On November 20, 2009, Ohio Attorney General Richard Cordray announced (here) the filing of a lawsuit in the Southern District of Ohio on behalf of five Ohio pension funds against Standard & Poor’s, Moody’s and Fitch. According to his press release, the complaint, which can be found here, charges the rating agencies with "wreaking havoc on U.S. financial markets by providing unjustified and inflated ratings of mortgage-backed securities in exchanged for lucrative fees from securities issuers."

 

During the period January 1, 2005 through July 8, 2008, the plaintiff pension funds purchased a variety of asset-backed securities all of which had "false and misleading" ratings of AAA or equivalent. The complaint alleges that while the ratings purportedly were objective and independent, "in truth, the Rating Agencies subverted those principles and negligently provided unjustified and inflated ratings in exchange for the lucrative fees the ABS issuers paid the Defendants for not only rating the securities but also for helping to structure them."

 

The complaint makes liberal use of the rating agencies’ internal communications that the SEC disclosed following its own investigation of the firms, and also quote extensively from the SEC’s investigation report (about which refer here).

 

The complaint asserts that "when the housing and credit markets collapsed, the flaws in the Defendants’ AAA ratings gradually became clear." The value of the pension funds’ investments "dropped precipitously" which, the complaint alleges, caused the funds to lose over $457 million, as "these purportedly safe investments became obvious for what they were – high risk securities that both the issuers and the Rating Agencies knew to be little more than a house of cards." The complaint asserts claims for relief under the Ohio Securities Act and for negligent misrepresentation.

 

The Ohio action follow the similar action that Calpers filed in July 2009 against the rating agencies, as discussed here.

 

As I have previously discussed on this blog, the rating agencies have proven to be a popular target for investors angry about losses they sustained on mortgage-backed securities and other investments following the subprime meltdown. But as I have also previously noted, these investor actions could face significant hurdles, particularly with respect to the rating agencies’ constitutional defenses. Significant case law supports the rating agencies’ position that their ratings opinions are protected by the first amendment.

 

In attempting to overcome these arguments, the Ohio funds will undoubtedly seek to rely on Judge Shira Scheindlin’s September 2009 opinion in the Cheyne Financial case, in which she rejected the rating agencies’ argument that their rating opinions were entitled to immunity under the First Amendment.

 

But as I noted in my prior post discussing Judge Scheindlin’s opinion, the extent to which these plaintiffs will be able to rely on her opinion may be limited. First, as a district court opinion, it will be of at most persuasive but not precedential value. Moreover, Judge Scheindlin’s conclusions were made in the context of an action made under New York’s fraud laws, which may or may not be relevant to an action under Ohio’s laws.

 

In addition, Judge Scheindlin’s ruling in the case was limited by its own terms. In disallowing the first amendment defense, she said "where a rating agency has disseminated their ratings to a select group of investors rather than to the public at large, the rating agency is note afforded the same protection." To the extent the ratings the Ohio funds’ allege to be misleading were not made to a select group of investors, as was the case with respect to the investments involved in the Cheyne Financial case, Judge Scheindlin’s ruling arguably may not be relevant.

 

But despite the obstacles, Cordray appears enthusiastic about the case. In fact, he seems to have decided in general that he can extract significant political value by pursing securities litigation. On November 20, 2009, he wrote on his blog, Speak Out Ohio, that "my office is aggressively pursuing Wall Street corporations and executives that harm investors here in Ohio and around the world." (Yes, the Ohio Attorney General has a blog. Doesn’t everybody?) Among other things, he also references in his blog post the recent $400 million settlement in the Marsh contingent commission securities class action lawsuit, in which his office participated.

 

Just to underscore how enthusiastic he is about pursing securities class action litigation, Cordray also separately published on November 20, 2009 a detailed report of the securities class action lawsuits his offices has pursued or is pursuing.

 

The political value that Cordray thinks he can gain by initiating securities litigation may be discerned from the tenor and tone of some of his remarks in his blog. For example, with respect to the rating agency lawsuit, he says that:

 

This case goes to the heart of what’s wrong with Wall Street today. Ohio workers—including our families, friends and neighbors – work hard to create wealth in our economy. Then Wall Street corporations and executives manipulate that wealth, for their benefit, and they do so with total disregard for our life’s work and the importance of our retirement savings. Ordinary people throughout Ohio are hurt by this kind of misconduct. And we won’t stand for it.

 

If you are wondering whether Cordray’s litigation endeavors are producing their intended results (that is, by generating favorable publicity for Cordray, who clearly has higher political aspirations), you will be interested to know that the filing of the rating agency lawsuit made the front page of the business section of Saturday’s Cleveland Plain Dealer. Since the only thing in Cleveland worse than the Cleveland Browns is the Cleveland economy, the paper’s business section is actually widely read, for same morbid reasons that people gawk at traffic accidents.

 

Ben Hallman of the Am Law Litigation Daily has an interesting November 20, 2009 profile of Cordray and of the ratings agency case here. Among other things, Hallman notes that Cordray is a former five-time undefeated Jeopardy! champ. Hallman also (correctly, in my view) notes that Cordray is "making a strong bid to be the Midwest’s answer to Andrew Cuomo."

 

On the Other Hand, Securities Litigation Could Also a Scam Worse Than Bernie Madoff’s: While Cordray is convinced that he is helping to protect the little guy by pursuing securities suits against Wall Street, Lawrence W. Schonbrun, the executive director of Class Action Litigation Watch, asserts that securities class action litigation is "a financial rip-off worse than Bernie Madoff."

 

In a November 21, 2009 editorial in The Buffalo News (here), Schonbrun takes on the plaintiffs’ securities class action bar, asserting that class action securities litigation is "skimming hundreds of millions of dollars from investors in U.S. corporations." Using Judge Rakoff’s rejection of the SEC’s settlement of the BofA/Merrill Lynch bonus action as a starting point, Schonbrun argues that:

 

In a typical year, more than 200 securities class action lawsuits are filed against American companies, with an average settlement of more than $100 million each; that adds up to a staggering $20 billion a year! Over nearly 40 years, that means that the system has drained upward of $800 billion of shareholder wealth, not just from people who directly trade securities but from all Americans who own mutual funds, or have pension funds or other types of investments. Kind of dwarfs Madoff’s $65 billion, doesn’t it?

 

Schonbrun is rather obviously playing fast and lose with the numbers, since there has never yet been even one year when class action lawsuits settlements average $100 million, and there certainly have not be 40 years’ worth of average settlements of $100 million.

 

But his rant does raise an interesting question, which is — who is actually helped and who is actually hurt by the class action lawsuits? It is true that when class action settlements are funded in whole or in part by defendant corporations, it is shareholders that are hurt. As Schonbrun points out, among the most significant shareholders are the very kinds of pension funds on whose behalf Cordray is busy filing lawsuits. Schonbrun’s intemperate screed didn’t quite get there, but there is a very interesting question about whether the kinds of lawsuits Cordray is busy congratulating himself for filing (at least to the extent they are filed against publicly traded companies, as opposed to the rating agencies) actually benefit the pension funds over the long haul.

 

So here’s my idea: Let’s have a public debate between Cordray and Schonbrun. Call it "Class Action Smackdown" or something like that. To enhance the entertainment value, the rules of engagement could specify (drawing on Cordray’s Jeopardy! experience) all of the contestants’ statements would have to be expressed in the form of a question. That could be quite a spectacle.

 

And Speaking of Class Action Litigation: Meanwhile, back at the Southern District of New York courthouse, the Vivendi securities class action lawsuit trial is now in its sixth week. The trial disappeared from the radar screen for a while, but it was back in the news again this week, as former Vivendi CEO Jean-Marie Messier took the stand.

 

According to news reports, he told the jury that he might have made mistakes but her never misled shareholders. The AP newswire story quotes him as saying "Some of my management decisions turned out wrong, but fraud? No. Never. Never. Never." According to the AmLaw Litigation Daily account of his testimony, Messier also called the allegations in the case "blatant lies, infamous lies." Messier’s testimony reportedly will continue for several days.

 

And Speaking of Liability Exposures: I have been involved with D&O claims, one way or another, for well over 25 years. After such a long period observing the havoc of lawsuits against directors and officers, I never ceased to be amazed by corporate officials who are convinced they don’t need management liability insurance. To me, that attitude as foolhardy and dangerous as that of the soldier who is convinced he doesn’t need a helmet because he is sure that he is never going to get hit.

 

One product I have been particularly surprised that corporate officials often must be convinced they need is Fiduciary Liability Insurance. This insurance, which is quite inexpensive given the extent of the protection it affords, is designed to protect plan fiduciaries against claims by employee plan participants or beneficiaries that the fiduciaries breached their duties.

 

On November 19, 2009, CFO.com had a particularly good article entitled "Fiduciary Liabilities: Are you Covered?" (here) which describes Fiduciary Liability Insurance and explains why it is an indispensible part of every company’s insurance program. I commend the article for anyone involved in advising companies about their management liability insurance.

 

And Finally: So which country do you think has the most English speakers, India or China? You might might be tempted to say India. But you would be wrong. Correct answer? China. I guess if you start with a billion people, having the most of anything is a lot simpler.

 

Pop quiz: the law of which jurisdiction should govern a coverage dispute arising under D&O insurance policies issued by U.S-domiciled insurers to an NYSE company incorporated in Delaware with its headquarters in Oregon? If you find the answer "British Columbia" as surprising as I do, read on. The court decision discussed below could have important implications for the typical U.S. D&O policy, with its extension of "worldwide coverage," particularly as both commerce and litigation become increasingly global.

 

Background

Now-bankrupt forest products company Pope and Talbot, Inc. was incorporated in Delaware and had its corporate headquarters in Portland, Oregon. Until its bankruptcy, its shares traded on the NYSE. Pope and Talbot conducted business through several operating subsidiaries, the largest of which was P&T Ltd., a Canadian federally chartered company with its principal operations in British Columbia. The bulk of Pope and Talbot’s operations ran through P&T Ltd. and the bulk of Pope and Talbot’s employees were employed by P&T Ltd.

 

P&T Ltd. is now in receivership. PricewaterhouseCoopers is the receiver for P&T Ltd. PWC, in its role as receiver, has instituted an action in British Columbia seeking a judicial declaration of coverage under the parent company’s D&O insurance policies for claims against P&T Ltd.’s directors and officers brought by former P&T Ltd employees under the Canadian Business Corporations Act for unpaid wages.

 

Pope and Talbot’s D&O insurance program was structured in several layers, involving three U.S. domiciled insurers. The negotiation and placement of the policies took place in the United States.

 

In a prior ruling, British Columbia Supreme Court Justice Paul Walker determined that the British Columbia court had jurisdiction over PWC’s declaratory judgment action. The insurers then sought a declaration that Oregon law would govern the dispute.

 

The November 12 Opinion

In his November 12, 2009 decision (here), Justice Walker determined that British Columbia law is the proper law to be applied to the interpretation of the policy.

 

He began with the determination that the parties intended different laws to apply to different parts of the policy (a choice of law principle known as dépeçage). In reaching this conclusion, Justice Walker referenced several different parts of the policies at issue, including in particular the primary policy’s definition of "Loss," which contained a provision specifying that the policy’s coverage for punitive and exemplary damages would be determined under the law most favorable to the insured. Justice Walker also referenced the policy’s Oregon state amendatory endorsements, which specified that Oregon law would govern any disputes regarding alleged misrepresentations in the insurance application.

 

Justice Walker determined that given these clause-specific choice of law provisions, and given the absence from the policies of any general choice of law provisions, the "proper law" governing the disputes arising under other policy provisions "is left to be determined by the court hearing the dispute to find based on the application of its own laws, taking into account the directing language in the policies."

 

Reviewing these circumstances in this light, and discounting the policies’ various connection to jurisdictions in the United States, and applying British Columbia choice of law principles, Justice Walker concluded that "the policies have the closest and most substantial connection with BC," and therefore BC law governs the coverage dispute presented by the receiver.

 

In substantiating this decision, Justice Walker stated that given the importance of the Canadian subsidiary, "most of the claims could be expected to arise from Canadian operations," and he stressed that the P&T Ltd. employees’ wage claims are "unique to Canadian operations" and have "no equivalent in Oregon," as a result of which Justice Walker concluded that "the proper law of the policies to determine the carriers’ coverage obligations for these claims is BC law."

 

He added that the parties "would reasonably have expected BC law to apply to determine the insurers’ coverage obligations."

 

Discussion

Suffice it to say that I have concerns with Judge Walker’s analysis. He managed to blow right past the fact that all of the acts involved with the formation of the insurance contracts took place in the U.S. and that insurance contracts were formed between a U.S.-domiciled company and U.S.-domiciled insurers, and that the key risks insured against and for which the policy was purchased were U.S.-based.

 

Justice Walker simply jumps to the conclusion that given the size of the P&T Ltd’s operations, the insurance contracts were primarily designed to protect against Canadian exposures. However, the company that purchased the policy was the parent company, a U.S.-domiciled company whose shares traded on a U.S. securities exchange. Is there any possible doubt that the most important reason the company bought the policy – and the reason the policies cost so much in U.S. currency – is because the company and its directors and officers wanted protection against corporate litigation in U.S. courts under U.S. law?

 

Of course the policies do provide "worldwide coverage" and, yes, of course substantive local law governs the local claims wherever the claims might arise. But Justice Walker seems to have telescoped the primacy of local law regarding the underlying dispute into a determination that local law should govern questions of policy interpretation, which analytically are two completely different issues.

 

All of that said, there are a couple of points in Justice Walker’s analysis that do give me pause. In particular, the considerations on which he relied in concluding that principles of dépeçage control the choice of law issue are by no means far-fetched. His consideration of the "law of the most favorable venue" wording in the provisions relating to coverage for punitive and exemplary damages is interesting and raises issues I had not previously considered. He may have a point that this language could be interpreted to suggest that the parties intended the laws of different jurisdictions to apply to different parts of the policy.

 

Where his analysis goes off track, in my view, is having found that different jurisdictions’ laws may apply to different policy provisions, he concluded both that BC choice of law principles should determine which law should apply, and he applied these BC choice of law principles in a blunderbuss way to conclude that BC law governed interpretation of the policy (see, e.g., his assertion that the likeliest claims to arise under the policies were Canadian claims.)

 

But the most significant aspect of Justice Walker’s decision is the unmistakable message that if a policy provides "worldwide coverage," the policy not only applies to claims wherever they may arise, but courts in those far flung jurisdictions may push ahead and apply their own local laws to questions of coverage relating to the local claim.

 

In the increasingly global economy, many businesses have significant operating subsidiaries in many countries. And as the rest of the world become increasingly litigious, too, the possibility of claims arising in these multifarious jurisdictions is increasingly likely. But while the U.S. D&O insurance industry has long noted the increasing possibility of claims arising outside of the U.S., I suspect it may come as a big surprise to many U.S. D&O insurers that local will law will not only govern the local claim itself, but the local court could also determine that local law governs questions of policy coverage for the local claim.

 

I have no idea what the insurance coverage laws are in vast smorgasbord of countries outside the U.S. Who knows what a court in, say, Vietnam or Slovakia or Gabon might conclude about a U.S-issued D&O insurance policy’s coverage for a local claim? I doubt that many domestic U.S. D&O insurers do either, and I suspect they have little interest in finding out.

 

On that score, it should be noted that Justice Walker repeatedly recognized the right of the parties to choose the law that would govern the interpretation of the policies, and it was only the absence of any such a provision that allowed him to conclude that BC law should govern.

 

All of which suggests to me that we may have reached the point where, at least from the carriers’ perspective, it may be time to for U.S.-based D&O insurers to consider the inclusion of a general choice of law clause in their policy. The inclusion of a choice of law clause would have the advantage of predictability and certainty, and it would spare the parties from a post-claim surprise discovery that, for example, the parties reasonably expected that BC law would govern the interpretation of these policies. (I am sure it was news to these carriers to learn that they had "expected" the interpretation of these polices to be governed by the law of British Columbia.)

 

Given the increasingly global nature both of commerce and of litigation, the inclusion of a choice of law clause arguably could be the reasonable next step in the evolution of the U.S. D&O insurance policy. Many international contracts in many contexts (including the insurance and reinsurance context) as a matter of course specify which jurisdiction’s law should govern the interpretation of the contract. Indeed, the typical D&O policy, with its "worldwide coverage" provision, really is itself an international contract, and to that extent it may be anomalous that U.S. D&O policies often do not have choice of law provisions.

 

Of course, were general choice of law clauses to be included in D&O insurance policies, the clauses would have to be carefully coordinated with other policy provisions, including in particular the most favorable venue wording relating to coverage for punitive and exemplary damages.

 

I recognize that both my analysis of Justice Walker’s opinion and my suggestions about the inclusion of choice of law language in U.S. D&O insurance policies could be controversial. I can well imagine D&O professionals who advocate for policyholders arguing that the local law ought to govern policy coverage issues. I can also imagine some insurance professionals objecting that whatever benefit a choice of law clause might produce in the international context, it might produce some unexpected and even unwanted results in the domestic context.

 

I am very interested in readers’ views, particularly those who may have a perspective different than mine regarding Justice Walker’s opinion and also with respect to my suggestions about choice of law provisions.

 

Very special thanks to loyal D&O Diary reader Raymond Sieh, whom I just met for the first time at last week’s PLUS International Conference, for providing me with a copy of the opinion.

 

Beginning with the corporate scandals earlier in this decade and continuing with the more recent financial meltdown and Ponzi scheme revelations, these has been a widespread push toward corporate governance reform. In some European countries, these developments have been accompanied by the implementation of mechanisms to provide some form of relief to the victims of corporate misconduct.

 

These legal trends have in turn had a significant impact on the European D&O insurance marketplace, as discussed at length in the November 2009 Advisen report entitled "European D&O Insurance Market to Benefit from Governance and Legal Reforms" (here, $ required).

 

As discussed in the report, Europe has had its own share of accounting scandals, as a result of which "governments across Europe have passed laws requiring new disclosures, enhanced shareholder protections, and greater transparency." There have also been actual or proposed changes to litigation procedures, many of which represent moves toward the development of various forms of collective action. Though the progression of these changes varies by country, the "clear trend" is toward a "more collective-friendly civil legal system"

 

As a result of these developments (both the scandals and the legal reform), "the number of shareholder suits filed in European courts is substantially up."

 

In discussing this European litigation, the report uses its own terminology, and in particular, the report (apparently – the report does not expressly define the term as used in connection with the European litigation) uses the expression "securities suits" to describe both actions initiated by private litigants as well as regulatory enforcement actions.

 

With this specific use of the phrase "securities suits," the report states that since 2005, "32 large securities suits were filed in European courts against European companies." (The report does not specify what is meant by "large.") Of these 32 "large securities suits," 18 were filed in the first half of 2009 alone. In addition, of the 32, 29 were collective action suits. For cases settled since 2005, the average settlement per case was a "staggering" 117 euros ($155 million).

 

In addition, European companies have become increasingly susceptible to "securities suits," as the report uses that term, in U.S. courts as well. Claims against European companies doing business in the U.S., particularly those whose shares trade on U.S. securities exchanges, have "mushroomed" in recent years. The number of "securities suits" against European companies increased from 10 in 2005 to 37 in 2008, and to 23 in the first half of 2009.

 

Many of these "securities suits" against European companies in U.S. courts hare securities class action lawsuits – of the 113 "securities suits" filed against European companies in U.S. courts since 2005 (through mid-2009), 54 are securities class action lawsuits. The remainder of "securities suits" apparently includes enforcement actions, individual lawsuits and derivative actions.

 

The average settlement of "securities suits" against European companies in U.S. courts during the period 2005 through mid-2009 is 55 million euros ($78 million).

 

These litigation developments have amplified the risks to corporate directors and officers, and according to the report have affected the perceived need for D&O insurance as well. Most large European companies carry some amount of D&O insurance, although the "perceived level of D&O insurance coverage need varies among countries." Many small to mid-sized European public companies do not purchase D&O insurance at all. This relatively low penetration, together with the changing legal environment that could encourage more companies to purchase D&O insurance, represents a "once-in-a-lifetime growth potential" for D&O insurers.

 

The report estimates that the European D&O insurance market represents 2008 written premium of 1.37 euros ($2.0 billion), up from about 1.01 billion euros ($1.25 billion) in 2004. By contrast, the Advisen report estimates, the 2008 U.S. D&O insurance marketplace was worth about $6.8 billion.

 

The European market has grown in recent years at a compound between 2004 and 2008 of about 7.9 percent, but due to improved product take-up rather than to rate increases. The report projects that the European D&O insurance market is likely to continue to grow, though the growth is likely to vary from country to country, commensurate with the countries’ changing levels of legal reform.

 

The report contains a detailed overview of the specific legal developments in the U.K., German, Netherlands, Italy and France, and also includes summaries of legal developments in Austria, Denmark, Finland, Norway, Spain, Sweden and Switzerland.

 

The report is interesting and timely, and provides a thorough overview of European legal developments and the way they will impact the European D&O insurance marketplace.

 

My prior post on the development of collective action procedures in Europe and the contrast of these procedures with the U.S. class action system can be found here. My previous discussion of current D&O insurance issues in Germany can be found here. The state of securities litigation exposures for directors and officers of Japanese and Canadian companies, respectively, can be found here and here.

 

One interesting thing about the most recently filed securities class action lawsuits is what they have in common – that is, that while the companies sued are drawn from a surprising diversity of industries, none of them are in the financial services sector. The absence of new securities suits against financially related companies is quite a contrast to the lawsuits that were being filed a year ago, and for that matter that were being filed in the first few months of 2009. There is an increasingly strong suggestion that after more than two and a half years, the subprime and credit crisis-related litigation wave may have finally just about played itself out.

 

The latest securities lawsuit is representative. That is, on November 17, 2009, plaintiffs’ lawyers announced (here) that they had filed a lawsuit in the District of Rhode Island against CVS Caremark and certain of its directors and offices. The complaint, which can be found here, alleges that the defendants failed to disclose operating problems the company was having in its pharmacy benefits management (PBM) business, which the company acquired in 2007. On November 5, 2009, the company disclosed (here) the PBM problems and also disclosed that the company was the subject of an FTC investigation into the company’s drug benefits practices.

 

Whatever else might be said about the new CVS lawsuit, the suit clearly was not filed against a financial services company and the allegations appear unrelated to the financial crisis.

 

The several new securities cases filed over the last two weeks share both these traits. That is, the defendant companies are outside the financial sector and the allegations generally do not appear to specifically relate to the global financial crisis.

 

A case in point is the lawsuit filed last week against The Boeing Corporation and certain of its directors and officers. The plaintiffs’ lawyers’ November 13, 2009 press release (here) describes the securities suit that was filed in the Northern District of Illinois. According to the press release, the complaint (which can be found here) alleges that the company misrepresented the production timeline and anticipated delivery dates of the company’s Dreamliner 787 commercial aircraft.

 

Similarly, on November 6, 2009, plaintiffs’ lawyer initiated a securities class action lawsuit against jewelry retailer Zale Corp. (about which refer here) alleging that the company had improperly recorded certain prepaid advertising expenses and intercompany accounts receivable.

 

Other examples include the November 10, 2009 action against Hemispherix Biopharma, (refer here) alleging misrepresentations in connection with the new drug application of one of the company’s clincal stage products; the action filed on November 6, 2009 against STEC, Inc.(refer here), the memory drive manufacturer, which is alleged to have overstated demand for one of its products; and the November 6, 2009 action filed against specialty women’s clothing retailer Limited Brands (refer here), which is alleged to have made misrepresentations regarding the company’s direct-to-consumer ecommerce initiative.

 

Again, none of these cases involve financial companies and none are directly related to the financial crisis.

 

To be sure, all along as the subprime and credit crisis litigation wave unfolded over the last two and a half (actually nearly three) years, there have been cases that didn’t involve financial companies and that were unrelated to the credit crisis. However, this recent collection of cases, particularly the absence of any financial related suits, seems to represent a categorically different filing pattern.

 

At the same time, there are still some cases being filed that unquestionably reflect back to the credit crisis. Indeed, late last week I noted (here) that a credit crisis-related lawsuit had been filed against VeraSun Energy. Even though the company itself is not financially related, the claims in the complaint relate to the company’s alleged problems arising from the company’s wrong way bets on certain financial derivative hedging contracts.

 

There undoubtedly are other cases yet to come like that filed against VeraSun, where the allegations reflect back on the events of the financial crisis – particularly, as was the case with the VeraSun filing, if the plaintiffs’ lawyers’ continue to file suits where the proposed class period cutoff date is well in the past, and accordingly the lawsuits involved long past events. As I noted in my post about VeraSun, those kinds of cases could continue to arrive for some time to come.

 

But while there could and likely will be further additional cases relating to or arising from the financial crisis, it seems increasingly likely that the mix of cases will be much more diverse that has been the case for almost three years now. This may entail some adjustment for D&O insurance underwriters, who have been very defensive against financial company risks, but much more agreeable to accepting other kinds of risks. The pattern over the last few weeks suggest that securities litigation risk may once again be dispersed across a wide variety of sectors and industries, and a more generalized underwriting approach to risk selection may be required going forward.

 

So What About Bernard Madoff’s Insurance?: If you are like me, you have probably wondered since the very beginning of the Madoff scandal what kind of insurance his firm carried. It turns out that, other than a bond, his firm didn’t carry professional liability insurance.

 

As reflected in Susan Sclafane’s November 17, 2009 National Underwriter article (here), Madoff apparently had for years refused to buy D&O insurance, and instead carried only a $25 million financial institutions bond because he was required to do so by participants in his legitimate clearing trade business. (The bond carrier, which reportedly was on the risk for 15 years, apparently has filed a rescission action.)

 

Not that the D&O insurance would have gone very far, even if there had been D&O insurance in place, in view of the massive scale of the losses. For that matter, given Madoff’s guilty plea, coverage for claims against Madoff or his firm would have been excluded under most D&O policies anyway.

 

Perhaps it was Madoff’s awareness that of the unlikelihood of coverage that convinced him not to squander his ill-gotten gains on insurance designed to protect his victims.

 

Special thanks to a loyal reader for providing the link to the National Undewriter article.

 

Today’s Grammar Question: Observant readers may have noticed that in discussing the recent securities filings I used the plural form of the verb "to be" in connection with my use of the noun, "none" – as in, "none of them are," rather than "none of them is."

 

While I have no particularly strong feelings on the question of the proper verb form to be used with the noun "none," a little bit of Internet research convinced me there are quite a number of people who feel quite strongly on the subject.

 

I also am persuaded that the plural verb form is generally proper (as discussed here), and that even for those who feel that either usage is proper, the plural form is in any event most appropriate when the word "none" is used in the sense in which I used it – that is, to mean "not any, " in reference to plural entities (about which refer here).

 

If there are any readers out there who have a strong reaction to my resolution of this grammatical issue, I suggest that the best response is either a long walk or a short drink. (Or if you prefer, a short walk and a long drink. Better yet, skip the walk.)

 

Further Apologies: I apologize to everyone for continuing service problems with this site, particularly with respect to the delivery of email notifications. LexBlog, my blog hosting service, is continuing to suffer ill effects from a sustained spambot attack a few days ago. Along with everyone else, I sure hope things return to normal soon, if for no other reason than for the sake of my sanity.  

 

According to its November 13, 2009 press release (here), Marsh & McLennan has agreed to pay $400 million to settle the consolidated securities class action lawsuit pending in the Southern District of New York against the company, its insurance brokerage unit, and certain former officers of the company. The company also agreed to pay $35 million to settle the related ERISA class action suit filed on behalf of the company’s employees. Both settlements are subject to court approval.

 

As reflected in the press release, the company expects that $205 million of the $400 million securities settlement and $25 million of the $35 million ERISA settlement will be covered by the company’s insurance.

 

The securities suit settlement stipulation can be found here. The settlement stipulation in the ERISA suit can be found here.

 

These two consolidated class action lawsuits were both initiated in October 2004, in the wake of then-New York Attorney General Eliot Spitzer’s announcement that he had launched a fraud lawsuit against Marsh and others alleging that Marsh had engaged in bid-rigging, price-fixing and had accepted payoff from insurers in the form of "contingent commissions."

 

As reflected in greater detail here, the investor plaintiffs in the subsequently filed securities suit alleged that the defendants had failed to disclose that "the Company had implemented and executed an unsustainable business practice whereby the Company designed and executed a business plan under which insurance companies agreed to pay so-called ‘contingent commissions’ in return for Marsh to steer them business and shield them from competition." The securities suit further alleged that "the Company’s revenues and earnings would have been significantly less had the Company not engaged in such unlawful practices."

 

The ERISA suit alleged that the defendants had breached their fiduciary duties by "imprudently permitting" the company’s benefit plans to invest in and hold MMC stock, despite the fact that defendants knew or should have known that the company or its subsidiaries were engaging in bid-rigging and other illegal activities. As a result, it was alleged, the plan’s investment in MMC stock was no longer prudent and appropriate.

 

Based on the data reflected in the most recent Risk Metrics Group table of the 100 largest securities class action settlements (here), the $400 million securities lawsuit settlement, if approved, would represent the twenty-fourth largest securities largest securities settlement ever. The $35 million ERISA settlement would also be among the larges all-time ERISA class action settlements, as reflected in my table of ERISA case settlements, which can be accessed here.

 

The Marsh lawsuits were among several that were filed in the wake of Spitzer’s "contingent commission" investigation. And though some of these other cases also resulted in settlements, none were any near as large as the recent Marsh settlements.

 

For example, AON paid a comparatively modest $30 million to settle its contingent commission-related securities suit (about which refer here). The contingent commission-related securities suit filed against Hilb, Royal & Hobbs (about which refer here) was actually dismissed, and while the plaintiffs appeal was pending the parties negotiated a stipulation of dismissal.

 

The massive size of the Marsh settlements is impressive, but similarly noteworthy is the extent to which both of these settlements exceeded the amount of insurance available. One of the perennial questions in D&O insurance placement is the issue of "limits adequacy" – that is, the question of how much insurance is enough. The significant extent to which these settlements exceeded the available insurance underscores the dramatic potential for catastrophic claims to exceed the limits of even very large D&O insurance programs.

 

A smart-alecky observer might be tempted to try to extract some irony from the fact that an insurance advisor like Marsh was caught short with insurance limits that proved insufficient. The reality is that very serious claims of the kind filed against Marsh have the terrible potential to exceed any realistically available amount of insurance. As a practical matter, as some level, there is no available and affordable amount of insurance that could be sufficient to ensure limits sufficiency for every possible claim. In any insurance program, even one that is very large, there will always be some risk that the costs associated with serious claims could exceed the available limits.

 

This inherent potential for limits inadequacy underscores the extraordinary importance of limits selection issues. Well-advised insurance buyers will want to purchase limits calculated to reduce the risk of limits insufficiency as much as practicable, consistent with competing concerns regarding affordability and insurance availability.

 

As the same time, the inherent risk of limits inadequacy highlights the need for well-advised insurance buyers to consider program structure issues as well program limits. A well-constructed insurance program should incorporate not only appropriate limits of liability, but should also include appropriate alternative insurance structures, such as Excess/Side A DIC insurance and perhaps even independent director liability insurance, as a way to try to reduce the possibility that individuals might face further potential liability without insurance available to protect them.

 

One final note is that there have now been a couple of dozen securities class action settlements of $400 million or greater. While settlements of this enormous size are still noteworthy, the fact is that it is becoming increasingly common for securities class action settlements to exceed any theoretically available amount of insurance. This troublesome fact has significant risk management implications. Simply put, insurance alone may be insufficient to fully protect against liability exposures under the federal securities laws. There is a longer essay for another day here, but the unmistakable conclusion is that corporate risk management must address far more than just insurance-related issues.

 

The November 13, 2009 press release of Ohio Attorney General Richard Cordray relating to his office’s role in negotiating the Marsh settlement on behalf of various Ohio pension funds can be found here. A post on the 10b-5 Daily blog discussing the settlement and linking to various rulings in the underlying securities suit can be found here. Ben Hallman’s November 13, 2009 AmLaw Litigation Daily article discussing the attorneys involved in the settlement can be found here.

 

DoJ Targets Pharma Company FCPA Violations: Earlier this week, I linked to a recent Business Insurance article suggesting the Foreign Corrupt Practices Act-related claims could produce increasing claims costs for D&O insurers. But knowing that there could be growing numbers of FCPA claims does not tell D&O insurance underwriters which of their policyholders or prospective policyholders are likeliest to produce these kinds of claims.

 

Recent comments by a DoJ official suggest at least one industry that could prove to be a significant source of FCPA-related losses. According to a November 12, 2009 Blog of the Legal Times article (here), Assistant Attorney General Lanny Breuer recently told a pharmaceutical industry conference that the application of the FCPA to the pharmaceutical industry will be a priority in the "months and years ahead."

 

The particular concern is that government involvement in foreign health care systems means that health care and medical officials in many countries are government officials, creating a "significant risk that corrupt payments will infect the process." Breuer and others emphasized that their enforcement actions will not be limited to corporate actors, but where facts warrant will also include criminal actions against individuals.

 

Dick Cassin has a post on his FCPA Blog (here) with a link to a complete copy of Breuer’s remarks, as well as Cassin’s own comments on the prospects for increased FCPA enforcement activity in the pharmaceutical industry.

 

And in This Week’s Ponzi Scheme News: I was struck by the news late last week that prosecutors had brought criminal charges against two computer programmers for aiding Bernard Madoff’s fraudulent investment scheme. I think we all suspected that a fraud as massive as Madoff’s could not have been sustained without the complicity of other individuals. Of course there were individuals like these programmers, who apparently were actively complicit – along with those like the regulators and other gatekeepers who may have been passively complicit.

 

The latest Ponzi scheme story involving Florida lawyer Scott Rothstein is all too familiar. The November 14, 2009 Wall Street Journal’s front-page story about Rothstein reflects all of the now-standard features, including large boats, expensive homes and fast cars – all of the accoutrements of accomplishment, where all that had been accomplished was deception. The Miami Herald reports that investigators "do not believe this was a one-man show." That is, the Rothstein scheme may have had other features in common with other Ponzi schemes, including the complicity of others.

 

The Journal’s account of Rothstein’s fraudulent scheme brought home to me that these schemes require yet another kind of complicity — that is, the complicity of investors seeking outsized returns. It would be unduly harsh (not to mention smug) to presume to blame the investors for their losses. They were, after all, actively misled. By the same token, however, the schemes would have gone nowhere if investors had not been willing to accept the schemes’ unconventional investment proposition in exchange for the promise of returns unavailable from conventional sources. A November 9, 2009 Fort Lauderdale Sun Sentinel article examining this angle of the Rothstein story can be found here.

 

We can bemoan the failure of regulators and other gatekeepers that allowed the schemers to escape detection. But at the same time, a healthy skepticism, including in particular a suspicion of consistently market-beating returns, may be something that no investor can afford to do without. I do not mean to suggest that the victims of these schemes are to blame for their own losses. Rather, I am saying that the rest of us can learn from these events, and with benefit of the lessons from these examples perhaps avoid  these kinds of losses in the future.

 

 

As the dramatic events in the financial marketplace during fall 2008 recede further into the past, the wave of related litigation activity has also clearly started to slow. But a newly filed lawsuit arising directly from the financial crisis suggests that there may still be further credit crisis cases yet to come, particularly as plaintiffs’ lawyers continue to initiate class action litigation with proposed class period cut-off dates well in the past.

 

As reflected in their November 10, 2009 press release (here), plaintiffs’ lawyers have launched a securities class action lawsuit in the Southern District of New York against certain former officers VeraSun Energy Corp., a of South Dakota-based ethanol producer that filed for bankruptcy on October 31, 2008.

 

According to the press release, the complaint (a copy of which can be found here) alleges that the defendants failed to disclose that:

 

(i) VeraSun was, in part, a speculative commodities trader in addition to an ethanol producer; (ii) VeraSun engaged in speculative and risky derivate transactions that exposed the Company to substantial financial and liquidity risk; (iii) VeraSun experienced substantial loses on speculative derivative transactions causing margin pressures on the Company; (iv) as a result of margin pressures from bad speculative derivative transactions, the Company sold out of a large short position in corn and incurred substantial losses; (v) the Company entered into highly risky "accumulator" contracts that obligated VeraSun to purchase increasing amounts of corn after the price of corn fell in price per bushel; and (vi) VeraSun’s financial condition and especially its liquidity were negatively impacted as a result of speculative commodity transactions, ultimately causing the Company to file for bankruptcy.

 

The complaint further alleges  that:

 

On September 16, 2008, VeraSun announced that it commenced a public offering of 20 million shares of its common stock to raise money for "general corporate purposes." The true purpose of this public offering was to raise capital in an effort to prevent a disastrous impact from the huge losses experienced by the Company as a result of its speculative trading and risky bets on the price of corn.

 

Not only are these events all well over one year ago, but the proposed class period also covers a segment of time that is also well past — the complaint purports to be filed on behalf of a class of persons who purchased VeraSun shares between March 12, 2008 and September 16, 2008.

 

The complaint’s allegations resemble the facts and circumstances alleged in a number of credit crisis-related cases that were filed last fall, where (as described here) the defendant companies were alleged to have suffered significant financial reverses due to wrong way bets on commodities or currencies, often (as was the case with VeraSun) in connection with hedging transactions. In each case, the sudden and dramatic events in the financial markets during September and October 2008 produced a magnified impact on financial condition of these companies.

 

The prior lawsuits generally were filed closer in time to the events involved, while the VeraSun case has only just been filed. The lapse in time between the events alleged and the VeraSun lawsuit filing is, however, consistent with the filing pattern that has emerged during 2009, where (as noted here) numerous newly filed complaints have proposed class period cutoff dates that fall well before the filing date.

 

I have previously speculated that these seemingly belated filings may perhaps reflect a filing backlog that developed as plaintiffs’ lawyers were caught up in the rush of credit crisis related lawsuits and Madoff related litigation. The VeraSun case filing suggests that this apparent backlog may even include yet to be filed credit crisis-related lawsuits, which in turn suggests that there there may be more credit crisis suits yet to come.

 

The VeraSun case is also the latest example of a securities class action lawsuit arising in the wake of a corporate bankruptcy. The surging numbers of business-related bankruptcies may further contribute to the further instigation of securities class action litigation. The possibility of these kinds of cases arising, like the VeraSun case, well after the bankruptcy date suggests these cases could continue to arrive for some time to come.

 

All of which suggests to me that, even of the pace of new credit crisis-related securities lawsuit filings have declined, the litigation fallout from the global financial crisis is likely to continue to accumulate in the months ahead.

 

I have in any event added the VeraSun case to my list of credit crisis related cases, which can be accessed here.

 

Another Options Backdating-Related Securities Suit Settlement: Another one of the remaining options backdating-related securities lawsuits has settled. As reflected in their October 15, 2009 stipulation of settlement (here), the parties to the Sonic Solutions options backdating-related securities suit have agreed to settle the case for $5 million.

 

A complete list of the options backdating-related lawsuit resolutions can be accessed here.

 

Adam Savett of the Securities Litigation Watch blog has been tracking (here) the options backdating related settlements.Adjusting his data to take account of the Sonic settlement would mean that 30 of the 39 options backdating-related securities class action lawsuits have now been resolved, with nine of these cases having been dismissed and twenty-one of them having been settled. Prior to the Sonic settlement, the average settlement amount was $77.8 million – or $33.23 million if the outsized UnitedHealth settlement is disregarded.

 

UPDATE: The Securities Litigation Watch has updated its options backdating settlement tally and analysis to reflect the Sonic settlement, here.

 

My Dinner with Bill: I am in Chicago this week at the PLUS International Conference, where the keynote speaker was none other than Bill Clinton. Let me just say that he though he is now "only" a former President, he retains all of his rhetorical powers. His speech was entertaining, thought-provoking, funny and serious, and impressive.

　

During the Q&A, one of the questions he was asked is a rather conventional parlor game question: if you could have dinner with any historical figure, who would you choose and why? Perhaps because it was a conventional question, he gave a rather conventional, almost undergraduate-approval-seeking type answer. And being a politician, he couldn’t name just one person – he named three: Socrates, Jesus, and Genghis Kahn. Clinton had his reason for each of the three.

 

I will grant you that Genghis Kahn is an interesting answer, but the other two are safe, predictable and, well, kind of boring. I will stipulate that everyone if they had a chance would want to meet Jesus. Socrates is pretty much in the same category. (Same with Gandhi and Winston Churchill) So if we all agree that Jesus and Socrates (and Gandhi and Churchill) are not available, which historical figure would you want to have dinner with?

 

Because Clinton gave himself three choices, I am going to give myself three as well.

 

First, I would choose Charles Maurice de Talleyrand-Perigord, also known as the Bishop of Autun. Talleyrand lived through some of the most interesting events in all of human history and somehow not only managed to be involved in them all, but what is perhaps a more impressive feat, to have survived them all. He was involved in the French revolution from the start and even acted as foreign minister to the revolutionary government. He later managed to become a key advisor to Napoleon, until they fell out over policy. Ultimately, he became one of the key players in the Bourbon restoration. Though often reviled as unprincipled and cynical, I believe he may have been one of the most interesting people in the grand march of history, and he certainly led one of the most interesting lives.

 

Second, I would choose Moshe ben Maimon, now known as Maimonides, the Jewish theologian, physician and philosopher. He also lived at an incredibly interesting time, having been born in Islamic Spain in the twelfth century and then fled persecution through Northern Africa. His wisdom, scholarship and knowledge of languages have shaped European thought up until this very day. He was among the first Europeans both to appreciate and advocate Aristotle. His rationalist philosophy would still appeal to most moderns, which to me is a reflection of what an original and powerful thinker he was.

 

Having chosen two historical figures, I feel I should be a little bolder and unconventional with my last choice. So my third selection is John Lennon. He was a radical advocate for peace whose art and originality touched the lives of millions.

 

A dinner with all three of these persons simultaneously would be chaos. But a dinner with any one of them (language and cultural issues aside) would be fascinating.

 

So, now you have Bill Clinton’s choices and my choices. Who would you choose? And why? If you are attending the conference and you have views on this question, I hope you will stop me and let me know your thoughts. And if you are not at the conference, I hope you will use the comment function on this blog to let me and other readers know what you think.

 

The one final thought I have to add is that , after having heard Bill Clinton speak today, honestly, I think a dinner with him would be pretty damn interesting, too.  I suspect we could talk about Talleyrand and Maimonides and even John Lennon or Genghis Kahn and it would be memorable and entertaining.

 

UPDATE: My friend and former colleague Marty Hacala provided the following e-mail answer to my dinner guest question: 

 

I agree that Clinton’s answer was boring and conventional. We are after all talking about a dinner party and not a lecture. Who wants to listen to a failed carpenter and a suicidal Greek talk about the hereafter while picking at their food? Genghis Khan is an interesting choice if only because he might tire of the conversation and dispatch the first two before dinner has even begun.

 

My invitations would go to Oscar Wilde, Abraham Lincoln and Groucho Marx. (I could substitute Churchill for Lincoln, but I fear the alcohol wouldn’t last and so the meal would end on an unhappy note.) Just imagine the stories they would tell? I see myself sitting there mesmerized listening to Wilde and Marx trade high and low-brow barbs, while Lincoln tells long stories of how they remind him of mostly made up characters from his youth. It would be an evening to remember. 　

 

There are certain constant issues in the D&O insurance marketplace, but at the same there is always a steady stream of critical issues that emerge and dominate the dialog. In the latest issue of InSights (here) entitled "What to Watch Now in the World of D&O," I take a closer look at the current hot topics affecting the marketplace for D&O insurance.

 

Bribery Probes and D&O Insurance: Regular readers know that I have written frequently on this blog (most recently here) about the increasing concerns about  the rising number of Foreign Corrupt Practices Act enforcement actions, including possible threats arising from follow on civil actions. The problems that issues may present for D&O insurers is discussed further in an article by Zack Phillips in the November 9, 2009 issue of Business Insurance entitled " Rise in Bribery Probes May Hit D&O Insurers" (here). Special thanks to a loyal readers for sending along a link to this article.

 

On a related note, Frederick Bourke, Jr., the individual mentioned in the Business Insurance article as having been convicted on criminal FCPA charges, was sentenced yesterday to one year in prison. Refer here for Andrew Longstreth’s November 10, 2009 AmLaw Litigation Daily article.

The onslaught of bank closures continues. The FDIC’s closure of five more banks this past Friday night brings the 2009 YTD total number of bank failures to 120 – including twenty-one in just the last three weeks alone. There are a variety of reasons for the growing number of bank failures, but clearly one important reason is the continuing deterioration of commercial real estate loans.

 

As I noted in a prior post (here), there may be further bank failures ahead as commercial real estate mortgages come due or default. A November 5, 2009 BusinessWeek article entitled "The Commercial Loan Nightmare Facing U.S. Banks" (here) suggests that banks’ commercial real estate loan problems may be worse even than may be currently apparent.

 

According to the article, "many banks have been forestalling the day of reckoning" by using an approach the article described as "extend and pretend," which consists of allowing "temporary extensions to trouble borrowers on maturing commercial loans to give them, and the bank, some breathing room."

 

The problem for the banks is that "surging delinquencies and defaults will eventually catch up with them." Many banks are currently showing no charge-offs, but as much as $500 billion in commercial real estate loans will mature within in coming months, while commercial real estate values have declined as much as 40 percent since the beginning of 2007. As these issues catch up with the banks, according to the article, more banks could fail.

 

The article includes a list of the 30 publicly traded banks that may have the most exposure to commercial real estate. The 30 banks have more than 50 percent of their loan portfolios in commercial real estate loans. To be sure, the banks’ heavy concentration in real estate loans is not the same as being burdened with bad loans, but it does mean that the listed banks "have more exposure to the commercial real estate sector."

 

Among the bank closed this past Friday night was the California-based United Commercial Bank, as reflected in this November 6, 2009 FDIC Press Release (here). The bank’s parent holding company, UCBH, and certain of its directors and officers, were already the subject of a securities class action lawsuit, as I discussed in a prior post, here. The UCBH lawsuit and the failure of the bank operating company may represent examples of the ways in which the growing numbers of troubled banks could lead to an increased amount of litigation arising from the banks’ woes.

 

Another Subprime Securities Suit Dismissal: In an October 6, 2009 order (here), District of Massachusetts Judge Nathaniel Gorton granted the defendants’ motion to dismiss the complaint that had been filed against the commercial construction firm, Perini Corporation and certain of its directors and officers. Judge Gorton’s dismissal ruling granted the plaintiffs leave to amend, but he warned that if the amended complaint is deficient, "dismissal will be with prejudice."

 

As reflected here, the plaintiffs had alleged that Perini had failed to disclose that the developer on a major Las Vegas construction project was experiencing financial difficulties, including difficulties in obtaining project financing for the Las Vegas project. The complaint further alleged that as a result of these difficulties the Las Vegas project faced possible delays and that the developer faced a risk of default. The complaint further alleged that the Las Vegas project represented as much as 20% of the Perini company’s construction backlog and that as a result of the difficulties the company’s ability to maintain its profit margins was in doubt.

 

As Judge Gorton later summarized, the "crux" of the plaintiffs’ complaint is that the company knew about the developer’s financial troubles, "which rendered statement that, in essence, all was well at Perini, false and misleading."

 

In his October 6 ruling, Judge Gorton found that the plaintiffs had failed to adequately allege scienter. He said that even assuming the defendants were aware of the developer’s financial difficulties "the complaint fails to attribute the requisite high level of culpability to them. To the contrary, the complaint sets forth facts showing that the defendants were actively and ultimately successfully, working to ensure that any difficulties of [the developer] did not impact Perini."

 

The court found that the non-fraudulent inferences from the defendants’ conduct and statements to be "more compelling that any inferences of culpable scienter." Moreover, Judge Gorton found further that the plaintiffs had failed to "plead adequately that the defendants were even ‘aware of’ [the developer’s] financing difficulties in the first instance."

 

Finally, Judge Gorton found that even if the plaintiffs had adequately alleged scienter, the allegedly fraudulent statements do not provide a basis of liability. He found that most of the statements came within the safe harbor for forward looking statements and that the few remaining statements that were not forward looking were not otherwise actionable

 

I have added the Perini decision to my running tally of subprime and credit crisis-related dismissal motion resolutions. The tally can be accessed here.

 

Special thanks to Adam Savett of the Securities Litigation Watch (here) for providing copies of the Perini ruling.

 

Another FCPA-Related Civil Lawsuit Settlement: Regular readers know I have written frequently about civil litigation that can follow in the wake of Foreign Corrupt Practices Act (FCPA) investigations and enforcement actions. (Refer for example here.) In the latest resolution of this kind of follow on civil action, on November 6, 2009, Nature’s Sunshine Products announced (here) that the court had preliminarily approved the settlement of the lawsuit in which the company had agreed to pay $6 million.

 

As reflected here, the plaintiffs in the securities lawsuit had alleged in connection with the improper payments that the company lacked appropriate internal controls and that the company’s books and records did not reflect the foreign transactions. As noted here, the court had denied the defendants’ motions to dismiss.

 

The company’s FCPA-related problems received additional attention earlier this year when (as noted here), the SEC brought control person liability charges against the company’s CEO and CFO, even though the individuals were not alleged to have had any involvement in or even awareness of the company’s allegedly improper payments.

 

The company’s $6 million securities class action settlement is just the latest in a line of settlements in securities cases following in the wake of FCPA-related investigations and enforcement actions. My prior overview of FCPA-related follow-on civil litigation can be found here.

 

The Financial Crisis and D&O Insurance: A wide variety of litigation has arisen out of the global financial crisis, much of which has implicated the D&O insurance of the defendant companies. The involvement of the companies’ D&O coverage in turn has underscored the importance of the applicable policies’ coverage and in particular the sufficiency of the policies’ terms and conditions.

 

A recent memo entitled "Directors’ and Officers’ Coverage Priorities in the Financial Crisis: A Seven-Point Inspection for Your D&O Policy" (here) by Ernest Martin Jr. and Micah Skidmore of the Haynes and Boone law firm presents a comprehensive overview of the critical D&O insurance issues arising from the current financial crisis. The article is thorough and timely.

 

Apologies: Due to a massive spambot attack directed at the "Comment" function of blog sites hosted by the LexBlog network (on which The D&O Diary is hosted), there have been a variety of service and performance disruptions on this site over the last several days. Among other things, the comment function has been disabled and the email notification system was interrupted. I have also had intermittent difficulties just adding new content.

 

I apologize to readers for any difficulties you may have had accessing this site, posting comments, or receiving email notifications. I am hopeful that the problems are now or will soon be completely resolved.

 

My special thanks to everyone at LexBlog for the courteous and attentive service while managing this crisis.

 

This Week: The D&O Diary’s publication schedule during the week of November 9 will be disrupted because I will be in Chicago for the annual PLUS International Conference. I know many readers will also be there and I hope readers who see me there will be sure to say hello and, if we have not met before, to introduce themselves. I look forward to seeing everyone in Chicago.

 

Upcoming Conference: On November 30-December 1, 2009, I will be co-Chairing the American Conference Institute’s Fifteenth Annual Advanced Forum on D&O Liability in New York. This event will include presentations from the leading figures in the D&O insurance field, and the program will address the most critical issues facing the D&O insurance industry today. The program agenda, including registration information, can be found here.

The D&O Diary is pleased to present the following guest blog post, written by Angelo Savino (pictured),  a partner at the Cozen & O’Connor law firm. Angelo is resident in the firm’s New York office. Angelo’s guest blog post follows:

　

As noted in prior posts (here), the U.S. Supreme Court is considering whether to grant certiorari in the National Australia Bank ("NAB") case, which involves foreign-cubed or f-cubed litigation. At the Court’s invitation, the Solicitor General and the SEC have now weighed in with the government’s position by submitting a joint brief.

 

Oddly, as noted by 10b-5 Daily, the government argues that (1) every Circuit Court that has considered the extraterritorial reach of the federal securities laws since Judge Friendly’s 1975 decision in Bersch has focused on the wrong issue and (2) there is currently a conflict among the Circuits regarding the standard to be applied to foreign-cubed cases under the cause test, but that the Court should nevertheless deny certiorari. Ironically, the government’s position may increase the likelihood that the Court will grant cert.

 

Background

NAB involved claims on behalf of a class of foreign purchasers of stock in NAB, an Australian corporation, on foreign exchanges. The complaint alleged accounting irregularities at NAB’s Florida mortgage servicing subsidiary, Homeside, that were transmitted to NAB headquarters in Australia and incorporated into NAB’s financial statements, which were then disseminated from outside the U.S. The District Court dismissed the claim for lack of subject matter jurisdiction and the Second Circuit affirmed.

 

In considering the extraterritorial reach of the U.S. securities laws, the Second Circuit applied the cause test, which the Court articulated as follows: "subject matter jurisdiction exists if activities in this country were more than merely preparatory to a fraud and culpable acts or omissions occurring here directly caused losses to investors abroad." Relying on two 1975 decisions by Judge Henry Friendly – Bersch v. Drexel Firestone Inc. and IIT v. Vencap Ltd., the Court sought to identify which actions constituted the fraud and directly caused harm, or as the Court stated elsewhere in the opinion "what is central or at the heart of a fraudulent scheme."

 

Applying the above standard, the Court held that subject matter jurisdiction did not exist because NAB, not Homeside, was the publicly traded company and its executives at the Australian headquarters were primarily responsible for the company’s public filings, relations with investors, and public statements. Thus, the conduct that directly caused any loss occurred outside the U.S.

 

Thereafter, the plaintiff petitioned for cert. and the Supreme Court invited the government to submit its view on the petition. Although the SEC had previously submitted an amicus brief to the Second Circuit siding with the plaintiff and asserting that subject matter jurisdiction existed in the case, its current brief urges the Supreme Court to deny cert. because, although the Second Circuit analyzed the wrong issue, it reached the correct result.

 

Discussion

The most striking aspect of the government’s analysis is the assertion, contrary to the jurisprudence of the last 34 years, that "the geography of an alleged fraudulent scheme – i.e., whether it was conceived and executed in whole or in part outside the United States – is irrelevant to the district court’s subject-matter jurisdiction." Instead, the government would engraft a geographical component onto the 10b-5 cause of action. The government notes that in cases of transnational fraud, a private plaintiff should be required to demonstrate a direct causal link between his injury and the U.S. portion of the alleged scheme. The government concluded that, in this case, the link between Homeside’s accounting numbers and the harm to the plaintiffs was too attenuated because, as the Second Circuit explained, the numbers had to pass through numerous checkpoints manned by NAB’s Australian personnel before reaching investors.

 

In an action by the SEC, however, the government asserts that the transnational nature of a fraudulent scheme is relevant only insofar as it has a sufficient connection to the United States to bring it within section 10(b)’s substantive prohibition. This begs the question what is a sufficient connection. The government’s answer this time is to characterize Homeside’s conduct as integral to the overall scheme and, therefore, sufficient to support an SEC enforcement action.

 

So after trashing the analytical method applied by every court to consider the extraterritorial reach of the securities laws over the last 34 years, the government next concludes that the conduct at Homeside is insufficient for foreign private plaintiffs but sufficient for an SEC action. This tends to give the government’s analysis the appearance of intellectual gymnastics designed to preserve or extend its own ability to bring cases. It seems more analytically satisfying to accept the traditional jurisdictional analysis as correct, and require foreign-cubed plaintiffs to satisfy the cause test while requiring the SEC to demonstrate satisfaction of the effects test, which focuses on harm to U.S. investors and U.S. markets. Moreover, to the extent that the SEC seeks, in a given case, to prevent export of fraud from the U.S., it should rightly bear the burden on a motion to dismiss of demonstrating that the resources of U.S. courts are appropriately being used, as it would if the issue is jurisdictional, but not if it is part of the 10b-5 cause of action. The government’s analytical model would shift that burden for private plaintiffs as well, making it more likely that they would bring more actions in U.S. courts.

 

The government’s brief also recognizes the existence of a split among the Circuits, but characterizes it as "much less pronounced than petitioners contend." Different Circuits have in fact articulated different formulations of the cause test, as noted in the brief. Add to that calculus, the Eleventh Circuit’s recent decision in the CP Ships case, affirming a District Court’s finding of subject matter jurisdiction in a case that, like NAB, involved alleged accounting irregularities at the Florida subsidiary of a foreign company whose stock traded predominantly on foreign exchanges. The apparent inconsistencies among the Circuits, of course, may simply be the product of the fact-intensive inquiry inherent in analyzing causation regardless of how courts articulate the cause test. But even then, it would be preferable to have a single nationwide standard. Nevertheless, the government concludes that NAB is not a suitable vehicle for resolving the conflict because the petitioners identify no case indicating that any other Circuit would allow their suit to go forward.

 

Conclusion

The government’s arguments seem motivated by a concern that analyzing foreign-cubed cases as a jurisdictional issue and using the Second Circuit’s short-hand formulation of the cause test (where did the heart of the fraud occur?) could prevent the SEC from bringing enforcement actions in certain cases. The government’s reasoning, however, seems to miss the mark. The cause test will have an impact primarily, if not solely, in the foreign-cubed context where there is a foreign plaintiff. The SEC will be bringing cases generally when it perceives an effect on U.S. investors or markets and may, therefore, be evaluated under the effects test. Alternatively, it will need to justify invoking the power of the U.S. courts to protect primarily foreign interests by demonstrating domestic conduct that directly caused the losses. In any event, the jurisdictional analysis rightly places the burden of demonstrating that the action should proceed on the party bringing the case, which the government’s suggested analytical model would not, at least at the motion to dismiss stage.

 

Despite believing that courts have been misanalyzing the issue for over three decades and despite recognizing a split in the Circuits, the government urges the Court to deny cert. By stressing these issues in its brief, however, the government may very well persuade the Court of the need to resolve these questions in an era of increasing globalization of the capital markets and increasing incidence of foreign-cubed litigation.

 

The D&O Diary is very grateful to Angelo Savino for submitting this article for publication on this site. I welcome draft proposed guest posts from other authors. Anyone interested in submitting a proposed guest post should just drop me a note using this blog’s contact function (see the Contact link in the right hand column, above).

　　　

Where securities class action lawsuits are concentrated tends to vary over time. At various times over the past several years, companies in the high tech sector, telecommunications category and, more recently, in the financial services industries, have found themselves for a period to be the most popular targets for plaintiffs’ securities class action attorneys. However, beginning in August of this year and accelerating since then, exchange-traded funds (ETFs) appear become among the hottest new targets for securities class action lawsuits. Signs are that there could be more ETF-related securities suits ahead.

 

By my count there have been at least eight or nine and arguably as many as eleven (or more) new securities class action lawsuits filed against ETFs since August. (See my note below about the difficulty in counting these cases.) Though these lawsuits are separate and are separately filed on behalf of separate investors against separate ETFs, the allegations of these suits are quite similar – indeed, in many cases, virtually identical.

 

Two recent cases filed against ProShares Ultra Short Dow 30 Fund (refer here) and Direxion Shares Daily Financial Bear 3X Fund (refer here) illustrate the nature of this category of securities suits. The lawsuits overall, like these two, generally are filed against some variation of the funds themselves, the funds’ investment advisors or managers as well as the funds’ distributors, and the funds’ individual trustees. The ETFs themselves allegedly were designed to provide some multiple of the return (or of the inverse of the return) of some benchmark index or measure.

 

The complaints basically allege that the defendants failed to disclose to investors the risks associated with the investments, and in particular allegedly did not disclose the significant likelihood of losses to the value of the funds’ shares if held over time or even just for more than a single day, nor did the funds disclose the extent to which the funds’ results would likely diverge from their benchmark over time.

 

Though there have been many of these ETF-related securities lawsuits filed recently, there may be many more yet to come. Among other things, as inevitably seems to happen when plaintiffs’ lawyers start racing to stake out their piece of a hot property, at least one plaintiffs’ firm has issued a press release (here) announcing that it is investigating a whole raft of ETFs – indeed, the particular plaintiffs’ firm’s press release lists 75 different ETFs the firm is investigating.

 

Whether these cases will ultimately succeed or fail of course remains to be seen, but the plaintiffs’ firms’ actions clearly suggest that they think they are on to something.

 

These lawsuits already represent a significant part of the total number of securities class action lawsuits this year (depending on how you count, between five and ten percent of the total). If as seems likely at this point new ETF-related cases continue to be filed, the ETF cases will not only represent an even more significant portion of the total number of new securities cases this year, but they could also produce a material increase in the overall number of lawsuits that are filed this year.

 

But whatever the ultimate number of ETF-related cases ultimately proves to be, I believe that we have already reached the point where these cases represent their own separate phenomenon and therefore worthy of tracking on that basis.

 

Accordingly, I have created a separate list of the ETF lawsuit filings, which can be accessed here.

 

It is entirely possible that this list is incomplete, and I would be grateful if readers would let me know about any cases I may have missed. I will be updating this list as new ETF-related cases come in.

 

I should add that trying to keep track of these cases and to tell them apart is a particularly vexing task. Many of the ETFs have bewilderingly similar names, and some of the lawsuits purport to file claims on behalf of investors in multiple ETFs. Figuring out which suits are separate and which are duplicates is a considerable challenge. For each case presented separately on this list there have been multiple other apparently duplicate other filings that I have not listed. Some of these cases do overlap and there may well be consolidation of some (or, who knows, perhaps many or all) of these cases before all is said and done. I have tried as best as I can to identify separate cases separately. I welcome readers’ observations and comments about the list.

 

Though there have been a number of these suits, and though there could be many more, most of these suits are filed against ETFs within one single fund family. As a result, the extent of the contagion effect from this lawsuit outbreak so far has been relatively isolated. This concentration of many suits within a single fund family may diminish the insurance impact of this category event, as the single fund family likely carried only a single insurance program for all of the funds in the family. I stress that I have no direct knowledge one way or the other, but it is relatively unlikely that each new lawsuits represents a significant new insurance related loss or loss exposure.

 

Perhaps the Theory is "Better Late Than Never"?: In recent posts (most recently here),  I have noted another trend, which is the apparently belated filing of securities class action lawsuits, where the date of the proposed class period cut off is well in the past. For example, the new suit filed on October 28, 2009 against Pitney Bowes (refer here) has a proposed class period cut off date of October 29, 2007, suggesting that the case was filed just prior to the expiration of the two-year statute of limitations cut off date.

 

Well, if the cases I previously discussed could fairly be described as "belated," then the securities class action filed in the Southern District of California on October 30, 2009 against Avanir Pharmaceuticals and certain of its directors and officers can only be described as superannuated. Or more succintly, old. Perhaps even stale.

 

The actiion purports to be filed on behalf of persons who acquired shares of the company’s stock between July 1995 and October 31, 2006. That is, the complaint (a copy of which can be found here) was not filed until nearly three years after the proposed class action cutoff date.

 

There is no way of telling from the face of the complaint how the plaintiffs intend to try to overcome the rather obvious statute of limitations objection that the defendants will raise, expecially given that the complaint expressly alleges that the company’s true condition was revealed in an October 31, 2006 disclosure.  It will be interesting to see how the plaintiffs attempt to respond to the statute of limitations defense.