As reflected in the most recent dismissal motion rulings in the Countrywide subprime securities lawsuit, the proper use of a Rule 10b5-1 trading plan can provide a substantial defense to allegations of securities law violations. In her April 6, 2009 opinion (here), Central District of California Mariana Pfaelzer dismissed the insider trading allegations against certain individual defendants whose trading plans were in order. However, she refused to dismiss the insider trading allegations against Countrywide CEO Angelo Mozillo, whose plan was ‘unusually modified," demonstrating that merely having a plan is by itself not enough, if the plan is not structured properly or has been altered.

 

This difference in outcome underscores the need for certainty about what plan features and practices will afford the desired protection under the Rule. In a March 25, 2009 update (here), the SEC’s Division of Corporate Finance updated its Exchange Rules Compliance and Disclosure Interpretations (C&DI) to provide additional guidance on Rule 10b5-1.

 

As reflected in an April 17, 2009 DLA Piper memo (here) discussing the SEC’s recent updated guidance, the update "comes at a time of heightened and well-publicized scrutiny by the Enforcement Division of the SEC regarding trading activity in and around Rule 10b5-1 plans." According to the law firm memo, the updated C&DI includes "some important new guidance."

 

As discussed in the memo, the updated guidance clarifies that "the cancellation of one of more plan transactions" affects the availability of the affirmative defense under the Rule, because the cancellations represent an alteration of or deviation from the plan. Similarly, the facts and circumstances surrounding the creation of a new plan after the cancellation of a prior plan needs to be evaluated to determine the "good faith" intent of the person creating the plan.

 

The updated guidance also clarifies that the affirmative defense is not available if a person establishes a plan while in the possession of material nonpublic information, even if the plan is structured so that the transactions will not begin until after the information is made public.

 

The SEC’s issuance of updated guidance is instructive and helpful, because Rule 10b5-1 plans can be a very important tool for individuals to use to try to limit their liability when they trade in the personal shares in company stock. As discussed at greater length here, the Eighth Circuit’s October 16, 2008 opinion in the Centene Corporation securities litigation underscored the fact that these plans are still a good idea, notwithstanding some of the concerns that recently have been raised. In that case, the court held that there could be no inference of scienter from insider sales made pursuant to Rule 10b5-1 plans.

 

Melissa Klein Aguilar has an April 21, 2009 article in Compliance Week (here) discussing the SEC’s updated guidance. Hat tip to Bruce Carton at the Securities Docketfor the tweet that alerted me to Aguilar’s article.

 

New ERISA Litigation Study: A frequently recurring question is whether I know where to find good statistical information about ERISA litigation. Unfortunately, the publicly available resources in this area are limited.

 

However, as reflected on the Susan Mangiero’s Pension Risk Matters blog (here), on April 15, 2009, Pension Governance Incorporated and its partner Michael-Shaked Group debuted a new study of over 2,400 ERISA cases that were filed between January 1, 2005 and August 31, 2008. A copy of the study can be found here.

 

The study reports a number of interesting findings, including in particular the fact that "ERISA lawsuits are increasing in number and complexity in terms of combinations of allegations." The study also breaks down the ERISA cases in the study database by type of allegation; by Circuit; by disposition; and by distribution of outcomes. The study also analyzes top litigated ERISA Code sections.

 

This new study is a great resource, which I hope the authors will continue to update and publish. I also hope that in future updates, the authors might consider publishing aggregate settlement data, along the lines that NERA and Cornerstone publish with respect to securities class action cases.

 

And Finally: At least according to a story that is making the rounds on the Internet (here), Demitrius Soupolos of Stuttgart, Germany, and his former beauty queen wife, Traute, were unable to have children because, as he was advised by his doctor, Soupolos is sterile. So Soupolos paid $2,500 to his neighbor, Frank Maus, already the father of two children, to impregnate Traute.

 

About three times a week over the course of six months — a total of 72 different times — Maus "attempted to impregnate" Traute. When Traute did not become pregnant, Maus had his own medical exam.

 

Turns out that Maus, too, is sterile, which "shocked everyone but his wife, who was forced to confess that Maus was not the real father of their two children." Soupolos has now sued Maus to get his money back. Maus’s defense? He did not guarantee conception, only that he would give it "an honest effort." The news articles do not report on how things stand now between Maus and his wife.

 

All of which makes me wonder, shouldn’t somebody look into whether there is something in the water supply that is causing the men in the neighborhood to become sterile? And do you suppose Soupolos will ask Maus’s wife for the name of the father of her children?

 

The collapse of the market for auction rate securities (ARS)  has generated a flood of litigation, mostly brought by angry ARS investors against the broker dealers who sold them the securities or against the mutual funds that allegedly failed to disclose that their assets were invested in these kinds of securities. More recently (refer for example here), companies that invested in ARS and carried the securities on their balance sheet have been sued by their own shareholders in connection with the companies’ ARS disclosures.

 

A recently filed lawsuit presents yet another variant of ARS litigation – in this most recent case, the directors and officers of a student loan originator that issued ARS have been sued by the company’s own shareholders for failing to disclose the company’s dependence upon and susceptibility to the weaknesses of the ARS marketplace.

 

Until it filed for voluntary Chapter 7 bankruptcy on February 9, 2009, MRU Holdings was an originator and holder of federal and private student loans which it marketed through its consumer brand My Rich Uncle. MRU collected its loans into student loan pools that were packaged and sold by broker-dealers (including Merrill Lynch) to investors. The interests in the pool were issued as auction rate securities. This securitization process freed up capital to make new loans and also generated fee income and other revenues. During its fiscal year ended on June 30, 2007, 58% of the company’s income came from securitizations, more twice the income the Company earned on interest from student loans.

 

On April 15, 2009, plaintiffs’ counsel filed a complaint in the Southern District of New York against four of MRU’s former directors and officers on behalf of persons who purchased MRU’s shares between July 9, 2007 and September 19, 2008. A copy of the complaint can be found here. The company itself, which is in bankruptcy, was not named as a defendant.

 

The complaint alleges that the company failed to disclose that the ARS market was illiquid and depended on the illusion of liquidity created by the broker-dealers’ undisclosed interventions to prop up the marketplace and prevent failures of the auction process. The complaint alleges that this illusion "allowed the Company to pay a lower interest rate" in the notes issued in connection with the company’s 2007 securitization, and that the spread allowed the company to realize a $16.3 million gain.

 

The complaint also alleges that the Company failed to disclose that once the "true nature of the ARS market became known," the Company’s future securitizations would not be as favorable and that "without the favorable terms available in the ARS market as a result of the manipulation by broker-dealers, the Company would not have sufficient capital to originate loans, making the Company’s business model untenable."

 

The complaint alleges that the Company failed to disclose the impact that the February 2008 collapse of the market for ARS would have on its ability to depend on securitizations to sell loans and free up capital. The complaint further alleges that on July 3, 2008, the Company announced the pricing of a $140 million private student loan securitization; however, on July 7, 2008, the Company further announced that the bonds to be issued in the pending securitization would be sold at a discount, and that rather than generating income, "the securitization would result in a significant write-down of assets."

 

Thereafter, the company’s share price declined, and Moody’s subsequently downgraded the company’s ARSs. On September 5, 2008, the Company announced that it would "pause" its student loan program. On September 19, 2008, the Company announced that its September 15, 2008 audit report contained a going concern opinion. The company later filed for bankruptcy.

 

As noted above, this new complaint against the former MRU directors and offices differs from prior ARS lawsuits, both in terms of who the plaintiffs are and in terms of the allegations raised. In the vast bulk of the ARS lawsuits filed under the securities laws, the plaintiffs are ARS investors who are suing broker-dealers who sold them the securities and whom the investors allege made misrepresentation in connection with the ARS. Similarly, mutual fund investors have sued the funds for failing to disclosure the funds’ investments in ARS. More recently, shareholders of companies that were ARS investors and that suffered balance sheet write-downs (and ensuing share price declines) have sued the companies because of the companies’ investment in ARS.

 

By contrast to those other case, the plaintiffs are neither ARS investors nor shareholders of companies that invested in ARS instruments. Rather, the plaintiffs in the MRU case are shareholders of a company that put loans into pools out of which the securities were issued.

 

And again by contrast to the other cases, the misrepresentation alleged in the MRU case are not about the nature of the ARS investments (as in the broker dealer cases}, or even about a balance sheet exposure to ARS investments (as in the prior public company cases), but rather about the company’s alleged dependence on the availability of the artificially favorable ARS marketplace as a way to generate income and as a way to free up capital.

 

While the MRU case may represent a new variant on the ARS theme, more cases of the now familiar forms of ARS litigation have continued to accrue.

 

For example, on April 16, 2009, Ashland Inc. filed a lawsuit in the Eastern District of Kentucky against Oppenheimer & Co. (copy of complaint here), in which Ashland alleged that Oppenheimer convinced Ashland to hold and to continue to invest in ARS "at a time when Oppenheimer knew the market for those ARS was collapsing."

 

The Ashland complaint alleges that after August 2007 disturbances in the marketplace for ARS based on municipal government bonds, that Oppenheimer steered Ashland toward ARS based on student loan obligations ("SLARS"). The complaint alleges that after the market for SLARS collapsed in 2008, Ashland was left "with approximately $194 million of illiquid Oppenheimer-brokered SLARS."

 

In a separate complaint also filed on April 16, 2009, Braintree Laboratories and related entities sued Citigroup Global Markets in the District of Massachusetts (complaint here). Braintree alleges that between June 2008 and August 2008, Citigroup sold Braintree approximately $33.3 million of ARS, which Citigroup allegedly had referred to not as ARS but as "seven day rolls" and as "government backed ‘money market’ investments."

 

Braintree alleges that despite its admissions in its various regulatory settlements, Citigroup has refused Braintree’s demand for rescission of the transactions. Among other things, Braintree alleges that in connection with the sale of the ARS to Braintree, "Citigroup acted with criminal and flagrant indifference to the rights, interests and property of the Braintree Entities and the public" and that the sales "resulted from ongoing fraudulent practices."

 

The Braintree complaint also alleges that the ARS sales to Braintree "fell close in proximity to Citigroup erasing recordings of conversations involving employees at its auction rate desk." The complaint alleges that "when engaging in these acts of spoliation of evidence and obstruction of justice, Citigroup acted willfully and with scienter."

 

If nothing else, the one thing that is absolutely clear about the breakdown of the auction rate securities marketplace is that it has proven to be an absolute litigation generating machine.

 

The Ashland and Braintree cases also demonstrates, as I have argued elsewhere (refer here), that neither the dismissal of the UBS auction rate securities lawsuit nor the ARS regulatory settlements marked the end of ARS litigation. As I noted more recently (here), the ARS litigation has continued to come in – and as the Braintree lawsuit demonstrates, interesting new allegations (such as the spoliation charge) continue to emerge.

 

The MRU lawsuit also shows that the auction rate securities litigation wave has continued to evolve as it has continued to grow. Further lawsuit variants seem likely as the wave continues to progress.

 

I have in any event added the MRU lawsuit to my table of credit crisis related class action securities litigation, which can be accessed here.

 

Special thanks to Adam Savett of the Securities Litigation Watch blog (here) for providing a copy of the MRU complaint.

 

A Tribute to Susan Boyle: If you have not yet seen the video of Susan Boyle, an unemployed 47 year-old, singing a song from Les Miserables on the April 11, 2009 episode of Britain’s Got Talent, then you must drop everything and watch the video right now. Due to YouTube restrictions, I can’t embed the actual video in this post, but the video can be seen here.Take the time to watch the entire video; it is worth the seven minutes it takes to watch it. (Hat tip to the Drug and Device Law Blog, here, for the link.)

 

The video is even more moving if you follow the lyrics of the song she is singing, which are as follows (thanks to the Conglomerate blog, here, for the lyrics):

 

I dreamed a dream in time gone by,
When hope was high and life, worth living.
I dreamed that love would never die,
I dreamed that God would be forgiving.

Then I was young and unafraid,
And dreams were made and used and wasted.
There was no ransom to be paid,
No song unsung, no wine, untasted.
 

But the tigers come at night,
With their voices soft as thunder,
As they tear your hope apart,
And they turn your dream to shame.
 

And still I dream he’ll come to me,
That we will live [our lives] together,
But there are dreams that cannot be,
And there are storms we cannot weather!
 

I had a dream my life would be
So different from this hell I’m living,
So different now from what it seemed…
Now life has killed the dream I dreamed…
 

 

In an interesting decision that raises a host of important issues, a federal district court applying Arkansas law held that due to renewal application misrepresentations, a hospital’s D&O insurance policy is void ab initio, and therefore that the hospital must refund amounts the insurer previously paid as defense costs. The April 17, 2009 opinion, written by Eastern District of Arkansas Judge Susan Webber Wright can be found here.

 

Background

The insurance dispute involves three key events: the May 22, 2003 adoption by Baptist Health, a nonprofit corporation that operates hospitals in Arkansas, of an Economic Conflict of Interest policy (ECOI policy), commonly known as "economic credentialing"; Baptist Health’s December 16, 2003 renewal of its D&O insurance; and the February 2004 filing of the first of three lawsuits filed against Baptist Health relating to its adoption of and enforcement of the ECOI policy.

 

The ECOI policy provided that no physician that directly or indirectly owns or acquires an interest in a competing hospital will be eligible to apply for an initial or renewed appointment or clinical privileges for the professional staff at any Baptist Health hospital. The physicians were required to disclose their financial interests, and physicians failing to meet the eligibility requirements were not entitled to any hearing or appellate review.

 

Judge Wright’s opinion has a detailed review of the events and deliberates that led up to Baptist Health’s adoption of the ECOI policy, because the events and deliberations preceding the adoption were relevant to the subsequent insurance dispute.

 

As summarized on pages 31 and 32 of the opinion, Judge Webber found, among other things that Baptist Health knew at the time it adopted the ECOI policy that legal challenges had been raised in connection with at least four other hospitals’ attempts to adopt similar policies ; that questions had been raised whether the ECOI policy violated federal kickback laws; that at an FTC hearing prior to Baptist Health’s adoption of the ECOI policy, and in the presence of Baptist Health’s CEO, the head of one of Baptist Hospital’s competitors had raised questions about the legality of ECOI policies.

 

In addition, by the time Baptist Hospital adopted the ECOI policy, hospital administrators had compiled a list of physicians whom they anticipated would be affected by the policy (all of whom subsequently were plaintiffs in lawsuits against Baptist Health). When asked at a deposition in the subsequent underlying litigation if Baptist Health had adopted the policy "knowing that it could result in a lawsuit," the CEO answered "Yes, sir." (However in the separate coverage litigation with the D&O insurer, the same CEO submitted an affidavit in which he swore that at no time prior to the filing of the first of the underlying lawsuits did he believe that it was likely that the adoption of the ECOI would result in litigation.)

 

In December 2003 – that is, after the ECOI policy was adopted but before the first of the three underlying lawsuits had been filed – Baptist Health renewed its D&O policy. Its expiring coverage, in force during the period December 12, 2002 to December 12, 2003, had been with one of the larger, more well-established insurance carriers. However, during the policy period of Baptist Health’s D&O policy, the individual that had underwritten the Baptist Health account for the incumbent carrier left that job to join a new, start-up insurance company. For reasons Judge Wright discusses at greater length in her April 17 opinion, Baptist Health moved its coverage from the incumbent carrier to the new, start-up carrier at the time of its December 12, 2003 renewal.

 

In connection with the renewal process, Baptist Health completed two  applications, first completing one on the incumbent carrier’s renewal application form, and then later on the start-up carrier’s application form. Each of these two application forms asked "prior knowledge" questions (discussed below). Although there were slight differences in the questions each form asked, the difference proved to be unimportant for the outcome of the subsequent coverage dispute.

 

The prior knowledge question in both forms asked whether any entity or individual proposed for coverage is aware of any fact, circumstance, situation or event that could result in a claim. Both renewal application forms also stated that if any such fact, circumstance, situation or event exists, any claim arising thereform is excluded from coverage. In response to this question in each of the application forms, the hospital responded "None," indicating that it was not aware of any such fact or circumstance.

 

In February 2004, a group of physicians filed the first of three lawsuits against Baptist Health alleging that the ECOI policy violated anti-kickback and Medicaid statutes. Baptist Health submitted this claim and the two subsequent lawsuits to its new D&O insurer as claims under its D&O policy. After the third lawsuit was filed, the D&O carrier became aware of some of the circumstances that had preceded the hospital’s adoption of the ECOI policy.

 

The D&O insurer subsequently filed an action seeking a judicial declaration that the hospital was required but failed to disclose in the application forms the information that its adoption of the ECOI policy may lead to claims, and as a result there is no coverage under the policy for the three subsequent lawsuits about the ECOI policy. Baptist Health counterclaimed, seeking a judicial declaration of coverage. The parties filed cross-motions for summary judgment.

 

The April 17 Opinion

In her April 17 opinion, Judge Wright granted the insurance carrier’s motion for summary judgment and denied the hospital’s summary judgment motion.

 

The essence of her ruling, on pages 30-32 of the opinion, is her conclusion that Baptist Health was "specifically aware" of a wide variety of circumstances that suggested the possibility of a claim when it answered the prior knowledge questions on the application. She found that, given Baptist Health’s awareness of the likelihood of litigation, the conclusion that Baptist Health’s answers to the prior knowledge questions in the renewal applications "were misrepresentations" seems "inescapable."

 

Among other things, Judge Wright noted that Baptist Hospital was aware of that other hospitals’ adoption of similar policies had led to litigation. She specifically found that "a reasonable person would foresee that adoption" of the policy "in these circumstances may give rise to or result in a claim." She also noted that Baptist Health’s CEO acknowledged in a deposition in the underlying action that the ECOI policy "was adopted knowing that a claim would result."

 

Judge Wright reviewed Baptist Health’s responses to other questions in the applications that called for relevant information but that Baptist Health had failed to supply. She found Baptist Health’s attempts to explain its answers to these questions to be "reflective of an apparent tendency on the part of Baptist Health to contort language to its own purposes" and "disingenuous." She said of Baptist Health’s defense of its responses to one application question "reflects a parsing of language that might properly be characterized as a misrepresentation."

 

Judge Wright held under Arkansas law that because the application misrepresentations were material to the underwriting of D&O insurance policy, the policy "is void ab initio and rescinded as if it were never in effect." She also found that even if some of the hospital’s answers were not misrepresentations, the prior knowledge exclusion in the renewal applications "operates to bar coverage."

 

Finally, Judge Wright held that Baptist Health’s retention of the defense expenses the insurer had paid would represent "unjust enrichment," and therefore the insurer is entitled to recover those amounts from the hospital. She did hold that the insurer had to return to Baptist Health the amount of the premium the hospital had paid.

 

Discussion

I have four different reactions to this decision, each one based on different perspectives I have acquired over the years as a participant in different parts of the insurance underwriting and claims handling process.

 

The first reaction I have is based on my many years of representing insurance companies in coverage litigation similar in many ways to this case, as well as my years as an insurance company manager. From this insurer-oriented perspective, this decision represents a complete sweep for the carrier of a kind that rarely occurs. Judge Wright’s ruling that Baptist Health had to return the amount of previously paid defense fees put an extra olive in a sweet martini that insurance company lawyers rarely get to enjoy. As one who knows how these things go, I tip my hat to the counsel that successfully represented the insurance carrier in this case.

 

But these considerations lead to the second of my reactions to this decision, which is more from the perspective of a neutral observer. That it, it seems pretty obvious that by the time Judge Wright ruled on the summary judgment motions, she had developed a less than flattering view of Baptist Health.

 

For instance, I think the opinion suggests pretty strongly that she didn’t think much of the ECOI policy itself, which her opinion describes in negative tones. I also think Judge Wright was genuinely offended that Baptist Health’s CEO submitted an affidavit in support of the summary judgment motion, claiming that Baptist Health was not aware that its adoption of the ECOI policy would result in litigation, even though the same individual had testified in a deposition in the underlying litigation that Baptist Health had adopted the ECOI policy knowing that litigation would result.

 

When a federal judge refers to a litigant as "disingenuous" and accuses it of "contorting" and "misrepresenting" insurance policy language, that litigant is going down.

 

My third reaction to this case is based on the perspective from my current role counseling and advocating for policyholders. Here, I am not as concerned with Baptist Health itself and the merits of its particular case, but rather what these facts suggest. Looked at from this perspective, there are a couple of things that trouble me.

 

First, the insurance dispute arises out of a policy renewal, not the initial placement of a policy. Why then was Baptist Health being asked to answer the "prior knowledge" question in the first place? Yes, both the incumbent and the new carrier asked the question. But to me, the insertion of a "knowledge" question in a application at the time of renewal is inconsistent with the theoretical justifications insurers routinely provide for claims made coverage.

 

That is, in exchange for the improved loss exposure determinations offered with respect to claims made policies, insurers undertake to provide coverage for any claims made during the policy period, regardless of when the underlying circumstances may have occurred.

 

Insurance carriers rightfully should not be expected to cover claims that are known or anticipated when coverage initially incepts. But implicit in the "claims made bargain" is that policyholders should be entitled to expect continuity of coverage as the claims made policy renews, so that the policyholder is not susceptible to losing coverage due to the mere caprice of the date on which a claimant chooses to file a claim. The inclusion of the knowledge question into the application at the time of renewal of a claims made policy represents the insertion of a jagged edge that could – and here, did – result in stripping the policyholder of coverage that would have been available under an expiring policy if the claim had been filed before the prior policy expired.

 

I do not mean to find fault with anyone who was involved in this policy renewal. The insurance marketplace in late 2003 was different than it is today, and I do not mean to judge former circumstances by today’s standards. But even allowing for all of that, I find the inclusion of the knowledge question in a claims made policy application at the time of renewal surprising, troubling, and arguably inconsistent with the very nature of claims made coverage.

 

The other thing I find troublesome from the policyholder’s perspective about this decision is that Baptist Health’s answer to the knowledge question (which comes with and supposedly is enforced by its own prior knowledge exclusion) resulted not just in an exclusion of coverage, but in a policy rescission rendering the policy void ab initio. For most of the last decade the D&O insurance industry collectively has struggled to develop insurance policy provisions to narrow the coverage forfeiture consequences of application misrepresentations. As part of this dialog, insurers try to characterize the prior knowledge exclusion in a policy application as a stepped-down threat from the possibility of policy rescission, since the remedy it triggers results only in the exclusion of coverage and not in the entire policy being voided.

 

Yet here, Baptist Health’s answer to the knowledge question (as well as its answers to other questions, to be sure) resulted not just in noncoverage of a claim, but the rescission of the entire policy (which clearly is yet another reason why the inclusion of the knowledge question in a renewal application is highly objectionable).

 

The fourth and final set of reaction I have to this decision really represents a combination of all points of view. That is, I can’t help but observe that this case involves a couple of very significant missed opportunities.

 

The first of the missed opportunities was the chance Baptist Health had to lock in coverage for the subsequently filed claims, under the incumbent carrier’s policy that expired on December 12, 2003. That is, if you accept Judge Wright’s findings of fact as true, Baptist Health knew prior to the time this policy expired that it was probably going to get sued; it knew who was probably going to file the lawsuit(s); and it even knew what legal theories were likely going to be asserted.

 

In short, Baptist Health had at its disposal, prior to the expiration of the incumbent carrier’s policy, all of the constituent elements required to have provided notice of circumstance that might give rise to a claim. Had this notice been provided to the incumbent carrier, then any subsequently filed claim would have related back to the incumbent carrier’s policy.

 

Again, I am not trying to find fault with anyone that was involved in insurance issues for Baptist Health, particularly since I know I now have the benefit of hindsight and the convenience of the factual recitations in a carefully groomed judicial record. This perspective and these facts may not have been available to the persons directly involved in the insurance transaction. However, if Baptist Health had provided notice of potential claim under the incumbent carrier’s expiring policy, then it could have avoided the problems that later arose with the new carrier under the subsequent policy. (As an aside, I note that this notice of potential claim opportunity may represent the best response to the concerns I noted above about claims made issues).

 

The final missed opportunity that may have been involved here is the chance the parties had to negotiate a compromise of the insurance coverage dispute. Footnote 1 to the opinion reports that a settlement conference in the case took place before a Magistrate Judge, but that the conference "proved unsuccessful." There are innumerable reasons why any case might not settle. But parties that are motivated to settle can usually find a way to get it done.

 

Here, Baptist Health had ample reasons to try to seek a compromise, whether it realized it or not. The hospital CEO’s deposition testimony in the underlying case that when Baptist Health adopted the ECOI policy it anticipated getting sued arguably should have motivated the hospital to seek a compromise of this claim (and that is without even considering the deeply troubling conflict between the CEO’s deposition testimony on this point and the contrary affidavit he supplied in connection with Baptist Health’s summary judgment motion in the coverage case.)

 

There are even reasons why an insurer in this situation might arguably want to consider a compromise. I know many readers would find this observation surprising, especially given how sweeping the insurer’s litigation victory subsequently proved to be. Long experience has taught me that even very strong cases can turn out far differently than expected, and this uncertainty alone ought to counsel any litigant to remain open to possible compromise, regardless of how strong their case may seem.

 

In addition, as I have previously discussed at length (here), the thing about rescission as a policy defense is that it is such a powerful weapon, its effects can not always be predicted in advance. I have direct, relevant personal experience from which to say that even a complete victory in a highly meritorious rescission case can produce unanticipated collateral damage for an insurer. Based on what I have seen and know, any carrier involved in a rescission case, no matter how meritorious, would be well advised to consider opportunities to resolve the case without taking it all the way to the end.

 

One final note about this decision is that it is worth reading for the interesting glimpse it affords into the operations of a fledgling insurance company in its earliest stages. I will not characterize here what the opinion reflects, except to say that most industry participants will find the "inside baseball" description of  the start-up operation interesting.

 

Special thanks to Karen Ventrell of the Troutman Sanders law firm, who together with her colleague Whitney Lindahl represented the insurer in this case, and who provided me with a copy of the decision. I hasten to add that the views expressed in this post are exclusively my own, and nothing I said here about the insurance transaction should in any way reflect on the outstanding job the insurer’s lawyers did in this case.

 

Although a wide variety of surprising details have come to light as the Madoff scandal has been exposed, there has as yet been no reported connection between the scandal and Britney Spears—that is, until now. A handwritten complaint filed in the Eastern District of Michigan on March 16, 2009 raises a number of, well, colorful allegations involving Spears and an assortment of other unexpected persons.

 

The complaint (here) purports to be filed on behalf of none other than Bernard L. Madoff himself, whom the complaint further characterizes as "d/b/a Jonathan Lee Riches," who in turn is described as "a/ka Gino Romano, Inc." The named defendants include Spears, her ex-husband Kevin Federline and the Securities and Exchange Commission.

 

Among other things, the complaint alleges that Spears is in possession of "1.6 billion of Ponzi money from victims of ours." Riches claims that he and Spears met on eHarmony.com in 1996 and that Spears "stole" his American Express Black card to "purchase her circus tour outfits." (You were wondering where she got those, weren’t you?)

 

The complaint links Spears in some rather unexpected ways to two of the most prominent names in the current financial crisis. First, the complaint alleges that Spears has a "secret affair" with Angelo Mozillo. Next, the complaint alleges that Spears has been visiting Madoff’s New York Penthouse for "secret affairs with Madoff" in return for Saks Fifth Avenue gift certificates.

 

Riche’s real objection to Spears seems to be that allegedly she has tattooed his name to her, um, back, which she allegedly displays during concerts. Riches seeks $20 million from Spears and a restraining order against Spears’s younger sister, Jamie Lynn, who allegedly has "threatened Plaintiffs with various unknown teenagers who are pregnant."

 

Riches (a/k/a Gino Romano) is a prisoner in the federal prison system. According to Wikipedia (here), he has filed over 1,000 federal lawsuits since 2006, against, among others, George W. Bush, Steve Jobs and Martha Stewart. Readers may recall a prior post (here), in which I described an earlier lawsuit Riches had filed against Madoff.

 

Indeed, this lawsuit is not even the first complaint Riches has filed against Spears. According to news reports (here), Riches previously alleged that Spears held him at gunpoint and forced him to commit an array of crimes. He also alleged that Spears forced him to pay for abortions, breast implants, cocaine and alcohol.

 

I certainly don’t want to seem like I take threats involving unknown pregnant teenagers lightly. But even though the allegations do have a certain entertainment value, somebody needs to take away this guy’s pencil.

 

I have in any event added this Riches complaint, along with a variety of other recently filed Madoff-related actions, to my register of Madoff-related lawsuits, which can be accessed here. I have to say that I never anticipated that I would be referring to Britney Spears on this blog, for any reason whatsoever. Just goes to show, you never know.

 

Special thanks to a loyal reader for providing me with a copy of the Riches complaint. Thanks also to the alert reader who previously steered me to the Wikipedia item about Riches.

 

Repeat After Me: Correlation is Not Causation: And speaking of unexpected connections, we feel compelled to report on the February 18, 2009 article "Regulators and Redskins" (here), which discloses the unexpected connection between federal government activity and the performance of the Washington Redskins.

 

The authors report "a significantly positive, non-spurious, and robust correlation between the Redskins’ winning percentage and the amount of federal government bureaucratic activity as measured by the number of pages in the Federal Register."

 

The authors’ explanation for this "surprising result" is that "a winning football team makes for a commonly shared source of joyous optimism to lubricate [the bureaucrats’] negotiations." The authors note however that they do not find the same correlation when examining Congressional activity "which we attribute to legislator loyalty to their home state’s team(s)."

 

Hat tip to the Ideoblog (here) for the link to this truly groundbreaking academic study.

 

One of the recurring issues in securities litigation is the way the erstwhile class counsel and their clients, the prospective class representatives, come together. In what one federal judge described as a "blatant, shocking conflict of interest," it appears, from testimony at a recent lead plaintiff selection hearing, that the leading plaintiffs’ firms are providing investment portfolio "monitoring services" for which the firms are paid only if their public pension fund clients pursue litigation recommended by the law firm. In a post-hearing brief in the case, the  firm involved defended its practices as appropriate.

 

These issues arose at an April 1, 2009 hearing before Southern District of New York Judge Jed Rakoff, involving two cases, the Credit Based Asset Servicing case (about which refer here) and the Merril Lynch Mortgage Pass Through Certificate case (refer here). Both cases involve alleged misrepresentations in connection with the initial public sale of certain mortgage-backed securities.

 

At the April 1 hearing, Judge Rakoff consolidated the two cases. The primary purpose of the April 1 hearing was to determine which of the two proposed plaintiffs was the "most adequate" to represent the class in the consolidated case.

 

As reflected in the hearing transcript (here), Judge Rakoff first heard testimony from an administrator for Iron Workers Local No. 25 Pension. In response to questions from the Judge, the administrator testified that they way he learned about the allegations in the case was that "they were brought to me by counsel."

 

The administrator explained that the lead plaintiffs’ firm representing the pension fund in the case has a long-standing investment portfolio monitoring contract with the fund. Under this contract, the law firm monitors the fund’s investments and advises the firm when circumstances arise that would warrant a lawsuit. The plaintiffs’ firm is only paid if they bring a lawsuit and recover.

 

Among other things, Judge Rakoff called this arrangement "about as obvious an instance of conflict of interest as I’ve ever encountered in my life," noting that the plaintiffs’ counsel,

 

under the guise of monitoring the [pension fund’s] investment to determine whether or not there are any violations of the law …have made an arrangement whereby they will only get paid if there are lawsuits brought that they can recover on, and that they will be plaintiffs’ counsel in that lawsuit.

 

Judge Rakoff observed that "if that isn’t a gross conflict of interest in violation of the most elementary fiduciary duties, I don’t see what is." He added that the arrangement inherently compromises the objectivity of the monitoring they’ve been asked to undertake. Indeed, to be frank, I’m shocked that any law firm would enter into such an arrangement."

 

Counsel for the Iron Workers gamely defended the arrangement, among other things asserting that "this portfolio monitoring is not something unique to this firm," an argument that did not impress Judge Rakoff. In response to plaintiffs’ counsel’s suggestion that his law firm analyzes and evaluates the merits of the case before recommending that the fund become involved in litigation, Judge Rakoff said that arrangement "makes crystal clear that the Iron Workers are being led by counsel rather than the other way around," a circumstance the PSLRA had tried to eliminate.

 

Judge Rakoff then heard testimony from the Special Assistant to the Mississippi Attorney General, on behalf of the other proposed lead plaintiff, the Mississippi Public Employees Retirement System. The representative’s testimony established that Mississippi also had monitoring arrangements with plaintiffs’ law firms, but with twelve separate firms rather than just one. The representative also testified that the possibility of bringing this particular action had been brought to the state’s attention by a separate firm that performs bankruptcy related services for the state.

 

The representative explained by using plaintiffs’ firms for monitoring , rather that paying for independent monitoring services, the state was able to save costs. The state representative described the use of plaintiffs’ firms for monitoring services as a "commonplace practice," in response to which Judge Rakoff observed

 

Yes, well, I’m learning that, and to be frank, that doesn’t make me less shocked, that makes me more shocked, because what you’re telling me is that persons, entities with a fiduciary duty, which includes a fiduciary duty to monitor the investments they’re making with their members’ money, have concluded that to save a few bucks they will employ as monitoring entities firms that can only profit of their advice goes one way and not the other.

 

Judge Rakoff did find certain distinguishing characteristics in Mississippi’s case, in that one of its twelve monitoring firms had not brought the case to the state (although it turns out that the bankruptcy firm that did bring the case to the state does have a contingency fee interest in the case); and that even if one of the twelve firms were to bring a case forward, the case would be independently evaluated by other firms and the state’s own representatives. Finally, the state representative testified that in this case the state had reached out to the lead plaintiffs’ firm, rather than the other way around.

 

Ultimately Judge Rakoff did not rule at the April 1 hearing on the question of which of the two proposed plaintiffs would be the lead plaintiff in the case. Rather, he asked for further briefing, noting a concern that at the hearing he might have been "overreacting because of hearing about this arrangement for the first time."

 

Even though Judge Rakoff ultimately did not rule at the April 1 hearing, his shocked response to the practices that were described multiple times at the hearing as "commonplace" does seem to suggest that there may be concerns with the monitoring arrangements. Certainly, the language the Judge used to characterize the arrangements is impressive, to say the least.

 

Pursuant to Judge Rakoff’s briefing schedule, and in response to his comments, on April 8, 2009, the Iron Workers filed a legal brief (here), that among other things defends the monitoring arrangements on the grounds that the monitoring agreement does not itself authorize the firm to initiate litigation on the fund’s behalf without the fund’s authorization, and that the fund is under no obligation if it decides to pursue litigation to use that particular law firm.

 

In addition, the Iron Workers’ brief cites multiple cases in which various courts found that the existence of similar monitoring arrangements were not a barrier to the proposed plaintiffs’ service as a class representative.

 

Finally, the brief also includes an opinion from the distinguished legal scholar Geoffrey Hazard that the portfolio monitoring services were not "professionally improper" and that there is no conflict of interest in these circumstances because the pension fund is not obligated to bring suit even if the firm recommends it. Hazard also stated that the mere fact that the plaintiffs’ firm was "working for a contingent fee" does not present an "inappropriate bias."

 

The Mississippi Public Empoyees’ Retirement System’s brief regarding the alleged conflict and the lead plaintiff issue can be found here. Merrill’s brief can be found here.

 

UPDATE: In an  April 23, 2009 order (here), Judge Rakoff appointed the Mississippi Public Retirement System as the lead plaintiff in the cases. In the April 23 order, Judge Rakoff also stated that  the lead plaintiff determination "involved the Court’s resolution of several difficult issues, which will be elaborated in a written opinion." Judge Rakoff said that he would issue the detailed opinion after he completed an ongoing criminal trial that he has been conducting.

 

Special thanks to a loyal reader for providing a copy of the hearing transcript.

 

 

In prior posts (most recently here), I discussed the fact that while litigation against the financial sector has predominated recent securities lawsuit filings, plaintiffs’ attorneys also have targeted other sectors, including in particularly the life sciences sector. An April 2009 memorandum by David Kotler of the Dechert law firm entitled "Dechert Survey of Securities Fraud Class Actions Brought Against Life Sciences Companies" (here) takes a closer look at the 2008 life sciences securities lawsuits and analyzes the allegations on which the claims are based.

 

The memo notes that the 23 securities lawsuits filed against life sciences companies in 2008 is about the same number as the 25 life sciences securities lawsuits filed in 2007. However, the report also notes that the 2008 life sciences securities lawsuit filings represented only 10% of all securities lawsuit filings during the year, compared to 14% in 2007. The report attributes this slight drop to the fact that securities lawsuits in the financial sector "skyrocketed" in 2008.

 

The memo reports that, similarly to prior years, half of the life sciences companies sued in 2008 were very small, with market capitalizations below $250 million. However, by contrast to 2007, when nearly half of the life sciences companies sued had market capitalizations greater than $10 billion, on 2008 "only 13% of total actions were brought against the largest companies."

 

With respect to the allegations raised in the new lawsuits, the memo notes that in 2008, the majority of claims "pertained to accounting improprieties and/or misstated or misleading financial results and forecasts, by comparison to the 2007 filings, where industry-specific issues such as product safety, efficacy or marketing predominated.

 

The memo does note that about 25% of the 2008 filings contained allegations of alleged misrepresentations or nondisclosure regarding the commercialization or marketing of the product, and about 25% alleged that the defendants had made false and misleading statements about the safety of their product.

 

The memo also notes that one trend observed in 2007 had continued in 2008; that is, the plaintiffs’ lawyers are continuing to include key research personnel as defendants, on the apparent theory that these individuals "had a high level position within the company and access to internal information," and therefore "they knew and failed to disclose the allged adverse non-public information." The memo reports that key research personnel were named as defendants in five of the 23 life sciences securities lawsuits filed in 2008.

 

With respect to the likelihood of future litigation in the sector, the memo notes that life sciences companies "are particularly vulnerable to securities lawsuits because of their inherently volatile stock prices, often driven by a drug or device product life cycle that is fraught with potential for adverse and unpredictable events." That vulnerability "may increase in coming months and years when the boom of securities class actions in the financial sector busts." The memo speculates that "once plaintiffs’ targets in the financial sector dry up, other sectors, including life sciences, may see an increase in lawsuits aimed their way."

 

In discussing the 2007 version of Dechert’s life sciences securities litigation report, I had raised (here) the question whether or not the numerous lawsuits against life sciences companies actually were successful, and in particular, I asked whether or not the cases were dismissed more frequently than other securities lawsuits. The 2008 Dechert memo addresses these questions by taking a look at how the 2007 life sciences securities lawsuits have fared so far.

 

The 2008 memo reports that of the 25 life sciences securities lawsuits filed in 2007, eleven have been dismissed and two have settled. The memo states that the two settlements are "within the standard range" for securities lawsuit settlements generally, and that the dismissal rate "mirrors that of securities class actions in general."

 

The dismissals largely have been based on the plaintiffs’ failure to fulfill the requirements for pleading scienter. The memo comments that "though plaintiffs may be given multiple opportunities to amend their complaints, they will not be able to survive a motion to dismiss with general, conclusory or generic allegations of knowing misconduct."

 

The Dechert memo’s tally of 23 life sciences securities lawsuits in 2008 squares with my own count. I note that in preparing my count of the life sciences lawsuits, I had used a rather narrow definition of the category, limiting the "life sciences" companies to those either in SIC Code series 283 (Drugs) or SIC Code series 384 (Surgical, Medical and Dental Instruments and Supplies).

 

The memo, which concludes with practical risk minimization suggestions, is quite good and merits reading at length and in full.

 

Special thanks to the author of the Dechert memo, David Kotler, for providing me with a copy of the memo.

 

The Rise and Fall of Bill Lerach: The Professional Liability Underwriting Society (PLUS) has posted its acclaimed video, "The Rise and Fall of Bill Lerach," on the members’ section of its website. PLUS members can access the video here. The video alone might justify cost of membership. A trailer of the video can be found on the Securities Docket site, here.

 

A growing chorus of voices is calling for public companies to make the separation of the Chairman and CEO functions the default governance structure. This movement, which may have the support of the new SEC Chair, appears likely to lead to some type of "adapt or explain" approach. Increasing evidence that the companies where the CEOs also act as board Chair are likelier to have "certain troubling governance characteristics" will likely encourage shareholder interest in the initiative as well.

 

The idea of separating the two roles is hardly new, but it has gained significant support from a wide variety of sources recently. First, on March 30, 2009, the Chairmen’s Forum of the Millstein Center for Corporate Governance at Yale School of Management issued a report entitled "Chairing the Board: The Case for Independent Leadership in Corporate North American" (here) calling on all North American companies to "voluntarily adopt independent chairmanship as the default model of board leadership," and if they chose to take a different course "to explain to their corporate shareholders why doing so represents a superior approach to optimizing long-term shareholder value."

 

(The Chairman’s Forum is a group of more than 50 current and former board chairs, directors and CEOs convened at the Millstein Center.)

 

The Millstein Center’s March 30, 2009 press release (here) reports that while in the U.k. only 5% of the FTSE 350 companies combine the chairman and CEO roles, over 60% of the S&P 500 companies have boards that are chaired by their CEOs. The press release quotes one commentator as saying that the independent chair model "has been adopted successfully by many companies in many regions of the globe as a means to further ensure and empower board independence."

 

The press release also quote the former chairman of Northwest Airlines as saying that combining both roles puts both functions in one person who "is obviously conflicted in the essential duty of providing oversight and monitoring the CEO and management team."

 

A March 30, 2009 Wall Street Journal article discussing the Chairmen’s Forum’s report can be found here.

 

Recent remarks from, Mary Schapiro, the SEC’s new Chair, in her April 6, 2009 speech to the Council of Institutional Investors (here), seem to suggest the possibility of an SEC move to a disclosure based approach toward separating the two roles. Among other things, she said that "we’ll also be considering whether boards should disclose to shareholders their reasons for choosing their particular leadership structure—whether that structure includes an independent chair, a non-independent, or a combined CEO/Chair."

 

As Professor Jay Brown has suggested on his Race to the Bottom blog (here), Schapiro’s remarks may suggest a SEC attempt to influence corporate governance through disclosure. Professor Brown has been a vocal advocate in favor of separating the two roles (as shown here).

 

The logic of targeting this particular issue as an important corporate governance objective was reinforced by the research recently released by The Corporate Library. As described in their March 25, 2009 press release (here), companies whose CEOs also serve as board Chair are "more likely to have certain troubling corporate governance characteristics than companies where the roles are separated."

 

The troubling characteristics, which are "associated with board entrenchment or lessened oversight of management," include relatively long CEO tenures; fewer board meetings per year; classified board structure; and "the presence of executive committees, which are typically given the power to act on behalf of the entire board, potentially allowing for a concentration of power."

 

The Corporate Library’s findings raise the possibility that having a single person as the Chair and CEO could be a risk factor for D&O insurance underwriters to assess. Along those lines, it is worth considering, as noted by the Chairmen’s Forum report, that "the overwhelming majority of financial institutions had combined roles before the current crisis erupted" – including, among others, Bear Stearns, Lehman Brothers, Citigroup, Washington Mutual and Wachovia.

 

On the other hand, there may be limits to how much can be expected or discerned from this single governance trait. As the Chairmen’s Forum’s report also notes, "splitting the role of chairman and CEO does not guarantee the application of independent oversight," adding that "it is no secret that certain companies, featured in some of the most famous corporate debacles, had separate CEOs and chairmen." Splitting the roles must be accompanied by other steps "in order for the independent chairman to fulfill the important leadership role."

 

In other words, while the continued combination of the two roles in a single person may (particularly in the current climate) represent something of a risk factor, the separation of the two functions alone is no guarantee of the absence of risk.

 

In any event, it seems likely that pressure for change will continue for all companies, and that companies that do not change will find themselves increasingly called upon to explain.

 

Deteriorating economic conditions threaten a massive wave of corporate defaults.  Corporate borrowers’ inability to fulfill debt obligations could not only prompt a bankruptcy filing surge, but could also result in a flood of lawsuits and claims as creditors and shareholders seek to recoup their losses.  These claims could present a host of challenging D&O coverage issues. 

 

In the latest issue of InSights (here), I take a look at the conditions that could contribute to an increase in corporate bankruptcies, the likelihood that more bankruptcies could translate to increased litigation, and the D&O insurance issues that bankruptcy litigation could present.

Antitrust regulation and securities enforcement each involve entirely separate areas of the law. However, an increasingly frequent follow-on effect of a regulatory investigation for allegedly anticompetitive conduct is an ensuing class action lawsuit under the securities laws. A lawsuit recently filed in the Southern District of New York, which also has some unique characteristics all of its own, is the latest example of this kind of follow-on securities litigation. These cases may present important D&O insurance considerations, as well.

 

According to their April 9, 2009 press release (here), plaintiffs’ counsel have filed a securities class action lawsuit against Mechel OAO and certain of its directors and officers. Mechel is a Russian mining and metals company whose American Depositary Receipts trade on the NYSE. The securities complaint (which can be found here) follows in the wake of declines in the company’s share price after allegations of "anticompetitive and monopolistic practices."

 

The sequence of events surrounding the allegations involves a remarkably compressed time frame. According to the complaint, on July 24, 2008, then-Russian Prime Minister Vladimir Putin "called for antitrust authorities to investigate Mechel’s raw material pricing policies," amid allegations that Mechel charged Russian customers twice what it charged non-Russian customers. On July 28, 2008, Putin also stated that Mechel had used offshore traders to minimize tax payments, which he characterized as "tax evasion."

 

According to the complaint, on August 14, 2008, barely three weeks after Putin’s initial statement, Mechel was found guilty of breaking competition laws; discriminating against Russian consumers; and maintaining a monopoly in the coal market. Mechel was ordered to take several remedial steps, including cutting prices and signing long term deals with local clients. The company was also ordered to pay a $32 million fine.

 

The securities complaint filed on April 8 alleged that the defendants failed to disclose:

 

(i) that the Company had engaged in anticompetitive conduct by employing a discriminatory pricing policy for raw material sales between domestic and foreign steel firms; (ii) that the Company had engaged in monopolistic conduct by fixing and maintaining coking coal prices at artificially high levels and unreasonably refusing contracts; (iii) that as the Company’s anticompetitive and monopolistic practices were discovered, the Company would incur a significant level of fines, and would be forced to enter into long term coking coal supply contracts below market prices; (iv) that a portion of the Company’s revenue was derived from anticompetitive and monopolistic conduct, and when such behavior was discovered, the Company’s revenue would significantly decline in future periods; (v) that the Company had used a sophisticated sales and distribution scheme involving wholly owned offshore trading companies to evade paying taxes on a portion of its revenue; (vi) that the Company lacked adequate internal and financial controls; (vii) that the Company’s financial statements were not prepared in accordance with United States Generally Accepted Accounting Principles ("U.S. GAAP"); and (viii) that, as a result of the foregoing, the Company’s financial statements were materially false and misleading at all relevant times.

 

The Mechel complaint has a number of distinctive and noteworthy features, but in addition it shares one characteristic in common with several other recently filed securities lawsuits – that is, the alleged securities law violations are based on an alleged disclosure failures relating to supposed anticompetitive behavior.

 

For example, in August 2008, investors filed a securities class action lawsuit in the Eastern District of Michigan against Reddy Ice Holdings and certain of its director and officers. Background regarding the case can be found here. The complaint alleges that the company engaged in a price-fixing conspiracy that permitted the company to report revenues that were "derived from illegal activities in violation of the U.S. antitrust laws."

 

Similarly, in December 2008, investors filed a securities class action lawsuit in the District of Delaware against container shipping company Horizon Lines and certain of its directors and officers. Background regarding the case can be found here. The securities lawsuit followed in the wake of guilty pleas entered by three Horizon employees to fixing shipping fees in the Puerto Rico shipping Lane. The securities complaint alleges, among other things, that as a result of the price fixing, Horizon’s revenues had been inflated and its earnings reports and revenue guidance had been misleading.

 

These lawsuits alleging violations of the securities laws based on allegations of anticompetitive conduct should be distinguished from cases in which plaintiffs seek to allege antitrust violations as a way to circumvent the procedural requirements of the PSLRA. The U.S. Supreme Court rejected this kind of "end run" in the IPO Laddering Antitrust Case (Credit Suisse v. Billing), which is discussed at greater length here. The Supreme Court said in that case that it could not allow the antitrust case to proceed, as "to permit an antitrust lawsuit risks circumventing [the statutory requirements of the PSLRA] by permitting plaintiffs to dress what is essentially a securities complaint in antitrust clothing."

 

By contrast, the Mechel case and the other cases above are seeking to accomplish the reverse; that is, they are seeking to dress allegations of anticompetitive behavior (and the economic consequences of the regulatory enforcement action) in the clothing of a securities class action lawsuit. The plaintiffs will of course have to satisfy the PSLRA’s pleading requirements in order to be allowed to proceed. But the point that should not be overlooked is that there has been a string of cases in recent months where plaintiffs have filed follow-on securities lawsuits in the wake of allegations of anticompetitive behavior.

 

Given the predominance of the subprime and credit-crisis securities litigation since early 2007, it is easy for less conspicuous trends like this to be overlooked. The likelihood is that there could be more of this kind of litigation ahead as a result of the current economic turmoil, because of the danger that desperate companies might do desperate things, like calling a competitor to try to work things out.

 

The possibility of securities litigation based on allegations of anticompetitive behavior does raise an important D&O insurance consideration. Although it is relatively uncommon in public company D&O insurance policies, some private company D&O insurance policies contain an antitrust exclusion. For example, one private company D&O insurance carrier’s form excludes coverage for loss "based upon, arising from, or in any way related to any actual or alleged violation of any law, rule or regulation relating to anti-trust, restraint of trade, unfair business practice or interference with another’s business, contractual or economic relationships or interests."

 

These kinds of exclusions are objectionable on a number of different grounds, but the cases described above demonstrate one very specific reason to avoid policies containing this language. Were this language to make its way into a public company D&O policy, the insurer might, especially given the breadth of the preamble language ("based upon, arising from, or in any way relating to"), attempt to rely on this provision to try to preclude coverage for the kind of claim described above. The typical public company D&O policy does not contain this exclusion, but its mere existence even just in some private company forms is reason enough to be on guard.

 

While the Mechel case shares some attributes with the two other cases discussed above, it is in most ways a strikingly unique case. Among other things, the complaint’s references to Vladimir Putin’s statements represent an element of a kind not found in many complaints – with one other significant exception, as described below.

 

Mechel itself is not the first Russian company to become involved in a U.S. securities lawsuit. For example, investors in Yukos Oil tried to bring a U.S. securities lawsuit against the company (refer here), but with little success. The Yukos investors also separately attempted to sue the Russian Federation, several Russian oil companies, and a number of Russian officials (including the current Russian Prime Minister Dmitry Medvedev). Putin himself was not named as a defendant in the case but the complaint did quote certain statements attributed to him. As described here, this separate case ultimately was dismissed on jurisdictional grounds.

 

Mechel is merely the latest of many foreign domiciled companies to become involved in securities litigation in the U.S. Just in 2009 alone, as many as 14 of the roughly 65 securities class action lawsuits filed so far this year (about 21%) have been filed against companies domiciled outside the U.S. Similarly in 2008, 34 of the 226 securities class action lawsuits (about 15%) were filed against foreign companies. Clearly the non-U.S. companies are sued at a greater rate than are domestic companies. Some of the foreign companies may simply make attractive targets, but the number of suits may also suggest that the foreign companies are not always ready for the scrutiny that comes with a U.S. listing.

 

An April 9, 2009 Bloomberg article by Thom Wiedlich about the Mechel case can be found here.

 

Optional Federal Insurance Regulation?: A recurring topic in recent years has been the possibility of the introduction of federal insurance regulation. Although this idea has a long history, it could received greater attention in the current environment.

 

The idea was recently revived in proposed legislation introduced on April 2, 2009. The National Insurance Protection Act (H.R. 1880) would allow insurers and insurance producers to elect federal regulation. An April 8, 2009 memorandum from the Locke, Lord, Bissell & Brooke firm entitled "Once More into the Fray: National Insurance Consumer Protection Act Revives Optional Federal Charter Discussion" (here) describes and analyses the bill in detail.

 

Among other things, the memo notes that the recent financial turmoil has "increased momentum for change to regulation of the financial services industry and the insurance industry is no exception." However, the memo also notes that it is unclear how the proposed legislation would fit within the Treasury Department’s overall plan for regulatory reform, and until the Treasury details its plan, the proposed legislation "may not gain much legislative traction."

 

Special thanks to Peter Schwarz of the Securities Mosaic for providing a copy of the memo.

 

On April 9, 2009, the subprime securities lawsuit pending against Radian Group joined the growing list of subprime-related cases in which the dismissal motions have been granted. Eastern District of Pennsylvania Judge Mary McLaughlin entered the order dismissing the case, without leave to amend. A copy of the opinion can be found here.

 

As reflected in an earlier post about the lawsuit (here), Radian provides credit protection products (such as mortgage guarantee insurance). The lawsuit related to an affiliate company in which Radian was a minority owner, Credit Based Servicing & Asset Securitization (C-Bass), an investor in the credit risk of subprime residential mortgages. Radian was a joint venturer in the affiliate with MGIC, with which Radian also had an agreement to merge.

 

The plaintiffs alleged that the defendants (the company and several of its directors and officers) made false and misleading statements about C-Bass’s profitability and liquidity position and thus, the value of Radian’s investment in C-Bass. The statements allegedly inflated Radian’s share price, which led to losses to shareholders when Radian announced an impairment of its investment on July 30, 2007. The turbulence surrounding the C-Bass affiliate may also have undermined the pending merger with MGIC. Further background about the case can be found here.

 

Judge McLaughlin granted the motion to dismiss based on the plaintiffs failure to adequately plead scienter. She found that the plaintiffs’ allegations "do not establish either motive and opportunity or conscious misbehavior or recklessness on the part of the defendants" and that the plaintiffs therefore have not "raised a strong inference of scienter." She also found that the inference of scienter the plaintiffs sought to draw "is neither cogent not at least as compelling as the plausible opposing inferences suggested by the defendants."

 

The plaintiffs had alleged that the defendants had delayed announcing the material impairment to the C-Bass investment in order to allow the completion of the MGIC merger, and also to allow the defendants to sell shares in their personal holdings of Radian.

 

Judge McLaughlin found the motivation to complete the merger is not "distinctively unique" as it is like "the motives that have been found to be generally possessed by most corporate directors." She also found that the plaintiffs failed to allege any concrete and personal benefit the completion of the merger might provide the individual defendants.

 

Judge McLaughlin found further that the allegations of insider trading inadequate to establish motive and opportunity. One of the three individual defendants more than tripled his investment during the class period, which a second sold only 2.7% of his holdings, and the related Form 4s showed they were sales of restricted stock, and in part motivated to pay taxes. The third individual defendant sold a much larger percentage of his holdings but the public record showed that he was not planned to be a part of the merged company and was divesting his ownership.

 

In support of their allegation that the defendants had been reckless, the plaintiffs had argued that as a result of their positions with Radian, the defendants were aware of the risky nature of C-Bass’s business and the deteriorating conditions of the subprime industry. Judge McLaughlin found first that the plaintiffs’ allegations did not establish that C-Bass was in fact impaired before the company took the impairment charge. Judge McLaughlin also found that the plaintiffs’ allegations "did not establish with sufficient particularity that the defendants knew or should have known that their statements presented an obvious danger of misleading the investing public."

 

The plaintiffs had also argued that the defendants had to be aware of the problems at C-Bass because of their positions of responsibility within the company and the relation of the C-Bass investment to the "core operations" of the company. Judge McLaughlin said that while some courts have found that knowledge of core activities can be imputed to company officials under some circumstances, they had done so only when there were particularized allegations showing that the defendants had ample reason to know of the falsity of the allegedly misleading statements.

 

Judge McLaughlin said that the plaintiffs had failed to explain why C-Bass’s activities were part of Radian’s core activities. She also found that the plaintiffs had failed to show why defendants must have known that their statements presented a danger of misleading investors. In this connection, Judge McLaughlin reviewed the plaintiffs’ extensive allegations about the deteriorating conditions in the subprime marketplace, which the plaintiffs alleged the defendants must have known.

 

With respect to these allegations, Judge McLaughlin observed that "these facts were known to the plaintiffs and by the market at large, and the [amended complaint] itself establishes that Radian publicly disclosed its knowledge of these facts and their potential to effect on Radian’s investment in C-Bass."

 

Judge McLaughlin also found that the plaintiffs’ attempt to establish scienter in reliance on confidential witnesses, the defendants’ sox certifications and the company’s alleged violation of GAAP were equally unavailing,

 

Judge McLaughlin’s opinion joins the growing list of subprime and credit crisis-related securities class action lawsuits in which courts have granted preliminary motions to dismiss. It is also is yet another case that seems to reflect a general judicial unwillingness to conclude that merely because companies were caught in the downdraft accompanying the subprime meltdown that the company had engaged in fraud. (Refer here for similar observation regarding the recent dismissal motion grant in the subprime case involving Downey Financial.)

 

I have in any event added the Radian opinion to the table in which I have been tallying the subprime case resolutions. The list can be accessed here.

 

Special thanks to a loyal reader for forwarding me a copy of the Radian decision.

 

Dismissal Denied Again in Countrywide Case: Perhaps by contrast, and in one of the prominent cases in which a dismissal motion has been denied, on April 6, 2009, Judge Mariana Pfaelzer largely denied the defendants’ renewed motions to dismiss. A copy of Judge Pfaelzer’s opinion can be found here.

 

In a prior opinion (available here), Judge Pfaelzer had substantially denied the defendants motions to dismiss, although she did granted the motion in certain respect with leave for the plaintiffs to amend. The plaintiffs filed an amended complaint and the defendants renewed their motions to dismiss.

 

In her April 6 opinion Judge Pfaelzer largely incorporated her reasoning from her prior opinion. However there were a couple of respects in which the April 6 ruling is noteworthy. First, she found that the plaintiffs’ revised allegations against defendant KPMG, whose dismissal motion previously had been granted, would now "suffice" and therefore KPMG’s renewed dismissal motion was denied.

 

However she also found that insider allegations as to certain insider defendants, whose sales were made pursuant to written Rule 10b5-1 trading plans, were insufficient and accordingly the insider trading were dismissed. However she refused to dismiss most of the insider trading allegations against former Countrywide CEO Angelo Mozillo, even though he too purported to have traded pursuant to a Rule 10b5-1 plan, because of "unusual" modifications he had made to his plan.

 

Allison Frankel’s April 8, 2009 American Lawyer article about Judge Pfaelzer’s latest opinion can be found here. I urge everyone to read it, if for no other reason that along the way Frankel refers to The D&O Diary’s author (that would be me) as "our favorite subprime litigation savant." I am humbled by the accolade.

 

Special thanks to several loyal readers who supplied me with a copy of the April 6 opinion.