter of time before we see the FDIC pursuing many claims against the directors and officers of failed financial institutions. As the Integrity Bank case makes clear, the FDIC as receiver has rights under FIRREA to pursue derivative claims against the Ds and Os of the failed banks.

 

Strap on your helmets.

Very special thanks to Henry Turner of the Turner Law Offices for providing me with a copy of Judge Story’s opinion.

 

More About Iqbal: Judge Story’s reference to Iqbal reminds me to advise readers that the Senate Judiciary Committee held a hearing today on Senator Specter’s bill to set aside Iqbal. The Witness Testimony and Members’ Statements can be found on the Committee’s Hearings page, here. The Blog of the Legal Times has a short summary of the hearings, here. The short version is that the Democrat members ot the Committee think Iqbal is bad.

 

Those readers interested in the intellectual debate over the merits of Iqbal will want to refer to the Drug and Device Law blog, where the authors have agreed to engage in a point/counterpoint on the Iqbal decision with Univesity of Pennsylvania Law Professor Stephen Burbank. The first volley in the exchage can be found here.

 

Vanity Fair on Goldman: If you have not yet seen it, you will want to take a look at the article about Goldman Sachs by Bethany McLean in the January 2010 issue of Vanity Fair, entitled "The Bank Job" (here). The article reviews Goldman’s perspective on the its role in the global financial crisis and its aftermath. It also does a good job capturing the widespread outrage regarding Goldman’s compensation, as well as the conspiracy theories about Goldman’s various connections to official Washington. Basic theme: storied but aggressive bunch of capitalists has managed to draw a huge target on its own back.

 

Bethany McLean is an old hand at reporting on arrogant corporations, having co-authored Enron: The Smartest Guys in the Room.

 

Speakers’ Corner: On Thursday December 3, 2009, I will be presenting at Skadden’s Annual Securities Litigation and Enforcement Seminar.

 

 

Courts in the financial center of New York and the tech hotspot of California tend to be where much of the headline grabbing securities law action usually takes place. But this week, the most significant action is in  Washington, D.C., as the Supreme Court and Congress are weighing into several of the hottest topic under the U.S. securities laws.

 

First, on Monday, November 30, 2009, the Supreme Court granted the petition for writ of certiorari in the National Australia Bank case. As a result of taking the case, the Supreme Court is likely to confront generally the question of extraterritorial application of the U.S. federal securities law and will address specifically the question of when U.S. court can properly exercise jurisdiction over securities law claims of so-called "f-cubed" claimants (that is, foreign investors who bought their shares in foreign-domiciled companies on foreign exchanges.) Background on the NAB case can be found here.

 

Second, and also on Monday, November 30, the U.S. Supreme Court heard oral argument in the Merck Vioxx case, in which the Court will address the question of what is required in order to establish "inquiry notice" sufficient to trigger the two-year statute of limitations for private securities lawsuits under the ’34 Act. Background on the Merck case can be found here.

 

Third, on December 2, 2009, the Senate Judiciary Committee is scheduled to hold a hearing on Senator Arlen Specter’s proposed legislation entitled "The Notice Pleading Restoration Act of 2009," which is calculated to set aside the U.S. Supreme Court’s holdings in the Twobley and Iqbal cases. These cases define standards for threshold pleading issues in all federal civil cases, including securities cases. A discussion on the background on the significance of the Iqbal decision for securities cases can be found here.

 

A link for the Senate Judiciary Committee session, which is entitled "Has the Supreme Court Limited Americans’ Access to Justice?," can be found here. The Committee hearing will be webcast and a link of the webcast can be found on the Committee’s hearings webpage.

 

Each of these developments has potential to work sufficient alterations to important aspects of the securities laws or to their application.

 

The NAB case potentially could represent a very significant milestone on the issue of the overseas reach of domestic securities laws in a global economy. The Merck case, though focused on a technical statute of limitations issues, could have important practical consequences (particularly these days when for whatever reason plaintiffs’ lawyers increasingly seem to be filing cases belatedly). Finally, Senator Specter’s bill could produce significant changes on the threshold pleading standards for all civil cases, including securities cases.

 

A November 30, 2009 Law.com article (here) suggests that the Supreme Court showed substantial skepticism that there were sufficient "storm warnings" earlier on that would have put plaintiffs on "inquiry notice" sufficient to trigger the running of the statute of limitations. Ashby Jones also has an interesting post on the WSJ.com Law Blog (here) about the oral argument.

 

Soon Everyone Will Have a Blog: A column in yesterday’s Wall Street Journal reports (here) that Iranian President Mahmoud Ahmadinajad maintains a blog, called "Mahmoud Ahmadinajad’s Personal Memos." (No link supplied here, it just seems ill-advised to visit the site). Not only does Ahmadinajad have a blog, but his blogging experience is one to which many bloggers – including your humble correspondent — can relate. The column reports that Ahmadinajad "allots himself 15 minutes a week to write his blog, but admits that at times, he exceeds this limit."

 

Yes, it really is hard finding time when you have important things to blog about, particularly when that pesky day job can interfere with important blogging activities. (For the record, I allot myself more than 15 minutes a week for blogging.)

 

In a series of recent rulings in coverage litigation arising out of the 2007 collapse of Brookstreet Securities Corporation, a California-based securities broker-dealer, Central District of California Judge Cormac Carney addressed the claims of several claimants to the proceeds of a professional liability insurance policy that had insured the defunct company. Though the rulings are narrow and tied to the specific facts presented, the issues in dispute are likely to recur in claims arising from the subprime meltdown and accordingly the rulings may be of more general interest on that basis.

 

Background

Brookstreet provided broker dealer services nationwide until mid-2008 when the company experienced a financial collapse. The company ceased operations in June 2007 and is now insolvent.

 

Brookstreet was insured under a Securities Broker Dealer Professional Liability Insurance Policy for the period November 8, 2006 to November 8, 2007. The policy provides coverage for claims made against Insured Persons for actual or alleged Wrongful Acts in the rendering of "Professional Services." The policy had limits of $3 million.

 

The policy is an express "claims made and reported" policy, requiring in order for coverage to apply both that the claim be made within the policy period and that notice of claim be given within thirty days and during the policy period.

 

The insurer brought an action for interpleader and posted a $3 million bond. The insurer then filed three separate motions for summary judgment as to certain separate groups of interpleader defendants, all of whom are in turn claimants against Brookstreet or certain of its former directors, officers or employees.

 

Judge Carney’s Rulings

In a three separate rulings, Judge Carney addressed each of the insurer’s summary judgment motions.

 

Claims Made/Late Notice Issues: First, in a November 20, 2009 opinion (here), Judge Carney addressed the insurer’s motion for summary judgment as to the defendant claimants who had not made their claim against Brookstreet prior to the policy’s expiration or with respect to whose claims Brookstreet had not provided notice of claim to the insurer prior to the policy’s expiration.

 

Judge Carney quickly granted the insurer’s motion as to the claimants whose claims were made after the policy’s expiration, or with respect to whose claims Brookstreet had not provided notice of claim to the insurer during the policy period.

 

The more interesting questions about notice sufficiency arose with respect to the claimants who had made their claims during the policy period and with respect to whose claims Brookstreet had provded notice of claim during the policy period, but with respect to whose claims Brookstreet had not provided notice within the 30-day period required under the policy.

 

Judge Carney, enforcing the policy’s notice requirements strictly, found that the insurer was entitled to summary judgment even as to this latter group of claimants. Judge Carney found that the 30-day notice requirement was a "condition precedent" to coverage and that "to force" the insurer to have to demonstrate prejudice in order for the notice provision to be enforced "would be to rewrite the insurance contract, and the Court is unwilling to take this step."

 

Derivative Claim Exclusion: The insurer had also moved for summary judgment as to those claimants whose claims arose out of or were based on transactions involving Collateralized Mortgage Obligations (CMO). The insurer relied upon a policy exclusion precluding coverage for claims "based upon, arising out of or attributable to the sale, attempted sale, or servicing of … any type of …derivative." Relying on this exclusion, the insurer argued that the CMOs are derivatives, and therefore the policy precluded coverage for claims relating to the CMOs.

 

In a November 20, 2009 ruling (here), Judge Carney concluded, based on extensive material provided by the insurer, that CMOs are "derivatives" within the meaning of the policy. Accordingly, he granted summary judgment as to those claimants whose claims were based on CMOs.

 

Interrelated Acts: The insurer had also moved for summary judgment as to a claimant who asserted that a Brookstreet employee had mismanaged her investments, through a pattern of "churning, making unauthorized trades, buying and selling high risk stocks, and failed to advise [her] of investment losses" during the period 1996 though June 2006.

 

The insurer argued that her claim arose out of an Interrelated Wrongful Act that first occurred prior to the policy’s September 10, 2002 retroactive date. The insurer further argued that the pre- and post-September 10, 2002 conduct constituted a single, non-covered Interrelated Wrongful Act. The claimant asserted that each of the improper acts was a separate Wrongful Act, and that each time Brookstreet failed to supervise its employee, it also committed a new and discrete Wrongful Act.

 

In a November 18, 2009 ruling (here), Judge Carney held that while he "does not discount the possibility that [the employee’s] actions may have constituted an Interrelated Wrongful Act …there are genuine issues of material fact as to whether the acts after September 10, 2002 were interrelated with those occurring before that date." Because a "reasonable jury could conclude" that each time the employee "made an unauthorized trade, churned [the claimant’s account] or bought and sold high risk stocks" each was a separate Wrongful Act.

 

Discussion

Judge Carney’s rulings are interesting in and of themselves, but they are also interesting for what they suggest more generally.

 

First, his holding that the claims based on CMOs were precluded from coverage under the Brookstreet policy’s exclusion for derivatives claims is a reminder that the way insurance policies respond to many of the current claims based on complex financial instruments could involve a host of complicated insurance issues.

 

Although the exclusion that the CMO claims triggered in the Brookstreet case is peculiar to the specific type of insurance policy involved in that case, similar questions could arise under other policies in connection with other claims relating to complex investment securities and other financial instruments.

 

Many of the types of recurring claims asserted in the current litigation wave (e.g., the auction rate securities suits and the Madoff feeder fund lawsuits) present allegations of the type for which professional liability policies like that involved in the Brookstreet case were designed to respond. However, as the Brookstreet case shows, there potentially could be a host of complex coverage issues associated with many of these claims, depending on the facts alleged and the specific policy language involved.

 

Second, Judge Carey’s ruling on the interrelatedness issue is a reminder of how difficult interrelatedness questions can be. The term "interrelated" is neither defined in the typical policy nor is it self-defining. At a certain level of generalization, everything in the universe is interrelated, and at the same time, at another level, nothing is interrelated. What makes something interrelated for insurance coverage purposes can become quite situational and subjective, which leads many judges, like Judge Carney here, to want to leave interrelatedness questions to the jury.

 

Many of the cases in the subprime and credit crisis litigation wave present interrelatedness questions. Different complaints against the same or similar defendants in different policy periods raise the question whether one or several policies have been triggered. Judge Carney’s ruling in this case shows how difficult it may be for carriers seeking to rely on interrelatedness arguments. My own experience, consistent with Judge Carney’s ruling, is that courts tend to resolve interrelatedness questions in a way that maximizes the amount of insurance available.

 

Finally, Judge Carney’s rulings on the claims made and late notice issues are largely unremarkable, except as pertains to the question of the timeliness of notice for notices provided within the policy period but beyond the 30-day notice period. Judge Carney strictly enforced the policy’s 30-day notice requirement, and declined to even consider arguments based on the absence of prejudice.

 

Judge Carney’s literal enforcement of the notice requirement is is particularly noteworthy in that his ruling operated to preclude coverage for the claims of claimants where were in no way themselves involved with or responsible for the late provision of notice. ‘

 

In any event, Judge Carney’s rulings present an interesting case study. Special thanks to a loyal reader for providing me with copies of Judge Carney’s rulings.

 

With the United Nations Climate Change Conference set to begin December 7, 2009 in Copenhagen, activists and observers are dialing up the volume both with calls for reform and with updated reports of the projected risks that global warming threatens. Among the long-standing initiatives advocates are now seeking to advance is the petition before the SEC calling for the adoption of climate change disclosure requirements.

 

These renewed calls for disclosure reform, as well as the release of additional data regarding insurance industry exposure to climate change, are clearly intended to coincide with the upcoming UN conference. One question, however, is how much recent email revelations of climate change researchers’ practices will affect the current dialog.

 

First, with respect to climate change disclosures, on November 23, 2009, a coalition of twenty public pension funds, public officials and environmental groups filed a "Supplemental Petition on Interpretive Guidance" (here) renewing their call for the SEC to "act promptly to clarify that existing disclosure requirements apply to climate change." Background regarding the group’s initial September 2007 petition can be found here.

 

As described in their November 23, 2009 press release (here), the group has renewed its call for climate change disclosure reform because of the "spate of recent regulatory, legislative and scientific developments – including the Environmental Protection Agency’s new mandatory greenhouse gas reporting rule – and the new economic opportunities that dramatically change the landscape of corporate climate change disclosure."

 

In a separate development, a November 23, 2009 report issued jointly by Allianz and the World Wildlife Fund entitled "Major Tipping Point in the Earth’s Climate System and Consequences for the Insurance Sector" (here) asserts that rising sea levels due to global warming could put trillion of dollars of U.S. assets at risk. Among other things, the report states that the planet’s atmosphere is close to dangerous atmospheric thresholds or "tipping points" that could cause dire environmental and economic consequences. The World Wildlife Fund’s November 23, 2009 press release regarding the report can be found here.

 

In addition to rising sea levels, the report also cites three additional "tipping points" that likely to have an impact: an increasingly arid climate in California; disturbances in the summer monsoon in India and Nepal; and reduction to the Amazon rainforest due to drought.

 

At the same time, the upcoming Copenhagen conference is clearly creating pressure for governmental action, as suggested by the announcements last week that both Chinese and U.S. officials will arrive at the conference with various country-level carbon emissions goals (as discussed here).

 

This same pressure could increase the likelihood of implementation of reforms such as the proposed climate change disclosure requirements, as these types of initiatives afford governmental officials the opportunity to show they are taking actions without at the same time requiring theme to address proposals that could directly affect economic activity or that could prove politically more controversial.

 

However, one wild card that has been played in the midst of all of these developments is the recent revelation of email communications amongst climate change researchers. These emails have been portrayed as suggesting that the researchers manipulated data to support their findings of climate change and that they suppressed contrary points of view. The question arises of how much these disclosures will undermine the perception of trustworthiness of the scientific conclusions on which so much of the current dialog is premised.

 

One example of the way in which the email revelations can affect perceptions is the joint Allianz/WWF report described above. Two of the three individual authors of the report are affiliated with the Tyndall Centre for Climate Change at the University of East Anglia, which is the institution form which the hacked emails were obtained. While the report’s authors’ affiliations would hardly have occasioned comment previously, now these institutional associations will inevitably raise the question whether the report and its conclusions reflect trustworthy and objective scientific analysis, or something else.

 

Climate change skeptics and reform opponents are already attempting to seize on the email disclosures to try to suggest that, due to the damage to the perception of trustworthiness of the climate change science, reform initiatives are doomed.

 

There is no doubt that the email disclosures have affected the dialog. At the same time, events such as the upcoming Copenhagen conference carry their own inertial dynamic. President Obama’s commitment to address the conference certainly will reinforce this dynamic. In this context, reform initiatives, such as the proposed climate change disclosure application, could acquire a certain inevitability. That is certainly the hope of the initiative’s proponents.

 

The prospect for increased climate change-related disclosure requirements, and the continuing agitation of climate change activists, will put increased pressure on public companies to address climate change issues in their public filings. As I recently noted (here), investor interest in climate change-related disclosures, along with the effects of voluntary initiatives (such as the NAIC’s climate change disclosure project, about which refer here), may separately create their own independent pressures for corporate climate change disclosures.

 

As these disclosure expectations become more generalized, the possibility of investor litigation relating to climate change disclosure also increases. As I recently noted (here), litigation developments in other areas of the law have moved the possibility of climate change-related disclosure litigation one step closer.

 

Bankruptcy cases filed in the U.S. federal courts continued to surge in the twelve months ended September 30, 2009, according to statistics released on November 25, 2009 by the Administrative Office of the U.S. Courts. The statistical release, which can be found here, shows that for year ending on September 30, 2009, there were 58,771 business bankruptcy filings, up 52 percent from the 38,651 business filings in the 12-month period ending September 30, 2008.

 

Data accompanying the release show that the number of filings has increased in the 12-month periods preceding the quarter end for each quarter since the end of the third quarter of 2006.

 

Though the twelve-month data show a rising number of bankruptcy filings, the quarterly data for the most recent quarter show a slightly different picture, suggesting that the number of bankruptcy filings may have peaked earlier this year, and that during the most recent months the number of business-related bankruptcy filings may even have begun to decline slightly, at least from their 2009 year-to-date highs.

 

Thus, according to the Administrative Office’s monthly filing data (which can be found here), there were 15,177 business-related bankruptcies in the third quarter of 2009, compared to 16,098 during 2Q08, which represents a third quarter filing decline of about 5.7%. The highest monthly total during 2009 was in April 2009, when there were 5,621 business-related bankruptcy filings, compared to 4,853 in September 2009.

 

But while the 3Q09 business filings were down slightly from the preceding quarter, the third quarter filings nonetheless remained at very high levels. Thus, by way of comparison, the third quarter business bankruptcy filing total of 15,177 filings is considerably higher than the quarterly totals in 4Q08, when there were 13,021 filings, and in 1Q04, when there were 14,425 filings.

 

Whether or not bankruptcy filing peaked earlier this year, the number of bankruptcy filings remains significant. The possibility of bankruptcy remains a significant threat for financially troubled businesses. As I have previously noted (here), among the events that often follows after the filing of a bankruptcy petition is the arrival of claims against the bankrupt firm’s directors and officers.

 

Bankruptcy associated-claims present a host of complications, not least of which is the intricate way that D&O insurance policies respond in the bankruptcy context. One recent development illustrating the difficulties that can arise in the bankruptcy context was the July 2009 decision in the Visitalk case (about which refer here), in which the Ninth Circuit upheld the carriers’ denial of coverage for a lawsuit brought by a company as debtor in possession against former directors and officers of the company, as a result of the policies’ insured vs. insured exclusion.

 

These kinds of complications underscore the need for D&O insurance policies to be closely scrutinized for their ability both to withstand and to respond to claims arising in the context of bankruptcy.

 

Hat tip to the SOX First blog (here) for the link to the bankruptcy statistics.

 

More About FCPA Enforcement and Pharmaceutical Companies: As I recently noted (here, scroll down), both the DoJ and the SEC have indicated that Foreign Corrupt Practices Act enforcement has a high priority and that FCPA enforcement in the pharmaceutical industry is a particular focus.

 

A November 24, 2009 memo from the Latham & Watkins law firm entitled "U.S. Department of Justice Announces Stepped-Up Criminal Enforcement of Foreign Corrupt Practices Act Against Pharmaceutical Industry" (here) takes a closer look at these prosecutorial priorities.

 

The memorandum explains that among other reasons for the new focus on pharmaceutical companies is that "many foreign health systems, are regulated, operated and financed by government entities, and competition is intense, which creates more opportunities to ‘pay off foreign officials for the sake of profit.’" Of particular concern is the fact that it may not always be obvious which medical functionaries are "foreign officials" within the meaning of the FCPA.

 

The article includes a variety of suggested practical steps that pharmaceutical companies can take in light of these concerns.

 

Special thanks to Adam Savett of the Securities Litigation Watch for providing a copy of the law firm memo.

 

The FDIC’s latest Quarterly Banking Profile (here) shows that as of September 30, 2009, the country’s commercial banks are continuing to struggle, and that as a result of the banks’ woes the FDIC’s Deposit Insurance Fund (DIF) is $8.2 billion in the red. The rising numbers of "problem" institutions suggests both that the number of failed banks could continue to grow and that the DIF could remain under pressure – although as discussed below, the DIF situation may not be quite as dire as the headline details might otherwise suggest.

 

The FDIC report states that the number of banks on the FDIC’s "problem" institution list rose during the third quarter to 552 from 416 at the end of 2Q09, and that the total assets of "problem" institutions increased from $299.8 billion to $345.9 billion. If assets at "problem" institutions of a third of a trillion dollars sound bad, that’s because it is. The FDIC reports that both the numbers and assets of "problem" institutions are "now at the highest level since the end of 1993."

 

The FDIC defines "problem" institutions as "those with financial, operational or managerial weaknesses that threaten their continued financial viability." To be classified as a "problem," an institution would have to be ranked as either a "4" or a "5" on the FDIC’s "scale of 1 to 5 in ascending order of supervisory concern." The FDIC does not provide the names of the "problem" institutions, nor does it specify how many of them are rated "4" and how many are rated "5."

 

To put the number (552) and assets ($345.9 billion) of the third quarter-end "problem" institutions into some perspective, there were "only" 171 "problem" institutions as of the end of 3Q08. In twelve months, the number of "problem" institutions more than tripled, and the assets at "problem" institutions more than doubled.

 

Along with the growing numbers of "problem" institutions have come an escalating number of bank failures. During the third quarter of 2009, "fifty insured institutions with combined assets of $68.8 billion failed," which represents "the largest number [of bank failures] since the second quarter of 1990 when 65 insured institutions failed." As of the September 30, 2009, 95 banks had failed, and as of November 20, 2009, the 2009 YTD total number of bank failures stood at 124.

 

This wave of bank failures has taken its toll on the Deposit Insurance Fund (DIF). During the third quarter, the DIF decreased by $18.6 billion, to negative $8.2 billion, "primarily because of $21.7 billion in additional provision for bank failures."

 

Although these DIF figures sound disastrous, there is more to the story than just the reported negative figure. The FDIC’s November 24, 2009 press release accompanying the report (here) explains that the negative balance reflects a $38.9 billion "contingent loss reserve that has been set aside to cover estimated losses over the next year." In addition, the DIF balance is not the same as the FDIC’s cash resources, which stood at $23.2 billion as of the end of the third quarter.

 

To further bolster the FDIC’s cash position, on November 12, 2009, the FDIC’s board voted to required insured institutions to prepay three years’ of deposit insurance premiums – worth about $45 billion – at the end of 2009. The press release on the prepayment assessment can be found here.

 

With the increase in the number of "problem" institutions and the obvious relationship between rising numbers of "problems and the likely number of future bank failures, signs are that we could continue to see significant numbers of bank failures as we head into 2010. While I still don’t think we are going to see 1,000 failed banks by the end of 2010, we are clearly going to be seeing a lot more failed banks.

 

As bad as all of this is, the Quarterly Banking Profile hints at the possibility that all of the bad news might not even be out in the open yet. Among any other details, the Quarterly Banking Profile also reports that "growth in [loan loss] reserved continued to lag the rise in noncurrent loans, and the industry’s ratio of reserves to noncurrent loans declined for a 14th quarter, from 63.6 percent to 60 percent."

 

In terms of what all of this means for the economy, perhaps the most significant detail in the document is its report that "loan balances declined by the largest percentage since quarterly reporting began in 1984." The FDIC’s press release quotes FDIC Chairman Sheila Bair as saying that "there is no question that credit availability is an important issue for economic recovery. We need to see banks making more loans to their business customers."

 

Europeans Worried About Proposed U.S. Investor Protection Law: According to a November 23, 2009 Financial Times article (here), the European Commission is worried about legislation currently before Congress that would specify the circumstances under which investors could sue foreign domiciled companies in U.S. courts.

 

As I discussed in a prior post (here), Section 215 the Investor Protection Act of 2009 is addressed to "Extraterritorial Jurisdiction" which would amend the ’33 Act, the ’34 Act and the Investment Advisors Act of 1940 to specify that U.S. courts could properly exercise jurisdiction in any action involving "conduct with the United States that constitutes significant steps in furtherance of violation, even if the securities transaction occurs outside the United States and involves only foreign investors," as well "conduct outside the United States that has a foreseeable substantial effect in the United States."

 

Under the first of these two prongs, U.S. based conduct alone would be sufficient jurisdictional basis, even with respect to foreign purchasers of who purchased their shares of foreign-domiciled companies on foreign exchanges (so-called "f-cubed claimants").

 

The article quotes the former director of litigation for Bank of America as saying that "if this legislation passes, there will be greater opportunity for foreign companies to be hauled into U.S. courts." The article also reports that Charlie McCreevy, the European Union Commission for Internal Markets as having "expressed concern over the measure."

 

All-Time Worst E-Mail Faux Pas?: The title of the Clusterstock’s post (here) pretty much says it all: "Cornell Business School Employees Accidentally Email Everyone with Their Dirty Email Love Notes." Clusterstock observes that the "this might set some kind of record for the worst email mistake anyone has ever made."

 

Due to the family-oriented nature of this blog, The D&O Diary will not reproduce any examples of the couple’s inadvertently forwarded emails.

 

The good news is that the two employees involved are married. The bad news is that they are not married to each other.

 

One of the more interesting securities class action lawsuit filing patterns that has developed as 2009 has progressed is the number of securities suits that have been filed long after the end of the purported class period cut-off date, as I have previously noted here. A November 21, 2009 National Law Journal article entitled "Securities Fraud Suits Resurface" (here, registration required) examines these patterns and reports that as plaintiffs’ lawyers turn away from credit crisis-related cases and turn back to "traditional securities suits," the plaintiffs are "slapping public companies with securities class actions months or years after the fraud came to light."

 

According to the article, eight of the 23 securities class actions filed against public companies in October and November 2009 "define the class as investors who bought or acquired the company’s stock during some time between 2006 and the first half of 2009." My prior posts (here and here) demonstrate that this pattern of filings with the class period cut-off date well in the past emerged well before October.

 

The article attributes a statement to Sam Rudman of the Coughlin Stoia law firm to the effect that "he’s working through a backlog of potential targets." The explanation for the backlog is that "lawsuits related to subprime mortgages and financial instruments consumed much of Coughlin Stoia’s energy in recent months," but the new subprime and credit crisis-related filings are "waning." The article quotes Rudman as saying about the subprime and credit crisis cases that "we’re busy litigating cases, but not a lot of new ones are being started," so now the firm is looking at cases "we kind of backburnered for two years."

 

As a result, the firm is "putting many prior stock drops under the microscope before the statute of limitations runs out." Rudman is quoted as saying about the number of cases the firm is looking at, "my list is long."

 

As I noted in my prior posts about the backlog, the plaintiffs’ efforts to work off the backlog poses a challenge for D&O underwriters, because it means that companies with long distant stock price drops could still find themselves involved with securities litigation long after the event. As a result, it is hard for underwriters to be sure when a company is "out of the woods."

 

Another consideration as the backlog cases come in is that the new cases are more broadly distributed across the economy than was true for the filings during at least the last couple of years. Since mid-2007, the new lawsuits have largely been concentrated in the financial sector. But in the second half of 2009, there have been fewer cases against financial companies and the cases that have been filed have hit a much broader variety of industries, as I recently noted in detail here. This filing shift may require a recalibration of risk distribution and, consequently, risk selection.

 

Lawyers tell me that these older cases pose a problem for the companies too. The target companies may have new management that is unfamiliar with the events that gave rise to the prior stock price drop. The company may also be involved in M&A activities, and the overhang of a past stock price drop can, for example, present an uncertainty to an acquirer.

 

One challenge plaintiffs may face with these lawsuits is that in some cases they brush right up against the applicable statute of limitations for securities fraud suits, as was the case with the new lawsuit filed on October 28, 2009 against Pitney Bowes, where the suit was filed one day short of the two-year statute of limitations (as I discuss further here, scroll down).

 

Some of these recent cases have even been filed seemingly after the statute of limitations period has passed, as Adam Savett noted on his Securities Litigation Watch blog (here), with respect to the complaint against Avanir Pharmaceuticals, which was filed three years after the proposed class period cut-off date.

 

There’s delayed, and then there’s stale. In at least a few instances, these cases are being offered up after the sell-by date.

 

Arkansas Securities Plaintiff Attorney Sentenced: Readers may recall the courtroom drama earlier this year when Arkansas-based securities class action attorney Gene Cauley took the Fifth in response to questions from Southern District of New York Judge Jed Rakoff about $9.3 million missing from the funds escrowed in connection with the settlement of the Bisys Group securities class action lawsuit. Shortly thereafter, Cauley agreed to plead guilty to wire fraud and criminal contempt for misappropriating the escrowed funds.

 

Today, Cauley was sentenced to 86 months in prison, and ordered to pay $8.8 million in restitution, in addition to the $500,000 he previously paid, as reported here on the WSJ.com Law Blog.

 

An earlier WSJ.com Law Blog post reported (here) that Cauley was in fact a protégé of Bill Lerach. Today’s article on Bloomberg (here) about Cauley’s criminal sentencing notes that Cauley joins a growing list of plaintiffs’ securities class action attorneys who have "been jailed for felonies," including Bill Lerach himself and his former law partners, Mel Weiss, Steven Schulman and David Bershad, and including even Marc Dreier.

 

These gentlemen of course made their living for many years accusing corporate officials of fraud. Ahem. Yes, well…isn’t ironic, don’t you think?

 

Welcome: The D&O Diary would like to welcome the latest new addition to the blogosphere, the CyberInquirer blog. The blog is maintained by Rick Bortnick and Pam Pengelley of the Cozen O’Conner firm and is devoted to "news and views on recent developments in Cyber Law and Insurance." The blog looks promising and looks like a great new source of new and information about insurance and law issues relating to Cyberspace. I look forward to following future posts and wish the site’s authors great success. They appear to be off to a great start.

 

Speaker’s Corner: Next week, I will be co-Chairing the American Conference Institute’s 15th Annual Advanced Forum on D&O Liability in New York. The faculty for this event includes an all-star cast of insurance industry professionals and leading attorneys. The conference will be held on November 30 and December 1, 2009 at The Carlton Hotel in New York. The event website can be found here and the agenda, including a complete list of speakers and topics, can be found here.