Private equity firms and the funds they organize frequently place individuals on their portfolio companies’ boards. However, all too frequently, it is not until a claim has arisen that the various entities consider how the potentially implicated indemnities and insurance will interact. Unanticipated interactions sometimes can produce unintended consequences, particularly from the perspective of the private equity firm.

 

A March 19, 2009 article by the Latham & Watkins firm on the Harvard Law School Corporate Governance Forum blog entitled "Indemnification of Director-representatives by PE Firms" (here) takes a closer look at these issues.

 

Among other things, the authors note that "the allocation of responsibility for indemnification and advancement obligations … are not considered until after litigation has been filed" and the same "holds true with respect to the amount of available insurance, especially at the portfolio company level."

 

The authors offer a number of excellent practical suggestions.

 

First, they suggest that the contractual arrangements between the private equity firm and the individuals serving on the portfolio company boards "provide clearly that the private equity firm’s indemnification and advancement obligations to its director-representatives are secondary to the indemnification and advancement obligations of the portfolio company." Otherwise, courts may consider the private equity firm and the portfolio company to be "co-equally liable," which could prove very costly for the private equity firm if it advances costs in the first instance and later seeks reimbursement from the portfolio company.

 

Second, the authors suggest that if the indemnification documents with the director-representative cannot be modified, the private equity firm "should seek an assignment of the director-representative’s rights to indemnification and advancement from the portfolio company prior to the fund paying out defense or settlement costs on their director-designees’ behalf."

 

Third, the authors point out that advancement rights are distinct from indemnification rights, and they suggest that the portfolio company’s advancement commitments "should be examined to be certain that advancement is contractually required and that any advancement obligations owed by the private equity firm or its fund are secondary to the obligations of the portfolio firm."

 

The authors’ final observations relate to insurance. They comment that typically "neither the director nor the private equity firm will look at the portfolio company’s D&O insurance policies until after the director needs to defend/or settle such claims."

 

The authors correctly note that the private equity firm should review the portfolio company’s policies to ensure that the policies are "adequate to protect their director-representatives." The authors also suggest a review of the provisions that will determine how the portfolio company’s policies and the private equity firm’s policies will interact in order to "prevent a battle of the insurance companies."

 

The authors cite the interaction between the portfolio company’s D&O insurance policy and the private equity firm’s policy as a potential concern. These insurance issues become particularly critical if the portfolio company goes bankrupt, in which case portfolio company indemnity issues drop out of the picture and the portfolio company’s insurance can becomes critical.

 

Bankruptcy often has a way of demonstrating the insufficiency of the limits of insurance that the portfolio company purchased. Moreover, bankruptcy also has a way of demonstrating –after the fact – the need for auxiliary insurance structures (such as Side A/DIC insurance or independent director insurance) to protect individuals in the event of complex claims while the portfolio company is bankrupt.

 

The authors are correct that the the various potentially implicated insurance policies terms and prospective insurance interactions all too often go unexamined. However, looking at the terms alone is not enough. Limits selection and program structure should also be carefully considered. Private equity firms should take steps to ensure that the portfolio company’s insurance program will sufficiently protect the director-representatives in all contingencies, even bankruptcy—or, rather, especially in bankruptcy.

 

I disagree with the article’s authors on one point. The authors state that "private equity firms should also strongly consider having the same carrier write the primary policies at both the firm and at each of its portfolio companies." The authors suggest this approach avoids the "other guy’s" policy coverage dodge.

 

The authors are correct that this would avoid the "not my problem" dodge. But it could be a terrible insurance solution in every other respect, both for the private equity firm and for the portfolio companies. First, from the private equity firm’s perspective, there are relatively few carriers willing to write those kinds of risks in the first place, and within that small group, the available terms and conditions vary dramatically. The private equity firm should focus first on placing the optimal insurance solution for its own risks and needs, without being forced to accept a suboptimal solution out of an artificial effort to try to match carriers with its portfolio companies.

 

By the same token, the portfolio companies are unlikely to have uniform exposures and interests. Given the incredible diversity of potential insurance alternatives available in the marketplace, it is very unlikely that the same carrier would provide the best insurance solution for each of the various portfolio companies. And by the same token, the portfolio companies should not have their range of potential D&O insurers restricted only to the relatively few carriers that also will write private equity firm D&O insurance.

 

In short, trying to cram all of the various insured entities under a single carrier’s umbrella could address one single issue but create a host of potentially more significant problems as a result. The preferred approach is exactly the one the authors otherwise recommend, which is to consider policy interaction issues in connection with the insurance placement process – a process that should in the first instance be addressed to providing the best solutions for each respective entity.

 

The authors’ interesting article highlights the need for private equity firms to enlist knowledgeable and experienced insurance professionals in connection with their insurance placement and in connection with their consideration of the issues discussed above. Insurance can sometime appear like a peripheral or relatively unimportant matter– unless things go seriously wrong, in which case insurance can turn out to be the most important thing. At the point that things have gone seriously wrong it a very poor time to discover that critical insurance issues were insufficiently considered.

 

Break in the Action: The D&O Diary is taking its act overseas, and so the publication schedule will be disrupted for the next few days. Regular publication will resume the week of March 30.

 

The current global financial crisis may result in "unprecedented levels of litigation" that "will either serve to identify ‘weak links’ in the chain of participants who originate, appraise, and service collateral and underwrite, manage, insure, rate and sell securities," or it will serve to "highlight where the market may have underappreciated certain risks or failed to appreciate certain circumstances," according to a paper featured in a March 17, 2009 post (here) on the Harvard Law School blog.

 

The paper, entitled "Legal and Economic Issues in Litigation Arising From the 2007-2008 Credit Crisis," was written by Babson College Professor Jennifer Bethel, Harvard Law Professor Allen Ferrell, and Babson Professor Gang Hu, can be found here.

 

The paper explores the "economic and legal causes and consequences of the 2007-2008 credit crisis." In particular, the paper examines "the risks that can arise from financial and technology innovations and losses that are uniquely related to correlated events in the setting of loan markets." The paper sets for a detailed and interesting overview of the economic and financial causes that contributed to the current credit crisis.

 

The paper also notes that "the credit crisis is not solely an economic phenomenon, but a legal one as well." The paper discusses a number of different types of lawsuits that have arisen, but focuses in particular on securities class action lawsuits against public companies, which the paper describes as "by far the most important litigation likely to arise out of the credit crisis."

 

The paper asserts that "plaintiffs that bring Rule 10b-5 class action lawsuits will face substantial challenges," and notes in particular that the securities plaintiffs will have to navigate around three basic legal principles: "(i) there can be no ‘fraud by hindsight’; (ii) there can be no actionable disclosure deficiency with respect to information the market already knew (the ‘truth on the market’ defense); and (iii) plaintiffs must establish loss causation for their claims."

 

First with respect to the "fraud by hindsight" concern, the paper notes that it will not be enough for plaintiffs to show that there have been economic losses; they will also have to show that the adverse developments were reasonably foreseeable at the time the supposedly disclosures were made. The authors note that

 

Whether a failure of certain market participants to provide detailed disclosures regarding the implications of an event – the first full national fall in housing prices since World War II in conjunction with a dramatic and increasingly global crisis – from which the actors themselves suffered huge losses is actionable will likely prove an important stumbling block, in our judgment, for a number of actions being brought.

 

The authors add that "the presence of disclosure failures and materiality thereof must be assessed in light of what was known at the time of the disclosures without the benefit of 20/20 hindsight, even if losses occur."

 

Second, with respect to the "truth on the market" defense, the authors question whether the target companies in fact had "special knowledge that was not known by the market at large." The authors suggest that this may have been a situation where the market was at least as informed, or at least no less informed, than the defendants on relevant issues.

 

Third, the authors suggest that "loss causation is likely to be a challenging litigation issue for plaintiffs, because market prices, especially of financial-sector securities, declined overall."

 

The few dismissal rulings that have accumulated so far provide at least some support for the authors’ theories. In at least two cases where dismissal motions have been granted with prejudice – the NovaStar Financial case (about which refer here) and the Impac Mortgage case (refer here) – the courts seemed particularly concerned that the defendant companies had been caught in an industry-wide or even economy-wide downturn. Even if the courts did not use the price phrase "fraud by hindsight," the concept was seemingly implied in the rulings.

 

At the same time, however, there have also been significant cases where courts have had no difficulty denying dismissal motions – for example, New Century Financial (refer here) and Countrywide (here) – in which the courts have expressed open outrage regarding the alleged misrepresentations and omissions. The authors’ analysis seems deficient to me to the extent it fails to recognize the possibility that at least some courts’ judgments potentially may be affected by this sense of outrage, particularly over the extent of damage done, to investors and to the economy. (A list of all of the subprime dismissals and dismissal motion denials can be accessed here.)

 

In addition, given the authors overall hypothesis that plaintiffs will face substantial hurdles in pursuing these cases, it seems a noteworthy and even odd omission that the authors detailed and exhaustive paper neglects to even mention the possibility that the U.S. Supreme Court’s decision in the Tellabs case could also represent a significant hurdle for the plaintiffs. In that regard, the Tellabs decision has generally proven instrumental in those cases where dismissal motions have been granted thus far.

 

Finally, with respect to the authors’ suggestion that loss causation issues may prove critical, I note that in a prior post (here) I discussed the challenge that plaintiffs may face where they have sued for supposed economic losses on securities that continue to provide scheduled interest payments on time and in full. These arguments may be particularly relevant in claims brought by mortgage-backed securities investors who have sued the securities issuers and the securities offering underwriters.

 

Defenseless: Laura Pendergast-Holt, the erstwhile Chief Investment Officer of Stanford Financial Group, has a few legal problems to sort out. First, she is a defendant in an SEC enforcement proceeding involving the Stanford Group. Second, she was arrested on February 26, 2009 and charged with obstructing a proceeding before an agency of the United States. Third, she has been named as one of the defendants in numerous civil lawsuits brought by irate Stanford group investors. (A complete list of Stanford-related litigation can be accessed here.)

 

Ms. Pendergast-Holt clearly needs the services of an attorney. Unfortunately, she is also party to one more lawsuit, one in which she is the plaintiff, and which suggests the challenges she may have in providing for her legal representation in the above matters.

 

On March 17, 2009, she filed a lawsuit in Texas (Dallas County) District Court against Stanford Group’s directors and officers’ liability insurer, alleging that the insurer has "failed and refused to provide a defense so that she can defend herself in the SEC action, the civil class action, and in the criminal matter." A copy of her Original Petition can be found here.

 

Ms .Pendergast-Holt seeks a judicial declaration of coverage. Arguing that she has no way of satisfying any self-insured retention, she also seeks a "declaration that any self-insured retention or deductible be waived, held inapplicable or enjoined." She also alleges breach of contract and bad faith. She seeks damages estimated to exceed $5 million, as well as punitive damages estimated to exceed $40 million.

 

The bases on which the insurer has declined coverage for Ms. Pendergast-Holt’s defense are not specified in her Original Petition. While the scandal surrounding Stanford Group is notorious, as yet there have been no verdicts and no guilty pleas, nor to my knowledge have there even been any admissions. Whatever the facts ultimately prove to be, nothing has as yet been determined. These considerations may prove relevant to the coverage dispute, for example, with respect to the potential applicability of policy exclusions. On the other hand, representations made in connection with Stanford’s policy application (particularly with respect to Stanford’s finances) may also figure into the insurer’s coverage position.

 

A March 18, 2009 AmLaw Daily post regarding the coverage lawsuit can be found here. Hat tip to the Courthouse News Service (here) for a copy of the Original Petition.

 

Last fall, the New York Department of Insurance ignited a firestorm when it issued an opinion that a D&O insurance policy may not place the duty to defend on the insured. As I discussed in an earlier post (here), the opinion is contrary to both the uniform practice of the D&O insurance industry and the unambiguous preference of public company D&O insurance buyers.

 

On February 26, 2009, following his keynote address at the the Professional Liability Underwriting Society (PLUS) D&O Symposium, New York Insurance Superintendent Eric Dinallo acknowledged the industry’s reaction to his department’s opinion, and indicated that the department would reconsider the issue and address it through the issuance of a new regulation. He also invited the industry to help his department to shape the new regulation.

 

Based on the Superintendent’s invitation, PLUS is now working with the American Insurance Association (AIA). The AIA has drafted proposed revised regulatory language that is now being circulated among its members. PLUS has also invited its member companies to comment on the draft regulatory proposal. PLUS will compile the comments and share them with the AIA and the New York Department of Insurance.

 

One representative from each PLUS member company can obtain a copy of the draft proposed regulatory language by contacting PLUS’s Executive Director, Derek Hazletine, dhazeltine@plusweb.org.  

 

I am setting all of this information out in a separate blog post because the deadline for comment to be received is next Monday, March 23, 2009, so companies that want to participate will have to move quickly.

 

In his Feb. 26 presentation, Dinallo indicated that he intends to act quickly on the proposed regulations and that he hopes to have the regulations in place by late spring.

 

Insurers Must Disclose Climate Change Exposures: On March 17, 2009, the National Association of Insurance Commissioners adoped a "mandatory requirement that insurance companies disclose to regulators the financial risks they face from climate change, as well as the actions the companies are taking to respond to those risks." According to the NAIC’s press release (here), all insurance companies with annual premiums of $500 million or more will be required to complete an annual Insurer Climate Risk Disclosure Survey with an initial deadline of May 1, 2010. 

 

In the Survey, insurers will be required to report on "how they are altering their risk-management and catastrophe risk moedline in light of the challenges posed by climate change" and they will also be required to report  on "steps they are taking to engage and education policymakers and policyholders on the risks of climate change" as well as "whether and how they are changing their investment strategies." 

 

These reporting requirements could have a singificant impact, not just on insurers disclosures, but on their conduct as well. The requirement to disclose what the carriers are doing to "engage and educate" policymakers seems to suggest that the NAIC expects carriers to become proactive on the legislative and regulatory front regarding climate change. The disclosure regarding investment strategies potentially could influence insurers” investment decisions. The clear implication of the NAIC’s rule is that the regulators expect the disclosure requirements will motivate the carriers to become proactive in these areas.

 

 

The web page for the NAIC’s Climate Change and Global Warming Task Force, including a link to the draft language of the new disclosure requirements, can be found here.

 

The Hits Just Keep on Coming: Bernard Madoff may now be in jail following his recent guilty plea, but that does not seem to have slowed the flow of new Madoff-related lawsuits. As the new suits have come in, I have added the new suits to my running tally of the Madoff-related litigation, which can be accessed here.

 

The litigation register has now grown to be quite lengthy. Madoff’s fraudulent scheme may have cost investors billions, but he has stimulated a heaping stack of litigation.Special thanks to the many readers who have been sending me the new complaints as they have come in, especially Jon Jacobson of the Greenberg Traurig law firm. Readers may be interested to know that Jon is also reporting on the new cases on Twitter (here) as they come in.

 

Speaker’s Corner: Next week I will be in London speaking at the C5 D&O Liability Insurance Conference. The specific panel on which I will be speaking is entitled "Current Litigation Trends in Europe and the U.S.: Are Class Actions on the Horizon?" The conference, which will take place March 24 and 25, 2009 at the Grange City Hotel., will feature a diverse array of speakers on a wide variety of D&O insurance related topics. The entire program agenda can be found here.

 

A liability insurance policy is not intended to provide policyholders a means to shift to the insurer their separate, voluntarily undertaken contractual obligations. Private company D&O insurance policies generally embody this principle in a separate exclusionary provision. However, the wording of the exclusionary clause can substantially affect the scope of coverage otherwise available under the policy. In particular, the expansive reading given certain exclusionary language in recent cases suggests that a more narrowly constructed exclusion would more appropriately address the concern that the provision was originally intended to address.

 

Background

Long standing case law establishes that liability insurance policies do not cover breach of contract claims, because a contractual duty is not a liability imposed by law but is rather a voluntarily undertaken obligation. By way of illustration, a debtor ought not to be able to borrow funds, neglect to repay the debt, and then shift the repayment obligation to an insurer.

 

While these case law principles are well-established, some years ago private company D&O insurers nevertheless began to insert express contract exclusions in their policies. In part the insertion of the contract exclusion was intended to address the recurring policyholder objection that the policy does not say that it will not cover contractual liability. The insurers also wanted policy language to try to address recurring problems presented by claims against insured companies that sound both in contract and in tort (e.g., a complaint that asserts both a breach of contract claim and a claim for tortious breach of contract).

 

In addressing these issues, some carriers have adopted broadly worded exclusionary language. For example, one leading carrier’s private company D&O insurance policy contract exclusion precludes coverage for claims "based upon, arising from, or in consequence of any actual or alleged liability of an Insured Organization under any written or oral contract or agreement provided that this exclusion… shall not apply to the extent that an Insured Organization would have been liable in the absence of the contract or agreement."

 

As an important aside, most public company D&O insurance policies typically have no contract exclusion, for the simple reason that the company (or "entity") coverage provided in most public company D&O insurance policies is limited exclusively to Securities Claims. Because contract claims are not within the scope of entity coverage provided in the typical public company policy, there is no need to exclude contract claims. The contract exclusion (in some form) is, however, a relatively standard part of most private company D&O insurance policies because the entity coverage afforded under the private company policy is more expansive and is not restricted merely to a single category of claims.

 

While most private company D&O insurance policies have some form of contract exclusion, not all policies have adopted the more expansive exclusionary language of the type illustrated in the example quoted above. The scope of language in the exclusion can substantially affect the extent of coverage available under the policy; in particular, courts have applied a broadly preclusive interpretation to the expansive exclusionary language of the type quoted above.

 

Recent Case Examples

Spirtas: In an April 2008 opinion (here), the Eighth Circuit affirmed an Eastern District of Missouri opinion granting summary judgment on behalf of a D&O insurer on the basis of the applicable policy’s contract exclusion.

 

The insured, Spirtas Company, had entered a contract to perform construction contract demolition work. The project manager later sued Spirtas claiming that it had not performed the demolition work properly and had failed to use funds the project manager had supplied Spirtas to pay subcontractors and suppliers. The complaint alleged breach of contract, breach of express or implied trust, conversion and unjust enrichment. Spirtas sought coverage for the claims under its D&O insurance policy.

 

The D&O insurer denied coverage in reliance on a policy exclusion that, in pertinent part, precluded coverage "based upon, arising from or in consequence of any actual or alleged liability of an Insured Organization under any written or oral contract or agreement." In the ensuing coverage litigation, the district court granted the insurer’s motion for summary judgment holding that the underlying cause of action, including the tort claims, arose from Spirtas’s obligations under the demolition contract.

 

The Eighth Circuit affirmed, holding that the contract exclusion "applies to claims sounding in tort as long as they flowed from or had their origins in the breach of contract." The Eighth Circuit made it clear that its conclusion was reinforced by the broad scope of the exclusion’s "arising from" language.

 

GE HFS: The difficulty with the breadth of scope given the "arising from" language in this context is that it potentially lacks a logical stopping point. A 2007 opinion in the GE HFS case in the District of Massachusetts illustrates the how broadly this expansive reading just might extend. (The magistrate’s report and recommendation, which was subsequently adopted by the district court, can be found here; this post refers to the magistrate’s report and recommendation.)

 

In the GE HFS case, a home health care company had a line of credit in which the company was obliged to provide the lender certain status reports, upon which the lender relied in advancing additional credit. After receiving reports and advancing funds, the lender claimed the company had overstated its assets, as a result of which it had overextended the credit. The company went bankrupt. The lender sued certain of the company’s directors and officers.

 

The lender’s complaint, by its own terms, sought damages from the individual defendants for "negligent misrepresentations…with respect to collateral available to satisfy loans." The complaint also sued certain of the individual defendants for breach of contract on a personal guaranty. (There was no contention that the claims based on the personal guarantees were covered under the policy.) According to the magistrate in the coverage action, the "crux" of the lender’s complaint is its allegation that the individual defendants in the underlying action "failed to exercise reasonable care and competence in the preparation and communication" to the lender, as a result of which the receivables collateral were overstated and the lender advanced more money than it would have if the reports had been accurate.

 

The coverage case involved one of the individual defendants, Ingoldsby, who asserted among other things that the underlying complaint did not allege that he had prepared or compiled the disputed reports, and therefore that the claim against him was in effect a claim for negligent supervision or mismanagement, rather than misrepresentation. Indeed, the magistrate assumed for purposes of its opinion that the claim against him was for "negligent supervision."

 

The D&O insurer nevertheless denied coverage for Ingoldsby’s defense expenses on the basis of the applicable policy’s contract exclusion. The exclusion precluded coverage for claims "alleging, arising out of, based upon or attributable to any actual or alleged contractual liability of the Company or any other Insured under any express contract or agreement."

 

The magistrate found that the "arising out of" language "must be read expansively," holding that because the "allegedly wrongful conduct" was "dependent upon and in furtherance of" the loan, the loan "provided more than context: the entire claim was based upon the performance under the contract." Because the "allegedly wrongful conduct was part and parcel of performance under the contract," the contract exclusion applied.

 

The court also rejected the Ingoldsby’s argument that "the exclusion is void as it excludes virtually all types of coverage." The magistrate found that "misrepresentations may occur in a business setting yet not be related to a contractual duty."

 

Discussion

The outcome in the GE HFS case may be entirely appropriate give the facts and the contractual language involved, but the practical consequences of the case should not be overlooked. The court denied coverage for an individual director and officer for a negligent supervision claim, because of the relation of the claim to the underlying contract and because of the breadth of the contract exclusion.

 

The troublesome thing about the breadth of the preclusionary effect applied in these cases is that some type of transaction is at the heart of many claims under a private company D&O insurance policy. The danger is that insured individuals could find themselves facing claims of a kind that might well have assumed would be covered (say, for example, a negligent supervision claim), because of the involvement in the claim of an underlying transaction and because of the expansiveness of the D&O insurance policy’s contract exclusion.

 

Which brings me to the ultimate point– that is, the real problem here may be the expansiveness of the preamble to the exclusion. Clearly, the use of the broad "based upon" and "arising out of" language was instrumental in the two cases discussed above.

 

The court in the GE HFS case more or less recognized this when it acknowledged that "the coverage provided by the policy at issue… may be more limited than other available D&O policies." The inverse of this statement is, of course, that coverage provided by other policies is less limited. While that does not necessarily mean that a differently worded policy would have covered the claims at issue in the GE HFS case, the differently worded policy would not be as "limited."

 

My own observation is that carriers whose policies have the broad preamble language in the contract exclusion of the type discussed above perceive that coverage under their policies is indeed limited, demonstrating that as a practical matter there may be no logical stopping point in interpreting the coverage restrictions created by an expansive exclusionary provision.

 

By significant contrast, certain carriers’ private company D&O insurance policies have contract exclusions that do not use the broad omnibus "based upon" or "arising out of" preamble language. Rather, these carriers’ policies use the more restricted "for" wording.

 

Given the extent of the preclusive effect that courts have found in interpreting policies with the broad omnibus wording, policy forms using the narrower "for" wording are, in this respect at least, clearly superior from the policyholder’s perspective, particularly if carriers whose policies have the broader wording choose (as some are now doing) to try to apply the exclusion to preclude a wide swath of otherwise covered claims, including not just contract claims against entities but tort claims against individuals.

 

Indeed, I would argue that the "for" wording is much closer to the original purposes for the inclusion of the contract exclusion in private company D&O insurance policies – that is, an exclusion with the "for" wording makes it clear that insurers do not intend to pick up the insured company’s contractual liability, without extending the potential preclusive effect, for example, to tort claims against individuals.

 

Many prospective insurance buyers would be surprised indeed to learn that their prospective insurer intended to take the position that their policy would not cover even defense expense for, say, a negligent supervision claim if the claim also involves an underlying business transaction. Indeed, I suspect that many D&O underwriters would be surprised to learn that the claims handling counterparts would take such a position.

 

The use of the "for" wording in the contract exclusion provides at least some assurance that these reasonable expectations will not later be defeated by a reading of the contract exclusion that is so broad that is arguable defeats coverage for claims that might reasonably be presumed to be covered.

 

One final note. I want to acknowledge that my thoughts on this topic were triggered by the excellent November 2008 PLUS Journal article by Joseph A. Bailey III of the Drinker Biddle law firm entitled "Trio of Recent Cases Affirms Broad Scope of Contract Exclusion" (here). I hasten to add that the views expressed in this post are exclusively my own.

 

In a prior post (here), I discussed Judge William Alsup’s rejection of the proposed settlement of the options backdating-related derivative lawsuit involving Zoran Corporation, in which the parties had proposed to resolve the case without any cash payment to the company. A more recent case presents another example of a court’s similar unwillingness to approve an options backdating derivative lawsuit settlement in the absence of any cash payment to the company. The events ensuing after the settlement’s rejection represent a rather noteworthy and surprising outcome.

 

In a January 8, 2009 order (here), Judge Sam Sparks of the Western District of Texas rejected the proposed settlement of the Cirrus Logic options backdating-related derivative lawsuit. Judge Sparks first noted that "while the Settlement consists of no monetary benefit to Cirrus, it does include a provision by which Plaintiffs’ attorneys will be paid $2.85 million in fees by Cirrus’ insurer."

 

With respect to his obligation to determine that a proposed derivative settlement is "fair, reasonable and adequate," Judge Sparks said this "does not mean that the settlement must be fair to the attorneys (as the Stipulation of Settlement no doubt is) but that it must be fair in light of the corporation’s interests."

 

Judge Sparks went on to observe that the parties had "utterly failed to convince the court that it is fair."

 

Judge Sparks stated that the supposed "substantial benefits" were "for the most part, cosmetic." He found that the proposed governance reforms "appear far too meager." He added that "the Court simply is not convinced that the proposed reforms alone present any meaningful compensation to Cirrus for the extreme damages Plaintiffs claimed were suffered by the corporation as a result of the backdating." The proposed reforms "confer so little value" that that the settlement, Judge Sparks found, could only be approved "by showing that the suit brought by the Plaintiffs was virtually meritless."

 

The plaintiffs’ lawyers had argued that their proposed attorneys’ fees were "well within the range of attorneys’ fees paid in shareholder derivative backdating cases, especially given the substantial benefit to Cirrus brought through the prosecution of the Litigation." However, Judge Sparks said with respect to these proposed fees and their purported justification that

 

For obtaining a minimal (if not non-existent) benefit to Cirrus, Plaintiffs’ attorneys under the terms of the Stipulation of Settlement would earn $2.85 million in attorney’s fees for a suit that has been pending less than two years. Although the Court would prefer to give deference to all parties’ counsel’s views and opinions regarding whether the settlement is satisfactory given the risks of continued litigation, the Court simply cannot fathom (and was entirely unconvinced by Plaintiffs’ counsel at the hearing) how counsel feels they could have earned these fees. Viewed objectively, the attorneys are requesting top-dollar fees for their inability to be successful in this case. By approving this Stipulation of Settlement, the Court would be compensating Plaintiffs’ counsel handsomely and encouraging plaintiffs’ attorneys in the future to go on fishing expeditions against corporations. Sometimes when at [sic] attorney goes fishing he catches fish, and sometimes he does not – but when he does not he should not eat filet mignon afterwards.

 

Duly chastised by Judge Sparks’ vituperative rejection of their initial proposed settlement, the parties regrouped and on March 10, 2009, they submitted a revised proposed settlement stipulation (here).

 

The revised settlement not only includes significant alternations to the proposed governance reforms, but also provides that Cirrus’ D&O insurer will pay its "remaining Limit of Liability" of $2,850,000 directly to Cirrus, "in consideration of which Plaintiffs and Plaintiffs’ Counsel will waive and relinquish any claim for attorneys’ fees and expenses."

 

Although Judge Sparks’ January ruling rejecting the initial proposed Cirrus settlement makes no reference to Judge Alsup’s earlier rejection of the Zoran settlement, both decisions are very much in the same vein. (To be sure, Judge Alsup’s rhetoric, replete with words such as "collusive" is more heavily freighted than that of Judge Sparks, although the outcome in both cases was more or less the same.)

 

Certainly, both opinions underscore the fact that courts take their responsibilities to absent class members very seriously and in particular that courts will take a dim view of proposed settlements in which plaintiffs’ attorneys’ reap substantial fees but in which the purportedly harmed corporation receives no monetary benefit.

 

The surprising finale in the Cirrus Logic case, in which plaintiffs’ attorneys wound up waiving their fee in order to complete the settlement, highlights how critical it may be for plaintiffs’ attorneys to be able to demonstrate in the first instance that it is the corporation and not the attorneys that benefit the most from a proposed settlement.

 

I noted in my prior discussion of Judge Alsup’s rejection of the Zoran settlement that there may be an increasing sense in which the plaintiffs’ attorneys seem to be growing weary of the options backdating cases and indeed may just want them to go away. The plaintiffs’ attorneys’ willingness to resolve the Cirrus Logic case without any provision for the payment of their own fees would certainly seem to corroborate this point. Whether or not the plaintiffs’ attorneys want the options backdating cases in general to go away, the specific lawyers in the Cirrus Logic case pretty clearly were committed to bringing an end to that particular case. Given some of Judge Sparks’ comments, who could blame them?

 

I have in any event added the revised proposed Cirrus Logic settlement to my updated table of options backdating settlements and case resolutions, which can be accessed here.

 

Special thanks to a loyal reader for a copy of Judge Sparks’ January 8 opinion.

 

Curses, Foreclosed Again: It may be supposed that growing wave of residential mortgage foreclosures is sufficiently awful that there would be no need for further dramatization. However, that supposition fails to reckon with Hollywood’s capacity to sensationalize anything, even something as banal as a bank officer’s decision to foreclose on an overdue mortgage. 

 

"Drag Me to Hell," a new movie by Sam Raimi, the director of the "Spiderman," involves a young bank office (Alison Lohman) who, in order to show herself worthy of a promotion, decides to foreclose on a home owned by a frail eldely woman. In response, the old woman lays a curse on the bank officer, whose career and life suddenly becomes very dark and gruesome. The ensuing mayhem may somehow be metaphorical of the financial chaos in which we all find ourselves.

 

I have linked below to a trailer for the movie. After viewing the trailer it may be unnecessary to actually see the movie, which in at a time when everybody is trying to save a few bucks may be good thing. However, the movie itself may be too dark to satisfy any populist need for vengence on supposely cruel and insensitive banks.

 

Hat tip to the NPR Planet Money blog (here) for the link to the trailer.

 

http://www.traileraddict.com/emd/9446

On March 9, 2009, in a short but strongly worded opinion, Judge Andrew Guilford of the Central District of California dismissed with prejudice the third amended complaint in the subprime-related securities class action lawsuit filed against Impac Mortgage Holdings. A copy of the opinion can be found here.

 

Background

As discussed here, on October 6, 2008, Judge Guilford had dismissed plaintiffs’ second amended complaint with leave to amend. Plaintiffs filed their third amended complaint on October 27, 2008, and the defendants renewed their motion to dismiss.

 

The third amended complaint essentially alleged that contrary to the company’s public statements and to the company’s own underwriting guidelines, the company’s Alt-A loans were being sold to less creditworthy borrowers, so that the Alt-A loan portfolio was as risky as a portfolio of subprime mortgages. The plaintiffs further alleged that at the same time, the company misrepresented its true financial condition by its failure to write down the value of its loan portfolio. Further background regarding the lawsuit can be found here.

 

The March 9 Opinion

In his March 9 opinion, Judge Guilford noted that the in opposing dismissal the plaintiffs had quoted from the court’s opinion in the New Century case denying the motion to dismiss (about which refer here), contending that this case, like the New Century case, is about a "staggering race-to-the-bottom of loan quality and underwriting standards as part of an effort to originate more loans for sale through secondary markets."

 

Judge Guildford said that he "disagrees" with this characterization, noting that in his view, "this case is about a company involved in a volatile industry at the onset of a long, destructive economic downturn."

 

The specific basis on which Judge Guilford granted the motion to dismiss is his finding that the third amended complaint "fails to plead a strong inference of scienter." He found that the former employees’ statements on which the plaintiffs relied were just "vague accusations and conjecture." The third amended complaint’s reference to follow due diligence or loan guidelines were just generalizations lacking connection to specific actions or events.

 

The plaintiff had also relied on the "core operations inference" to try to satisfy the scienter requirement. While noting that there may be rare instance in which an event is so prominent that it would be "absurd" to suggest that key officers lacked knowledge of it, this, Judge Guilford found, was "not one of those exceedingly rare cases."

 

Discussion

Judge Guilford’s opinion joins a growing list of subprime and credit crisis-related securities lawsuits in which dismissal motions have been granted. (To access my running scorecard of subprime and credit crisis-related securities lawsuit settlements, and dismissal motion denials, refer here.) To be sure, there have also been a number of cases, including some higher profile cases – particularly the Countrywide case (about which refer here) and the New Century case (refer here) – where dismissal motions have been denied.

 

However, Judge Guilford’s express rejection of the Impac plaintiffs’ attempt to compare their case to the New Century case, and to use that as a way to avert dismissal, may suggest the constraints that plaintiffs in other cases may face in trying to rely on the Countrywide and New Century dismissal motion denials.

 

It should be noted that relatively few of the dismissal motion denials thus far have been with prejudice. Indeed, of the dismissals granted, only the Impac dismissal and the dismissal in the NovaStar Financial case (about which refer here) have been with prejudice. However, in both of those cases, the courts seemed particularly concerned with the fact that defendant companies had been caught in an industry-wide or even economy wide downturn, and as a result were openly skeptical of plaintiffs’ claims of fraud.

 

It is still too early to generalize about how these cases are faring or will fare overall, as most of them are only in their earliest stages. But at a minimum it appears that some courts, fully aware of the global financial turmoil, are viewing at least certain of these cases with skepticism. By the same token, there have been courts that have found the plaintiffs’ initial pleadings to be sufficient to survive a motion to dismiss.

 

Judge Guilford’s refusal to consider the core business operations inference stands in contrast to the opinion denying the motion to dismiss in the RAIT Financial subprime-related securities case, where the court held that the allegations regarding the defendant company’s core business operations were adequate to satisfy the scienter requirement. As I noted in my discussion of that ruling (here), earlier courts had rejected this theory as inconsistent with the PSLRA’s pleading requirements, but more recently courts, for example, in the Ninth Circuit (refer here) and the Seventh Circuit (refer here), have taken it up. As noted in a recent commentary by the Katten Muchin law firm entitled "Reform Act Under Attack?" (here), the core operations theory "has made a comeback in 2008," which the authors contend is inconsistent with the PSLRA’s meaning and intent.

 

In any event, I have added the Impac dismissal to my list of subprime and credit crisis securities lawsuit resolutions, which can be accessed here.

 

The "Ultimate Solution" to Corporate Financial Misconduct?: In a March 10, 2009 press release (here), Fuwei Films, a China-based plastic films manufacturer whose shares trade on Nasdaq, reported that it had "become aware" of an "initial verdict" by the Jinan Intermediate People’s Court, in the city of Jinan, in the Shandong province. The verdict related to an action brought against three major shareholders of the company, for misappropriation of state-owned assets worth tens of millions of renminbi, during the reorganization of Shandong Neoluck Plastics. The three shareholders were identified as Mr. Jun Yin, Mr. Tongju Zhou, and Mr. Duo Wang.

 

According to the press release, the verdict found the three individuals guilty of the charges. The court "sentenced Mr. Yin to death, with a stay of execution of two years." The other two defendants received life imprisonment. The court will transfer to the Chinese government all of the personal property of the three defendants, including their holdings in two entities that owned approximately 65% of Fuwei’s common shares.

 

The press release stated that "none of these individuals is currently involved in Fuwei’s day-to-day operations."

 

Prospective investors will be happy to know that with this bit of unpleasantry put to rest, the company will now "be able to focus exclusively on executing Fuwei’s strategy to emerge from the current economic crisis." In light of the court-ordered ownership change, it is probably good that the company added that "we believe the Chinese government will support our long-term growth."

 

Special thanks to a loyal reader for the link to the Fuwei press release.

 

Options Backdating Update: The Securities Litigation Watch has updated (here) its helpful scorecard of the options backdating-related securities lawsuits. As reflected in the scorecard itself (here), of the 39 options backdating related securities lawsuits, 26 have now been resolved – nine have been dismissed and 17 have settled.

 

According to the Securities Litigation Watch, the average settlement for these cases is $83.1 million. However, if the largest settlement (United Health) is removed, the average is $32.37 million, which is roughly line with the overall average class action settlement level noted by Cornerstone in its recently released study of securities lawsuit settlements.

 

My own detailed running tally of the options backdating lawsuits settlements and dismissal motion grants and denials can be accessed here.

 

Last year, investors filed numerous lawsuits against the investment banks and broker dealers who sold the investors auction rate securities. However, in a recent lawsuit, the targeted company was not an auction rate securities seller; rather, it was an auction rate securities buyer, which is alleged to have misrepresented to its own shareholders its exposure to auction rate securities in which it had invested.

 

According to their March 11, 2009 press release (here), the plaintiffs’ attorneys have initiated a securities class action lawsuit in the Southern District of New York against Perrigo Company, a Michigan-based pharmaceutical manufacturer and distributor, and certain of its directors and officers. The complaint (which can be found here) alleges that Perrigo had invested in $18 million in auction rate securities and that until September 15, 2008, the company had a reasonable expectation of redeeming its auction rate securities.

 

However, the complaint alleges that on September 15, Lehman Brothers, which had underwritten and sold Perrigo’s auction rate securities, went bankrupt. The complaint alleges that

 

On November 6, 2008, the beginning of the Class Period, defendants reported the "fair value" of Perrigo’s ARS as $14,500,000, but concealed the impact of Lehman’s bankruptcy on Perrigo’s ARS. Then just three months later, on February 3, 2009, defendants disclosed, for the first time, that Lehman had underwritten and sold the ARS to Perrigo. They also announced that the Company was writing off the entire value of its ARS, wiping out over a third of Perrigo’s earnings in the quarter. As a result of this disclosure, the stock price plunged 18% that day, causing massive losses to investors.

 

Although the allegations brought against Perrigo as an auction rate securities investor may seem unusual, the Perrigo complaint is actually not the first to assert securities fraud in connection with a company’s disclosures concerning its investment in auction rate securities. Indeed, as noted here, shareholders raised allegations against NextWave Wireless in connection with that company’s auction rate securities investment.

 

Nor is Perrigo the first company to be exposed to securities litigation as a consequence of Lehman’s bankruptcy. As I noted in prior posts, Constellation Energy (about which refer here), Reserve Fund (here), JA Solar (here), and Farmer Mac (here) have all found themselves hit with securities lawsuits in part due to the impact on them from the Lehman Brothers bankruptcy.

 

All of these cases represent what I previously called (here) the new wave of subprime and credit crisis-related securities litigation, in which the thrust of the allegations is not that the target companies themselves are exposed to subprime-related risks, but rather that the companies were exposed to other companies or assets that were themselves exposed to the subprime or credit risk.

 

The fact that this lawsuit is filed against Perrigo, a pharmaceutical company, underscores a point I have previously noted about the new wave of subprime and credit crisis related litigation, which is the potential for this new wave to bring the credit crisis litigation wave, which up until now has been largely restricted to the financial sector, to companies throughout the larger economy.

 

In any event, despite the much ballyhooed auction rate securities settlements, lawsuits related to the frozen auction rate investments continue to flow in. Indeed, on March 10, 2009 Careerbuilder LLC filed an action (here) in Illinois (Cook County) Circuit Court against Bank of America, alleging that even though BofA has reached at least two prior regulatory settlements regarding the auction rate securities, Careerbuilder remains stuck with the $32 million in auction rate securities that BofA sold them.

 

Yet Another Form of Credit Drawn in the Litigation Wave: As I have previously noted (most recently here), the current litigation wave long ago ceased to be just about subprime debt and has expanded to encompass a wide variety of different kinds of lending. The most recent example of this spread to other kinds of lending is the lawsuit filed on March 11, 2008 against Corus Bankshares.

 

According to their press release (here), plaintiffs’ counsel filed the suit against Corus and certain of its Chief Executive Officer in the Northern District of Illinois. The complaint (which can be found here) alleges that the company’s disclosures were misleading because they failed to disclose

 

(i) that Corus was failing to recognize losses on its condominium loans in accordance with generally accepted accounting principles ("GAAP"); (ii) that Corus and/or its affiliates was purchasing condominiums in developments Corus had financed in an attempt to: (a) inflate the appraised values of condominiums to delay having to recognize losses on financing for such condominiums; (b) inflate developers’ sales figures to increase the likelihood of successful future sales; and (c) create the illusion of successful sales histories in order to inflate appraisal values for the condominiums to ensure inflated future prices for the condominiums; and (iii) that Corus was involved in detailed and in-depth negotiations with the Federal Reserve Bank of Chicago and the Office of the Comptroller of Currency regarding its deteriorating pool of condominium loans.

 

The complaint alleges that when on the company released its financial results on January 29, 2009 and disclosed that "Corus is suffering from the extraordinary effects of what may ultimately be the worst economic downturn since the Great Depression," the company’s shares fell nearly 47% to close at $.59 per share on February 2, 2009.

 

So add condominium loans to the kinds of lending that has become involved in the subprime and credit crisis related litigation. I have added the Perrigo and Corus lawsuits to my running tally of the subprime and credit crisis related securities class action lawsuits, which can be accessed here. A spreadsheet with the 2009 subprime and credit crisis-related securities class action lawsuits can be found here.

 

On March 11, 2009, Cornerstone Research released its report of 2008 securities lawsuit settlements entitled "Securities Class Action Settlements: 2008 Review and Analysis" (here). Cornerstone previously released its review of 2008 securities class action filings, which can be found here. Among other things, the newly released Cornerstone Report concludes that "the value of cases settled in 2008 was lower than the historically unprecedented high totals reported from 2005 through 2007." Cornerstone’s March 11, 2007 press release regarding the report can be found here.

 

Although the Cornerstone Report is more or less consistent with prior analyses of the 2008 settlements (for example, the previously released study by NERA Economic Consulting, which can be found here), it also differs in some specific details. The differences are in part explainable due to the methodology used to assign settlements to a particular year. In the Cornerstone Report, the designated settlement year corresponds to the year in which the hearing to approve the settlement was held, rather than the year in which the settlement was first announced.

 

The Report finds that the median value of 2008 settlements was $8 million, which is lower than 2007’s all-time high median of $9 million but is higher than the median of $7.4 million for all cases settled during the period 1996 through 2007. Median settlements as a percentage of estimated damages were generally higher for cases settled in 2008 compared to settlements during the period 2002-2008. Just over half of the 2008 settlements were for less than $10 million, although the number of "very small settlements" is declining, while the number of settlements in the $20-$25 million range is increasing.

 

The average settlement in 2008 "fell dramatically" from $62.7 million in 2007 to $31.2 million, which is partly due to the fact that there were no settlements approved in 2008 that exceeded $1 billion (by contrast to 2007, during which the massive Tyco settlement was announced). If the top four all-time settlements are excluded from the analysis, 2008’s average settlement of $31.2 million is "in line with" the average settlement during the period 1996 through 2007 of $34.6 million. (All settlement amounts are adjusted for inflation and are expressed in 2008 dollars.)

 

The Report found that the average time from filing to settlement has increased steadily. Whereas historically cases settled approximately three years after filing, during 2007 and 2008, the average time from filing to settlement increased to three and a half years.

 

The Report also identified a number of factors that appeared significant with respect to settlement values:

 

1. GAAP Violations: The Report found that GAAP violations, which were alleged in 70% of 2008 settled cases, "continued to be resolved with a larger settlement amount and a higher percentage of estimated damages relative to cases not involving accounting allegations."

 

2. Restatements: Allegations involving restatements were involved in 35% of 2008 settlements. However, cases with restatements "are no longer associated with a statistically significant increase in settlement amounts," consistent with PCAOB research concluding that restatement announcements "are viewed by the market as less significant events." However, cases in which an accountant was named as defendants continued to settle for the "highest percentage of estimated damages among cases with accounting allegations."

 

3. ’33 Act Claims: Controlling for the presence of underwriter defendants, the presence of Section 11 or Section 12(a)(2) claims is "not associated with a statistically significant increase in settlement amounts." The Report does note that suits with ’33 Act allegations reached "historically high levels" in 2007 and 2008, and that as these cases settle over the next few years, the importance of ’33 Act claims in determining settlement amounts "may increase."

 

4. Institutional Investor Plaintiffs: When institutional investors are lead plaintiffs, settlements are "significantly higher." However these higher settlements are "associated with public pension plans, as opposed to union funds or other types of institutional investors."

 

5. Accompanying Derivative Claims: The number of settlements of securities class actions that were accompanied by derivative actions decreased in 2008 compared to prior years. But with respect to the securities suits that were accompanied by derivative actions, the settlement amounts were "significantly higher." In general, cases with accompanying derivative actions tend to be larger (in terms of estimated damages) and also typically involve accounting allegations and public pension plaintiffs, and include accompanying SEC actions. Controlling for these other factors, the Report concludes that cases involving derivative actions "are associated with statistically significant higher settlement amounts."

 

6. SEC Actions: Cases with associated SEC actions are involve "significantly higher settlements" as well as higher settlements as a percentage of estimated damages.

 

7. Non-Cash Components: 9% of 2008 settlements involved non-cash components. Settlements involving non-cash components are statistically higher in value, even controlling for estimated damages and the nature of the allegations.

 

The Report concludes with several remarks about the recent wave of subprime and credit crisis related securities litigation. First the report notes that the three settlements of these cases so far include the $475 million Merrill Lynch class action settlement. The Report notes that the Merrill case reached settlement in 18 months, which is relatively quick compared to other cases. Otherwise, however, the Report notes that, with only three of these cases settled so far, "it is still too early to anticipated what impact, if any" settlements of the credit crisis cases will have on overall settlement trends.

 

(My running table of subprime and credit crisis related securities lawsuit settlements and dismissals can be accessed here. My commentary on the Merrill Lynch settlement can be found here.)

 

The Report concludes with an observation regarding the damages represented in the 2008 securities lawsuit filings. That is, the "disclosure dollar losses" (a defined term in the Report representing one measure of investor losses) associated with the 2008 filings "reached historic highs in 2008." Because disclosure dollar loss is a "significant predictor of settlement size," the size of settlements "may increase in the future."

 

The Report reflects a number of different findings of significant interest to D&O insurers. In particular, the Reports finding regarding the increase in settlements in the $20 to $25 million could have significant implications for excess insurers that are active in this space. Moreover, the Report’s detailed analysis of factors affecting settlement values could be important considerations in setting case reserves.

 

However, D&O insurers will also want to take a couple of additional considerations into account in assessing the implications of this report. First, the Cornerstone report reflects only settlement amounts. D&O insurers’ losses in connection with any given claim also include defense expense, which is not reflected in the Cornerstone study. Indeed, D&O insurers can incur significant amounts of defense expense even if a case is dismissed and there is no settlement.

 

In addition, the Cornerstone study reflects only class action settlements. It does not take into account any amounts that defendants or their insurers were obligated to pay as part of settlements to plaintiffs that opted out of the settlement class. As I have noted previously, opt outs are an increasingly important factor in the resolution of securities lawsuits. As a result, class action settlement data along may insufficiently express the overall dollar exposure of securities class action defendants and their insurers.

 

The Cornerstone contains extensive additional analysis and warrants reading at length and in full. Once again, the Report’s authors, Laura Symons and Ellen Ryan, have done an outstanding job analyzing the latest settlements and explaining their findings.

 

The current financial crisis involves a potent witches’ brew of bankruptcies, mortgage bailouts, failed banks, blame assignment, and liquidity issues. Because every one of these ingredients contributes in some important way to the total mix of current woe, this post briefly references each one of these issues and concludes with a video that manages to find humor despite the current dismal circumstances.

 

Bankruptcies Double: Though it is early yet, one of 2009’s stories of the year has to be the surge in corporate bankruptcies. According to recently published data (here), bankruptcies this year by publicly traded companies are running at more than twice their 2008 pace. Bankruptcies of companies with assets over $1 million are fueling the surge.

 

According to the data, there have been 46 bankruptcy filings (under Chapter 11 or Chapter 7) by public companies in 2009, with total combined assets of $74 million. As this point last year, there were only 21 bankruptcies totaling $11 billion.

 

Some context is required for these numbers, however. This year’s bankruptcy pace is still below that of 2002, a "record-breaking" year in which there were 60 bankruptcies by early March.

 

The financial market turmoil is producing numerous casualties. Indeed, Blackstone Chairman Stephen Schwarzman was quoted today (here) as saying that "between 40 and 45 percent of the world’s wealth has been destroyed in little less than a year and a half." Give the staggering scale of market losses, even optimists will recognize that further bankruptcies undoubtedly lie ahead.

 

My recent post discussing D&O insurance issues arising from bankruptcy can be found here.

 

A Successful Mortgage Bailout: As depressing as the current circumstances are, a sucessful bailout from an earlier era may provide reason to hope that it may be possible to manage our way out of the current mortgage crisis.

 

A March 6, 2009 post in the Harvard Business Review Editors’ Blog entitled "The Mortgage Bailout That Worked (here) describes a "remarkably similar catastrophe" that "happened during the real estate boom of the 1920s." In that earlier time, an investment frenzy developed over "guaranteed mortgage certificates" that were issues, in denominations as small as $100, for shares in residential mortgages and groups of mortgages. The certificates were issued by guaranty companies and backed by the state of New York.

 

Investor demand for the certificates soon outstripped the supply of mortgages, in turn fueling a demand for even more mortgages, whether or not the mortgages were compliant with regulatory requirements. The frenzy to supply investors with more certificates also encouraged the guaranty companies to assume borrowers’ loan fees and offer bonuses to brokers for mortgages. Ultimately, to protect their own investments, the guaranty companies swapped good mortgages out of customers’ certificates and transferred them to their own certificates. (Sound familiar?)

 

Eventually, the scheme collapsed and the state of New York stepped in and "amazingly, managed to clean up the bulk of the mess in just four years of hard, hard work." The state formed a Commission, which eventually had over 1,000 employees, to "take over the guaranty companies and sort out the certificates." What they did was to "preserve the value of the certificates by preserving the value of the underlying real-estate assets."

 

The process the Commission followed, which was designed to work out the mortgage or dispose of the property in some productive way, could be a useful model for today. The lesson for the current circumstances from the prior effort, according to the HBR post, seems to be to "hire a sufficiently large group of people to track down and preserve the value of the assets underlying all of our current toxic real-estate securities" in a similar manner. It certainly worked in the earlier era; the Commission "recouped 84% of the value of the certificates" and brought "order out of chaos."

 

Are Bank Failures a Necessary Recovery Prerequisite?: Some readers may have noted that this past Friday night, the FDIC took control of yet another bank, Freedom Bank of Georgia (as noted here). Prior to its closure, the bank, which was located in Commerce, Georgia, had assets of $173 million. This latest bank closure brings the year to date total of failed banks to 17, and the number of banks that have failed just since July 1, 2008 to 39. The FDIC’s complete list of banks that have failed since October 2000 can be found here.

 

While bank failures are one among the more disturbing parts of the current economic turmoil, they may also be a necessary part of the recovery as well. A March 7, 2009 Washington Post article entitled "Every Bank Failure is Also a Beginning" (here) states that the increase in bank closures is "a sign of the nation’s economic distress," but it is also a "first step toward revival." According to the article, "in wiping away problem loans and brining in new investors, the government is creating the necessary conditions for new lending."

 

The Post article explains the FDIC’s bank closure process, including its efforts to transfer the bank’s existing banking relationships to a healthier institution. The process is not without its pitfalls, but it is, according to the article, essential to ensuring that a community has banking resources available despite the closed bank’s failure.

 

The Post article focuses on the events surrounding the closure of the Community Bank of Loganville, Ga., which failed in November 2008 (refer here). Last Friday’s bank closure involved yet another bank from Georgia, the seventh bank in Georgia to fail since October 2007. Many of the failed banks were located in or around Alphretta, Georgia, which earlier this year the Wall Street Journal referred to (here) as "Bank-Failure Central."

 

Among other things, commentators cited in the Journal article ascribed the rash of bank failures in Georgia to "overabundant home building, years of risky lending and one of the most relaxed environments in the U.S. for starting new banks." The Journal article also states that the failures "reflect an unusually dense concentration of go-go optimism run amok."

 

Credit Agency Focus: When assigning blame for the current crisis, many commentators often cite the credit rating agencies. Indeed, Time Magazine’s list of the 25 people to blame for the current financial debacle included Kathleen Corbet, who ran S&P for most of the last decade. Whether or not the credit rating agencies are blameworthy is one question; whether they can be held liable for it is yet another, as this blog has previously noted (here).

 

A recent memorandum by the Jenner & Block firm entitled "Credit Rating Agencies in the Spotlight: A New Casualty of the Mortgage Meltdown" (here) admirably summarizes the legal issues that investor litigation against the credit rating agencies might present. One noteworthy observation in the memo is the possibility federal preemption of state regulatory action under the Credit Rating Agency Reform Act of 2006. In addition to discussing other defenses that may be available to the credit rating agencies, the article also helpfully cites a lists a number of cases currently pending against the firms.

 

A recent post in which I discussed the partial denial of the motion to dismiss in the securities lawsuit that Moody’s shareholders filed against the company, and the ruling’s possible implications for the rating agencies’ potential liability for their ratings activities, can be found here.

 

Liquidity Issues Affect Everything: A company’s inability to access cash when needed can raise a host of complications, including even with respect to pending securities class action lawsuit settlements. As reflected in its March 10, 2009 press release (here), due to liquidity constraints, Korean semiconductor company Pixelplus is unable to fund its agreed $1 million cash contribution to the settlement of the securities class action lawsuit that had been filed against the company.

 

According to the press release, the court has approved an addendum to the parties’ settlement stipulation with respect to the company’s agreed settlement contribution. The press release states that the company could not make its contribution "due to the economic turmoil in Asia arising from the global financial crisis and the world-wide recession, which continues to have a severe negative impact on the financial position and business operations of the company."

 

In lieu of the company’s contribution, its insurance carrier is paying about $331,000 (at current exchange rates). The company will make up the difference "if and when such funds become available."

 

There may be implications here for the growing wave of subprime and credit crisis-related litigation. A cause of action is not worth much if the target company can’t even fund an eventual settlement. There may be more than a few target companies that might eventually prove unable to fund their portion of any eventual settlements.

 

Citi of the Future: Citigroup’s shares were up today on relatively positive news. However, according to an article in today’s Wall Street Journal (here), "barely a week after the third rescue of Citigroup," U.S officials are weighing "what fresh steps they might need to take if its problems mount." The bank’s continuing problems have, among other things, fueled rampant speculation that the government eventually will be forced to nationalize Citigroup.

 

The prospect of a nationalized Citigroup might have been unimaginable even a short time ago, but now some at least some folks apparently have no trouble imaging what a government-owned Citibank might be like, as reflected in the following video. (Sensitive readers should be forewarned that this video makes rather promiscuous use of the F-bomb and may otherwise be offensive. On the other hand, it is also very funny.)

 

http://player.ordienetworks.com/flash/fodplayer.swf

Early in my career when I was doing legal work for London insurers, we communicated with our U.K. clients using telex, a technology that is to communications what smacking clothes on a rock is to cleaning fabric. It seemed a huge leap when we progressed to faxes, even though the pages rolled off of cylindrical drums, producing curling documents covered with indistinct, easily smudged characters.

 

In our current Internet age with emails and text messages, these obsolete technologies now seem quaint, perhaps (in retrospect only) charming in an old-fashioned way. But as relatively advantageous as the latest tools are, even newer communications and information-sharing tools continue to emerge. At a minimum, these new alternatives already offer important supplements to the existing standard media, and potentially even offer entirely new ways of communicating and exchanging information.

 

What is Web 2.0?

Most of us have become very comfortable using the Internet tools to retrieve information – for example, using a Google search to locate information or find useful sites. The newly emerging tools, sometimes referred to collectively as the Web 2.0, offer more than just the opportunity to retrieve information – they offer the ability to interact and communicate with the network in general, and with a customized, personal network in particular.

 

I review and comment on some of these new tools below. As a preliminary matter, I think it is important to draw a theoretical distinction between these other tools and email. When using email, you are limited to communicating with persons whose email addresses you already have in advance, which is fine if you only need or want to communicate with a specific, pre-identified group of persons. These new tools, all of which are essentially free, allow you to communicate more broadly, even to persons you may not know, or at least may not know how to locate. This feature of these tools allows you to reach new audiences and to develop new relationships, as well as to be able gather information a diverse variety of new sources.

 

The Web 2.0 Tools

Twitter: A cross between blogging and instant messaging, Twitter offers users a way to communicate broadly, using no more than 140 characters. I confess that at first, I just didn’t get Twitter. After signing up and staring at my Twitter home page while nothing happened, Twitter seemed pretty pointless.

 

However, at the suggestion of Kevin O’Keefe of LexBlog, I began using a Twitter application called TweetDeck. Tweet Deck allows you to monitor a series of columns of "tweets" across your desk top, with a column of constantly updated tweets from the sites you have signed up to follow on the left side of the screen. Additional columns are arranged from left to right across your page relating to additional search topics you are following (for example, "lawsuits" or "securities" or "Madoff"). After using TweetDeck, I now appreciate the Twitter’s potential.

 

With TweetDeck (or one of several similar applications, such as Twhirl or Twitterific), you can tap into the steady stream of Twitter dialog that is constantly rippling across the Internet.

 

Twitter simultaneously facilitates several different types of activities. First, it accelerates real time news and information gathering. Most of the major news organizations are on Twitter. For example, I am a Twitter subscriber to a huge number of news sources, such as The New York Times, the Washington Post, the Wall Street Journal, Business Week, the Financial Times, American Lawyer, NPR Money, Reuters, Yahoo News and dozens of other groups. A list of some of the many news organizations on Twitter can be found here. These news outlest are frequently tweeting on subjects that may or may not eventually make their way into published articles. Other tweets have links to articles that have just been posted on their web pages. In addition, many governmental organizations, such as the SEC, Congress and the White House, also are on Twitter. A list of federal government Twitter sites can be found here.

 

Second, there is an entire parallel universe of bloggers, commentators, observers and other Net-based hunter gatherers who are constantly twittering their insights and comments, many of which might not make their way into full-blown blog posts or articles. This commentariat also reliably "retweets" an incredible variety of articles, links and other tidbits. (The "retweets" are readily identifiable by the prefix "RT" preceding the name of the source site.) It takes time to build up a good list of Twitter sites and sources worth following, but one good starting point is the list of "Twitter Feeds for Securities Counsel" that Bruce Carton of the Securities Docket has developed (here).

 

Third, Twitter provides a medium for information exchange. Because a Twitter message is essentially broadcast to all of your followers and also available to the wider web through Twitter tools like TweetDeck, you can launch an announcement or post a question and reach an enormous network. For example, I recently spotted a tweet from a journalist looking for information about Canadian securities class actions. We did not know each other, yet his question reached me and I was able to reply to him via Twitter to point him toward a recent post on my blog about Canadian class actions. (Replies can be discerned by the "@" prefix preceding the name of a Twitter site).

 

Fourth, and perhaps most significantly, Twitter allows you to quickly search for and retrieve tweets on a particular topic, many of which contain links to news articles and other resources. A Twitter search produces a harvest of tweets on the search topic. For example, after the Stanford Financial Group scandal broke, I used the search function to quickly retrieve the tweets about Stanford, many of which had links to sites and sources I would not otherwise have found. I also opened a new TweetDeck category through which to monitor the ongoing Twitter traffic about the Stanford Group.

 

For insurance professionals, Twitter offers a potential new source of underwriting and claims information. For example, a D&O underwriter could search for tweets about a particular company by doing a search on the company’s name, and the underwriter could then monitor ongoing Twitter traffic relating to the company using a separate Tweet Deck column. For all insurance professionals, the ability to broadcast questions or information offers another way to obtain information. The news site tweets allow anyone to monitor a steady stream of headlines and other information on a real time basis. Twitter also offers a means of announcing company events or publications.

 

Finally, the ability to develop a group of "followers" and to communicate with them and others using the reply and "retweet" functions provides a way to network and expand professional contacts. The March 7, 2009 Wall Street Journal has an excellent article (here) about how to develop Twitter followers and how to use Twitter to expand your personal network. I have further comments below about using all of these Web 2.0 tools to develop contacts and to network.

 

The New York Times also had a recent article (here) on the advantages and opportunities of using Twitter. A recent Law.com  article describing the different ways professionals might use Twitter can be found here.

 

One final note about Twitter. The 140 character limit can be a challenge. Using Twitter can sometimes feel like writing haiku. One way to make the most of the limited number of characters is to reduce a lengthy web address link by translating it into a short web address using a site like TinyURL.com. TweetDeck also has a function to shorten lengthy web address. A list of other useful Twitter pointers can be found here. A useful list of Twitter related tools and applications can be found here.

 

LinkedIn: LinkedIn is a networking site for professionals that has over 30 million users. As a minimum it is a place to post your resume and contact information, which if nothing else makes it easier for others to find you.

 

But LinkedIn is all about building connections. By asking others to join your network of connections, you add their names to the group of connections listed on your LinkedIn page. Each new connection allows you the opportunity to browse your new connection’s own network list, as a way to find others to add to your network. I have found this process interesting and it has allowed me to build my network out in unexpected ways. For example some of my connections are industry colleagues, some are contacts in my immediate locality, some are people whom I have just gotten to know who want to build out their own networks.

 

In addition, there are numerous LinkedIn affinity groups, where persons with similar interests can identify each other and exchange news and information. There are, for example, a host of insurance-related groups. For example, the Professional Liability Underwriting Society (PLUS) has a LinkedIn group (here). So does RIMS (here). There are numerous other insurance groups, and innumerable groups related to other topics as well.

 

In many ways, LinkedIn it still realizing its full potential, at least for the insurance community. Many of the insurance-related groups, for example, are characterized by a relatively low level of activity. However, I think there is enormous potential in these groups – frankly, one of my motivations in writing this blog post it a desire to spark others’ interest in vitalizing these groups, particularly the PLUS group. I can easily imagine these group sites functioning as community bulletin boards where important information is regularly updated and read by people from throughout the community

 

But even if LinkedIn may not yet have fully realized its full potential overall, I have personally had several experiences where my LinkedIn presence enabled me to form new and valuable relationships. Among other things, I was recently retained by a private equity firm to consult with them on an information-related project. The private equity firm found me through my LinkedIn site. I have further comments on these kinds of network and contact building possibilities below.

 

Facebook: For a long time I was skeptical that Facebook offered anything of value to me. I considered it a place where college kids wasted time and posted career-limiting pictures of themselves doing embarrassing or incriminating things. However, a friend who was for many years a Wall Street media analyst and who now teaches at a local university convinced me that I needed to get on Facebook. Among other things, she told me that that over 20 million of Facebook’s 150 million users are over the age of 30, and that the over 30 crowd is by far Facebook’s fastest growing demographic.

 

Facebook provides another way to establish an Internet presence and to develop or expand a network of contacts. What I have found in a relatively brief foray is that Facebook facilitates a way to reconnect with a lifetime’s worth of acquaintances. The reconnection potential is not only personally rewarding, it is also valuable from a business networking perspective. For example, in recent days I have reconnected with a childhood friend who now, it turns out, is the CFO of a publicly traded company right here in my home state. Another college classmate I found through Facebook is general counsel of a financial services firm; I had not seen him in years, but now we are scheduled to have lunch in a few days.

 

Facebook also has an astonishing variety of groups and affinity sites. I have already signed onto my undergraduate college alumni site and even a group page for my college fraternity. Some of these groups are larger and more dynamic than the groups on LinkedIn, but the most active groups are more social than many of the LinkedIn groups.

 

In any event, as with Twitter and LinkedIn, Facebook offers a way to expand your network and develop your business contacts. Some might be concerned that getting active on Facebook might risk mixing social and business contacts in an undesirable way. However, Facebook allows you to create separate friends’ lists, with different privacy settings. That way you can control who sees which of your various Facebook posts.

 

Are These Tools "Worth It"?

No doubt about it, these tools all have the potential to become time sinkholes. Fooling around with any one of these sites, not to mention all of them at the same time, could easily become a time-consuming exercise in pushing electrons around the Web. Moreover, much of the activity, particularly on Twitter, is not worth the electrons consumed. Some people – perhaps many people – may conclude that these media are just not for them, and they might well be right.

 

These new tools definitely have their critics. Just this week, Time Magazine ran a story (here) critical of Twitter and the shallowness of many of the messages, and the New York Times ran a story (here) noting privacy concerns associated with Facebook. Certainly, these new communications tools, like any other tool, can be used a variety of ways, some of which that are not beneficent.

 

My own view is that these tools, used properly, all have valuable potential to provide a way for anyone to expand their network of business contacts and business opportunities. At the same time, the inner paranoid within me that is always present just below the surface is also afraid that if I do not understand and take advantage of these tools, I will be losing a critical step to my competitors, or at least to someone other than me, who will figure out a way to take advantage of these tools, as a result of which I risk falling behind.

 

My own experience as a blogger also convinces me that the opportunities these tools afford are real. Over the almost three years that I have been blogging, I have had the experience numerous times of meeting someone virtually through my blog, and then having that virtual contact turn into a real relationship, which in turn has led to real opportunities and real projects.

 

In addition, my blogging experience reinforces for me the potential to use these web-based tools to develop or enhance both a personal brand and a corporate brand. I am based in suburban Cleveland, yet Ithrough my blog I have developed an International audience and a professional profile, because I have been able to exploit the communications potential of the Web. (A more detailed view on my blogging experience can be found in a prior post, here).

 

The interesting thing to me about Twitter, LinkedIn and Facebook is that they each offer a similar potential to leverage the Web, but in ways that are not only distinct from blogging, but that are also unique to each separate tool. I have already found that the networks I have formed from each of these tools largely do not overlap. Facebook in particular has allowed me to expand my network in directions far different from the other tools.

 

Every insurance professional knows that we are in a relationship business. Business opportunities come from having contacts. These tools allow a new means to develop the contacts that can raise your profile, enhance your personal brand and expand your opportunities. Moreover, these resources are available from anyone’s desktop and for free.

 

I am very interested in readers’ thoughts and experiences about these tools. I encourage readers to use this blog’s comment feature to share their own experiences with Web 2.0, whether positive or negative.

 

I also welcome all readers to join me on LinkedIn by clicking on the LinkedIn button in the right hand margin. I hope readers will consider joining the PLUS group on LinkedIn. I also invite readers to follow me on Twitter, which they can do by clicking here or on the button in the right hand margin above.

 

Finally, readers who would like a more detailed, multi-media introduction to Web 2.0 should be sure to watch a replay of the February 17, 2009 Securities Docket webcast entitled "Web 2.0: Leveraging New Media to Maximize Your Securities and Compliance Practice," which can be found here. The webcast has additional useful information about the Web 2.0 media discussed above, and in addition has a detailed discussion of how to use RSS feed reader technology gather useful news articles and other information on subject you want to monitor.