Several of the recipients of TARP funding have also been the targets of securities class action lawsuits and other litigation. In an April 29, 2009 post on the DealBook blog (here), Dan Slater, formerly of the WSJ.com Law Blog, raises the concern that TARP money could be used “to line the pockets of allegedly aggrieved shareholders and the lawyers who, wrapped in the flags of corporate governance, are in the process of making a billion-dollar cottage industry out of filing strike suits.”

 

As an example, Slater cites the case of Merrill Lynch, which, on the same day as its new corporate parent Bank of America announced that it was receiving an additional $20 billion in TARP money, announced that it would pay $550 million to settle a securities class action lawsuit and an ERISA lawsuit. (For further detail regarding the Merrill settlement, refer here.) Slater contends that as a result of the settlement either BofA will be less able to repay its TARP obligation or must cut its TARP allotment to settle up

 

 

Slater also notes that 19 of the 32 recipients of $1 billion or more of TARP money have since January 2008 been sued in securities class action lawsuits. “Put another way,” Slater states, “of the more than $300 billion that’s been paid out in TARP money, nearly $240 billion of it, or 78 percent, is subject to shareholder suits.”

 

 

Slater argues that while there has always been a circularity involved in the funding of securities lawsuit settlements, now, “in the world according to TARP,” the securities settlement money could be coming from taxpayers.

 

 

Slater raises an interesting point, and the example of Merrill Lynch is particularly telling. I think his analysis is incomplete, however, to the extent that it disregards the existence of D&O insurance, E&O insurance, and fiduciary liability insurance, which will be funding a very substantial amount for the defense and settlement of these lawsuits.

 

 

However, the Merrill Lynch settlement unquestionably raises the concern, given its sheer size, that the resolution of these cases could require funding that far exceeds that amount of insurance available. To that extent, at least, there arguably is a concern that TARP money could fund, or at least offset the cost of, securities class action settlements.

 

 

Slater’s points are, to that extent at least, well taken. I think it should be noted that plaintiffs’ lawyers are well aware of these concerns – many of the lawsuits to which Slater refers were filed before TARP was instituted, and since the TARP payments were first made, plaintiffs’ attorneys have had to take these kinds of concerns into account on deciding whether or not to file new cases.

 

 

These kinds of issues may also be part of the constellation of considerations that has been affecting courts’ reactions to the early motions to dismiss. As I have previously noted (most recently here), while it is still early, many of the subprime and credit crisis-related cases have not been faring particularly well in the courts at the motions to dismiss stage, and concerns like those that Slater has raised may be part of the reason.

 

 

An April 29, 2009 Am Law Litigation Daily post discussing Slater’s article can be found here.

 

 

Madoff Redemption Clawbacks?: One of the more interesting and complicated questions that has arisen lately is the extent to which Irving Picard, the trustee for the Bernard Madoff Investment Securities liquidation, wil be able to "clawback" amounts from BMIS investors who redeemed their investors who redeemed their investments prior to the firm’s collapse. An April 28, 2009 paper by NERA Economic Consulting entitled "Clawbacks from Madoff Investors: Questions of Economics, Equity and Law" (here) takes a detailed look at the issues surrounding the extent of the trustee’s ability to recover the amounts previously redeemed. As the paper reviews at length, there are a variety of competing considerations that will have to be balanced in determing the extent to which the trustee appropirately may clawback these amounts.  

With the addition of four more bank closures this past Friday night, the YTD number of bank failures now stands at 29, which already exceeds 2008’s total of 25 and is the highest annual total since 1993, at 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 already affecting the D&O insurance marketplace, even for smaller community banks. 

 

The four banks that closed this past week were: American Southern Bank of Kennesaw, Georgia, which prior to its closure had assets of $112.3 million (for further details about its closing, refer here); Michigan Heritage Bank in Farmington Hills, Michigan, which previously had assets of $184.6 million (refer here); First Bank of Beverly Hills in Calabasas, California, which previously had assets of $1.5 billion (refer here); and First Bank of Idaho in Ketchum, Idaho, which has assets of $488.9 million (refer here). 

 

 

Although the assets of three of the banks were sold to other financial institutions, the FDIC was unable to find a buyer for First Bank of Beverly Hills, forcing the FDIC to assume the financial institutions assets. 

 

 

The closure of American Southern Bank adds to the growing list of failed banks in Georgia, which, as I noted at length here, leads the nation in number of bank failures. With the addition of American Southern, there have been ten bank failures in Georgia since January 1, 2008, including five already in 2009. California is a close second behind Georgia in number of failed banks, and the failure of First Bank of Beverly Hills brings the number of California bank closures since January 1, 2008 to nine. 

 

 

But the overall geographic distribution of the latest four banks to fail, and indeed of the banks closed so far in 2009, highlights the fact that the bank woes are not concentrated in any one geographic area. Rather, the banking troubles seem to be distributed around the country. Banks have failed in 16 different states already this year, sprinkled across the national map. The FDIC’s complete list of failed banks since October 1, 2000 can be found here. 

 

 

These latest four closures also highlight the fact that the banking woes are not limited just to the largest banks; to the contrary, the bank failures increasingly seem to involve the smaller community banks. Three of the four most recently closed banks had assets below $500 million, and many of the other banks closed this year also were similarly smaller banks.

  

 

One generally accepted definition of a community bank is a banking institution with assets below $1.0 billion (refer here). By this definition, 25 of the 29 banking institutions that have failed this year are community banks, as only four the failed banks had assets over $1 billion. Indeed, most of the failed banks are very small; only seven of the 29 banks that have failed in 2009 had assets over $500 million. 

 

 

For many years, and even throughout the recent financial turmoil, community banks have been viewed as relatively safe. Their lack of involvement both in commercial lending and in subprime loans seemingly spared them the most significant problems that have characterized the current crisis – until now. The growing problems in residential real estate and rising unemployment levels are raising problems even in the community banking sector, as the bank closures described above demonstrate. Based on the 2009 bank closures, the community banking sector may now have become the leading edge for problems in the banking sector. 

 

 

Unfortunately, all signs are that these difficulties will continue in the months ahead. In the FDIC’s most recent Quarterly Banking Profile (as of December 31, 2008), the FDIC counted 252 institutions with assets of $159 billion on its “Problem List,” up from 171 institutions with $116 billion in assets at the end of the third quarter of 2008. (The FDIC does not identify the problem banks by name.) With unemployment growing and the number of troubled loans increasing, the number of banks on the “Problem List” undoubtedly will have grown when the FDIC releases its Quarterly Banking Profile for the first quarter of 2009 in a few weeks. And the bank closures are likely to continue to accumulate. 

 

 

The D&O insurance marketplace for the community banking sector had been a placid, quiet area where many insurers were willing to offer broad terms at low prices. However, as a result of the recent deterioration in the sector, the D&O insurance marketplace has very recently begun to change. There are still a number of carriers active in this space, but a number of players have recently started to take more conservative positions, even nonrenewing insureds in certain geographic areas or with certain characteristics. 

 

 

More restrictive terms that had largely disappeared, such as the regulatory exclusion, are suddenly reappearing in coverage proposals for some accounts. And banks that have been declined by several carriers may find they can only place their coverage at significantly increased premiums. The D&O insurance marketplace for community banks is placid no more. 

 

 

Perhaps the most noteworthy thing about these changes is how quickly they have taken place. This heretofore quiet corner of the D&O marketplace has very quickly become characterized by rapid chance. Although I have been and remain skeptical of some of the predictions about when we may see a hard insurance market, the speed of the changes in community banking sector represents the type and velocity of change that can occur in a market turn. It is still premature to say definitively that we are headed into a hard market anytime soon, even just for community banks, but there is some evidence to suggest that a harder market could well lie ahead.

 

 

Bank of America’s acquisition of Merrill Lynch went through, so we will (fortunately) never know what would have happened if the deal had collapsed. But as detailed in the April 23, 2009 letter (here) from New York AG Andrew Cuomo to Sen. Chris Dodd, Rep. Barney Frank and others, if it had been up to BofA, the deal would not have closed, and it was only as a result of a combination of threats and inducements from Henry Paulson and Ben Benanke that BofA and its Chariman, Kenneth Lewis, were convinced to complete the deal.

 

In his letter, Cuomo urged Congressional and regulatory officials to examine the pressure that Paulson and Bernanke applied to Lewis and to BofA. Cuomo wrote that the federal officials’ actions "raise fundamental questions about the interactions of regulators and those they regulate, as well as important issues of corporate responsibility and shareholders’ rights." 

 

The information in the April 23 letter and accompanying documents is fascinating, but the still-incomplete picture of the December meetings in which BofA was convinced to complete the deal raise a number of serious questions. The letter and the accompanying exhibits can be found here.

 

1. Why did Lewis contact Paulson and Bernanke to tell them that BofA wanted to invoke the "material adverse event" clause and kill the deal? Presumably, the merger agreement was a private transaction between two private parties. Right? Well, maybe not. Apparently, as a result of its role in having brokered the Merrill deal, the government retained something more than a gaming interest in the transaction.

 

But why did Lewis have to report to the feds? Doesn’t it seem like he was asking their permission? Why? Was there a prior strong-arm session, perhaps back in September, where the government previously offered threats and inducements to BofA to get them to accept the deal in the first place? Did BofA make a commitment to the feds, and vice versa, as part of the events that led to the original deal?

 

2. Did Lewis and the BofA board accede to the fed officials’ demands in order to preserve their positions? Cuomo’s letter certainly intends to communicate that Lewis was convinced to go through with the deal in order to be able to keep his job. Lewis undeniably testified when examined by NYAG’s office personnel that Paulson threatened BofA’s board and Lewis with a loss of their positions. (A transcript of Lewis’s testimony can be found here.)

 

BofA’s December 22, 2008 Board of Directors Meeting minutes (here) reflect that Lewis reported to the board that Paulson had threatened them (Lewis and the board) with the loss of their positions if the deal failed to go through. Cuomo’s letter also reports that Paulson told the NYAG’s officials that the job threat to Lewis "changed his mind about invoking the MAC clause and terminating the deal."

 

To be sure, the December 22 board minutes also very carefully recite that "the Board clarif[ied] that is [sic] was not persuaded or influenced by the statement by federal regulators that the Board and management would be removed if federal regulators if the Corporation were to exercise the MAC clause and failed to complete the acquisition by Merrill Lynch." And both the December 22 and December 30, 2008 board minutes (here) reflect concerns about the possible damage to the global economy if the deal failed to go through.

 

But there doesn’t seem to be any doubt that the threats were made, that Lewis reported the threats to the BofA board, that the board and Lewis discussed the threats, and Paulson at least seems to think the threats had the effect he intended.

 

3. Realistically, could BofA have turned down the fed officials’ demands? It is not as if just that the Secretary of the Treasury and the head of the Federal Reserve Board alone were strong-arming BofA. BofA’s December 30 board minutes reflect that Bernanke was communicating about the deal to the Office of the Comptroller of the Currency, the FDIC, and the "incoming economic team of the new administration." The existence of these communications were revealed to reassure BofA that it could count on promised additional TARP money, but the existence of the communications also carried an unsubtle implied threat for a high profile company in a highly regulated industry.

 

At a minimum, BofA had to wonder how regulators might respond, at a very precarious time for the company, if it walked away.

 

4. Who said what to whom about disclosure? The April 23, 2009 Wall Street Journal led with the story, supported by the transcript from Lewis’s testimony before NYAG officials, that Paulson directed Lewis to withhold disclosure of BofA’s concerns with the deal in order to ensure that it went through. Whether or not these directions took place will be the central issue in the investigative frenzy that is no doubt about to unfold.

 

The one thing that is clear is that the BofA board was concerned about disclosure. Among other things, the minutes of the BofA’s December 30 board meeting show that the reason the federal officials could not give BofA written assurance that additional TARP funds would be forthcoming if the deal closed is that "written assurances would require formal action by the Fed and the Treasury, which formal action would require public disclosure." The wording of this sentence makes it unclear whether it is BofA or the feds that were worried about disclosure, but it seems clear that the feds were aware of and involved in the disclosure question.

 

A December 22 email from Paulson to the BofA board (here) seems to suggest that Lewis and the board was concerned about preventing disclosure, but the email arguably is ambiguous. In the email Lewis told the board that Paulson "could not send a letter of any substance without public disclosure, which of course, we do not want." The problem with this sentence is the question of who the word "we" refers to? Is Lewis reporting that Paulson used the word "we" (referring, perhaps, Paulson and his fellow regulators, or perhaps, to Paulson and Lewis), or is does the statement attributed to Paulson stop at the comma, and is the clause after the comma a statement of Lewis’s own, with the word "we" referring to BofA’s board?

 

 

Cuomo’s letter and Lewis’s transcript both seem to suggest that disclosure was not just a concern on the part of the BofA board, but that it was also a concern of Paulson’s, and that he actibvly sought to avoid disclosure related to the unreported Merrill losses. Disclosure was a concern, a topic of discussion and focus in discussions between Lewis and Paulson. Which leads to my next two questions.

 

5. Did Paulson or Bernanke provide Lewis with immunity assurances? We are talking about some very smart guys, and they were fully aware of the legal requirements of disclosure, even if they didn’t pause to analyze the legal particulars. Lewis had to have known that by going through with the deal even though the Company felt entitled to invoke the MAC clause, and that by withholding disclosure of Merrill’s huge and unexpected fourth quarter losses, he and even perhaps the BofA board were potentially undertaking a massive legal exposure – at a minimum, a civil lawsuit exposure, and possibly even much worse exposures.

 

Did Lewis raise these issues with Paulson and Bernanke? (I find it almost impossible to believe that he did not.) Did they provide any assurances to him? Was he given assurances of immunity or indemnity? Did they promise him a "get out of jail free" card? Without these assurances, how could he possibly have been persuaded to "take one for the team"? Doesn’t it seem wildly improbable that these issues were not discussed?

 

6. Are Paulson and Bernanke or others potentially exposed to aiding and abetting liability? This question is not facetious and in fact it is particularly important to me, because I have former colleagues from GenRe, people whom I knew and whom I respect, who are going to jail for their complicity in a deal that seems miniscule and trivial compared to this minuet. Certainly, if the federal regulators directed Lewis and BofA not to disclose material nonpublic information, their involvement in nondisclosure that is later found to constitute securities fraud could implicate them as well.

 

But could they be implicated even if they did not direct the nondisclosure but simply accommodated and facilitated it (for example, by not following through on required federal processes that would have compelled public disclosure)? That is certainly all the Gen Re officials did, and as a result they are going to be spending some serious time in the federal penitentiary.

 

Let me hasten to add that I am not suggesting that criminal prosecution is something that I think will happen here, or even that I think should happen here. But if these kinds of questions are later raised, the questions clearly should be followed all the way to their logical conclusion.

 

7. The strong-armed deal may have hurt BofA shareholders, but could it have been worse for them if the deal crumbled? There is no doubt that Paulson’s demand that BofA go through with the deal despite the BofA’s view that it was entitled to invoke the MAC clause had the effect of requiring the BofA shareholders to take a big hit for the sake of the global economy. But that does not necessarily mean it was contrary to the BofA’s shareholders’ interests for BofA to go through with the deal.

 

Given how massively disruptive Lehman Brothers’ collapse was to the global financial marketplace, it is almost inconceivable how disruptive it could have been if the Merrill deal had fallen through. Merrill would have been cast off, and the revelation of its staggering and unexpected fourth quarter losses would have triggered its immediate collapse – or maybe federal officials could have tried a huge AIG-style rescue of Merrill while somehow trying to reassure that global financial marketplace that there was no reason to panic.

 

My point is that if the Merrill deal had fallen through, the collateral damage from the ensuing firestorm could have substantially damaged BofA’s near and longer term interests.. It is impossible to know now, but the fact is that it may well have been in the BofA shareholders overall best interests for the firestorm to have been averted. Of course, it does seem like the BofA shareholder ought to have had the right to decide for themselves, doesn’t it?

 

8. Is there a national interest exception to the disclosure requirements in the federal securities laws? Imagine for a second if BofA had come right out and disclosed that it felt entitled to invoke the MAC clause but that in order to support the global economy and in exchange for some additional TARP money, it was going through with the deal anyway. Now basic principles dictate that they should have disclosed all of this. But if they had, the chaos that would have followed might have been as bad or even worse than what happened if the deal failed to close – which might well have happened anyway in the wake of these kinds of disclosures.

 

It is easy for commentators to try to argue now what should have been done, as if this were just an amusing question in a parlor game. At the time, however, the principals had no way of knowing how close they were running to potentially catastrophic financial disruption. In view of the weakness in the financial markets and the economy, it was no time for any experiments.

 

But do their fears, even if well founded, earn them a pass for their silence? If they get a pass, on what basis? What is the legal justification and where is it found? On what standard is it based? And who gets to decide when interests are sufficiently important to override the securities laws – can any government official decide that national interests override disclosure requirements? And what precedent would be set for the future? And isn’t it a duty of public officials to ensure compliance with the law, rather than encouraging noncompliance?

 

9. Given the facts on the table at the time and the surrounding revelations about Merrill’s fourth quarter losses, how is it possible that the controversial Merrill bonuses were permitted? Obviously, there is a lot more to be told on this score, but if the federal regulators had the authority to tell BofA it had to complete the deal, and if they felt empowered simply to override federal disclosure requirements, surely these same people had the clout to shut down the bonuses? If they felt they had the ability to trample, or simply disregard, BofA shareholders’ rights, why would they hesitate to bar the payment millions in bonuses for billions of losses?

 

Given all that was going on, that the bonus payments happened seems even more incomprehensible to me – and I am sure I am not the only one.

 

10. How long will it be before this all gets sorted out? I suspect this will go on for years and years to come. Expect the most immediate steps to include a cycle of sessions in Congressional hearing rooms, replete with the revolting spectacle of speechifying politicians grandstanding at the expense of public dignity. The various judicial processes, some of which are already well underway, some of which will be launched in the months ahead, will grind on for years, with at least two or three round trips to the Supreme Court. My prior post about lawsuits already filed about these circumstances can be found here.

 

At some point, possibly in the near future, a coalition of crusaders, a lynch mob, or a gang of zealots will try to organize Lewis’s ouster, and who knows, maybe they may well succeed this time. Indeed, for those wondering why all of this is coming to light all of the sudden now, the timing was obviously due to the fact that the BofA shareholders’ meeting is next week — leaving just enough time for the voices of outrage to get fully tuned up for the meeting.

 

Whatever else you want to say about these circumstances, the spectacle to which we are all about to be subjected will not be pretty and is unlikely to be edifying.

 

The recent Environmental Protection Agency (EPA) proposal to find that greenhouse gases "contribute to air pollution that may endanger public health or welfare" is just the latest in a series of actions and events suggesting that climate change related issues could affect a large number of companies, in a variety of ways, including most specifically with respect to at least some companies’ disclosure obligations. These trends could have important implications for potential liability exposures of directors and officers of public companies.

 

On April 17, 2009, the EPA released a proposed "endangerment finding" with respect to six greenhouse gases (including carbon dioxide). The EPA’s April 17 press release can be found here and a summary of the proposal can be found here. Under the EPA’s proposed finding (which can be found here), the EPA is proposing that the six gases "threaten the public health and welfare of current and future generations." The EPA also proposes to find that motor vehicle emission of these gases "contribute to concentrations of these key greenhouse gases and hence to the threat of climate change."

 

The proposed endangerment finding was promulgated in response to the 2007 U.S. Supreme Court decision in Massachusetts v. EPA (discussed at length here). The EPA’s proposed finding, which is now in its public comment period, does not itself include any specific regulatory action or requirements. However, if the proposed finding is adopted, regulatory and even legislative action seems probable, especially given the politics and inclinations of the current President and Congress. Indeed, the adoption of the proposed finding could motivate legislators to act preemptively, to try to avert regulatory provisions they might find unacceptable.

 

The potential scope of any future regulatory or legislative action can be gauged by the specific observations in the EPA’s proposed endangerment finding. That is, the proposed finding not only concludes that climate change "impacts human health in several ways" (such as increased threat of catastrophic weather activity or harm to water and other natural resources), but also that the effects of climate change will have a "disproportionate impact" on certain vulnerable segments of the populations, such as the very poor, the elderly and those already in poor health.

 

The EPA’s report also includes the suggestion that climate change has "serious natural security concerns" based on the instability that could follow in the wake of "increasing scarcity of resources."

 

With these kinds of concerns as a starting point, the potential for any ensuing regulatory or legislative activity to have a disruptive impact on many industries and companies seems high. Indeed, if the risk assessments in the EPA’s findings are anywhere near accurate, the climate change itself, independent of any governmental action, could have a disruptive impact on many industries and companies.

 

Many of the industries and companies likeliest to be affected already are under pressure to anticipate these changes and assess their possible future impact.

 

The most recent effort to mandate these kinds of assessments is the disclosure requirement adopted on March 17, 2009 by the National Association of Insurance Examiners (NAIC). The NAIC’s March 17 press release can be found here and further background regarding the NAIC’s disclosure initiative can be found here.

 

The NAIC’s new disclosure requirements specify that no later than May 1, 2010, all insurance companies with annual premiums over $500 million must complete a Insurer Climate Risk Disclosure Survey. The Survey is designed to require the insurers to disclose "the financial risks they face from climate change, as well as the actions the companies are taking to respond to those risks."

 

Under the NAIC’s mandate, insurers will be required to report on "how they are altering their risk-management and catastrophe-risk modeling in light of the challenges posed by climate change." Insurers must also report on "steps they are taking to engage and educate policymakers and policyholders on the risk of climate change," as well as "whether and how they are changing their investment strategies." As discussed below, the requirement for insurers to disclose how they are "engaging and educating" policymakers and policyholders could be the bridge that extends the NAIC’s initiative to many other industries.

 

Another industry under pressure to analyze and assess climate change impacts is the utilities industry. As discussed (here), in August 2008, New York Attorney General Andrew Cuomo reached the first of several regulatory settlements with utilities companies, in which the settling companies agreed "to disclose financial risks that climate change poses to investors."

 

Among other things, the settling utilities have undertaken to disclose risks associated with probable future climate change regulation; climate change related litigation; and the physical impacts of climate change. In his press release relating to the first of these settlements, Cuomo expressly stated that he expected these companies’ disclosure undertakings to "establish a standard."

 

The insurance and utilities industries may be the most likely industries but they are far from the only industries that potentially will be affected by climate change regulation and the physical impacts of climate change. Other obvious possibilities include auto manufacturing; oil and gas extraction, production and distribution; transportation and shipping; mining; agriculture; tourism; and forestry.

 

But the comprehensive nature of climate change suggests that the potential impacts will not be restricted just to these more obvious industries; the regulatory and the physical impacts of climate change are likely to extend to any business that is engaged in manufacturing; owns or operates vehicles; owns or operates buildings or other physical facilities; or has any other process or activity that has carbon outputs.

 

In other works, the impacts could well reach every company and enterprise. This assessment may seem overly dramatic, but at a minimum it seems likely that the kinds of disclosure requirements now facing insurance companies and the utilities industry could come to be expected of many other companies. As Cuomo said in connection with the settlement described above, he expects that the disclosure requirements will "establish a standard."

 

Whether these changes will actually take place remains to be seen. But whether or not they ultimately happen, the prudent course would seem to be to anticipate that they will. Which leads to the point referenced above, about the prospect that insurers could wind up driving change for many other companies.

 

That is, with insurers themselves obliged to start reporting next May among other things on what steps they are taking to engage and educate policymakers and policyholders on climate change, one possibility is that insurers could take the lead in communicating the message that prudent companies should assume that these changes are coming. Insures could wind up spurring their policyholders to undertake the same kind of risk assessment and disclosure that Cuomo is requiring in the regulatory settlements with the utilities.

 

Specifically, it seems possible that D&O insurers, in order to fulfill their own disclosure obligations under the NAIC’s mandate (and to look proactive while doing so) could undertake to "educate" their policyholders about the need to assess both the possible regulatory and physical impacts of climate change on their operations and financial condition, and to disclose those assessments to investors, as a way to manage a variety of climate change related risks.

 

In any event, whether or not insurers actually take that step, well-advised companies may independently conclude on their own that given the possible regulatory and physical impacts of climate change, risk assessment and disclosure is simply prudent.

 

One of the lurking dangers when a single issue predominates, as the global financial crisis recently has, is that all other concerns may seem trivial and unimportant by comparison. For many companies, especially those outside the insurance and utilities industries, climate change issues may now seem subordinate and remote to the point of irrelevance. But when we finally emerge from the current crisis, we may find that the climate change risks loom larger than ever and are more important than anyone now imagines.

 

This is not the first time I have raised these climate change related issues (refer for example here). I know there are those who think I am alarmist about this issue, and I suppose the skeptics could be right. However, even the most hardened cynic will have to acknowledge that, given the EPA’s recent pronouncement and given the current political environment in Washington, regulatory and even legislative activity seems likely, which is clearly a risk, trend or uncertainly that prudent companies will be assessing and disclosing.

 

And allow yourself for a moment to consider the possibility that the risk assessments in the EPA report could actually come to pass. At a minimum, if these things are possible, shouldn’t companies also be assessing the possible impact of climate change on their operations and financial condition?

 

Many companies today might conclude that there will be time enough tomorrow to deal with tomorrow’s problems. That was exactly the logic that led Detroit to keep grinding out SUVs and Hummers for the last twenty years, when more forward-looking competitors were already capturing market share by making hybrid vehicles. Just as Detroit’s past leaders are now criticized for their lack of vision, so too may other corporate leaders who now defer on these issues find themselves later under siege for failing to look ahead and anticipate the changes and problems just ahead.

 

Somehow, on Earth Day, these issues seemed particularly important for me. And for my kids.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

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

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

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

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

 

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

 

Background

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

The April 17 Opinion

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

 

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

 

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

 

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

 

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

 

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

 

Discussion

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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