In the latest twist in the long-running options backdating saga, and in what appears to be a significant milestone in the options backdating-related gatekeeper claims, on June 15, 2009, Vitesse Semiconductor announced (here) that it had reached a settlement with its former auditor, KPMG LLP, in connection with the option backdating related allegations. In the settlement KPMG agreed to pay $22.5 million and to forgive past indebtedness.

 

As discussed at greater length here, in June 2007,Vitesse sued KPMG in Los Angeles County Superior Court alleging that KPMG had been negligent in auditing the company’s stock option grants and financial statements during the years 1994 to 2000. Vitesse later amended the complaint to include the years 2001 to 2004.

 

Vitesse itself had been the subject of an options backdating-related securities class action lawsuit in the Central District of California, as described here. Vitesse settled that lawsuit for a payment $10.2 million in cash, $8.75 million of which came from the company’s D&O insurance carrier, and the balance in payments from individual defendants. The settlement also included the transfer of shares of Vitesse stock from Vitesse and from the individual defendants.

 

The plaintiffs in the options backdating securities lawsuit had also sued KPMG and as reflected here, on June 16, 2008, the parties to the securities lawsuit filed a stipulation of settlement in which KPMG agreed to contribute $7.750 million toward the class settlement.

 

KPMG’s recent $22.5 million settlement of Vitesse’s own lawsuit is in addition to KPMG’s separate $7.750 million contribution to the settlement of the securities class action lawsuit.

 

As I recently noted (here), the options backdating securities class action lawsuits themselves appear to be winding down, but until word circulated of KPMG’s settlement with Vitesse, I had not heard of the resolution of any cases that companies themselves had filed against their outside professional advisors.

 

Even if there were prior outside gatekeeper settlements that I missed, the KPMG settlement with Vitesse has to be the most significant settlement between an outside gatekeeper and a company with respect to the options backdating scandal. It will be interesting to see whether the final stage of the options backdating saga includes further significant gatekeeper claim resolutions. Given the magnitude of the KPMG settlement, it would certainly seem that there could be other significant settlements and perhaps even the assertion of additional claims.

 

I would be very interested to know if readers are aware of the resolution of any other cases that companies have filed against their outside professionals in connection with the options backdating scandal.

 

As noted here, KPMG is also the subject of a trustee’s claim in connection with the New Century Financial Corp. bankruptcy proceeding. KPMG also remains a defendant in the New Century subprime-related securities class action lawsuit, after its motion to dismiss in that case was denied, as discussed here.

 

How Will GM Sell Cars Now?: General Motors certainly faces a daunting challenge trying to sell cars as a bankrupt company. I have posted a video link below of an irreverent but particularly funny take on what a bankrupt GM’s ads might look like. The spoof ad does a great job ripping conventional car ad clichés, which clearly won’t work now (if they ever did).

Hat tip to the Planet Money blog for the link to the video. Warning, the ad contains language some might consider offensive.

http://current.com/e/90184685/en_US

Most reasonably sophisticated consumers understand that the cheapest running shoes may be no bargain, that the least expensive cellular plan may have big gaps, and that selecting legal counsel based on which attorney charges the least is fraught with peril. Yet when it comes to D&O insurance, these same buyers are often only concerned with which is the lowest cost alternative, without complete consideration whether the cheapest coverage fully addresses their insurance needs.

 

The assumption behind many insurance purchasing decisions is that the various alternatives are basically equivalent, and the only relevant variable is price. Whether or not this assumption would be valid for personal insurance like home or auto, for which the insurance is generally issued on standard forms, it definitely is not true with respect to D&O insurance.

 

 

There is no standard D&O insurance policy form; to the contrary, the various carriers’ base forms vary significantly, and many of the key terms are negotiable, particularly with respect to public company D&O insurance.

 

 

So the assessment of D&O insurance alternatives often involves – or rather should involve – careful comparison between a host of relative advantages and disadvantages, among which price is one of many important factors to be considered.

 

 

Despite the many subtle but nonetheless critically important differences between D&O insurance alternatives, many insurance buyers, even those who otherwise qualify as very sophisticated, ultimately make their selection based solely upon price, even though they would never depend solely on price alone when selecting, say, a pair of running shoes, a cellular plan, or an attorney to represent them.

 

 

When it comes to running shoes, cellular plans or attorneys, consumers both understand what these goods and services are for and they also fully expect to use these goods and services. When it comes to D&O insurance, however, the same buyers are unconsciously assuming that they will never actually need to use the product, and that the insurance acquisition is nothing more than a box-checking exercise. D&O insurance? Yep, got that.

 

 

The one subset of insurance buyers who do not need to be reminded when selecting among D&O insurance alternatives of how important it is to consider all issues, and not just price, are company officials who have previously been involved in a D&O claim. These individuals fully understand what D& O insurance is for, and they often have a deep appreciation of the way that seemingly small difference in policy language can have a significant impact on the extent of coverage in the event of a claim.

 

 

After over a quarter of a century of involvement with directors’ and officers’ liability issues, I have seen hundreds of claims involving thousands of individual director and officer defendants. I have seen highly regarded individuals, who have amassed a lifetime’s worth of wealth and prestige, have everything they worked for their entire careers come crashing down around them. I have seen formerly powerful executives taken away in handcuffs. I have seen grown men cry. None of these individuals ever thought they would ever find themselves in these circumstances – but they did. I guarantee you that not one of them, finding themselves caught up in these circumstances, thought to themselves “Boy, I sure am glad we got the cheapest D&O insurance we could find.” .

 

 

The D&O insurance acquisition process cannot be built on the assumption that those things might happen, but not to my company and certainly not to me.  The entire acquisition process has to be built on the assumption that these things will happen to this company.

 

 

Of course, not all D&O claims are catastrophic, but the one thing I know for sure about D&O claims is that, whether or not they are catastrophic, the quality of the D&O insurance available at the time of the claim is critically important. The time to analyze whether or not the D&O insurance program is built to respond to the range of possible claims circumstances is not when the claim comes in, but when the insurance is purchased.

 

 

Cost is of course an indispensible consideration and price considerations should always be taken into account. In fact, I have many times recommended to clients that they select an alternative that is the lowest cost option. But when I make that recommendation, price alone is neither the sole nor the most important criterion.

 

 

D&O insurance buyers whose advisors recommend the lowest priced alternative need to consider whether (a) the advisor is recommending the lowest priced alternative because it really is the best option for the company based on full consideration of all relevant factors; (b) the advisor is recommending the lowest price alternative because he or she thinks that is what the buyer wants to hear and that’s what it will take for the advisor to get or keep the business, and he or she doesn’t have the guts to provide an independent and fully considered recommendation; or (c) the advisor doesn’t have a clue what the important differences are between the available alternatives and the only distinction the advisor can explain is the cost difference.

 

 

I am often asked to review public companies’ D&O insurance programs. In many cases, the companies have insurance programs that are more or less matched to their requirements and circumstances. But in a surprising number of cases, the programs I review lack critically important features that could dramatically affect the availability of coverage in various claims circumstances. Sometimes these underserved policyholders are also over-paying for their insurance, which has its own set of implications. But more often, the company itself has selected into an inadequate insurance program because they chose their insurance based solely on price.

 

 

Price considerations alone are not enough to allow a buyer to select the best running shoes, cellular plan or legal counsel. Price considerations are important of course, because no one should overpay for something. Often the way to make the optimal purchase is to get assistance from someone who knows more about the products and services.

 

 

Insurance buyers may never have to use their D&O insurance, but policyholders don’t want to find out when a claim arises that the cheap insurance they bought was no bargain. That is why it is indispensible to have a skilled and experienced insurance advisor involved in the D&O insurance transaction, one that understands and can explain the differences between the insurance alternatives and that can recommend the alterative that will best meets the company’s needs and finances.

 

 

Where are You Going, Al? Can’t You Read?: Any alpaca having the temerity to disregard this sign will find itself in very serious trouble.

 

In what has become a weekly ritual as 2009 has progressed, each Friday evening after the close of business, the Federal Deposit Insurance Corporation (FDIC) announces the names of the banks it has taken over that week. The current number of year-to-date bank closures stands at 37, which already represents the highest annual total since 1993, the end of the last era of failed banks. All signs are that the number of bank failures will continue to grow in the months ahead, a prospect that is affecting the D&O insurance marketplace, even for smaller community banks.

 

In the latest issue of InSights (here), I take a look at the background regarding the current wave of bank closures and examine the D&O insurance marketplace’s reaction to these developments.

 

 

One of the issues discussed in the article is the surprising number of failed banks in Georgia. The June 10, 2009 Wall Street Journal has an article entitled "Failed Banks’s Dot Georgia’s Vista" (here) discussing the reasons for the high number of bank failures in that state.

A variety of news articles and blogs have expressed surprise and even outrage that Bank of America is advancing the legal expense that former Countrywide CEO Angelo Mozilo is incurring in defending against the various claims that have been raised against him, including the recent SEC enforcement action.

 

There is no particular reason for me to bestir myself to justify BofA’s action, particularly since Mozilo has done such an effective job making himself look like a cartoon villain (as I discussed here). But under Delaware law and under the legal understandings that BofA reached when it acquired Countrywide, BofA has a legal obligation to advance Mozilo’s expenses. The only outrage would be if BofA refused to do so.

 

Countrywide was a Delaware Corporation. BofA is a Delaware Corporation. Under Section 145(e) of the Delaware General Corporation Law, companies are permitted to advance expenses directors and officers incur in defending claims brought against them for actions undertaking in their capacities as directors and officers. Most companies’ by-laws make these advancement requirements mandatory, which I presume would have been the case for Countrywide. Mozilo may even have had a separate advancement and indemnification agreement; many senior executives do. In addition, as reflected in a June 9, 2009 Bloomberg article (here), the two companies’ July 1, 2008 merger agreement specified that Bank of America would maintain Countrywide’s existing indemnification rights for six years.

 

There is a very good reason for the legal formality surrounding advancement and indemnification; that is, the question of entitlement to these rights usually comes up only after serious allegations have arisen. Accordingly, it is important to lock down rights and obligations at a calmer time, so that duties and expectations are clear if questions later do arise. Having entered these agreements, companies are not at liberty to dispense with the commitments simply because they later find it distasteful or repugnant to honor the commitments.

 

Mozilo may well be one of the most unpopular figures in the United States right now, and a lot of people want to make him the poster child for everything that went wrong with our financial system. But as reviled as some might perceive him to be, that does not deprive him of his legal rights nor does it relieve BofA, as Countywide’s successor-in-interest, of its legal obligations.

 

Keep in mind that Mozilo has not been convicted of anything (yet?) – indeed, though he is one of the subjects of an SEC civil enforcement action, no criminal charges have been brought against him. Nor has he yet been found liable in any of the many civil actions against him.

 

Indeed, even if criminal charges had been brought, Mozilo would nonetheless retain the right to advancement of his defense expenses. In considering the extent of Mozilo’s rights, it is important to recall the July 30, 2008 Delaware Chancery Court opinion (here) in which Vice Chancellor Leo Strine held that the Sun-Times Media Group had to continue to advance the defense expenses of four former officers, including Lord Conrad Black, even though: 1) the four had been convicted of various criminal offenses; 2) the four had already been sentenced; 3) the convictions had been upheld on appeal; and 4) the company had already advanced $77 million in defense expenses for the four. Vice Chancellor Strine held that under Delaware statutory law and the applicable by-law provisions, requiring advancement until "final disposition," the obligation to advance expenses continued until the "final, non-appealable conclusion" of the criminal action, which had not yet been reached.

 

Whatever else may be said, advancement rights are enforceable and durable. (I will leave aside the problem created by the Schoon v. Troy case, about which refer here, which did seemingly permit the retroactive elimination of advancement rights, the Delaware legislature recently created a statutory remedy for that bobble.)

 

BofA is of course entitled to obtain from Mozilo an undertaking to repay the expenses advanced if it is later determined that he did not act in "good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation." Mozilo is a very wealthy man, wealthy enough that if the statutory standard for repayment is triggered, BofA can try to recover the amount advanced – that is if there’s anything left at that point.

 

I understand that the main objection to BofA’s advancement of Mozilo’s defense expenses is that BofA has accepted $45 billion in bailout money. The objection is that taxpayers are effectively paying Mozilo’s legal fees, or something like that.

 

One might try to argue that, because taxpayers shouldn’t have to foot the bill, companies accepting bailout funds ought to be required to terminate advancement or indemnification rights of former officers and directors, but as far as I know there were no such requirements imposed in connection with the bailout money provided to BofA. Moreover, even though Congress has a pretty impressive record of trying to impose retroactive conditions on bailout recipients — without the slightest regard for the requirements of binding contracts — there are still some very good policy reasons why even Congress would have to hesitate to retroactively superimpose a bailout condition like that.

 

In any event, the objection about Mozilo’s defense expenses is not to advancement of defense expenses as a general matter, but to advancement for Mozilo in particular. There is no principled basis on which to isolate one individual, no matter how unpopular he may be, and single him out as the one person retroactively disentitled to his otherwise enforceable rights. To put it another way, if Mozilo is not entitled to advancement, then no current or former director or officer from an entity receiving bailout funds should be entitled to advancement. I suspect that even the most thick-skulled, grandstanding member of Congress would see the policy concerns with taking that position.

 

There is an added component to this question – that is, the extent to which Countrywide’s D&O insurance may be reimbursing BofA for its advancement of Mozilo’s defense expense. Countrywide undoubtedly carried D&O insurance, likely with limits of liability in the tens and perhaps in the hundreds of millions of dollars. The Countrywide insurance program may have had a significant self-insured retention, but that has likely been satisfied even if it is many millions of dollars.

 

The problem with D&O insurance as a source of reimbursement for defense expenses is that there are so many lawsuits against Countrywide and its directors and officers in so many different courts that the insurance limits could quickly be depleted or even exhausted, assuming for the sake of discussion that the carriers have not asserted defenses to coverage.

 

To the extent not reimbursed by insurance, BofA will have to advance Mozilo’s defense expenses. For those who still just find this too much to swallow, here’s one final thought – even if BofA is obliged to pay Mozilo’s defense expense due to an undertaking the merger documents, BofA appears to be making money from the Countrywide acquisition. According to Bloomberg (here), BofA reported mortgage-banking income in the first quarter of $3.71 billion, compared to $1.52 billion in the first quarter of 2008, "because of surging demand for home loan refinancings." This is a significant form of consolation for the fact that BofA is on the hook for Mozillo’s defense expenses.

 

Remember options backdating? There is still a raft of unresolved options backdating cases out there, but at least one of the remaining options backdating related securities class action lawsuits has now been settled.

 

On June 9, 2009, Marvell Technology announced (here) that it has reached an agreement to settle the case for a payment to the class of $72 million. I have added the Marvell case to my table of options backdating case resolutions, which can be accessed here.

 

With the addition of the Marvell case, 27 of the 39 options backdating-related securities class action lawsuits have now been resolved. Nine have been dismissed and eighteen have been settled. Twelve of the 39 have not yet been resolved. A complete list of the options backdating lawsuits can be found here.

 

According to the Securities Litigation Watch "Options Backdating Scorecard" (here), the average options backdating class action settlement (including the Marvell settlement) $82.5 million, but if the $895 million UnitedHealth Group settlement is excluded, the average settlement (again including the recent Marvell settlement) $34.71 million, which suggests that the Marvell settlement was well above the prior adjusted average options backdating securities class action lawsuit settlement.

 

Something hit me this past week as I was reviewing the latest Madoff-related complaint to cross my desk. The class action complaint (here), was filed on May 29, 2009 in the Middle District of Florida by a Florida physician who had a Swiss Life variable annuity policy that was invested in the Platinum All Weather Fund (the "Fund"), a mutual fund offered by Nomura. The Fund in turn was invested in certain other investment vehicles that had simply turned their assets over to Madoff. According to the complaint, the entire Fund has now been written down to zero.

 

The Madoff-related losses alleged in the complaint are all too familiar, but what struck me as I reviewed these latest allegations is what an incredibly far-flung, diverse and many-tentacled monster the Madoff fraud scheme was. And as diverse and dispersed as the consequences of the Madoff scandal have been, so too is the wave of litigation that has followed in the wake of the scheme’s collapse.

 

When I first started tracking the Madoff-related litigation last December, it seemed like a relatively straightforward undertaking. But now the list of Madoff-related lawsuits (which can be accessed here) runs to some 18 pages, and the lawsuits continue to pour in. In reviewing this now-lengthy and growing catalog of claims, the most striking thing is what a varied assortment of lawsuits the Madoff scandal has produced. Even though there is a great deal of duplication among the claims, the list encompasses a spread and scope of lawsuits that defied brief summarization.

 

At first, the stream of lawsuits involved the money managers that ran the now-infamous rogues’ gallery of Madoff-related "Feeder Funds," such as Walter Noel, Stanley Chais and Ezra Merkin. Lawsuits involving these individuals and their associated firms continue to come in. But as the lawsuits have piled up, the claims have targeted an ever-broadening array of individuals and entities, as demonstrated by the lawsuit described above against a Swiss insurer and a Japanese investment management firm.

 

The list of litigation targets includes Spanish and Austrian banks, Cayman Island hedge funds, Irish investment custodians, private banks based on Gibraltar, investment management firms in Luxembourg, and many other individuals and entities spread across the entire globe. The overall impression from this geographically diverse mix of defendants is that until the scheme collapse, the entire world seems to have gone completely Madoff.

 

Several other recently filed complaints highlight the geographic dispersion of defendants targeted in the Madoff-related lawsuits.

 

For example, on May 15, 2009, an investor filed a derivative complaint (here) in New York (New York County) Supreme Court against Kingate Global Fund Limited, a British Virgin Island fund, as nominal defendant, as well as against related Kingate entities and individuals. The complaint alleges that the fund was a Madoff feeder fund with substantially all of its assets invested with Madoff or his firm. (On April 17, 2009, Irving Picard, the liquidator of Madoff’s firm, separately filed an action, here, in the Southern District of New York bankruptcy court against Kingate and related funds.)

 

On May 7, 2009, investors who had purchased limited partnership interests in investment funds offered and managed by Swiss bank Union Bancaire Privée (UBP) and related entities filed a class action complaint (here) in the Southern District of New York against UBP and associated entities and individuals, alleging that the defendants had invested a "material amount of the investment capital of the UBP funds" with Madoff’s firm.

 

On May 29, 2009, the R.W. Grand Lodge of Free and Accepted Masons of Pennsylvania filed a complaint (here) in the Eastern District of Pennsylvania against Meridian Diversified Fund, a Cayman Island "fund of funds" that had invested in the Rye Select Broad Market XL Fund managed by Tremont Partners, which in turn had invested significant assets with Madoff. (The Meridian funds have themselves initiated a separate action, here, against Tremont and related entities.)

 

The claim diversity is not merely geographic. In looking over the lengthy list of lawsuits, some of the claims seem to have taken their inspiration from the theater for the absurd. For example, there is the pro se complaint (which can be found here and that is described in greater detail here), in which the plaintiff purported to sue, among others, Brittney Spears and Kevin Federline, on Bernard Madoff’s supposed behalf, alleging among other things that Spears had "secret affairs with Madoff in return for Saks Fifth Avenue gift certificates."

 

Some of the lawsuits reveal the private pain that has accompanied Madoff victims’ losses, as shown for example in the lawsuit (here) filed in New York (New York County) Supreme Court by Steven Simkin against his former wife Laura Blank, in connection with the Madoff-related investment the couple had maintained while married. It appears that in their divorce, Simkin had paid millions to buy out his wife’s share of the Madoff investment, which is now worthless. Simkin’s suit seeks reformation of the agreement in which the couple had divided the marital assets. A tough situation for Mr. Simkin, no doubt; one can only wonder about his former wife’s sympathies for his plight.

 

So much of this Madoff-related litigation is like that of Mr. Simkin, a desperate bid to salvage something from the losses on now worthless investments. Some of these lawsuits, particularly those against solvent, deep-pocketed defendants potentially could result in substantial recoveries. But in far too many of the other lawsuits, there may be no assets against which to recover, even if the claims are otherwise successful.

 

In some instances, the defendants may have insurance that these claims could implicate. However, the costs of litigation may erode or even deplete the available limits long before any claimants have a chance to access the policy proceeds. Moreover, in many cases, the same defendants have been targeted so many times by so many different claimants that whatever assets or insurance the targets may have are likely to satisfy only a very small amount of the various plaintiffs’ claims.

 

Despite these obvious difficulties, the Madoff-related lawsuits continue to pile up. In most instances, the complaints are salvage operations fueled by anger and frustration. The one thing that is clear is that the collapse of Madoff’s fraudulent scheme will be keeping lawyers occupied for years and years to come.

 

I would be remiss in closing this post if I did not recognize the contributions of the many loyal readers who have provided me with copies of complaints or alerted me to lawsuits that were missing from my list. The list truly is a product of this blog’s community of readers. My very special thanks to all who have contributed.

 

A Classical Allusion: Readers of a certain age may recognize the title of this post as an allusion to the 1963 movie, It’s a Mad, Mad, Mad, Mad World. The movie, whose all-star ensemble cast included, among others, Jimmy Durante, Spencer Tracey, Phil Silvers, Sid Caesar, and Jonathan Winters, involves the mad scramble of various drivers to recover the hidden loot revealed in the dying words of the automobile accident victim whose death they all witnessed.

 

Cherished memories of my childhood enjoyment of this movie motivated me to buy a DVD of the movie for my own children. Suffice it to say that both movie-making and kids’ taste in comedy have changed dramatically in a generation. Even I have to admit that by contrast to the pace of today’s movies, the pace of this movie classic is absolutely glacial. And the slapstick humor I remembered enjoying so much in my youth failed to amuse my kids. After the scene in which an enraged Jonathan Winters destroys a filling station with his bare hands, which I had remembered as hilarious, my then-eight year old son said, "Why would anyone think that is funny?"

 

Due to this failed attempt to take my family down my own memory lane, my access to the family’s movie queue on Netflix has been permanently barred. And whenever anyone in the house wants to veto a proposed movie, all they have to say is "It’s a classic!" and they can be sure no one will want to watch that particular film.

 

All of that said, a reference to the 60’s movie and its portrayal of an every-man-for-himself race to try to recover hidden and possibly nonexistent funds seemed particularly apt in connection with a discussion of the Madoff-related litigation scrum.

 

Even though my kids panned it, I still think the movie is funny. Readers unfamiliar with but curious about the movie may want to watch this trailer which captures the level of the movie’s humor (check out Jimmy Durante "kicking the bucket")

 

https://youtube.com/watch?v=OP2WCpHIg1Y%26hl%3Den%26fs%3D1%26

In its most significant enforcement action yet related to the subprime meltdown, on June 4, 2009, the SEC filed a civil securities fraud complaint (here) in the Central District of California against Angelo Mozilo, the former CEO of Countrywide Financial Corp., as well as the company’s former COO and CFO. The complaint alleges that the defendants mislead investors by misrepresenting the company’s loan origination standards and practices and by hiding the company’s deteriorating financial condition. The complaint also contains allegations of improper inside trading against Mozilo for initiating Rule 10b5-1 trading plans to sell shares while he was aware of material nonpublic information about the company’s deteriorating loan practices.

 

As discussed in its June 4, 2009 press release (here), the SEC’s complaint charges that from 2004 through 2007, Countrywide engaged in "an unprecedented expansion of its underwriting guidelines and was writing riskier and riskier loans, which these senior executives were warned might curtail the company’s ability to sell them" to investment bankers and other mortgage buyers.

 

The complaint alleges that while the company was issuing reassuring statements to investors, Mozilo "internally issued a series of increasingly dire assessments of the various Countrywide loan products and the risks to Countrywide in continuing to offer or hold these loans."

 

One of the more interesting aspects of the SEC’s press release about the suit is the accompanying document (here) in which the SEC summarizes email messages from Mozilo in which he delivered some of his "increasingly dire assessments." Among other things, an email attributed to Mozilo is quoted as saying that "we are flying blind on how these loans will perform in a stressed environment." Another email is also quoted as saying, with respect to the company’s subprime 80/20 loans, that "in all my years in the business I have never seen a more toxic prduct [sic]."

 

In other emails, Mozilo refers to the company’s 100% subprime second mortgages as "poison" and says that the 100% loan-to-value subprime mortgage is "the most dangerous product in existence and there can be nothing more toxic."

 

All of these statements attributed to Mozilo allegedly were made before Mozilo established several Rule 10b5-1 trading plans during the period October through December 2006. In December 2006 and February 2007, as the company’s share price was rising to record highs, he adjusted several previously established plans to allow him to sell even more shares. Pursuant to these plans and during the period November 2006 through August 2007, Mozilo exercised over 51 million stock options and sold the underlying shares for total proceeds of over $139 million.

 

Among other things, the complaint alleges that Mozilo approved his October 2006 trading plan one day after sending the email quoted above about "flying blind" on how the loans would perform. The complaint also alleges that five days before executing his December 2006 trading plan he circulated a memorandum to all managing directors and to the company’s board of directors noting a number of substantial concerns about the company’s subprime loan origination processes and noting that Countrywide expected its 2006 subprime loans to be the worst performing on record.

 

While many of these same kinds of allegations also appear in the pending Countrywide securities class action litigation (about which refer here), the SEC’s allegations nonetheless represent a significant development. SEC officials have been saying for over two years (as noted here, for example) that the agency would be cracking down on alleged Rule 10b5-1 trading plan abuses. Indeed, as discussed here, in an October 8, 2007 letter (here) to then-SEC Chairman Christopher Cox, North Carolina Treasurer Richard Moore had specifically asked the SEC to examine Mozilo’s stock trading pursuant to his Rule 10b5-1 plans.

 

With the SEC’s public commitment to cracking down on Rule 10b5-1 abuses and with the bull’s-eye drawn so specifically on Mozilo’s trading, it may have simply been a matter of time before some version of this complaint was filed. (Indeed, Alison Frankel’s June 4, 2009 American Lawyer article about the SEC’s complaint, which can be found here, is entitled "SEC (Finally) Charges Former Countrywide CEO Angelo Mozilo.") The SEC’s action nevertheless is a significant development, if for no other reason than the prominence of the company and of Angelo Mozilo and because of the nature and specifics of the allegations.

 

The more interesting question is the extent to which the SEC will be targeting other officials, whether for Rule 10b5-1 plan abuses or for disclosures relating to subprime loans and other lending practices. Given the continuing current public need to assign blame for the current crisis, the prospect for further enforcement activity in these areas seems likely.

 

Indeed, according to a June 4, 2009 Washington Post article (here), new SEC Chairman Mary Schapiro has specifically said that as part of her plan to try to rebuild the SEC’s tarnished reputation, she intends to step up enforcement efforts and to push cases related to the financial crisis. As a result, the Countrywide complaint may be only the first in a series of SEC enforcement actions designed to assign blame for the meltdown while also demonstrating that the SEC is "tough" again.

 

The World Was So Much Nicer Before Aggrieved Homeowners Had Access to Counseling Services:  Mozilo’s email practices got him in hot water even while he was still CEO of the company. In May 2008, Mozilo drew media attention (refer for example here) when he accidentally hit the "Reply" button rather than "Forward" after calling a homeowner’s plea for help "disgusting."

 

The borrower’s email had come from Daniel Bailey, a homeowner who was trying to stay in his home of 16 years. Bailey signed an adjustable rate mortgage and was told at the time that he could refinance after one year, before the payments became unaffordable. In drafting his note, Bailey had relied on suggested language from an Internet website that provided coaching services for troubled borrowers.

 

The email response Mozilo inadvertently sent Bailey said "Most of these letters now have the same wording. Obviously they are being counseled by some other person or by the Internet. Disgusting."

 

Mozilo seems to have had a deep commitment to ensuring that he would later look like a cartoon villain. I mean, here’s a guy who had just made a cool $140 million, yet when one of the suckers stuck with one of the loans that Mozilo himself described as "toxic" has the audacity to ask for relief, all Mozilo can think about is how "disgusting" it is that all of the losers stuck with these loans have the same grievances.

 

There is no question that the Amsterdam Court of Appeals’ May 29, 2009 action authorizing Royal Dutch Shell to begin funding the April 2007 securities settlement represents a landmark development. Under the ruling (a copy of which can be found here, in Dutch), Shell will begin paying a total of $381 million to a foundation that represents over 150 institutional investors in 17 European countries, Canada and Australia, in settlement of their securities fraud claims arising from allegations that Shell had overstated its oil and gas reserves.

 

A June 1, 2009 Law.com article describing the court’s action can be found here. The foundation’s May 29, 2009 press release describing the court’s action can be found here.

 

But while the court’s approval of the settlement unquestionably is a significant development, it remains unclear what this development implied about the likelihood of further collective settlements of the same kind, and in the short term it seems unlikely to overcome non-U.S. investors’ interest in pursuing relief in U.S courts, at least when that option is available.

 

Background

Royal Dutch Shell and certain of its directors and officers were first sued in a U.S.-based securities lawsuit in the District of New Jersey on January 29, 2004, following the company’s January 9, 2004 announcement that it was writing down its "proved" oil and gas reserves by 20%. Background regarding the U.S. securities suit can be found here. The class on whose behalf the U.S. action was initially brought purported to include European investors who had purchased their shares on exchanges outside the U.S.

 

In July 2005, Netherlands enacted the Dutch Act on Collective Settlements of Mass Damages, which, subject to considerations discussed below, allows for collective settlement of the claims of the members of a class who do not opt out.

 

Shell and its biggest investors are located in the Netherlands. As discussed at length in a January 7, 2008 American Lawyer article (here), the Dutch Act gave Shell and its European investors a way to settle "on their home turf." On April 11, 2007, Shell agreed to pay $352.6 million, plus administrative expenses, to Shell investors who purchased their shares and resided outside the U.S. (As explained in the foundation’s May 29 press release linked above, the amount of the settlement was later increased to align the Non-U.S. shareholders’ settlement with the settlement Shell had reached in the U.S action with U.S. investors.) A detailed description of the settlement can be found here.

 

The settlement was contingent on its approval by the Amsterdam Court of Appeals, which the court granted in its May 29 declaration. The Dutch Court’s approval is likely enforceable throughout Europe based on the European regulation on jurisdiction and recognition of judgments.

 

Discussion

The Dutch court’s refusal to approve the settlement would have represented a significant setback for the prospect of future similar settlements, as would the court’s refusal, for example, to approve the participation in the settlement of non-Dutch investors.

 

But while the court’s approval avoided these setbacks and while the settlement itself clearly provides an example of a way in which European investors were able to resolve their grievances against a European company in a European court, that does not mean that the Amsterdam Court of Appeals is now about to be inundated with these kinds of settlements. Indeed, given the clear advantages to proceeding in U.S. courts under the U.S. securities laws, aggrieved non-U.S. investors are likely to continue to attempt to pursue their claims in U.S. courts, as long as and to the extent that U.S. relief and remedies are available to them.

 

First, while the Dutch Act allows for collective settlements of the type involved in the Shell claim, it does not allow for collective damages claims. Indeed, as stated in the American Lawyer article linked above, the "innovative solution" involved in the Shell settlement was that Shell and the European investors used the Dutch Act to settle the European investors’ U.S.-based damages claims. While this allowed the European investors to "settle litigation on their home turf," it depended on the existence of the U.S. lawsuit on the front end, in order for there to be a Dutch settlement on the back end.

 

The Shell settlement basically represented an innovation, but the ability for other litigants to use the Shell settlement itself as a model will largely depend on the existence of a similar combination of circumstances. It is far likelier that the next set of European investors to try to use the Dutch Act will need to establish their own "test case" rather than simply modeling off of the Shell settlement. In other words, change in the form of a European collective action remedy for aggrieved investors has been and appears likely to continue to be episodic and incremental, rather than categorical.

 

In the meantime, the U.S. courts continue to offer potential claimants, even those located outside the U.S., with a host of potential advantages. The U.S lacks a loser pays rule; it allows contingency fees; it uses a jury system for civil cases; and it has a well recognized and understood class action mechanism. It also has a highly motivated, entrepreneurial plaintiffs bar. Its courts recognize the fraud on the market theory, which spares claimants from having to prove that the relied on alleged misrepresentations.

 

Of course, many potential claimants would prefer a remedy in their home country if one were available. However, the reason for which non-U.S. investors would seek to resort to non-U.S. courts is less likely to be due to the availability of possible alternatives like the Dutch Act and more likely to be due to jurisdictional constraints on their access to U.S. courts. Non-U.S. investors in Non-U.S. companies who bought their shares outside the U.S. – so-called "foreign cubed" or "f-cubed" claimants – who have jurisdictional access to the U.S courts are likely to continue to take advantage of it, at least as long as and to the extent that the access remains available. A detailed comment on ClassActionBlawg.com about the interaction between U.S. jurisdiction for f-cubed claims and the possibility of further Shell-type settlements can be found here.

 

As discussed in a recent post (here), last October, the Second Circuit declined to rule that U.S. courts could never exercise jurisdiction over the claims of f-cubed claimants. In the National Bank of Australia case, the Second Circuit held that 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 the losses abroad." However the court declined to find jurisdiction in that specific case.

 

The petition of the plaintiffs in the National Australia Bank case for a writ of certiorari case to the U.S. Supreme Court is pending. The 10b-5 Daily blog (here) reported earlier this week that the Supreme Court has asked the Solicitor General to present her views on the petition. A June 1, 2009 Bloomberg article discussing the Supreme Court’s request for the SG’s views in the NAB case can be found here.

 

There is of course no way of knowing now, but it is at least possible that the f-cubed jurisdiction issue will soon wind up in front of the U.S. Supreme Court. In the meantime, the Second Circuit’s decision continues to allow for the possibility of subject matter jurisdiction in f-cubed cases, at least under certain circumstances.

 

All of that said, the movement toward the development of collective remedies in jurisdictions outside the U.S. is now well-established and the Dutch Court’s approval of the Shell settlement undeniably represents another step in support of that movement. We are likely to continue to hear in the weeks and months ahead about the growing threat of collective investor actions outside the U.S. What remains to be seen is where the next "test case" will come from and how it will be framed.

 

My prior post comparing and contrasting in detail European and U.S. collective action procedures and approaches can be found here.

 

Very special thanks to Werner R. Kranenburg (who can be found on Twitter, here) for a copy of the Dutch Court’s ruling.

 

The high-profile bankruptcies of two of the country’s leading auto companies have dominated recent headlines, but for all their size, complexity and notoriety, the GM and Chrysler bankruptcies are only part of the recent wave of bankruptcies that have swept through economy. Numerous other companies have also found themselves in bankruptcy court. As these bankruptcies have spread, bankruptcy-related securities lawsuits against the bankrupt companies’ directors and officers have followed. Unlike much of the credit crisis-related litigation thus far, these latest bankruptcy-related securities lawsuits are not concentrated in the financial sector.

 

The most recent example of bankruptcy-related securities litigation is the securities class action lawsuit that was filed on June 1, 2009 in the Eastern District of Arkansas against the CEO, CFO and Chairman of Charter Communications. Charter, which filed for bankruptcy on Marsh 27, 2009, was not named as a defendant. The complaint, which can be found here, purports to be filed on behalf of all persons who acquired Charter shares between October 23, 2006 and February 12, 2009.

 

The complaint alleges that during the class period the defendants made a series of statements that misled the investing public about the company’s ability to service its debt, about its need to refinance or recapitalize, and about its cash resources. As reflected in plaintiff’s counsel’s June 1 press release (here), the plaintiff contends that "defendants failed to disclose, among other things, that Charter would not be able service its debt to September 2010, but rather Charter would file bankruptcy in March of 2009. Also, the Defendants issued misleading statements about Charter’s potential for mergers. As a result of defendants’ false and misleading statements, Charter’s securities traded at artificially inflated prices during the Class Period."

 

A second recently filed bankruptcy-related securities lawsuit is the action filed on May 18, 2009 in the Southern District of New York against the former CEO and former CFO of Nortel Networks. Nortel, which filed for bankruptcy on January 14, 2009, is not named as a defendant. The complaint, which can be found here, purports to be brought on behalf of persons who acquired Nortel shares between May 2, 2008 and September 17, 2008.

 

According the plaintiffs’ counsel’s May 19, 2008 press release (here), the complaint alleges that the defendants "failed to disclose material adverse facts about the Company’s true financial condition, business and prospects." Specifically, the complaint alleges that the defendants failed to disclose that

 

(i) that demand for the Company’s products was declining as carriers cut back their capital expenditures and other customers deferred purchase decisions; (ii) that the Company’s financial results were materially overstated as the Company was failing to properly write-down its goodwill; (iii) that the Company’s restructuring was not meeting with success as the Company was struggling to cut costs and improve profitability; (iv) and as a result of the foregoing, defendants lacked a reasonable basis for their positive statements about the Company, its business, operations, earnings and prospects.

 

These two actions join the bankruptcy-related securities lawsuits recently also recently filed against the directors and officers of Idearc (about which I previously wrote here) and MRU Holdings (about which I wrote here).

 

In addition to the common element of bankruptcy, and the fact that as a result of the bankruptcy in each of the cases the company was not names as a defendant in the lawsuits, the recent actions against Charter, Nortel and Idearc also share something else in common, which is that each of these companies is outside the financial sector.

 

As has been well-documented elsewhere (refer, for example, here), the securities litigation arising out of the credit crisis has to this point largely been concentrated in the financial sector. However, these recent actions suggest that the spread of adverse financial consequences from the current economic crisis will not only result in an increasing number of bankruptcies but also in an increasing number of bankruptcy-related securities lawsuits.

 

These bankruptcy-related securities lawsuits, like the ones described above, are likely to arise in a wide variety of business sectors, not just in the financial sector. Indeed, because the bankruptcies are and are likely to continue to be spread throughout the larger economy, it seems increasingly likely that going forward the litigation arising from the current economic crisis will not be concentrated just in the financial sector.

 

Whether or not these most recent lawsuits will be successful of course remains to be seen. The scienter allegations in the Charter and Nortel complaints are not overwhelmingly detailed. Neither complaint contains insider trading allegations; rather, the scienter allegations depend on assertions about what the defendants knew or must have known, without further elaboration showing that the defendants had contrary knowledge at the time of the allegedly misleading statements.

 

The other interesting detail about the Charter complaint is that a number of the allegedly misleading statements on which the plaintiff relies were actually made by a UBS media analyst. Neither UBS nor the analyst is named as a defendant; rather, the plaintiff alleges that the analyst was "directed" to make "statements related to Charter by the Defendants." The complaint further alleges that after making these statements and recommending Charter’s stock, the analyst "became Charter’s primary banker."

 

Allegations that securities litigation defendants misled the investing public through statements by third party analysts are certainly not unprecedented, but as a result of Regulation FD and other developments, these kinds of allegations have become relatively rare, particularly in private securities lawsuits. Whether and to what extend these allegations in the Charter case serves as the basis of liability will be interesting to monitor.

 

In a recent issue of Insights (here), I discuss at greater length the likelihood that more bankruptcies could result in increased securities litigation, and the D&O insurance issues that bankruptcy-related securities lawsuits could present.

 

One of Congress’ goals when it instituted the "lead plaintiff" provisions of the PSLRA was to encourage institutional investors to become more involved in controlling and monitoring securities class action lawsuits. But now that institutional investors are indeed more involved in securities lawsuits, the question has become – what difference has it made? A recent academic study suggests that institutional investor involvement in securities litigation not only enhances investors’ success in seeking financial recovery, but also improves the quality of the defendant companies’ corporate governance. The authors conclude that securities litigation is an effective corporate monitoring tool for institutional investors.

 

A January 2009 paper entitled "Institutional Monitoring through Shareholder Litigation" (here), by Agnes Cheng of LSU, Henry He Huang of Prairie View A&M University, Yinghua Li of Purdue, and Gerald Lobo of University of Houston, examined all securities lawsuits that were filed from January 1, 1996 to July 20, 2005 and that had been resolved by June 1, 2006. 1,811 lawsuits met these selection criteria, of which 1,525 lawsuits were led by individual lead plaintiffs, 178 lawsuits were led by at least one public/union pension fund or mutual fund, and 108 lawsuits were led by other categories of institutions.

 

Among other things, the authors found a "trend of increasing institutional involvement in securities litigation." The percentage of lawsuits with institutional investor lead plaintiffs has more than doubled from less than 15% in 1996 to more than 30% in 2004.

 

The authors were most concerned in determining the effect of institutional investor involvement in case outcomes. Prior research had already shown (as reflected in my prior post, here) that cases with institutional investor lead plaintiffs result in larger settlements, primarily because institutional investors tend to become more involved in the larger, more serious cases.

 

In order to be able to control for the differences due to the kind of case in which institutional investors become involved, the authors identified the "determinants" that affect institutional investor involvement and used these factors as control variables. The authors identified a range of variable associated with the increased likelihood of institutional investor involvement, including merit and potential damages, size of the defendant company, and prior performance of the defendant company.

 

Among other things, the authors found that institutional investors are more likely to be involved when the case does not involve an IPO, when accounting issues are present, and when accounting firms are involved. The cases also tend to involve longer class periods, more significant investor losses and companies with higher levels of institutional shareholdings.

 

The authors used a multivariable regression analysis to control for these case differences, in order to be able to determine the impact attributable to having an institutional investor as the lead plaintiff. The authors found that after controlling for the determinants of having an institutional investor lead plaintiff, "lawsuits with an institutional lead plaintiff are less likely to be dismissed and have significantly larger settlements."
 

 

Specifically, the authors found that "institutional plaintiffs play a significant role in defeating the defendant firm’s motion to dismiss," finding that "an institutional lead plaintiff can reduce the dismissal probability by 38.2%" The authors found this relationship held even when tested against control variables relating to the possibility that the institutional lead plaintiffs simply selected the most meritorious cases.

 

The authors also found that the presence of an institutional lead plaintiff "can increase the total settlement amount by approximately 59.8%," when controlling for all the various factors that might be due to the type of case in which institutional investors tend to become involved. The authors concluded that "having an institutional investor lead plaintiff is associated with both a statistically and an economically larger impact on the settlement amount than having an individual lead plaintiff."

 

Finally, the authors also found that within three years of the lawsuit filing, defendant companies that faced institutional investor lead plaintiffs experienced greater improvement in board independence than those facing individual lead plaintiffs.

 

To measure this impact, the authors looked at changes in three variables within three years of the lawsuit filing: percentage of independent boar members in the full board, percentage of independent audit committee members, and whether there is a lead director. The authors found that the presence of an institutional lead plaintiff was associate with more significant reform in these three areas, from which the authors concluded that "the impact of securities class action on governance change depends on the type of lead plaintiff."

 

From these various observations, the authors conclude that "institutional investors’ involvement in securities litigation enhances not only investors’ success in seeking financial recovery, but also the quality of the defendant firms’ corporate governance." From this, the authors further conclude that "institutional investors could use litigation as a mechanism to discipline management and to secure the long-term health of the firm"

 

The authors noted the increasing incidence of institutional investors choosing to opt out of certain class settlements, which the authors note suggests that some investors may find opting out and filing individual lawsuits to be a stronger monitoring tool that leading the class action. The authors, citing recent research by Columbia Law Professor John Coffee (about which refer here), observed that "while the reasons for institutions opting out are interesting, our empirical sample limits our ability to study that issue." The questions surrounding institutional investors’ willingness to opt out raises a host of interesting issues, not the least of which is the relative importance on a continuing basis of class action litigation of a monitoring tool along the lines the authors suggest. The authors note that this is an interesting question for another day.

 

One final observation about the authors’ interesting study is that their article, like an increasing amount of legal literature, depends on the application of sophisticated mathematical tools to problems arising in the legal context. While this approach unquestionably has its value, it does make for some daunting presentations and some impenetrable analyses.

 

I certainly am in no position to question (much less fully appreciate) the validity of the authors’ quantitative approach. I confess that I must simply take it on faith that the authors’ regression analyses are both suitable and properly applied. The more critical approach I generally prefer to take is simply not an option for me when it comes to considering this type of quantitative analysis. I am uncomfortable taking so much on appearances – the authors’ work certainly appears to be rigorous – but without undertaking a massive self-reeducation project, I am hardly in a position to do anything differently.

 

At least I understand and appreciate the authors’ conclusions. Like a docile and uncritical church congregation, I know when to say "Amen."

 

A post on the Harvard Law School Forum on Corporate Governance and Financial Regulation blog about the authors’ paper can be found here.

 

Inspiring Words: While reading Ronald C. White, Jr.’s literary biography of Abraham Lincoln entitled The Eloquent President (here), I had occasion to re-read Lincoln’s First Inaugural Address, including the speech’s stirring final paragraph:

 

I am loath to close. We are not enemies, but friends. We must not be enemies. Though passion may have strained it must not break our bonds of affection. The mystic chords of memory, stretching from every battlefield and patriot grave to every living heart and hearthstone all over this broad land, will yet swell the chorus of the Union, when again touched, as surely they will be, by the better angels of our nature.

 

It is easy for us now to admire the eloquence of these words at the remove of nearly a century and a half and with the luxury of time for quiet reflection, but the words are even more impressive when considered in the context of the circumstances in which they were first delivered. At the time of the inauguration, seven states had already seceded; the very next day, Lincoln would receive word from the commander of Fort Sumter that his supplies were nearly exhausted. Lincoln’s optimistic words reflect an earnest but nearly impossible hope for reconciliation at one of our nation’s darkest hours.

 

Reading Lincoln’s words filled me with the same feelings I had when listening to Winston Churchill’s "Battle of Britain" speeches while I was touring the War Cabinet Rooms in London earlier this year. Both examples underscore the powerful potential of words to illuminate and inspire, even in desperate and hopeless times.

 

One of the more interesting details about this paragraph of Lincoln’s speech is that it was the result of an unlikely collaboration between Lincoln and his Secretary of State, William Seward. As well-told in Doris Kearns Goodwin’s excellent book, Team of Rivals, Lincoln and Seward would go on to become political allies and close friends, but at the outset of Lincoln’s presidency, they were political rivals who hardly knew each other and who had never worked together. Lincoln set aside his ego and not only asked Seward to review his draft speech, but he adopted most of Seward’s suggestions.

 

The most fascinating part of this collaboration is how Lincoln adopted Seward’s suggestions. White’s book puts Seward’s suggestions and Lincoln’s final text in side by side columns, which highlights how Lincoln transformed Seward’s proposed language, sometimes in subtle, sometimes in powerful ways. For example, Seward did indeed suggest the phrase "mystic chords" but Lincoln rendered the phrase as "mystic chords of memory." Seward suggested "the guardian angel of the nation," which Lincoln changed into "the better angels of our nature." Lincoln turned Seward’s well-intentioned prose into meaningful, musical poetry, with words that still resonate and inspire.

 

The transformative power of Lincoln’s use of language was not lost on Seward; he came to appreciate the power of Lincoln’s words perhaps as much as anyone. Though Seward presumed to make six pages of suggestions to Lincoln’s First Inaugural Address, his presumptions changed as he came to know Lincoln better. Three years later, when asked if he had helped Lincoln write the Gettysburg Address, Seward said, "No one but Abraham Lincoln could have made that address."

 

One of the more remarkable things about Lincoln’s powerful use of language is that he had less than one year of formal education. For some reason, in our own time, we have restricted higher office eligibility to individuals who acquired at least a part of their higher education at one of two elite Eastern universities. Indeed, the current President and his three immediate predecessors all share this common educational connection. I am not sure why this peculiarly narrow form of educational elitism now predominates our politics, but the danger is that something vital and fundamentally American could be lost as a result.

 

One interesting note about Lincoln’s first inauguration is that Lincoln was the ninth President for whom Chief Justice Roger Taney administered the oath of office, a feat of longevity and endurance that so unlikely that is seems incomprehensible. Given our current Chief Justice’s relative youth, one can wonder whether he might eventually swear in as many Presidents as Taney. Perhaps in future inaugurations, Chief Justice Roberts will actually administer the Oath’s required words correctly, on the first try.

 

In our time, the Gettysburg Address, the Emancipation Proclamation and even Lincoln’s Second Inaugural Address may all be better remembered than the speech Lincoln delivered at his first inauguration. Lincoln’s words in his other speeches are indeed memorable. But it seems to me that in our time as throughout our history, the mystic chords of memory unite us to our past and our aspirations now more than ever and the prayerful hope for the influence of the better angels of our nature remain as strong as ever.

 

Lincoln’s words remind us that our nation’s history includes days that were darker than even those today, but even in those desperate times, we never lost hope and we did persevere — as Lincoln might have said, with God’s help.