Litigation over executive compensation is nothing new. The long-running clash over Richard Grasso’s $187 million NYSE pay package is only one of many titanic legal battles compensation issues produced in the past. But executive compensation litigation recently seems to have entered a new phase, fueled by moral outrage.

 

Drawing on popular anger evidenced most recently in the outrage surrounding the AIG bonuses, these most recent compensation-related cases could represent an even more pronounced litigation threat than prior lawsuits over pay. The same forces driving the litigation have also produced a variety of other corporate and social responses, some of which may or may not fully serve the purposes of overall social utility.

 

Among other recently filed lawsuits involving executive compensation is the derivative complaint filed on April 1, 2009 in California (Los Angeles County) Superior Court against the current AIG CEO Edward Liddy and several other AIG directors and officers. The complaint (copy here) among other things alleges that "there was no rational business purpose or justification for these lucrative additional payments, particularly given AIG’s deteriorating financial condition and dismal financial performance," and described Liddy’s explanation of the bonus payments as "outrageous on its face" and "absurd." The complaint seeks to recover damages for corporate waste, breach of fiduciary duty, abuse of control and unjust enrichment.

 

The bonuses paid to Merrill Lynch employees at year end just prior to the consummation of the company’s merger with Bank of America also features prominently in the shareholders’ litigation filed against Bank of America earlier this year, following the revelation of Merrill’s massive and previously unreported losses.

 

The $68 million exit package awarded Citigroup CEO Charles Prince following his November 2007 departure from the company is the subject of one of the claims in a Delaware shareholders’ derivative suit against Citigroup’s board. The claim, which alleges waste, is particularly noteworthy, because in a February 24, 2009 decision (here) in which the Delaware Chancery Court otherwise dismissed the plaintiffs’ claims against the Citigroup board for failure to monitor the company, the court found that the claim related to Prince’s compensation had been adequately pled. Unlike plaintiffs other claims, the claim for waste survived the motion to dismiss. An April 2009 memo entitled "Executive Compensation Under Fire" (here) from the Greenberg Traurig law firm described the denial of the motion to dismiss in the Citigroup case on the waste issue as "an unusual move from the traditionally pro-business courts."

 

As noted on the CorporateCounsel.net blog (here), the Delaware Court’s ruling in the Citigroup case regarding the compensation claims could be the most significant part of the decision and could suggest a possible judicial receptivity to waste claims related to executive compensation. The Greenberg Traurig memo cited above comments that as a result of this decision, "don’t be surprised if more companies face similar challenges to executive compensation in the future," adding that these challenges might include not only a derivative suit like the one involving Citigroup, but also shareholder demands on the board; books and records requests; and even proxy contests.

 

An April 6, 2009 Law.com article entitled "Executive Bonuses Triggering Lawsuits Nationwide" (here) observes that litigation triggered by executive compensation controversies not only include claims of excess compensation but also lawsuits ranging "from corporate officers who allege their companies reneged on bonuses to officers who believe they were fired for protesting them." The article, which cites several examples of each of these kinds of claims, also notes that "attorneys are bracing for more litigation and legislation involving executive bonuses and compensation matters."

 

In addition, another recurring theme currently surrounding executive compensation is the possibility of a clawback remedy, to recover compensation already paid, which is a topic I previously discussed here.

 

One positive consequence of the current furor over executive compensation is that at least some companies have become more solicitous of shareholders’ views on pay. Indeed, as discussed in an April 6, 2009 Wall Street Journal article entitled "Companies Seek Shareholder Input on Pay Practices" (here) reports that biotech firm Amgen invites its shareholders to complete a 10-question online survey to determine the shareholders’ views on whether the company’s compensation plan is based on performance and whether performance goals are clearly disclosed and understandable. The article identified other companies that are taking similar steps to consult or enlist shareholders.

 

That said, the actions taken based on current popular outrage over executive compensation issues also have an ugly side. The stones thrown through the home windows of former RBS chairman Fred Goodwin and the French workers’ recent seizures of local managers, among other recent examples, suggest the possibility that the current populist backlash could slip into far more dangerous manifestations, which is one of the dangers when politicians play to the galleries on these kinds of issues.

 

Popular anger over bonuses paid to money-losing managers is understandable. Indeed Goldman Sachs Chairman and CEO Lloyd Blankfein has said (here) that he recognizes why the public is angry and called for a reform of the way financial institution executives are compensated, particularly at companies receiving government bailout funds.

 

All the same, we should take care as a society that our proclivity for blamecasting and scapegoating does not unleash darker forces. Social disorder has arisen in past economic crises, and there is nothing that says that it can’t happen again.

 

An April 7, 2009 Wall Street Journal op-ed column considers (here) how generalized populist outrage can quickly transform into nationalist or ethnic rage.

 

My apologies to The Economist  for using the cover art from this week’s issue of the magazine to lead this post. I figure that on the cover of last week’s issue of the magazine, they shamelessly imitated the iconic Saul Steinberg Map of New York cover art from the March 29, 1976 issue of The New Yorker Magazine. In its original form, Steinberg’s map reflected a view of the world as seen from New York’s Ninth Avenue. On the cover of last week’s issue, The Economist adapted Steinberg’s map as a contemporary map of Beijing, adding an apology for the adaptation. I extend to The Econmist the same apology here for my adaptation of the magazine’s cover art here.

 

Subprime Securities Litigation: Early Trends: Even though the subprime and credit crisis-related litigation wave recently entered its third year (as I noted here), and though there have been a few settlements as well as a few rulings on motions to dismiss (refer here), by and large, the cases remain only in their earliest stages.

 

Nevertheless some trends have begun to emerge, as detailed in the March 23, 2009 memorandum from the Gibson Dunn law firm entitled "Suprime-Related Securities Litigation: Early Trends" (here). The memo does a particularly good job categorizing the various kinds of allegations that plaintiffs have alleged as well as the defenses that defendants have asserted. As for what may lie ahead, the memo states that "there is unlikely to be any slowdown in the near future of new filings of securities cases related to the credit crisis."

 

The National Map of Bank Distress: The FDIC did not close any banks this past Friday night, so the number of year-to-date bank failures remains at 21, and the total number of bank failure since January 1, 2008 remains at 46.

 

Those readers who are tracking these banking-related developments closely may want to refer to this nifty interactive graphic (here) from TheStreet.com, on which they have plotted the bank closures since January 1, 2008 on a map of the United States. Cool.

 

Some Things in the Insurance Industry Never Change: In his enjoyable book about the rebuilding of London following the Great Fire of 1666 entitled London Rising, author Leo Hollis discusses the innovation Nicholas Barbon introduced when he launched "the first fire insurance company in the world." Hollis writes that

 

His scheme was brilliantly simple: it offered a defence against the risks of living in the city while also making him a healthy profit. For a premium of 2.5 per cent of the yearly rent for brick buildings and 5 per cent for wooden-frame structures he offered insurance against fire for terms of seven, eleven, twenty-one and thirty-one years. By the 1680s, he would have over four thousand subscribers.

 

However, insurance industry behavior pattern apparently were established even in the industry’s earliest days; Hollis notes that "the problem with innovation is that it is often copied and Barbon’s ideas were swiftly replicated." The City Corporation offered its own competing scheme and offered terms for life. Barbon "had to work hard to sell his services before the opposition stole his market," while the Corporation soon found "that it was offering too much to get customers."

 

So it may be said, with respect to the insurance industry’s apparently inexhaustible capacity for self-destructive competition, ‘twas ever thus.

 

And Finally: On behalf of everyone who has watched as much college basketball on TV over the last few weeks as I have, I would like to make a motion – that is, that every single person associated in any way with the production or distribution of the Taco Bell "nacho drag" commercial should be taken out and summarily shot, without benefit of clergy. All those in favor say "Aye."

 

Following close on the heels of the Massachusetts regulator’s action filed last week against Madoff feeder-fund Fairfield Greenwich and related individuals, on April 6, 2009, New York Attorney General Andrew Cuomo initiated a civil action in New York (New York County) Supreme Court against J. Ezra Merkin and Madoff feeder fund Gabriel Capital Corporation. The AG’s April 6 press release, which links to the complaint and accompanying exhibits, can be found here.

 

The complaint alleges that over the course of many years beginning in the 90s and going through December 2008, Merkin earned $470 million in management and incentive fees, representing to investors and to nonprofits on whose boards he sat that he was managing their money when in fact he was simply handing much of the money over to be managed by Bernard Madoff, whom Merkin "failed to adequately oversee, audit or investigate."

 

The complaint alleges that through his "misrepresentations, concealment, self-dealing, reckless conduct and gross negligence," Merkin "abused the trust of investors" and "breached the fiduciary duties" he owed to the nonprofits on whose boards he sat. As a result, the complaint alleges, investors lost approximately $2.4 billion.

 

Merkin not only misrepresented his role as a money manager, but also, according to the complaint, concealed Madoff’s critical role in (supposedly) managing the funds. The complaint also alleges that not only was Madoff perhaps uniquely aware of many of the "red flags" about Madoff (including his uncanny returns, his suspicious clearing of trades every quarter end, and the suspicious identity of his auditor), but he also received numerous warnings about Madoff from "his closest and most trusted advisors." The complaint alleges that Merkin disregarded these warnings because his "financial incentive to keep funds with Madoff blinded him."

 

The complaint alleges that the Ascot funds, one of the groups of funds Merkin founded and supposedly managed, turned virtually all of its investor funds over to Madoff to handle. Of the $1.7 billion in the Ascot funds as of May 2008, $215 million, or about 12 percent, belonged to 35 nonprofit groups, of which more than half ($115 billion) belong to organizations on whose board Merkin sat as a director. The complaint alleges that "Merkin embedded himself in charitable boards and used those positions to solicit new investments."

 

The complaint charges Merkin with violations of the Martin Act for fraudulent conduct in connection with the sale of securities; with other statutory violations for "persistent fraud in the conduct of business"; and with violations of New York’s Not-for-Profit Corporation Law and breaches of fiduciary duty in connection with Merkin’s service on the boards of certain nonprofit entities. The complaint seeks payment of damages and disgorgement of fees, restitution and other equitable relief.

 

The NYAG’s complaint obviously presents a host of factual and legal issues. Among other things, it also raises some potentially complex and even vexing insurance complications as well.

 

Merkin will obviously seek to resort to his firm’s D&O and/or E&O coverage in connection with his defense against the AG’s claims. However, his firm’s insurance coverage may already be under significant pressure as a result of the extensive civil litigation already pending against him and his firm.

 

Moreover, his firm’s insurance coverage would only cover him as excess insurance in connection with the allegations against him in his capacity as a director of the referenced nonprofit entities. Insofar as he is named as a defendant in those capacities, his firm’s policy would cover him, if at all, after both the nonprofit’s available insurance and indemnification obligations were exhausted.

 

In other words, as a result of the allegations against him in his capacity as a director of those nonprofits, he would as a theoretical matter be in a position to attempt to resort to those organization’s insurance policies as well as to seek indemnification from those organizations.

 

The potential implications that these nonprofits insurance policies (and even indemnification obligations) would be called upon to respond to the claims against Merkin would raise a host of complex issues, including, for example, allocation issues (owing to the fact that Merkin is named as a defendant in multiple capacities). But as a strictly theoretical matter – and without expressing any opinion as to the merits of the effort or the justice it would or would not represent – Merkin certainly might well seek to access the various nonprofits’ insurance policies, at least to the extent he is named as a defendant in his capacities as a director of the nonprofits. However, even to the extent the policies afforded coverage in connection with this claim it would only be for Merkin as an individual and to the extent of his insured capacity under each particular policy, and it would not in any event extend to his funds.

 

One additional complicating factor, at least as a preliminary matter, is that the various nonprofit organizations are not referenced by name in the complaint. This initial hurdle is likely surmountable through discovery, and seemingly would quickly be overcome. (According to an April 7, 2009 Wall Street Journa article about the AG’s law suit, which can be found here, the institutions on whose Boards Merkin sat and which had funds invested with Merkin included New York University, New York Law School, Yeshiva University and Bard College.) Whether or not the potentially affected policies would in fact respond to these claims would of course have to be determined according to the applicable allegations and the applicable policy language.

 

Ironically, as least some of these nonprofit institsutions have separtely initiated their own actions against Merkin and his funds — for example, New York Law School (refer here for the complaint) and New York University (refer here) have each filed suit against Merkin . These separate actions against Merkin would likely trigger the insured vs. insured exclusion found in most D&O insurance policies and therefore would not themselves implicate coverage. The irony is that these same institutions, who are pursuing substantially the same claims against Merkin as is the NYAG,  could  see their insurance policies accessed and potentially depleted by the NYAG’s complaints, assuming for the sake of discussion that the policies are in fact implicated as discussed here.

 

A detailed and particularly compelling portrait of the long relationship between Madoff and Merking is set out in New York Magazine’s February 22, 2009 article entitled "The Monster Mensch" (here). The article describes Merkin as "an intellectual showman" and a "marvel of erudition" who commanded respect as a civil and philanthropic leader and as Chariman of GMAC, the finance arm of General Motors. He was, according to a friend quoted in the article, the "wisest man on Wall Street." Which may explain a lot, unintentionally and in retrospect, about Wall Street.

 

I have in any event added the NYAG’s complaint to my roster of Madoff-related lawsuits, which can be accessed here. (The list also includes a separate action filed against Merkin, Gabriel and the funds’ auditor on April 6 by publisher and real estate magnate Mortimer Zuckerman, who claims in his complaint that he lost $40 through his investments with Merkin.)I note that this list gets considerably longer every day, as new complaints continue to arrive. Special thanks to the many readers who continue to provide me with copies of the new lawsuits, particularly to Jon Jacobson of the Greenberg Traurig firm.

 

And Finally: Although arguably it has nothing to do with Merkin himself or any of the foregoing, I nevertheless feel compelled to alert readers to the interesting and somewhat peculiar meaning that the work "merkin" has in the English language.

 

According to Wikipedia (here), a "merkin" is "a pubic wig, originally worn by prostitutes, after shaving the genitalia to eliminate lice or disguise the marks of syphilis." The Wikipedia entry helpfully provides a picture of "a mock merkin."

 

Now you know.

 

Special thanks to the loyal reader who pointed out this fact – which, upon further reflection, may not be quite so unrelated after all.

 

The possibility that a conflict of interest could arise when an attorney or law firm simultaneously representes a corporation and one or more of its officers or directors is a a frequently recurring issue. The issue  was raised recently, for example, in the civil complaint that former Stanford Financial Group CFO Laura Pendergest-Holt filed against the firm’s former outside counsel, in connection with his conduct of the defense in connection with the SEC’s investigation of the firm. (A copy of Pendergest-Holt’s complaint can be found here.)

 

An April 1, 2009 opinion (here) by Central District of California Judge Cormac Carney in the Broadcom Corporation options backdating criminal case presents a far more dramatic example of the pitfalls that can arise from dual representations.

 

The opinion involves the Irell & Manella law firm’s "separate, but inextricably interrelated representations" of Broadcom and its CFO, William Ruehle. The law firm represented the company in its internal investigation of the backdating allegations. It also represented the company and Ruehle in the defense of the backdating related civil litigation.

 

In June 2006, two lawyers from the firm interviewed Ruehle, without disclosing possible conflicts or disclosing they might later reveal his statements to third parties (such as the government). Subsequently, the law firm, at the company’s direction, disclosed Ruehle’s statements to the company’s auditors, the SEC and the DoJ.

 

Ruehle sought to suppress the government’s reliance on his statements in connection with the criminal prosecution, because the statements represented privileged communications. Judge Carney agreed, but his April 1 opinion went far beyond this conclusion.

 

Judge Carney found that Irell "committed at least three clear violations of its duty of loyalty" – it failed to advise Ruehle of and obtain his written consent to the conflict; it interrogated him for the benefit of another client (Broadcom); and it disclosed privileged communications to a third party without consent.

 

Judge Carney said that he found Irell’s "ethical breaches" to be "very troubling," not only because they resulted in the suppression of relevant evidence, but also because they "compromised the rights of Mr. Ruehle, the integrity of the legal profession, and the fair administration of justice." Because of these concerns, Judge Cormac concluded that he "must refer Irell to the State Bar for discipline."

 

Judge Carney’s blistering opinion is noteworthy in and of itself, both because of the prominence of the firm involved and because of the heat of the rhetoric he employed. His opinion is also a cautionary example both to lawyers involved in corporate representations and to corporate officers whose interests may be being represented by the company’s own counsel in connection with serious investigations that may potentially involve criminal implications.

 

The opinion may also be relevant for insurance professionals who often are called upon to address questions surrounding the possible need for separate counsel for individual defendants. Judge Carney’s opinion in the Broadcom case underscores how serious these issues may be, and the consequences that can sometimes arise if separate counsel issues are not appropriately addressed.

 

Insurance professionals of course cannot become involved in the kinds of ethical questions presented in Judge Carney’s opinion, but an awareness of the kinds of issues that can arise is an important perspective to bring to the table when questions involving separate representation do arise.

 

It is sometimes the case that it is the firm’s outside law firm that is resisting the suggestion that the firm may not be able to maintain the multiple representations it has purported to assume. These kinds of discussions can be particularly vexing, as law firm can often dominate the dialog and the insured company or insured individuals may not see where their interests may diverge from the position the law firm is advocating. While these conversations can sometimes be extremely delicate, they can involve critical issues. Insurance professionals aware of the kinds of issues involved in the Broadcom case can at least raise appropriate questions to try to ensure that issues are discussed.

 

Special thanks to a loyal reader for proving a copy of Judge Carney’s opinion.

 

The consolidated  IPO Laddering Cases, that superannuated vestige of a long-gone era that has continued to grind on despite numerous procedural setbacks, apparently has been settled (again), at least according to the parties’ April 1, 2009 settlement stipulation (here). Hat tip to the WSJ.com Law Blog for the link to the stipulation.

 

According to the settlement stipulation, the aggregate gross amount of the settlement is $586 million, out of which will come both plaintiffs’ attorneys’ fees and extensive notice and administrative expenses. The amount of the plaintiffs’ attorneys’ fees are not specified in the agreement. News reports (here) suggest that the plaintiffs intend to seek fees of as much as $195.3 million, plus $56 million in expenses, from the settlement.

 

The stipulation provides for two different $10 million advances from the gross settlement fund for the payment of notice and administration expenses, and provides a mechanism should further expenses become necessary. Clearly, the parties anticipate that notice of and administration for the settlement will be massive, expensive undertakings.

 

The publicly available version of the stipulation does not answer the question I was most interested to know, which is who, between the underwriter defendants and the issuer defendants and their insurers, will be paying how much of the proposed settlement? Unfortunately, Exhibits E and F to the stipulation, which reflect the defendants’ respective settlement contributions, were filed under seal. The prying curiosity of nosy bystanders like me sadly will go unfulfilled.

 

My curiosity about the relative settlement contributions is driven largely by the convoluted history of the prior attempts to settle this case (or should I say these cases?). Readers will recall (as discussed at length here), that prior settlement attempts were derailed on December 6, 2006 when the Second Circuit held that the district court had erred in certifying a class against the offering underwriter defendants. Among other things, that decision vitiated the pending settlement in which the issuer defendants had agreed to pay the investor plaintiffs $1 billion, with the issuers’ contribution to be reduced to the extent of investor recoveries from the underwriter defendants. The decision also set aside J.P. Morgan’s proposed agreement to pay $425 million to settle its liability.

 

Following that setback, the case ground on. On March 26, 2008, Southern District of New York Judge Schira Schindlin denied the defendants’ renewed motions to dismiss, as discussed here. Though this case probably could have kept squadrons of attorneys employed from now until doomsday, there comes a time for all things to end.

 

So much as has changed since these cases first flooded in during 2001, particularly in recent months. Not only has Lehman Brothers gone bankrupt, but other high profile underwriter defendants have been merged out of existence. 41 of the issuer defendants have gone bankrupt. Indeed, Mel Weiss, who was at the outset at the vanguard on behalf of the investor plaintiffs, has pled guilty to criminal charges. And so this massive case, initially involving 55 underwriter defendants and 310 issuer defendants, may have finally come to an end.

 

Press reports (here) quote one of the plaintiffs’ attorneys as saying "When these cases were filed in 2001, no one would have believed that in 2009 Bear Stearns would be out of business, Lehman in bankruptcy, and names like Salomon and Merrill Lynch erased from the financial landscape…Under the circumstances, this settlement is the best available real-world alternative."

 

 

It should be noted that the agreement is subject to court approval as well as a host of contingencies, and could still be terminated by any one of a number of parties or contingencies.

 

The mammoth size of the proposed settlement is impressive. A quick look at historical settlement data suggests that this settlement would represent the 12th largest securities class action settlment of all time. Inevitably this latest settlement attempt will draw comparisons to the prior $1 billion minimum attempt to settle the case.

 

In addition, curious readers will want to take a look at the schedules to Exhibit C to the stipulation, which show a number of interesting things. First, the schedules show, as required by the PSLRA, the gross recovery per damaged subject security – in most cases, only a penny or two per share.

 

Second, the schedule also shows the plaintiffs’ preliminary estimate of the potential damages for class members, indexed by issuer defendant. These estimates reflect some truly staggering numbers. Even if they are purely theoretical, they are nonetheless impressive. Some of them, with respect to just a single issuer, exceed the entire amount of the settlement itself. For example, the estimate for Priceline.com is $1.166 billion. The estimate for Global Crossing is $780 million. Foundry Networks, $720 million; Commerce One, $641 million.

 

The schedule omits to provide an aggregate number for all of the issuer defendants, but I suspect that the figure would rival the kind of numbers that only someone like the late Carl Sagan and Timothy Geithner would be comfortable saying in public (and even then, in Geithner’s case, only recently). In any event, those are some big numbers.

 

One likely byproduct of this settlement will be the forthcoming mailings to the settlement class members. I can only imagine how many individual pieces of mail we are talking about, and how much the postage alone will cost. No wonder the notice and administrative expenses are expected to be so high. The class mailings by themselves could remedy the U.S. Postal Service’s chronic operating deficits.

 

In all seriousness, this settlement stipulation obviously was a maddeningly difficult thing to nail down. The attorneys who finally got this monster worked out in a global settlement (or at least an attempted global settlement) are to be congratulated on tackling what had to have been an extraordinarily difficult challenge. Even if history should ultimately little note nor long remember what happened here today, their efforts are worthy of respect.

 

The global financial crisis has produced challenges across the entire economy, but the financial sector, where all the problems arguably began, has been particularly hard hit. While the most investment firms and other banking institutions may have experienced the most dramatic consequences, insurance companies have also been swept up in the whirlwind.

 

The extent of the recession’s impact on insurance companies and the resulting consequences for the insurance marketplace are the subjects of an April 2009 paper from insurance industry data firm Advisen entitled "The Impact of the Economic Crisis on the P&C Insurance Industry" (here, $ required). Advisen’s April 2, 2009 press release describing the report can be found here.

 

According to the paper, the various economic forces at play will likely shrink insurers’ policyholder surplus, thus diminishing the supply of insurance. These circumstances ordinarily would produce a so-called "hard" market, characterized by rising prices for insurance. However, the reduction in economic activity as a result of the current recession could also reduce the demand for insurance, which in turn could complicate the insurance cycle’s transition and "make for a very turbulent 2009" for the insurance industry.

 

The major cause for the reduction in the demand for insurance, which according to the paper could delay the transition to a hard market, is "shrinking exposure units." An exposure unit is the basis for calculating premium – for example, the size of an employer’s workforce will determine the employer’s workers comp and EPL insurance premiums.

 

Many of the exposure units that are critical for determining pricing for a variety of insurance lines – such as sales, real estate square footage, number and mileage of vehicles, payroll, and property values – are all likely to shrink in the months ahead, as a result of the recession. The shrinking exposure base will produce a fall-off in insurers’ top-line revenue.

 

In addition, insurance demand will also likely be further eroded as businesses close or fail. Even companies that survive may seek to increase self-insured retentions or limits, as a way to cut costs.

 

The reduction in demand will also likely be accompanied by a reduction in supply, in the form of policyholder surplus, both as a result of increased claims losses and as a result of diminished investment income and investment losses.

 

The likely increased claims losses could arise from a variety of sources. The paper states that job losses frequently are accompanies by an increase in the frequency and severity of workers’ comp claims. Reductions in force also could trigger EPL claims. And as has been well documented on this blog (refer here), the current economic crisis has also produced a wave of shareholder claims. As the Advisen report notes, these claims are particularly complex which will make them costly to defend and could also make them costly to resolve. D&O claims arising from bankruptcies and E&O claims arising from the various Ponzi scheme scandals could exacerbate the claims losses that insurers experience.

 

On the investment side, insurers’ investment results have taken a massive hit. Many insurers have had to take huge write-downs, both in their fixed income assets and with respect to more exotic investments. A few insurers have been particularly hard hit with valuation issues concerning "toxic" assets.

 

In more typical cycle transitions, insurance pricing swings result from changes on the supply side (i.e., policyholder surplus). But the depth of the current economic crisis could also uncharacteristically affect the demand for insurance. One proxy for insurance demand is GDP. When policyholder surplus declines relative to GDP, a hard market usually follows. In the current circumstances, GDP is under pressure, but the decline in policyholder surplus is relatively greater.

 

These circumstances, together with the likely difficulty insurers will face trying to raise fresh capital, suggest that the insurance marketplace will eventually harden, and higher premiums eventually will result. The Advisen paper projects that the hard market could "begin to set in" as early as mid-2009, and in any event no later than 2010.

 

However, the hard market will "likely take off slowly" due to lack of consumer and business confidence. When it comes, though, the hard market "could extend longer than previous hard markets owing to the lack of new capital entering the market."

 

The Advisen report is accompanied by extensive supporting data and analysis, and I think the author makes an excellent point about the pressure that the recession will put on the demand side of the insurance equation

 

As for the report’s predictions of the arrival and timing of a forthcoming hard market, I guess time will tell. In my view, a hard market is characterized by more than just rising prices; among other things, it also means a shortage of capacity as well as a constriction of terms and conditions. If there really were going to be a hard market as early as mid-2009 (which at this point is only a couple of months away), you would expect some sign of these things in the marketplace, but so far there is very little evidence of any of these things. Which at a minimum suggests to me that if there is going to be a hard market, its arrival could be more delayed than the report suggests.

 

That said, the report does make a compelling case for the likelihood that there actually will be a hard market this time. It may not be a question of whether, but only of when. Overall, the report is interesting and provides useful analysis of the current insurance marketplace and its likely future direction. The report is well worth reading at length and in full and I commend it to everyone.

 

Rescission Denied: Policy rescission is a controversial topic. But because the debate often involves high profile cases where the insurer has successfully rescinded a policy, it is sometimes overlooked how difficult it is for insurers to rescind coverage. A recent decision illustrates the difficulties carriers face when they seek to rescind a policy.

 

In a March 25, 2009 opinion (here), New York (New York Country) Supreme Court Justice Charles Ramos granted summary judgment for JP Morgan Chase in an insurance dispute involving several high profile claims. An excess insurer in J.P. Morgan’s bankers professional liability insurance program had sought to rescind its policy based on alleged misrepresentations in the company’s 2001-02 insurance renewal.

 

The excess insurer claimed that the company had made misrepresentations about its exposure to Enron, both in a Notice of Potential Claim submitted under the prior insurance program and in a Press Release.

 

As reflected in the April 2009 memo from the Proskauer Rose law firm entitled "Court Grants Summary Judgment Dismissing Insurer’s Rescission Claim" (here), Judge Ramos found that the Notice and the Press Release were not part of the renewal materials, and the insurer had not asked the company to warrant either document in connection with the renewal.

 

Judge Ramos also found that there was no issue of triable fact either that the insurer’s underwriters relied on the documents or that the company officials who prepared the documents were aware of any misrepresentations in the documents.

 

Judge Ramos also found that the insurer had waived rescission because it did not raise the defense until 2006, several years later, and had retained the premium.

 

While much more might be said about this decision, if nothing else, Judge Ramos’s opinion demonstrates the many hurdles carriers face in attempting to rescind a policy. Any carrier considering policy rescission might well want to review the opinion.

 

A prior post in which I discuss the difficulties carriers face in attempting to rescind coverage can be found here. Among other things, I note that "policy rescission wreaks havoc on all concerned."

 

Special thanks to John Gross and Michelle Migdon of the Proskauer Rose firm for providing a copy of the opinion.

 

More About the Bailout: Much has been written and said about the gargantuan federal bailout. A March 19, 2009 Rolling Stone article entitled "The Big Takeover" (here) presents a particularly irreverent and occasionally profane perspective on the subject.

 

Although the overall tone of the article borders on feverish, and the article definitely tends toward the conspiracy view of the world, it also contains some funny lines as well as some interesting observations. I particularly liked the author’s take on AIG: "AIG is what happens when short, bald managers of otherwise boring financial bureaucracies start seeing Brad Pitt in the mirror."

 

The article’s overall take on the bailout is summarized in this paragraph:

 

In essence, Paulson and his cronies turned the federal government into one gigantic, half-opaque holding company, one whose balance sheet includes the world’s most appallingly large and risky hedge fund, a controlling stake in a dying insurance giant, huge investments in a group of teetering megabanks, and shares here and there in various auto-finance companies, student loans, and other failing businesses. Like AIG, this new federal holding company is a firm that has no mechanism for auditing itself and is run by leaders who have very little grasp of the daily operations of its disparate subsidiary operations.

The report concludes with the observation about the bailout that "it’s AIG’s rip-roaringly shitty business model writ almost inconceivably massive." (I should probably emphasize that the view in the article quoted above are those of the article’s author, and do not necessarily represent the view or sentiments of this blog’s author.)

 

Special thanks to a loyal reader for providing a copy of the Rolling Stone article.

 

On April 1, 2009, PricewaterhouseCoopers issued this year’s version of its annual study of securities class action litigation (here). The PwC report differs in certain particulars from previously released studies of the 2008 securities lawsuit filings, but the overall findings are directionally consistent with the prior reports. The PwC report also adds some interesting observations of its own.

 

My own analysis of the 2008 securities lawsuit filings can be found here. Cornerstone’s previously released study of 2008 filings can be found here and Cornerstone’s study of the 2008 securities lawsuit settlements can be found here. NERA’s 2008 study can be found here and Advisen’s can be found here.

 

The PwC study found, consistently with the prior reports, that as a result of the financial crisis, the number of securities class action lawsuits rose for the second year in a row in 2008. The PwC report tallied 210 securities lawsuits in 2008, a number that is notably below the numbers reported by other studies. The 2008 total represents a 29 percent increase over 2007. The report found that the filings were steady throughout the year, with a slight uptick in the fourth quarter.

 

The report found that the majority of the 2008 filings were related to the financial crisis. Indeed, the report noted that "for the first time since the PSLRA, in 2008 the plaintiffs’ bar filed more federal securities lawsuits against the financial services industry group (banking, brokerage, financial services and insurance) than any other industry." By the same token, for the first time since the PSLRA’s passage, high tech companies were not the most frequently targeted.

 

The number of filings against companies in the pharmaceutical industry remained consistent with 2007, with 21 lawsuits in the sector in both years. My own analysis of the 2008 securities filings in the life sciences sector can be found here.

 

Filings against companies in the Fortune 500 were up in 2008, with 37 filings during the year, or 18% of all cases filed. The average annual percentage of filings against Fortune 500 companies since the PSLRA’s enactment is 13%. The majority (65%) of the Fortune 500 companies sued in 2008 were in the financial sector.

 

The report notes that the profile of financial companies sued in 2008 changed from those named as defendants in 2008. The focus changed from loan originators in 2007 to entities involved in loan securitization in 2008. (I might add parenthetically that the loan securitizers remain a target in 2009.) In 2008, the auction rate securities lawsuits were a significant part (38%) of the suits filed against entities involved in loan securitization.

 

According to the PwC report, securities lawsuits in the United States against foreign issuers "reached an all-time high in 2008, with 36 cases representing 17 percent of the total federal securities class actions filed." These filings against foreign issuers represent the highest percentage of the total cases in any year since the enactment of the PSLRA. 15 (or 42%) of the 36 cases filed against foreign issuers involved companies in the financial services industry, and 32 out of the 36 of the suits against foreign issuers were filed in the Second Circuit. The countries whose companies were sued most frequently were Canada, China and Switzerland.

 

The report notes that the number and aggregate dollar value of securities lawsuit settlements declined in 2008. However, if the $3.2 billion Tyco settlement is excluded from the 2007 numbers, the remaining total value of the 2007 settlements ($3.3 billion) is 9 percent less than the total value of the 2008 settlements ($3.6 billion).

 

The average 2008 settlement of $41 million represented a substantial increase from 2007’s average of $28.3 million, but the 2008 average was still well below the 2005 average of $67.6 million. The median 2008 settlement of $8 million was unchanged from 2007.

 

The report has an interesting statistic showing that the 2008 average for settlements greater than $1 million but less than $50 million was $11.2 million, which not only represents an increase over the equivalent 2007 average of $9.6 million, but also represents the highest such average since the PSLRA’s enactment.

 

The report also has extensive additional interesting analysis regarding the prevalence and type of accounting allegations, and their impact on settlement; the nature of SEC enforcement activity; and the increase in foreign regulatory activity.

 

The report concludes by noting that there are three areas in which "companies will want to remain especially vigilant," which are "institutional plaintiff activity (particularly activity relating to public and union pension funds), internal controls accounting-related allegations, and FCPA enforcement." The report ends with the observation that "securities litigation activity in 2009 is likely to reflect [the] new era of accountability and oversight, particularly if the regulatory environment is overhauled, as most think inevitable."

 

An interesting interview discussing the PwC report can be found here.

 

Special thanks to a loyal reader for providing me with a link to the PwC report.

 

Georgia’s banks have issues. The state has led the nation in the number of bank failures since January 1, 2008, a fact that earlier this year (even before the most recent round of closures) led the Wall Street Journal (here) to describe the Atlanta area as "the bank failure capital of the world." Signs indicate there may be more Georgia bank failures yet to come.

 

After the FDIC moved in this past Friday night (refer here), Atlanta’s Omni National Bank became the ninth Georgia bank closure since the beginning of last year. (A tenth Georgia bank closed in September 2007.) Though banks in 19 different states have failed since the beginning of 2008, no state has had more bank failures than Georgia. Not even California, which has had eight banks fail during that period, or Florida, which has had four.

 

The Georgia bank failures represent a significant part of the total number of bank failures in recent months. Since the beginning of 2008, there have been a total of 46 bank failures. So the nine failures in Georgia during that period represent about one-fifth of the total. The pace of Georgia bank failures has continued in 2009, with four out of the 21 closures so far this year.

 

The nine Georgia bank failures since the beginning of 2008 had a total of $4.7 billion in assets. The failures’ estimated cost to the FDIC insurance fund is about $1.4 billion.

 

A January 2, 2009 Wall Street Journal article entitled "Bank Failure Central? Try Alphretta, Georgia" (here) noted that the Atlanta region has been "haunted by overabundant home building, years of risky lending, and one of the most relaxed regulatory environments in the U.S. for starting new banks."

 

Nor have these problems entirely played themselves out yet. The Journal article quotes industry sources as saying that "as many as 20 of the 122 banks still headquartered in or near Atlanta could go under before the credit crisis and recession are over."

 

A March 31, 2009 Street.com article entitled "Georgia Banks Face More Pain" (here) similarly projects that "there’s a lot more trouble ahead" for Georgia’s banks. The article’s accompanying analysis shows that over 30 of Georgia’s 331 banks and thrifts are "in a weakened condition."

 

The Street.com article identifies four banks (beyond those that have already failed this year) as "undercapitalized" as of December 31, 2008. The article also identifies thirty-three more that had "nonperforming asset ratios above 10%." On the other hand, the article also identifies 83 of Georgia’s 331 banks and thrifts as "good" or above.

 

These institutional failures have their costs, and even the closure of a smaller bank can leave problems behind. A March 28, 2009 New York Times article entitled "A Small Town Loses Its Pillar: Its Only Bank" (here) describes the difficulties experienced in Gibson, Georgia – a town far from Atlanta too small even for a hospital, a jail or a Wal-Mart – when it lost its only bank, FirstCity. (Refer here for background regarding FirstCity’s closure.)

 

The Times article recounts how the bank’s decline began with the 2001 sale of the former Bank of Gibson. After the sale, the bank rushed to "cash in on the expanding real estate market." By the time it failed, the bank was so weak that the FDIC couldn’t find another institution to buy its deposits. The article quotes the bank’s founder’s grandson as saying about the owners who acquired the bank in 2001 that "maybe they weren’t as smart as they thought they were."

 

The FDIC’s complete list of all bank failures since 2001 can be found here. Hat tip to Adam Savett of the Securities Litigation Watch for link to the Times article.

 

A Tweet Deal: I find myself becoming ever more deeply immersed in the world of Twitter. Among other things, I am more frequently adding links and comments on the same general topics as this blog, but between blog posts. An increasingly large number of people are now following me on Twitter as well. I invite all readers to join me on Twitter by subscribing here or clicking on the Twitter button in the right hand margin above.

 

And while on the Web 2.0 theme, I also invite readers to connect with me on LinkedIn by clicking on the relevant button in the right hand margin. A number of readers have joined my network recently and have also joined the industry groups of which I am also a part on LinkedIn. I welcome the connection with readers.

 

Earlier this week, I suggested (here) that the UBS auction rate securities lawsuit dismissal did not spell the end of the auction rate securities litigation. Two of the categories of likely future litigation involving auction rate securities I mentioned were lawsuits involving institutional investors (who are not covered, at least immediately, by many of the regulatory settlements) and lawsuits involving auction rate securities buyers that are targeted by their own investors.

 

As if to prove my point about the likelihood for continuing auction rate securities litigation, two significant auction rate securities lawsuits have arrived just since I added my post earlier this week.

 

First, in a lawsuit against an auction rate securities buyer, on March 31, 2009, PIMCO mutual fund investors filed a securities class action lawsuit in the Central District of New York against the funds’ investment manager and the funds’ sub-advisor, certain of the managers’ directors and officers (including bond investing guru Bill Gross). A copy of the complaint can be found here.

 

The complaint alleges that the funds concealed from the investors that

 

(a) The Funds lacked effective controls and hedges to minimize the risk of loss and risk of liquidity from auction rate securities ("ARS") which affected a large part of their portfolios; (b) The Funds lacked effective internal controls to ensure that the Funds would remain in compliance with restrictions and limitations related to their investment portfolios and strategies; (c) The extent of the Funds’ liquidity risk due to the illiquid nature of a large portion of the Funds’ portfolios, including ARS, was omitted; and (d) The extent of the Funds’ risk exposure to ARS was misstated.

 

The PIMCO mutual fund lawsuit joins recent lawsuits filed against Perrigo Company (about which refer here) and NextWave Wireless (refer here), as examples of cases in which auction rate securities buyers are targeted by their own investors for their exposure to the instruments. These lawsuits differ from the more standard auction rate securities lawsuits, in which the auction rate securities buyers were the plaintiffs and the defendants were the broker-dealers or others that had sold the instruments.

 

PIMCO’s woes with its funds’ investments in auction rate securities have been well-documented in the press in recent days, as the funds’ managers have struggled to manage problems stemming from the investments. A recent Wall Street Journal article discussing the funds’ woes can be found here.

 

The second of the two new auction rate securities lawsuits involves an institutional investor buyer, brining an action against the broker-dealers that sold the company the instruments. On April 1, 2009, Texas Instruments filed an Original Petition in Texas (Dallas County) District Court against Citigroup Capital Markets, BNY Capital Markets and Morgan Stanley, in connection with the company’s purchase of $524 million of auction rate securities backed by student loans. A copy of the Petition can be found here.

 

The Petition alleges that despite the defendants’ "assurances of liquidity and low risk," the company is now stuck with auction rate securities that it "cannot liquidate." The Petition alleges that the defendants "downplayed any risk of failed auctions" and "misrepresented the market demand" for the securities by omitting to disclose "the extent to which the entire ARS market depended on continued bidding and purchasing by the Defendants and other broker-dealers."

 

Beyond these more general allegations, the complaint contains some very case specific allegations relating to the defendants’ alleged failure to disclose that as 2007 progressed securities issuers (including issuers of securities that Texas Instruments held) were waiving the maximum interest rate limitations in connection with auctions of their securities. The company alleges that had it been advised of these waivers, it would have been alerted to the weakening demand for the instruments. The company alleges these omissions and affirmative reassurances induced it to continue to buy and hold the securities.

 

The Petition alleges violations of the Texas securities laws and seeks rescission of the securities purchase transactions as well as prejudgment interest.

 

Interestingly, the Petition does not mention the various regulatory settlements that Citigroup and others have reached with respect to the auction rate securities, presumably because the settlements do not provide relief (at least not immediately) to an institutional investor like Texas Instruments.

 

In any event, it is evident that the auction rate securities litigation is far from over.

 

Hat tip to the Courthouse News Service for the link to the Petition. Special thanks to Adam Savett of the Securities Litigation Watch for a link to the PIMCO lawsuit.

 

Dismissal Motion Ruling in Options Backdating-Related Securities Lawsuits: The options backdating cases continue to grind through the courts. On March 27, 2009, District of Arizona Judge Robert Broomfield issued a 138-page ruling (here) on the pending dismissal motion in the options backdating-related securities lawsuit against Apollo Group and several of its directors and officers. (Background regarding the case can be found here).

 

Judge Bloomfield’s ruling is very painstaking and detailed. He parsed the allegations against each of the defendants extremely finely. The outcome is rather complex, and it would require a spreadsheet to explain with respect to each of the plaintiffs’ substantive claims which defendants have been dismissed with prejudice, which have been dismissed without prejudice, and which have had their dismissal motions denied. The most critical aspect of his ruling is that the Court denied the motion to dismiss the plaintiffs’ claims under Section 10(b) against the Company and its most senior officers.

 

Apollo Group was also involved in a separate, rather notorious securities class action lawsuit that resulted in a January 2008 plaintiffs’ jury verdict that was overturned by the trial judge in August 2008 on a post trial motion. Refer here for background on this separate case.

 

I have in any event added the Apollo Group decision to my table of settlements, dismissals, and dismissal motion denials, which can be accessed here.

 

In a development that may foreshadow further "gatekeeper" claims as part of the current credit crisis litigation wave, on April 1, 2009, the trustee for the New Century Financial Corp. liquidation initiated lawsuits in California and New York against KPMG and its international parent, seeking to recover $1 billion in damages for negligence and for aiding and abetting breaches of fiduciary duty.

 

The California complaint, filed in the Los Angeles County Superior Court (copy here) against KPMG LLP, alleges that the firm "did not act like a watchdog" but rather "acted like a cheerleader for management."

 

The complaint alleges that KPMG "performed grossly negligent audits and reviews" and "failed to detect material errors" with respect to New Century’s residual interest on loans it securitized and on its loan repurchase liability. The complaint also faulted KPMG for its approval of faulty loan loss reserves, alleging that an audit partner silenced the concerns of a more junior audit team member who questioned the reserve calculation.

 

The complaint also alleges that KPMG "aided and abetted New Century’s directors’ and officers’ breaches of their fiduciary duties." The complaint alleges that KPMG knew that management was improperly reserving for risks the company faced and that management had failed to implement an effective system of internal controls.

 

The aiding and abetting allegations includes the charge that KPMG aided and abetted company officials "in maintaining material weaknesses and significant deficiencies in New Century’s system of internal controls over financial reporting." The complaint alleges that KPMG is "jointly responsible with the directors and officers for damages resulting from these breaches."

 

The complaint seeks compensatory damages of $1 billion, as well as punitive damages.

 

The complaint filed in the Southern District of New York (copy here) substantially repeats many of the same allegations as the California complaint, but addresses the alleged liability of KPMG’s international parent. The complaint alleges that the parent represented that it would "ensure that member firms’ work would meet professional standards and regulatory requirements."

 

The complaint alleges that KPMG International did not fulfill these responsibilities, and as a result New Century was harmed. The complaint seeks unspecified compensatory as well as punitive damages from KPMG International.

 

The trustee’s filings in these complaints certainly suggest the possibility that auditors and other "gatekeepers" could be targeted in the wake of the subprime meltdown. Leading accounting indusrty commentator Francine McKenna (also the author of the indispensible "re:The Auditors" blog) is quoted in the April 1, 2009 Wall Street Journal as saying that the case "may embolden others to look more closely at the possibiltiy of bringing [accounting] firms to some level of culpability for the things that happened" that led to the credit crisis.

 

But in assessing that possibility it may be important to note the particular key circumstances that preceded the trustee’s claims against KPMG.Specifically, the new lawsuits follow more than a year after the February 29, 2008 581-page report of Michael Missal, the KPMG bankruptcy examiner, in which the examiner concluded that KPMG had "contributed" to certain of New Century’s "accounting and reporting deficiencies by enabling them to persist in, and in some instances, precipitating the Company’s departure from, applicable accounting standards." A detailed review of the examiner’s report, including a link to the report itself, can be found here.

 

The examiner’s exhaustive review, which among other things specifically suggested the possibility of negligence claims against KPMG, was effectively a road map for the April 1 lawsuits. While the lawsuits might well have been filed even without the examiner’s report, few other prospective claimants considering "gatekeeper" litigation will have such a detailed script from which to compose their complaint.

 

On the other hand, many of the complaints already filed in numerous lawsuits as part of the current subprime and credit crisis-related litigation wave have already targeted a variety of gatekeepers, including offering underwriters, credit rating agencies, and, in some cases, even the outside auditors.

 

Indeed, the securities lawsuit filed against New Century’s former directors and officers also specifically named KPMG as a defendant. In his December 3, 2008 order denying the defendants’ motion to dismiss the securities lawsuit, Central District of California Judge Dean Pregerson specifically denied KPMG’s separate motion to dismiss, finding that the complaint in that case adequately alleged that KPMG was aware of accounting and internal control deficiencies but nevertheless issued its audit opinion in connection with the company’s 2005 financial statements. A detailed discussion of Judge Pregerson’s decision, including a link to the opinion, can be found here.

 

The outcome of KPMG’s dismissal motion in the New Century securities lawsuit, as well as the trustee’s filing of the April 1 lawsuit, among other things suggests that the U.S. Supreme Court’s decision in the Stoneridge case may not deter prospective litigants from pursuing claims against auditors and other gatekeepers.

 

One of the more interesting aspects of the trustee’s complaint against KPMG is his claim seeking to hold the accounting firm "jointly responsible" with New Century’s former directors and officers for the officials’ breaches of their fiduciary duties. While the trustee’s claims at this point represent nothing more than allegations and it remains to be seen whether his claims on this theory will result in any recovery, the possibility that auditors may be alleged to be "jointly liable" for directors’ and officers’ fiduciary breaches raises a host of concerns and questions, not the least of which relate to co-defendant (or third-party defendant) proceedings, such as cross-claims for contribution.

 

All of which leads to a point I have been asserting for some time, which is that we are still only in the earliest stages of the credit crisis related litigation wave. Not only are the cases against the defendant companies continuing to pour in, but the likelihood of further gatekeeper litigation like that filed against KPMG suggests that the litigation will continue for many, many years to come.

 

The "re: The Auditors" blog has an interesting and detailed analysis of the KPMG complaints, here.

 

Hat tip to the Wall Street Journal (here) for copies of the KPMG complaints.

 

Honoring Those Who Serve: A recent MSNBC segment reported on what my good friends, David Bell of AWAC and John McCarrick of the Edwards and Angell law firm, have been doing to honor those who have made the ultimate sacrifice in service to our country. As reflected in the video below, a group they helped to organize, Grateful Nation Montana, is taking steps to ensure that the children of U.S. soldiers killed in the battle will be able to pursue a college education.

 

Please watch this video. It is guaranteed to bring tears to your eyes, but it will also make you appreciate the efforts of a couple of industry leaders, who have done something substantial and worthy to help make a difference.

 

http://www.hulu.com/embed/dqNZB052Zl4t2S_GWHbX4A

In an April 1, 2009 administrative complaint (here), Massachusetts Secretary of the Commonwealth William Francis Galvin accused Madoff feeder fund Fairfield Greenwich Advisors and its Bermuda affiliate of "complete disregard of its fiduciary duties to its investors" and of "flagrant recurring misrepresentations" that "rise to the level of fraud."

 

If you have not yet seen the complaint, you should take a look, because it contains some rather striking allegations, the most provocative of which are based on the transcript of a telephone conversation in which Bernard Madoff coaches senior Fairfield officials on how to respond to inquiries from the SEC.

 

At one time Fairfield has a much as $14 billion of assets under management, of which nearly $7 billion was invested with Madoff through its flagship funds. The firm earned hundreds of millions of dollars in fees from investors in connection with the Madoff related investments. (Detailed background regarding the Fairfield group can be found here.) UPDATE: Fairfield’s principals were on track for payouts totalling over $117 million in 2008, before the scandal surfaced, as reflected in documents filed with complaint, according to the Dealbook blog (here).

 

The complaint alleges that Fairfield’s managers were "blinded by the fees they were earning" and "did not engage in meaningful due diligence" but instead "turned a blind eye to any fact that would have burst their lucrative bubble."

 

The complaint alleges that in contrast to the due diligence efforts Fairfield claimed in its marketing materials, the firm "neglected to do any meaningful check into whether Madoff was actually making trades he said he was making." The complaint further alleges that "the concept of due diligence was merely part of Fairfield’s marketing pitch, not an activity it meaningfully engaged in with respect to Madoff."

 

The centerpiece of the complaint is a transcript of a December 2005 telephone conversation between Madoff and several senior Fairfield officials. Fairfield apparently recorded the conversation then apparently unbeknownst to Madoff and produced the recording in connection with the Massachusetts investigation. The transcript of the call can be found here.

 

The SEC was about to interview the Fairfield officials in connection with the SEC’s investigation of allegations against Madoff by Harry Markopolos. The transcript shows that Madoff opened the call by stating "obviously, first of all, this conversation never took place, okay?"

 

Madoff then gave the Fairfield officials precise instructions on what to say in response to the SEC’s questions, noting at one point that "the secrecy as to information is the key issue for everybody," even going so far as to say to the Fairfield officials that "the less you know about how we execute… the better you are."

 

The complaint alleges with respect to this phone conversation that Madoff was "manipulating the flow of information to the SEC" and that as a result of its cooperation, Fairfield helped Madoff "evade SEC detection."

 

The complaint also alleges that Fairfield’s reliance on the outside audit firm’s audit of Madoff’s investment company was "absurd," and that Fairfield made "patently false representations" about the audit and the auditor even though Fairfield "did not know one thing about this one-person auditing firm."

 

The complaint also alleges that as 2008 progressed, client redemptions and larger problems in the financial marketplace began to trouble the Fairfield officials. They began to debate internally about "gaps" in their knowledge about Madoff. Their internal communications reflect liquidity concerns as well as concerns about Madoff’s counterparty exposures.

 

The complaint alleges that the officials did not follow up on these concerns. Instead, in response to Madoff’s anger about increasing fund redemption in the late fall 2008, they tried to support him by marketing against redemptions as well as by placing their own cash in new Madoff funds formed at the eleventh hour.

 

The complaint seeks a cease and desist order and restitution to all investors who invested in Madoff through Fairfield, as well as disgorgement of related fees and an administrative fine.

 

In response to the complaint, Fairfield issued an April 1, 2009 statement (here) in which it characterized the complaint as "false and misleading" and asserted that it "conducted vigorous and robust monitoring [of Madoff] on an ongoing basis." The complaint, according to the statement, is based on "nothing more than 20-20 hindsight that supposes that anyone familiar with Madoff’s operation should have determined that it was a Ponzi scheme." But, the statement notes, not one person detected the fraud.

 

Among the Fairfield officials mentioned by name in the complaint is Andres Piedrahita (a Fairfield partner and son-in-law of Fairfield founding partner Walter Noel), whom the complaint alleges in 2007 alone earned in excess of $45 million. The March 31, 2009 Wall Street Journal ran a fascinating front-page article about Piedrahita entitled "The Charming Mr. Piedrahita Finds Himself Caught in the Madoff Storm" (here), reporting among other things that Piedrahita had once told a friend that his "real job" was "to live better than any of my clients."

 

Piedrahita, trading on his "outstanding public relations skills," played a key role in "expanding the reach of the Madoff fraud by wooing wealthy Latin Americans and Europeans." Piedrahita is now under investigation with both Spanish and U.S. authorities, and is a defendant in numerous class action lawsuits, along with Fairfield and other Fairfield officials.

 

Meanwhile, the April 2009 issue of Vanity Fair has a lengthy article (here) about Fairfield founder Walter Noel and his family. The article features a particularly striking photgraph of Noel’s five daughters, one of whom is the wife of Piedrahita. An October 2002 Vanity Fair article focused just on the five daughters can be found here. After awhile, trolling through the backstory on these sidelights to the Madoff scandal begins to create the same sensation as reading an overwritten novel.

 

A comprehensive list of the Madoff-related lawsuits, including the numerous lawsuit filed against Fairfield and related entities and individuals, can be accessed here. I have added the new Massachusetts complaint to the list.

 

Hat tip to the Wall Street Journal for the Fairfield Statement.

 

Other Stories We’re Following: According to news reports (here), a man in Newark, Ohio has been charged with drunk driving on a bar stool. The man apparently had built a motorized bar stool using a dismantled lawn mower. He managed to crash the stool, apparently as a result of the 15 beers he reportedly consumed prior to the accident. Readers interested in seeing this amazing (albeit unexpectedly dangerous) vehicle will want to refer here.

Meanwhile, on March 27, 2009, the Macomb (Ga.) Daily reported (here) that "a woman who sued a city of Warren police dog that she says bit her on the buttocks was ordered by a judge to pay $500 for frivolously naming the dog as a defendant." Frivolous? Has the judge ever been bitten on the butt by a police dog? Incidentally, the dog’s name is "Liberty" which is clearly what the dog took with the plaintiff’s behind

And in world news, Barrack Obama has apparently given Queen Elizabeth II an iPod as a gift in connection with his visit to Buckingham Palace today, as reported here. Alas, it is too late now, but had I been consulted in advance, I would have suggested loading the device with the music of this year’s inductees into the Rock and Roll Hall of Fame, in particular the songs of Run-D.M.C.

The Rock Hall induction, by the way, is this Saturday, April 4, 2009, in Cleveland, Ohio. (Cleveland Rocks, baby.)