In a June 17, 2009 opinion (here), the Eleventh Circuit upheld the district court’s entry, in connection with the $445 million partial settlement of the HealthSouth securities action, of a bar order that extinguished Richard Scrushy’s contractual claims both for indemnification of any settlement he may enter in the case as well as for advancement of his legal defense costs. The opinion raises interesting and important issues and arguably includes some troublesome analysis, particularly with respect to the advancement issues.

 

Background

In 1994, Scrushy and HealthSouth had entered an agreement requiring HealthSouth to indemnify Scrushy to the fullest extent permitted by law. The agreement also entitles Scrushy to receive advancement of attorneys’ fees as they become due, provided he agrees to repay the amount advanced if it is later determined that he is not entitled to be indemnified.

 

In 2003, HealthSouth, Scrushy and several other HealthSouth officials were sued in a series of securities class action lawsuits that were later consolidated. Refer here for background regarding the case. In 2006, HealthSouth and several of the officials reached a partial settlement agreement in which HealthSouth and its insurers agreed to pay the plaintiffs $445 million. (The insurance carriers paid $230 million of this settlement amount.) Scrushy was not a party to this settlement, and he has still not settled.

 

The parties’ stipulation of settlement proposed several bar orders for the court’s approval. Among other things, the proposed bar order extinguished any non-settling party’s claim for contribution against settling parties. The contribution bar order is reciprocal (that is, HealthSouth’s contribution claim against Scrushy is also barred), and is also balanced by a judgment credit, under which a future judgment against non-settling party is to be credited by the amount of the settlement.

 

The district court entered the bar order over Scrushy’s objections that the order extinguished his contractual indemnification and advancement rights. Scrushy appealed to the Eleventh Circuit.

 

The Opinion

Scrushy raised several arguments against the bar order, contending first that the mandatory contribution bar in the PSLRA was exclusive, and therefore the bar could extend only to his rights to contribution, but not to his separate contractual rights of indemnification and advancement. The Eleventh Circuit held that the PSLRA’s contribution bar was not exclusive, and in fact was enacted against a background of established case law which had approved bar orders precluding indemnification claims.

 

Scrushy also argued that under case law and the PSLRA if he were to be deprived of valuable rights in a contribution bar order, he is entitled to compensation. The Eleventh Circuit held that the judgment credit represented very valuable compensation, since if Scrushy were to take the case to trial, the plaintiffs "will recover nothing at all from Scrushy and other non-settling defendants unless the verdict exceeds $445 million." The court also noted that Scrushy should be able to use that fact as "a very significant bargaining chip" in settlement negotiations with plaintiffs.

 

Scrushy argued further that depriving him of his indemnification rights would be contrary to public policy under Delaware law designed "to encourage qualified individuals to serve as corporate officers." The court said that these considerations must be "balanced against countervailing policies in favor of settlement." The court also referenced extensive case law that indemnification of securities violations is inconsistent with policies underlying the securities laws. The court concluded that the bar order’s elimination of Scrushy’s indemnification right was not against public policy.

 

The court then turned to Scrushy’s argument that the bar order’s elimination of his advancement rights was inappropriate. Scrushy argued that his rights of advancement were independent of any liability he might have to plaintiffs, and therefore it inappropriate in a settlement involving plaintiffs’ liability claims to strip him of his independent contractual rights.

 

The court conceded that "no circuit court… has addressed this issue" and acknowledged that the injury to Scrushy with respect to his advancement rights is not measured with respect to amounts Scrushy might have to pay to the plaintiffs. However, the court said that "the attorneys’ fees are nonetheless paid on account of liability to the underlying plaintiffs or risk thereof." The court found that the claim for attorneys’ fees "clearly cannot be considered to be independent of his liability to the underlying plaintiffs" because it is "so close in nature of the claims which established case law holds are appropriately barred" that so holding is "a minimal and reasonable extension thereof."

 

Scrushy raised a separate public policy argument with respect to his advancement rights, arguing that Delaware law "supports advancement of litigation fees for officers and directors to ensure that they will resist unjustified claims, and to encourage qualified individuals to serve."

 

The court recognized that in the absence of fee advancement "an innocent officer might have difficulty proving his innocence, and thus might have difficulty realizing a prevailing status." But the court said these considerations have to be balanced by policies in favor of settlement. It noted that HealthSouth might well have been reluctant to settle if "it would continue to be liable for endless legal fees to fund Scrushy’s individual defense" as that would constitute "limited peace." The Eleventh Circuit also said (and I want to take care to quote this carefully here) "advancement of legal fees might be inconsistent with the policies underlying the securities laws."

 

The court rejected Scrushy’s argument that he was not compensated in the bar order for the elimination of his advancement rights; the court said the "overall compensation was adequate" given the judgment credit.

 

Accordingly the Eleventh Circuit held that the district court to not abuse its discretion in entering the bar order.

 

Discussion

At one level, the outcome of this dispute is hardly surprising, as it is particularly difficult to meet the "abuse of discretion" standard applicable to the Eleventh Circuit’s review of the district court’s entry of the bar order.

 

On the other hand, the Eleventh Circuit’s apparent commitment to upholding the settlement and to rejecting Scrushy’s claims seems to have driven their consideration of these issues, and whether or not the outcome ultimately is appropriate, there are parts of the court’s analysis that I find less than comfortable.

 

Although I also have issues with respect to the court’s analysis of indemnification issues, my real concerns relate to the court’s holding regarding Scrushy’s advancement rights.

 

In particular, the court gave very short shrift to Scrushy’s public policy arguments regarding advancement. True, the court did concede that an innocent officer "might" have difficulty proving his innocence if his advancement rights are eliminated, and (the court delicately added) "might have difficulty realizing a prevailing status."

 

A fair assessment of these points would not be written in the conditional sense — there is no "might" about it. The reality is that company official whose advancement rights are cut off is pretty much screwed unless he or she has individual resources to defend him or herself. (I am setting insurance issues to the side here, in order to concentrate on the advancement issues).

 

I also think the court strained very hard but not very convincingly to substantiate its conclusion that Scrushy’s advancement rights are not independent of the plaintiffs’ liability claims against him.

 

My overwhelming impression of this opinion is that the outcome was dictated by the identity of the appellant. The fact that it was the notorious and reviled Richard Scrushy before the court clearly seems to have had an impact, and in particular a presumption of Scrushy’s liability for the violation of which he is accused pervades the Eleventh Circuit’s opinion. For example, the Eleventh Circuit said that "Scrushy made no showing in the district court that he was merely an innocent bystander with respect to the violations at issue here."

 

The court also noted, approvingly, that "a party in HealthSouth’s shoes might well have been more willing to leave extant the contractual claims for advancement of fees on the part of an outside director who could adduce evidence of excusable ignorance of the violations."

 

The unmistakable message seems to be that it is OK for the bar order to extinguish Scrushy’s advancement rights because we all know that he is a bad guy. Indeed, the popular consensus is that Scrushy is a bad guy and even that he did all the stuff that plaintiffs allege. But in our system, we generally require these kinds of things to be proven before they can serve as the basis for depriving someone of their contractual rights. Scrushy was in fact acquitted in the criminal trial relating to these allegations, though later convicted on unrelated bribery and racketeering charges. The entry of the bar order did not follow a trial, it followed only a fairness hearing. (Readers who feel I am disregarding some important findings of fact in connection with these proceedings are invited to let me know if I am overlooking something.)

 

Several days ago I defended Bank of America’s advancement of Angelo Mozilo’s defense fees (see my prior post here), and many of the things I said there seem applicable here. In reflecting on these issues, I find myself wondering about the Eleventh Circuit’s consideration of public policy under Delaware law. I can’t help but find the contrast overwhelming between the outcome of the Eleventh Circuit’s analysis on the advancement issue here, and the ruling of the Delaware Chancery Court in the Sun-Times case (linked in my earlier post about Mozilo) that the company had to continue to advance defense costs even though the former officers had been convicted of crimes, had been sentenced and were in jail.

 

It seems to me that the right way to think about the advancement issue is to forget that the appellant here was Richard Scrushy and imagine instead that we are talking about some poor anonymous sucker that got cut out of a settlement and now faces a panoply of securities law allegations by himself. Imagine further that unlike Scrushy the poor sucker has no independent resources with which to defend himself. Perhaps the outcome on the question of the appropriateness of a bar order extinguishing advancement rights might be the same for the poor sucker as it was here. But I find the impression overwhelming that the outcome of this case had to do with the fact that it was about Scrushy and not some anonymous poor sucker.

 

My final concern about this opinion is that in its zeal to uphold the settlement against Scrushy’s challenge the court managed to say some things that simply don’t stand up. The worst example is the court’s statement (which I quoted carefully above) that "the advancement of legal fees might be inconsistent with the policies underlying the securities laws." I really cannot explain or understand this statement, but it seems to be a very radical suggestion to even pose the possibility that it is against public policy for companies to advance defense fees on behalf of corporate officials who have merely been accused of securities laws violations.

 

I feel confident that this is a proposition that would elicit no assent in any quarter, but if it were an accurate statement of the law, I think we would see a wave of mass resignations as no one would voluntarily undertake the kind of risks that this proposition implies.

 

I have said some strong things here. I hope readers who disagree with my view of this case will take the time to add their comments to this post.

 

Many thanks to a loyal reader for providing me with a copy of the Eleventh Circuit opinion.

 

UPDATE: On June 18, 2008, a Jefferson County (Alabama) Circuit Court judge entered a $2.8 billion judgment against Richard Scrushy following a bench trial in a derivative lawsuit filed against him. Although there are no findings of fact in the Final Judgment (copy here), the order clearly represent a finding that Scrushy engaged in the alleged misconduct. This ruling obviously puts the Eleventh Circuit’s decision in a different light. However, this ruling had not yet been issued at the time the Eleventh Circuit issued its decision, so I think many if not all of my questions raised above remain valid given the record before the Eleventh Circuit at the time it ruled.

 

A frequent securities class action lawsuit accompaniment is a companion ERISA stock drop lawsuit brought on behalf of employee participants in the defendant company’s benefit plan. These ERISA lawsuits have in recent years resulted in a string of impressive settlements, although the plaintiffs have not fared as well in the few cases that have actually gone to trial. In a ruling that could have significant implications for other cases, on June 1, 2009, the court in the latest of these cases to go to trial – the high-profile Tellabs ERISA case – entered a sweeping ruling (here) in defendants’ favor. 

 

Because the court in the Tellabs ERISA case ruled in defendants’ favor following trial both with respect to the “prudence” and the “disclosure” issues, and because the disclosures at issue involve many of the same alleged misrepresentation issues as are raised in the much-chronicled Tellabs securities class action (about which refer here and here), the defense ruling in the Tellabs ERISA case could proved to be particularly significant.

 

 

Background

 

The Tellabs ERISA case relates to issues raised by participants in Tellabs’ retirement and savings plan. During the class period of December 11, 2000 through July 1, 2003, the plan offered participants twelve different investment choices, including one fund that was invested exclusively in Tellabs stock. 

 

Tellabs itself had a record year in 2000, but beginning in the first quarter of 2001, Tellabs began to experience a downturn in product demand as well as increased costs. As the year progressed, senior company officials (many of whom were plan fiduciaries and who were subsequently defendants in both the securities lawsuit and the ERISA lawsuit) made a number of statements about the company’s business performance and business prospects. The company along with the rest of the telecommunications industry continued to face business challenges during 2002 and 2003. During the class period, Tellabs share price declined from $63.19 to $6.58 per share.

 

 

In their lawsuit, the plaintiffs contended that Tellabs and the individual plan fiduciaries breached their duties under ERISA. Among other things, the plaintiffs contended that the defendants breached their fiduciary duty of prudence by allowing and holding instruments in the Tellabs stock fund. The plaintiffs also alleged that the defendants breached their duty to honestly disclose material information.

 

 

The case was tried in an eight day bench trial in late April and early May 2009, and on June 1, 2009, Northern District of Illinois Judge Matthew Kennelly issued his findings of fact and conclusions of law, which can be found here.

 

 

The Court’s Rulings

 

Judge Kennelly found for the defendants on essentially all points. With respect to the issue whether the defendants violated the duty of prudence by allowing the plan to continue holding and investing in Tellabs stock, the court found that the defendants demonstrated “procedural prudence.” He found that “by virtue of their roles as high level executives,” they had extensive discussion of Tellabs’ business and future prospects “albeit outside the context of investment and administrative committee meetings.”

 

 

The court added that “though it would have been wise for defendants to conduct a more formal review of the Tellabs stock funds and to document that review, its absence does not mean they were imprudent in light of their intimate knowledge of Tellabs.”

 

 

Judge Kennelly further held, on the issue of so-called “substantive prudence,” that the “evidence shows that a reasonably prudent individual in similar circumstances who undertook such an examination would not have sold the Plan’s stock or removed it as an investment options,” notwithstanding the business challenges that the company was facing. Based on his review of how the business issues unfolded and how the defendants’ responded, Judge Kennelly concluded that “a reasonable fiduciary in similar circumstances would not have concluded that the Plan should have divested its Tellabs stock or ceased offering it to participants as an investment option.”

 

 

With respect to the plaintiffs’ allegations about the inadequacy of defendants’ disclosures about Tellabs and its financial results and prospects, the court concluded that the defendants did not make any material misrepresentations, adding that “Defendants certainly made a number of predictions about Tellabs and the communications industry that turned out to be wrong,” but the “evidence does not demonstrate that defendants misrepresented either the facts or their expectations when they made these statements.”

 

 

Finally, Judge Kennelly also ruled in the defendants’ favor on statute of limitations issues. The defendants had argued that the plaintiffs’ claims were barred by the three year statue of limitations. Plaintiffs had argued that due to defendants’ concealment of the fraud, a six-year statute of limitations should apply and therefore the claims were not time-barred. In a pretrial ruling, Judge Kennelly had found that there were disputed issues of fact on the question of concealment. But following trial, he concluded that there was no evidence of concealment and therefore that the three-year statute applied and accordingly the plaintiffs’ claims also failed because they are time-barred.

 

 

Discussion

 

It is not just that Judge Kennelly’s rulings represent a clean sweep for the defendants. It is that this is the latest of the high profile post-Enron ERISA stock drop cases in which the defendants have prevailed following trial. Other high profile examples include the DiFelice v. U.S. Airways case, in which the defendants’ trial court victory was affirmed in 2007 by the Fourth Circuit (refer here). In addition, in 2008, the Seventh Circuit affirmed (here) the defense verdict in the Nelson v. Hodowal ERISA stock drop case (albeit in a narrow ruling).  

 

 

Trials in these cases are rare, but the track record of defense verdicts at some point may begin to tell, both with respect to which cases get filed and with respect to how the cases settle. In particular with respect to settlement, a demonstrated defense willingness to take a case to trial could begin to have a downward effect on settlements.

 

Chuck Jackson of the Morgan Lewis firm, who successfully represented the defendants at trial in both the Tellabs ERISA case and in the earlier DiFelice case, wrote (here) with his colleague Christopher Wells following the DiFelice case that:

 

 

a plaintiff’s knowledge that an insured and insurer are willing to go through trial if necessary should have the effect of driving down settlements to more properly correspond to the merits of the particular claims, rather than simply fixing a price based on perceived trends, the limits of the insurance polices and a mushy ‘what if’ analysis based on Rule 12(b)(6) rules.

 

 

These points seem even more valid in light of the outcome of the Tellabs ERISA case.

 

 

The DiFelice case has rightly been viewed as significant because the court ruled in the defendants’ favor on the prudence issue, even thought the company wound up in bankruptcy. The Tellabs ERISA case may be even more significant because the court ruled in defendants’ favor on both the prudence issue and on the disclosure issue.

 

 

Plaintiffs are often attracted to ERISA stock drop cases because they can allege disclosure shortcomings without having to plead or prove scienter, as they would in trying to make a claim for securities fraud. Plaintiffs also try to insinuate in settlement negotiations that the court will be predisposed to favor their claims because the plan participants have seen their retirement funds substantially or entirely diminished.Judge Kennelly ruled in the defendants favor notwithstanding and seemingly without regard to these presumed plaintiffs’ advantages.

 

 

Judge Kennelly’s rulings on the disclosure issues may also be significant because of the prominence of the virtually identical disclosure allegations in the high profile Tellabs securities case. The Supreme Court opinion and the subsequent Seventh Circuit opinion in the Tellabs securities case were based solely on plaintiffs’ allegations, which were taken as true due to the procedural posture of the case.

 

 

However, Judge Kennelly made specific findings of fact based on an evidentiary record. . Judge Kennelly clearly credited he testimony of the Tellabs witnesses. His conclusion that the defendants did not make any material misrepresentations suggests that the securities plaintiffs’ allegations also ultimately may be unsustainable. Judge Kennelly’s conclusions that the defendants did not misrepresent either the facts or their assessments provide an important context for subsequent proceedings in the case.

 

 

Judge Kennelly’s final ruling on the statute of limitations issues may be significant in another way, as it seems to be one more basis on which the ruling could withstand appellate scrutiny. Adding the statute of limitations ruling at the end of his findings and conclusions seemingly another way for the appellate court to adopt the district court’s rulings.

 

 

Many of these ERISA stock drop cases contain very similar allegations to those in the Tellabs ERISA case. That is, as in the Tellabs case, the plaintiffs allege that the defendants were imprudent in allowing plan assets invested in company stock and that the defendants failed to disclose to plan participants what the defendants knew about the company’s business results and prospects. According to Jackson, Tellabs counsel in the ERISA trial, the detailed findings of fact and conclusions of law provide “a blueprint for how to try this kind of case.” The court’s findings and conclusions certainly show the challenges plaintiffs face in trying to substantiate these kinds of allegations and also show how defendants can go about refuting the allegations.

 

 

To be sure, there may not be a sudden rush of trials in these kinds of cases. These cases can be notoriously expensive to litigate, and costs and uncertainty of litigation will undoubtedly continue to motivate parties to these cases to seek settlement. But the outcome of the Tellabs ERISA case will hearten those who want to fight these kinds of allegations, and may increase the likelihood that the cases settle for reasons related to the merits.

 

 

Our congratulations to Tellabs’ trial counsel, Chuck Jackson of the Morgan Lewis firm, for his great victory in this case, as well as in the DiFelice case. Jackson has clearly staked out a very clear specialty in trying these kinds of cases. His track record certainly is solid. 

 

 

Special thanks to a loyal reader for providing a copy of the findings and conclusions.

 

 

Seinfeld on Risk Management: George Costanza has to read a risk management textbook, takes advice from a blind man, winds up lecturing (unintentionally) about Ovaltine. Hat tip to the Insurance Journal for the video link.

 

https://youtube.com/watch?v=laKprX-HP94%26hl%3Den%26fs%3D1%26

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.