As a result of recent legislative changes, Canadian securities litigation filings increased substantially in 2008, according to a January 26, 2009 Report by NERA Economic Consulting entitled "Trends in Canadian Securities Class Actions: 1997-2008" (here). A January 26, 2009 press release describing the report can be found here.

 

According to the Report, plaintiffs filed a record nine new securities class action lawsuits in Canada during 2008, which represented an 80% increase over the previous annual maximum and a 125% increase over the prior year.

 

This level of filing activity is still "miniscule" compare to the securities litigation filings in the U.S., even allowing for the fact that the Canadian securities markets are in the aggregate much smaller than those in the U.S.

 

However, in recent years, four Canadian provinces have introduced "continuous disclosure" regimes and have enacted civil liability provisions as well. These provisions include certain "gate keeping" mechanisms (including, for example the requirement that the plaintiffs seek leave of court to pursue a class action), but plaintiffs nevertheless seem interested in pursuing relief under these new statutory regimes.

 

For example there have now been a total of twelve new securities lawsuits filed in Ontario since the 2006 revisions to the relevant laws. (The Ontario Securities Act, as amended, can be found here.)

 

One of these Ontario cases involves IMAX Corporation, which is also the subject of a U.S. securities lawsuit. As I discussed in a prior post (here), the prospect for Canadian securities actions may have, as the NERA Report puts it, "received a boost" with a ruling in the IMAX case, which permitted the plaintiffs in that case to conduct a certain amount of discovery at the pre-approval state.

 

As NERA Report observes, "for parallel US-Canada actions, the IMAX ruling may enable plaintiffs to do an end-run around the discovery stay provisions of the PSLRA by brining an action north of the border."

 

The NERA report also observes that the recent filing in Ontario of a class action against AIG may be an example of this tactic. My prior post discussing the Ontario securities action against AIG and its possible tactical purposes can be found here.

 

The NERA Reports that among the Canadian filings are cases demonstrating the impact of several trends that have also driven U.S. securities litigation. That is, the 2008 cases include lawsuit filings related to the credit crisis (against CIBC and AIG), as well as cases based on allegations of options backdating.

 

Nearly one-quarter of the Canadian class actions involve companies in the financial sector, and nearly one fifth involve resources companies.

 

The Report states that there have been twenty securities class action settlements, but only one (the Southwestern Resources case, which settled for CAN$15.5 million) involved a case brought pursuant to new securities legislation. The Report shows that cross-border cases tend to result in larger settlements than Canadian-only cases.

 

Overall the Report notes that while the plaintiffs’ bar is "more active than ever" and filed a record number of new lawsuits in 2008, "it remains to be seen whether the gate-keeping aspects of the new amendments to the legislation, as interpreted by the courts, will meaningfully hinder the ability of plaintiffs to prosecute class actions in Canada."

 

In recent days, all eyes have been on two of the world’s largest banks. Commentators have questioned, for example, whether Citigroup should be nationalized (refer here) or if the Merrill Lynch-related losses might cost Bank of America CEO Kenneth Lewis his job (refer here). These institutions’ enormous size makes their problems predominant.

 

But while the woes of the financial titans are undeniably deeply troublesome, I have found myself increasingly concerned about the problems involving three much smaller banks: First Centennial Bank of Redlands, California; Bank of Clark County of Vancouver, Washington; and National Bank of Commerce of Berkley, Illinois.

 

My concerns about these banks are not about their business prospects – it is too late for that, as these three banks have already failed. Regulators closed First Centennial after the close of business this past Friday, January 23, 2009 (about which refer here), and Bank of Clark County and the National Bank of Commerce were closed the preceding Friday, on January 16, 2009 (refer here and here).

 

My concerns relating to these banks have to do with the facts and circumstances surrounding their closures, as well what the closures may portend.

 

1. The Number and Pace of Bank Failures: The closure of three banks on two successive Fridays in just the first few weeks of the New Year shows that the pace of bank failures, which accelerated as 2008 progressed, has continued unabated as we have headed into 2009. In 2008, there were a total of 25 bank closures (complete list here), of which 21 were in the second half of the year. With three closures already this year, signs suggest the heightened level of bank closures at year’s end has carried forward into 2009.

 

2. Community Banks are Not Immune After All: All three of these banks fall within a standard definition of "community banks" – that is, they had assets below $1 billion. National Bank of Commerce had assets of $430.9 million; Bank of Clark County had assets of $446.5 million; and First Centennial Bank had assets of $803.3 million. The community bank sector has largely been viewed as less affected by the worst of the current credit crisis. However, these three banks’ failures, and their geographic dispersion, suggest that the problems in the community bank sector could be more widespread than previously perceived.

 

3. Is the Worst Yet to Come?: These three bank failures are likely only the first of many yet to come in 2009. A January 23, 2009 Wall Street Journal article entitled "Banks Die Too Fast for Regulators" (here) reports that "federal regulators are bracing for more than 20 bank failures in the first quarter of this year," which were it to happen would mean nearly as many bank failures in the first quarter as during all of 2008 (which in turn was the most active year for bank failures since 1994).

 

Moreover, the Journal article specifically noted that the banks "are failing with accelerating speed, exposing holes in the regulatory infrastructure designed to catch collapsing institutions."

 

A vexing related issue is the apparent intervention of politicians on behalf of troubled banks. A January 24, 2009 Wall Street Journal article entitled "Politicians Asked Feds to Prop Up Failing Banks" (here) describes the efforts of two Illinois politicians on behalf of the National Bank of Commerce prior to its failure. As the article notes, politicians’ efforts "recall the savings and loan turmoil of the late 1980s, when members of Congress pressured the government to go easy on struggling thrift institutions." As one commentator cited in the article stated, these kinds of things "made the saving-and-loan debacle into a political scandal as well as a financial scandal."

 

4. Dead Banks Mean More Dead Bank Litigation: Both historically and more recently, failing banks have meant failed bank litigation. The Cornerstone Research Report on the 2008 securities litigation activity specifically observed that "five of the 25 banks that failed in 2008 were named in federal securities class actions filed in 2008," even though "only 11 of the 25 banks that failed were publicly traded."

 

Indeed, already in 2009, another one of the 25 banks that failed in 2008 has been sued in a securities class action lawsuit. As noted here, on January 5, 2009, plaintiffs initiated a securities lawsuit against PFF Bancorp and certain of its directors and officers, whose banking subsidiary was closed on November 21, 2008 (about which refer here). This 2009 lawsuit suggests the likelihood of even further "dead bank" litigation ahead, especially of the heightened level of bank closures persists.

 

5. Will Asset Woes Afflict More Banks – And Other Kinds of Companies?: There is a specific aspect of the National Bank of Commerce failure that I find particularly troublesome. As noted in much greater detail in a January 23, 2009 American Banker article entitled "Failure Over Securities Losses Sets Off Alarm" (here, registration required), the National Bank of Commerce failed not because of liquidity issues (the usual reason for bank failures) but "because it suffered such massive losses on its investments in Fannie Mae and Freddie Mac stock that it had negative capital levels." As the article notes, the bank’s failure "heightens concern about the fate of some other banking companies that had heavy securities losses."

 

The American Banker article also specifically notes that similar problems indirectly led to the failure of PFF Bancorp, the banking company noted above as having been sued in 2009. PFF apparently had agreed in June 2008 to sell itself to FBOP Corp. of Oak Park, Illinois, but after FBOP wrote down at the end of the third quarter $936 million of investment securities, the $17-billion asset bank found itself undercapitalized and regulators refused to approve the pending deal. Undoubtedly other banks face similar challenges in their investment portfolios.

 

Concerns about banks’ troubled asset portfolios were the original basis for TARP, but the American Banker article noted that TARP money wouldn’t have been sufficient to save the National Bank of Commerce, as "the bank would have been eligible for a maximum of $12 million but needed at least $26 million to become well-capitalized again."

 

Financial institutions’ exposures to troubled assets could be widespread and could become significantly worse as the credit crisis continues to spread. In particular, the number of assets that are troubled continues to grow. They included not only all of the toxic mortgage-backed assets, but also securities and other assets related to Fannie Mae and Freddie Mac, and also assets related to a growing list of other institutions, including Lehman Brothers, Washington Mutual, American International Group, and the Icelandic banks.

 

More recent financial turmoil has made this list even longer. For example, just in the past few days, Aflac’s share price fluctuated sharply and the company’s financial strength rating was downgraded because to the company’s exposure to debt securities issued by the Royal Bank of Scotland, Barclays and other troubled European banks.

 

The Aflac example shows that the asset issues that capsized the National Bank of Commerce stretch far beyond the banking sector. Indeed, a January 24, 2009 Washington Post article entitled "Life Insurers Take a Hit" (here) cites Aflac and states, among other things, that "financial markets downward spiral has drawn the nation’s life insurers into its vortex, reducing the already depressed value of its stock by a third since early this month." The article specifically notes concerns that life insurance companies’ balance sheets and financial statements might not "fully reflect the reduced value of the investments they hold."

 

Nor are these concerns limited just to the banking and life insurance sectors. The Wall Street Journal’s January 24, 2009 Heard on the Street column (here) notes balance sheet concerns involving reinsurer Swiss Re.

 

The various companies’ balance sheet vulnerabilities arising from their exposure to the securities of other failed or failing financial institutions is precisely the circumstance to which I was referring when I asserted (here) that the credit crisis and its related litigation wave had reached an "inflection point" – that is, companies are getting punished in the financial marketplace (and also getting sued) not necessarily because of their own direct credit crisis-related problems but rather because of their exposure through their investment portfolios to other companies’ credit crisis woes.

 

Whether or not a revitalized TARP program would be sufficient to remediate these problems for troubled banks is a question our political leaders must decide. But in the interim, the widespread balance sheet exposure to trouble assets will continue to burden a wide variety of companies, including but not limited to banks.

 

Moreover as the list of companies whose related assets are toxic continues to grow (now including Royal Bank of Scotland with others yet to come), the number of companies struggling with toxic balance sheet assets will also grow. One inevitable consequence undoubtedly will be further litigation, both in the banking sector and elsewhere as well.

 

A Case of Earlier Indigestion: Concerns surround the most recent financial institution mergers, such as the Bank of America’s acquisitions of Merrill Lynch and Countrywide; Wells Fargo’s acquisition of Wachovia; and PNC Banking Corporation’s merger with National City Corporation.

 

But a recently filed lawsuit is concerned not with these recent deals, but rather a transaction froman earlier era – Wachovia’s ill-fated $25 billion acquisition of Golden West, which at the time was the nation’s second largest savings and loan.

 

The new lawsuit was filed in California (Alameda County) Superior Court on January 21, 2009. The complaint, which can be found here, alleges that as a result of the Golden West acquisition, Wachovia acquired a $120 billion portfolio of Option ARM (or "Pick-A-Pay" loans as they were called) which the complaint alleges were not properly underwritten, inadequately capitalized, and became delinquent at very high rates. Within two years of the Golden West transaction, the complaint alleges, Wachovia "ultimately collapsed under the delinquencies and defaults on the Pick-A-Pay loans."

 

The complaint alleges that Wachovia, certain of its directors and officers, and its offering underwriters failed to disclose these risks to investors who purchased Wachovia’s shares in various securities offerings between 2006 and 2008. The compliant alleges that when the concerns were "ultimately revealed" the company was "forced into a fire sale by the FDIC that finally revealed to investors what had been misrepresented for months, if not years, as a result of its toxic subprime assets, Wachovia was a shell of a corporation that could not exist independently."

 

The plaintiffs’ lawyers have chosen to file their lawsuit in state court in express reliance on the concurrent jurisdiction provisions of Section 22 of the ’33 Act. I have previously discussed the plaintiffs’ lawyers’ possible forum selection (shopping?) motivations for filing federal securities lawsuits in federal court, here. As I also discussed in a recent post (here), the federal courts are split on whether SLUSA or CAFA preempted the concurrent jurisdiction provisions in the ’33 Act, although the law is most favorable to a finding of state court jurisdiction in the Ninth Circuit.

 

In any event, I have added the new securities suit to my list of subprime and credit crisis-related cases, which can be accessed here. With the addition of this case, there have now been a total of 147 subprime and credit crisis-related securities cases filed during the period 2007 through 2009, of which seven have been filed already in 2009. A spreadsheet of the 2009 cases can be accessed here.

 

A Word to the Wise: Those of you who may be planning on attending the 2009 PLUS D&O Symposium, to be held February 25 and 26 at the Marriott Marquis in New York, will want to know that the early registration discount is about to expire. The registration fee for those registering prior to January 30, 2009 is $845 for PLUS members and $1,045 for nonmembers. For after January 30, the fee will rise to $975 for members, and $1,175 for nonmembers. Registration and agenda information can be found here.

 

This year’s conference promises to be particularly interesting and informative. I am co-Chairing this year’s Symposium with my good friends, Chris Duca of Navigators Pro and Tony Galban of Chubb. The key note speakers include former Secretary of States Madeline Albright and New York Insurance Superintendent Eric Dinallo. Other panelists and speakers include a number of noteworthy individuals, including Stanford Law Professor Joseph Grundfest, Wilson Sonsini partner Boris Feldman and many others.

 

The Symposium will also feature a reprise of the excellent video, first shown at the PLUS International Conference in November, of "The Life and Times of Bill Lerach." The Securities Docket recently featured a trailer of the video, here.

 

And Finally: On January 28, 2009, the Securities Docket will be sponsoring the latest in its series of free webinars on securities related topics. The upcoming webinar is entitled "FCPA Enforcement: The Paradigm Shift" and will feature F. Joseph Warin of the Gibson Dunn law firm. Further information can be found here.

 

As has been well-publicized, within a matter of weeks of closing its acquisition of Merrill Lynch, Bank of America announced previously undisclosed 4Q08 operating losses at Merrill of $21.5 billion that required BofA to obtain an emergency $20 billion cash injection from the U.S. Treasury, as well as an additional $118 billion asset backstop. BofA’s stock market valuation has dropped more $100 billion since the day before the merger was announced through the company’s January 16 earnings release.

 

As the Wall Street Journal reported (here), questions immediately arose following BofA’s announcement of the Merrill losses, such as why BofA’s CEO Kenneth Lewis "didn’t discover the problems prior to the Sept. 15 deal announcement" and "why he didn’t disclose the losses prior to the vote on the Merrill deal on Dec. 5 or before closing the deal on Jan. 1."

 

With these kinds of questions circulating, it comes as no surprise that plaintiffs’ attorneys have initiated litigation. There were actually two different lawsuits announced on January 21, 2009 relating to these circumstances. Both of the lawsuits purport to be filed on behalf of persons who held BofA securities on October 10, 2008, the record date for the December 5, 2008 special meeting of shareholders to approve the merger.

 

The first of these two lawsuits was filed in the Southern District of New York, as described in the plaintiffs’ lawyers’ January 21 press release (here). The second was filed in the Northern District of Georgia, as described a separate January 21 press release (here). The complaint in the N.D.Ga. action can be found here.

 

Both complaints name as defendants Bank of America and certain of its directors and officers. The S.D.N.Y. action also names Merrill’s CEO John Thain as a defendant as well. Both lawsuits allege that the defendants made materially false and misleading statements in the proxy materials in order to secure sufficient proxies to approve the merger. The defendants are alleged to have known that excessive losses at Merrill should have been disclosed to allow shareholders a well-informed vote on the merger.

 

Of all the interesting issues surrounding these circumstances, the most significant is the question of when BofA became aware of the magnitude of Merrill’s losses. (A related question is when Merrill became aware of the losses, but don’t expect any Merrill shareholders to raise the concern, as the completion of the merger was clearly in their best interest.)

 

The Journal article linked above reports that BofA now asserts that it learned of the magnitude of Merrill’s losses after the Dec. 5 shareholder vote, and that by Dec. 17, Lewis was so alarmed by the losses, which he reportedly characterized as "monstrous," that he traveled to Washington for an emergency meeting with Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson.

 

What happened at this Dec. 17 meeting presents its own interesting set of issues. Paulson and Bernanke apparently told Lewis that, according to the Journal, "failing to complete the Merrill acquisition would be disastrous" and would "further destabilize markets" and "hurt the bank" and potentially set off a "ripple effect that would exacerbate a fragile situation." The government officials also promised Lewis the backstop protection if the losses proved to be as significant as Lewis feared.

 

The meeting raises a host of questions, as discussed in the January 20, 2009 Wall Street Journal article entitled "BofA’s Merrill Deal Exposes Myth of Transparency" (here). The article suggests that "by most any reasonable measure, if the Merrill losses were concrete enough to seek a government lifeline, they were concrete enough to report to the company’s shareholders." The question is whether Lewis kept mum about the losses and the promised lifeline at Bernanke and Paulson’s request; the article asks whether perhaps the government was "complicit in nondisclosure."

 

While there may have been a marketplace interest in keeping the deal on track, there is no existing law that would relieve the company of its disclosure duties for the benefit of larger marketplace interests. The January 20 Journal article raises the question whether "a new legal standard could eventually emerge, sort of a ‘national interest’ doctrine absolving companies of governance actions that may be potentially harmful, but are important to an economic or defense emergency."

 

These are interesting questions. However, it should be noted that they arguably are irrelevant to the recently filed lawsuits, as the December 17 meeting took place well after the December 5 shareholder vote. There is of course always the possibility of a separate lawsuit on behalf of persons who acquired BofA shares, for example, between the December 17 meeting and before the company’s recent announcement of the Merrill-related losses. UPDATE: In the day immediately after I added this post, additional lawsuits came flooding in, including at least one (here) that is filed against, among others, a subclass of claimants who purchased Bank of America securities between January 2, 2009 and January 16, 2009.

 

Regardless whether or not other lawsuits in fact emerge, two questions will be paramount: when did the magnitude of the Merrill losses become apparent, and when did BofA have a duty to disclose this information to its shareholders?

 

Whatever else might be said about these circumstances, the certainly do underscore the magnitude of the problems confronting the economic and banking systems, as well as the challenges facing the incoming administration as it struggles to address these problems while taking up the reins of government.

 

These circumstances also raise serious questions about whether or not there are or should be exceptions to the transparency principles on which our entire system of securities and market regulation is based. It doesn’t require much imagination to picture the bedlam that could have ensued if the Merrill deal had fallen apart just before Christmas. The system can ill afford any more of the kind of chaos that enveloped the markets in September and October last year.

 

On the other hand, BofA’s shareholders might well feel that any analysis concluding that information was properly withheld from them for the sake of the overall market improperly negates their rights and expectations as shareholders.

 

It may or may not get addressed in a court in connection with the litigation involving the Merrill deal, but the question whether or not there is "national interest" exception to the standard disclosure principles is surely a very interesting question.

 

Professor Larry Ribstein discusses the question whether there is a national interest exception to the securities laws in his Ideoblog, here.

 

I have in any event added the Bank of America/Merrill Lynch litigation to my running tally of the subprime and credit crisis-related securities lawsuits, which can be accessed here. With the addition of this new litigation, the current tally of these cases now stands at 146, of which five have been filed in 2009.

 

More Madoff Litigation: The Madoff-related litigation wave has also continued to roll on. For example, on January 21, 2009, plaintiffs’ lawyers announced (here) that they had initiated a class action lawsuit in the Southern District of New York on behalf of persons who purchased between 2003 and the present variable universal life insurance issued by Tremont International Insurance Limited or Argus International Bermuda Limited.

 

The complaint (which can be found here) alleges that the insurer, an entity owned by Tremont Capital Management had breached its duties by offering Tremont-related funds as investment options for the variable investment account component of the policies. The complaint further alleges that the Tremont-related funds were heavily invested in Madoff funds.

 

The complaint alleges that the defendants violated a number of legal duties. The complaint does not, however, assert a violation of the federal securities laws. As a result I have included in the list of "other" litigation in my table of the Madoff-related litigation, which can be accessed here.

 

This latest lawsuit not only demonstrates that the Madoff litigation continues to roll in. It also shows what an incredible diversity of individuals and investors were harmed by losses from Madoff’s fraudulent scheme. It also shows how incredibly complicated it all is going to be to unwind this whole mess.

 

And Finally: Readers who registered the question posed on my preceding blog post whether President Obama had completed the oath of office as required by the Constitution will be relieved to know that the issue has been resolved.

 

On the apparent theory that there is nothing in the Constitution against do overs, Obama and Chief Justice reprised their roles in another rendition of the oath of office in a considerably less formal ceremony at the White House on the evening of January 21, 2009, as reported here.

 

That certainly is a load off my mind.

 

The question of coverage for fees and costs incurred in connection with responding to subpoenas is a perennial D&O insurance issue. Policyholders are sometimes surprised and disappointed when their D&O insurer takes the position that their policies do not cover these amounts.

 

Whether or not there is coverage for fees incurred in connection with a subpoena often critically depends both on the specific facts and circumstances surrounding the subpoena and the specific language of the applicable policy. The critical issue under the policy is whether or not the subpoena comes with the applicable policy’s definition of the term "Claim."

 

A January 21, 2009 memorandum from the Lowenstein Sandler law firm entitled "Does a Subpoena Constitute a ‘Claim’ for Purposes of D&O Insurance Coverage" (here) takes a detailed look at several recent case decisions exploring these issues. As the memorandum notes, the cases show that these issues "are fact intensive as to both the wording of the definition of ‘claim’ and the particular facts surrounding the subpoena."

 

The cases discussed in the memo show a number of things in connection with the question whether a subpoena is a "Claim."

 

First, the wordings of the policy definition of the term "Claim" vary substantially between policies and the precise wording used can be determinative.

 

Second, in addition to the wording of the policy, the nature of the subpoena involved also is critically important. A court may well have a different perception of, say, a grand jury subpoena, compared to an administrative subpoena, for example.

 

Third, courts apparently have been willing to consider outside factual matter (for example, the affidavit testimony of one of the attorneys involved regarding the nature of the investigation surrounding the subpoena), which can be highly relevant to a fact intensive inquiry.

 

Fourth, in addition to the definition of the term "claim," the presence of allegations of a "Wrongful Act" can also be an important determinant in the inquiry whether the fees and costs incurred in connection with a subpoena are covered. The typical D&O policy provides coverage for loss arising from a "Claim" based on an "actual or alleged Wrongful Act." As the memo shows, whether or not a subpoena represents a "Claim," there may still be a question whether an actual or alleged Wrongful Act is involved.

 

The question of what constitutes a "Claim" may be one of the most frequently recurring coverage issues under a D&O policy, and the actual wording used is critical. As the memo notes, "often seemingly minor differences can be coverage-determinative."

 

In that regard, in summarizing the lessons from the cases, the memo notes several truths about the D&O insurance coverage placement process with which I heartily concur:

 

it is essential that the insurance broker or consultant be expert in D&O policies and negotiate with the insurer for the best possible definition of claim. All D&O insurance policies are not created equal. More expensive D&O policies frequently provide better coverage than less expensive ones. Optimally, the insurance broker or consultant should not simply present the insured with a policy, but a consideration of different policies, so that the insured can perform a cost/benefit analysis.

 

The memo concludes with an observation of the need to provide timely notice.

 

And If SEC Subpoenas Are Involved: In many instances, the subpoena that is the source of the coverage dispute has been issued by the SEC. Readers who find themselves dealing with the issue of whether or not there is coverage under a D&O policy for fees and costs incurred in connection with an SEC subpoena may find it helpful to refer to the SEC’s Enforcement Manual, which can be found here.

 

The Manual, which was only recently made public, describes the SEC’s enforcement practices and policies in detail, and may prove useful in trying to understand what various SEC actions and processes may represent.

 

A Related Issue: An issue that also frequently occurs in conjunction with the question of coverage for fees and costs incurred in responding to a subpoena is the question of coverage for fees and costs incurred in connection with a criminal investigation. In a recent post (here), I reviewed the issues surrounding the question of coverage under a D&O policy for expenses incurred in connection with a criminal investigation.

 

Eleventh Circuit Affirms Options Backdating Lawsuit Dismissal: Although they may seem but a distant memory, the options backdating cases continue to grind through the courts. In a January 9, 2009 opinion (here), the Eleventh Circuit affirmed the lower court’s dismissal of the securities class action lawsuit filed in connection with the options backdating allegations involving Witness Systems. Background regarding the case can be found here.

 

The lower court had dismissed the case in reliance on the Supreme Court’s decision in the Tellabs case, holding that the complaint did not satisfy the PSLRA’s requirements for pleading scienter. The trial court dismissed the case without allowing the plaintiffs leave to amend, though the plaintiffs had requested leave in a footnote to an opposition brief.

 

A copy of the district court’s opinion can be found here. My prior blog post discussing the dismissal can be found here.

 

The Eleventh Circuit, after noting that as a result of the options backdating the company had "minimally overstated earning" between 2004 and 2006, affirmed the dismissal.

 

Among other things, the Eleventh Circuit noted that the complaint contained no allegation that the company’s CEO "had any knowledge of the accounting principles relating to stock options," and observed that the inference that the CEO "knew that backdated options in 2000 and 2001 had led to overstated earnings during the class period in 2004 to 2006 is not as compelling as the competing inference that he was unaware that backdated options had affected financial statements several years later."

 

The court specifically noted that the "de minimus change" in the financial statements was not a "glaring ‘red flag’" that the company was overstating earning.

 

The Eleventh Circuit also affirmed the district court’s denial of leave to amend, because the plaintiffs’ request for leave to amend was "imbedded within an opposition memorandum."

 

I have updated my table of options backdating securities lawsuit settlements, dismissals and dismissal motion denials in order to reflect the Eleventh Circuit’s decision. The table can be accessed here

 

A January 15, 2009 memorandum from the Carlton Fields law firm discussing the Eleventh Circuit’s decision can be found here. Special thanks to Dave Leonard of the Carlton Fields firm for sending along a link to the memo.

 

You Decide: Article II, Section 1 of the U.S. Constitution specifies with respect to an incoming President of the United States as follows: "Before he enter on the execution of his office, he shall take the following oath or affirmation:–‘I do solemnly swear (or affirm) that I will faithfully execute the office of President of the United States, and will to the best of my ability, preserve, protect and defend the Constitution of the United States.’"

 

Which raises and interesting question: Did Obama actually complete the oath as required by the Constitution? Roll the tape and decide for yourself. (Hat tip to the WSJ.com Law Blog for the link to the YouTube video.) Ask yourself as you watch whether or not it is relevant that Obama, while serving in the Senate, was one of 22 Democratic senators to vote against Roberts’ confirmation. This was, by the way, the first time that a Chief Justice has sworn in a President that voted against him.

 

https://youtube.com/watch?v=3q89grM9cPE%26hl%3Den%26fs%3D1

They aren’t the first subprime lawsuit settlements, but the two massive settlements Merrill Lynch announced this past Friday are unquestionably the largest subprime subprime securities lawsuit settlements so far, and they certainly suggest the enormous stakes that may be involved in the mass of subprime and credit crisis-related litigation cases that remain pending.

 

In a January 16, 2009 filing on form 8-K (here), Merrill Lynch announced that the Lead Plaintiff, the Ohio State Teachers’ Retirement System, had accepted Merrill Lynch agreement to pay $475 million cash in settlement of the consolidated securities class action settlement pending against the company and certain of its directors and officers. As reflected more fully here, the consolidated case involved the claims of a variety of claimants, the basic allegations in the litigation were that the defendants

 

knew or recklessly disregarded that (i) the Company was more exposed to CDOs containing subprime debt than it disclosed; and (ii) the Company’s Class Period statements were materially false due to their failure to inform the market of the ticking time bomb in the Company’s CDO portfolio due to the deteriorating subprime mortgage market, which caused Merrill’s portfolio to be impaired.

 

My initial post about the filing of the Merrill Lynch subprime-related securities class action lawsuit can be found here.

 

In addition to the consolidated securities settlement, Merrill Lynch also announced on January 16 that it had entered into a proposed settlement of the class action brought on behalf of Merrill Lynch employees who invested in or held Merrill Lynch stock in their retirement plans. Merrill Lynch will pay $75 million in cash under the terms of this settlement.

 

Both consolidated cases focused primarily on Merrill Lynch’s subprime-related losses and related disclosures during the class period, and both settlements are subject to court approval.

 

The $475 million securities class action settlement ranks among the largest ever; according to a review of RiskMetrics data, it appears to be in the top 20 securities class action settlements of all time. The $75 milion settlement of the employees’ claims is also one of the largest ERISA class action settlements ever; based on my informal survey, it may be among the top five largest of all time.

 

But the significance of the Merrill Lynch settlements may not be what they represent in and of themselves, but rather what their size may suggest for the remaining mass of subprime and credit crisis-related litigation.

 

To be sure, many of these cases may not be anywhere near the magnitude of the Merrill Lynch case, and many of the cases will be winnowed out through motions to dismiss. Yet among the over 140 subprime and credit crisis related securities lawsuits are many others that also involve huge shareholder losses, and many cases will survive the winnowing process of the motions to dismiss. If it is any indication of what may be yet to come, the Merrill Lynch settlements suggest the aggregate settlements of these cases could represent a staggering sum.

 

There are a couple of interesting things about the Merrill Lynch settlements. The first is that they came before any ruling on the many pending motions to dismiss in the consolidated cases. While the timing of the settlements, prior even to a ruling on the motions to dismiss, might be due to any number of factors, one likely possibility is that Merrill’s new owner, Bank of America, moved quickly to put the litigation in the past.

 

The other interesting thing about these settlements is that the 8-K does not mention the involvement of insurance money. That of course does not mean for sure that there will be no insurance contribution toward the settlements, but it does seem at least to make that suggestion. As I have noted elsewhere (here, for example), due to the insurance structures that many large banks have employed in recent years (some of which include only Side A insurance, which would not be triggered in many of these cases), insurance may not be a factor in many of the subprime and credit crisis-related cases involving the larger banks, which is a consideration that may mitigate the overall losses to the insurance industry from these lawsuits.

 

A January 16, 2008 Bloomberg article describing the Merrill Lynch settlement can be found here. Hat tip to the Securities Docket (here) for first highlighting the settlements.

 

In any event, I have added the Merrill Lynch settlement to my table of subprime and credit crisis related securities lawsuit settlements, dismissals, and dismissal denials, which can be found here.

 

And Finally: The January 18, 2009 Washington Post has an article entitled "Livid Investors Launch a Volley of Lawsuits" (here) that describes how investors angered by their investment losses are turning to the courts to seek recompense. (Full disclosure: I was interviewed in connection with the article.)

 

In order to assign responsibility in connection with the enforcement of public welfare objectives, courts have developed the "responsible corporate officer doctrine," which in recent years has been applied with increasing frequency in environmental enforcement. A California appellate court recently applied the doctrine to enforce civil liability on the officers of a family run business. The case, and indeed the doctrine itself, raise important concerns about the potential liability of directors and officers.

 

Background

John and Ned Roscoe were officers, directors and shareholders of a family company that had a underground storage tank. The tank leaked 3,000 gallons of gasoline. A company employee notified the county and hired a consultant to clean up the leak. However, as the appellate court later put it, cleanup "did not proceed timely and adequately," and though regulators sent multiple notices to the company, no one from the company "attempted to make sure the problems were addressed."

 

The county filed a civil lawsuit against the Roscoes and their family company for failure to remediate and to file certain reports as required by law. Following a bench trial, the court found the Roscoes and their company jointly and severally liable for $2.4 million in "civil penalties."

 

The trial court specifically found that the Roscoes had "overall authority" for the company, could have remediated the problems, but did not "exercise their responsibilities and power to use all objectively possible means" to remedy the problem. The Roscoes appealed.

 

The Appellate Ruling

In a December 26, 2008 opinion (here), the California Court of Appeal for the Third Appellate District applied the "responsible corporate officer doctrine" and affirmed the trial court.

 

As the appellate court noted, the responsible corporate officer doctrine was developed by the U.S. Supreme Court in the 1943 case of United States v. Dotterweich, to hold corporate officers in responsible positions of authority personally (and in that case, criminally) liable for violating strict liability statutes protecting the public welfare.

 

Though the Dotterweich case involved a criminal proceeding, the California court in Roscoe applied the doctrine to uphold the imposition of civil liability. The Roscoe court described the doctrine as "a common law theory of liability separate from piercing the corporate veil or imposing personal liability of direct participation in tortious conduct."

 

The appellate court in the Roscoe case held that the trial court properly applied the doctrine to the Roscoes because they had "overall authority," they "could have prevented or remedied promptly the problem," and because they did not "exercise their responsibilities and power to use all objectively possible means" to remedy the problem.

 

Discussion

Typically, the corporate veil doctrine would shield corporate officers or shareholders from direct personal liability for legal violations of the corporation, consistent with long-developed notions of the distinct and separate legal identity involved with the corporate form.

 

But the "responsible corporate officer doctrine" expands the power of government to impose liability on individuals, seemingly in disregard of the corporate form, and apparently without requirement of participation in the wrongful conduct or even the requirement of a culpable state of mind, in the name of protecting public health and welfare.

 

I understand from reviewing a variety of articles online (refer for example here) that there arguably may be nothing new about the California court’s invocation of the responsible corporate officer doctrine. It apparently has been applied in any number of states (refer for example here) and seems to be most frequently used in connection with environmental enforcement actions.

 

Indeed, the doctrine is embodied in the statutory wording of several fundamental federal environmental statues and has now found its way into the environmental statutes of many states that modeled the statutory scheme on the federal laws. I understand from conversations with an environmental attorney (I happen to be married to one) that this is a recognized and well-established doctrine in environmental law.

 

That the doctrine may have a lengthy pedigree behind it does not make it any less troubling to me. The idea that liability could be imposed on an individual for corporate misconduct, in apparent disregard of the corporate form and without even a requirement for a culpable state of mind, seems inconsistent with my (perhaps not fully informed) assumptions about the way the law ought to work.

 

To my mind, this doctrine seems to impose liability for nothing more than a person’s status. The word "responsible" in the responsible corporate officer doctrine’s name does not mean that the individual was responsible for the misconduct, but only that the individual was responsible for the corporation.

 

The California court did specify prerequisites that could circumscribe the doctrine’s application; that is, the court indicated that "there must be a nexus between the individual’s position and the violation in question such that the individual could have influenced the corporate actions" and that "the individual’s actions or inactions facilitated the violations." But while these requirements could constrain the doctrine’s application, they also seem to relate more to an individual’s position or status, rather than the individual’s actual state of mind or even direct culpability.

 

It appears that other courts have considered knowledge of the violation a prerequisite to the imposition of liability based on the responsible corporate officer doctrine, which to me seems like a minimal requirement for the doctrine’s application to be consistent with traditional notions of justice and fair play.

 

In any event, the typical directors and officers liability insurance policy would not likely respond to provide indemnification for these kinds of awards, for at least two reasons. The first is that most policies contain a broad form pollution exclusion. The second is that most policies will not cover fines and penalties.

 

While the typical D&O policy would not cover these kinds of penalties, I can imagine an argument that there should be insurance for these kinds of exposures. The fines are imposed on individuals essentially because they occupied a corporate office – that is, by reason of their status, seemingly without regard to actual fault. (It may well be that there are separate environmental liability insurance policies available in the marketplace that are designed to respond to these very exposures, an issue on which I invite readers’ comments and observations.)

 

A public policy advocate might well argue that individuals should have to pay these amounts out of their own resources, in order that the liability threat will deter future violations and motivate compliance. These kinds of arguments seem most compelling to someone who is secure in the knowledge that they will never have to worry about having liability imposed on them for conduct of which they might have been completely unaware.

 

A January 14, 2009 memorandum from Foley & Lardner law firm discussing the Roscoe case can be found here.

 

Special thanks to Damien Brew for providing a copy of the Roscoe opinion. I hasten to add that the views expressed in this post are exclusively my own.

 

Climate Change Disclosure: In prior posts, I have noted a variety of developments that are increasing pressure on publicly traded companies to increase their disclosure on climate change related issues. For example, I noted here the Petition for Interpretive Guidance on Climate Risk Disclosure filed with the SEC on September 18, 2007 by the Coalition for Environmentally Responsible Economies (CERES) and others. In another post (here), I discussed the settlements that Xcel Energy and others reached with the New York Attorney General regarding climate change risk disclosure.

 

These developments raise the question whether these and other circumstances have changed public companies’ disclosure practices regarding climate change issues. In a January 15, 2009 memorandum (here), the McGuire Woods law firm reports the results of its survey of the of the 2008 10-K filings of approximately 350 companies in order to determine the state of SEC disclosure practices regarding climate change.

 

What the law firm found was that "very few companies made any type of 10-K disclosure regarding [greenhouse gas, or GHG] emissions or climate change." Only 42 of 350 companies reviewed, about 12.2% made any disclosure whatsoever regarding GHG emissions or climate change. Unsurprisingly, the largest concentration of companies making some disclosure on these issues was among utility companies, particularly large utilities. Of the 26 non-utility companies making some disclosures, the next largest concentrations were in the energy and industrial sectors.

 

The memorandum observes that "very few companies outside the energy and utilities industries made any type of GHG emissions or climate change-related disclosures" in 2008. The memo goes on to predict, however, that "this state of affairs is likely to change in 2009," as a result of the change in administration and the changing political climate, as well as changing regulator and investor expectations.

 

The report concludes that "each company that does not currently provided GHG or climate change disclosures will need to carefully evaluate whether that is a reasonable approach given the kinds of risks, and opportunities, that GHG and climate change issues present." The report ends by noting that "we expect the number of public companies that make GHG and climate change disclosures in their SEC reports will increase in 2009."

 

On January 12, 2009, in the first dismissal motion ruling among the many subprime and credit crisis-related securities lawsuits pending in the Southern District of New York, Judge Shira Scheindlin granted the defendants’ motion to dismiss in the Centerline Holding Company securities case, with leave to amend. A copy of the opinion can be found here.

 

Background

As detailed more fully here, the plaintiff’s complaint basically alleges that the company and four individual defendants concealed from the investing public that they were structuring a sale of the company’s $2.8 billion portfolio of tax-exempt mortgage revenue bonds to a third party. When the company announced the sale, it also announced that it would be cutting its dividend from $1.68 per share to only 60 cents a share.

 

The company also disclosed at the same time that it had entered into a related party transaction with a company controlled by its Chairman, Stephen Ross, and its Managing Trustee, Jeff Blau, whereby this separate company agreed to provide Centerline with $131 million in financing in exchange for 12.2 million shares of newly-issued convertible stock that will pay an 11% dividend.

 

Upon the announcement of this news, the company’s share price declined 25% and the lawsuits followed.

 

The Motion to Dismiss Ruling

The defendants moved to dismiss the complaint on the ground that the plaintiff had not adequately pled scienter. Judge Scheindlin agreed. Specifically, she concluded that the plaintiff had neither alleged sufficient facts showing that defendants had the motive and opportunity to commit fraud nor adequately pled that defendants acted with recklessness.

 

The plaintiff had alleged that defendants Ross and Blau were motivated to "engineer" the related party transaction to increase their voting control of the company from 17% to almost 30%; to be paid an 11% coupon rate, "thereby diverting a material portion of the Company’s income to insiders…to the great detriment of shareholders"; and to have the opportunity to nominate an individual trustee.

 

Judge Scheindlin said that these allegations "do not explain why Ross and Blau would have wanted to fraudulently conceal the news" of their investment or of the bond portfolio sale. She also said that "if they had any motive, it would have been to disclose information about the bond sale and dividend cut sooner," since their preferred shares are only convertible at $10.75 a share, yet after the announcement of the bond sale, the company’s share price declined to $7.70 a share.

 

The court noted that if Ross and Blau had wanted a "sweetheart" deal, "the would have been motivated to cause information related to the sale of the bond portfolio and dividend cut to be disclosed sooner so that they could have negotiated a lower conversion price."

 

Judge Scheindlin also found insufficient the allegations that the other two individual defendants were motivated by reason of their high salaries, bonus compensation, equity awards or continued employment.

 

Judge Scheindlin also held that the plaintiff had not alleged facts sufficient to establish conscious misbehavior or recklessness. Specifically, she noted that "the Complaint does not allege any facts to show that defendants knew they should have disclosed information of the transactions prior to the date of the announcement, but recklessly failed to do so."

 

The defendants cited an SEC rule (promulgated in implement Section 409 of the Sarbanes Oxley Act) specifying that companies are required to disclose material definitive agreements within four business days of entry into the agreement, and argued that the plaintiff had not alleged that the company had failed to comply with the rule. The plaintiff argued that whether the defendants complied with the SEC’s rule, the company had failed to disclose information about the pending sale information about the pending sale and dividend cut while the company was making other disclosures on those topics, which made those other disclosures "false, inaccurate, incomplete or misleading."

 

Judge Scheindlin said that even if it were assumed that the statements were misleading, the defendants’ compliance with the SEC’s rule "suggests that Lead Plaintiff has failed to show defendants acted recklessly in omitting such information." She added that defendants conduct cannot be described as "highly unreasonable" when "it is arguable that they did not have a duty to disclose such information before they actually did."

 

Because she found that the plaintiff had not presented facts to make the Section 10 claims "plausible," Judge Scheindlin dismissed the claims, but she allowed plaintiff 30 days in which to file an Amended Complaint.

 

Discussion

The significance of Judge Scheindlin’s opinion is that it is the first dismissal motion ruling in a subprime and credit crisis-related case in the Southern District of New York. A very large number of the subprime and credit crisis-related securities lawsuits overall have been filed in the S.D.N.Y because the financial services industry is concentrated there. By my count, as many as 54 of the 101 subprime and credit crisis-related securities lawsuits that were filed in 2008 were filed in the Southern District of New York.

 

However, any inferences about the other cases that might be drawn from Judge Scheindlin’s grant of the dismissal motion in the Centerline case probably need to be heavily discounted because the opinion depends so heavily on case-specific allegations and the specifics of the transaction involved. For that reason the case may offer relatively little insight into the prospects for other cases pending in the S.D.N.Y., except to the extent that it illumines the legal standards that will be applied to scienter issues in other cases.

 

In any event, the ruling was without prejudice, and it remains to be seen whether or not the plaintiffs will be able to amend their pleadings sufficiently to survive a renewed motion to dismiss.

 

Those readers who may have had the thought, as I did, while reading about this case that the allegations really lend themselves more to a derivative lawsuit alleging breaches of the duty of loyalty and care will want to know that there was a separate derivative lawsuit filed in the S.D.N.Y. against Centerline, as nominal defendants, as well as certain of its directors and officers. A copy of the derivative complaint can be found here.

 

I have added the recent Centerline opinion to my table of subprime and credit crisis-related securities lawsuit dismissals, dismissal motion denials and settlements, which can be accessed here.

 

Another 2009 Credit Crisis Lawsuit: In their January 14, 2009 press release (here), plaintiffs’ lawyers announced their initiation of a securities class action lawsuit in the Western District of Washington on behalf of investors who purchased certain WaMu Mortgage Pass-Through Certificates. The Complaint (which can be found here) was filed against the various series of certificates, as well as Washington Mutual bank, WaMu Acceptance Corporation, and certain individuals.

 

According to the press release, the complaint alleges that the "defendants made material misstatements and omissions in connection with the offerings regarding the collateral underlying the certificates."

 

The new WaMu case is already the third subprime and credit crisis-related lawsuit filed so far in 2009. Because I thought that some readers might like to separately track the 2009 credit crisis securities lawsuits, I have created a separate spreadsheet (that can be accessed here) on which I will separately track the 2009 credit crisis cases. I will update the spreadsheet as new credit crisis cases are filed.

 

The addition of the WaMu case brings the total number of subprime and credit-crisis related securities lawsuits that have been filed since 2007 to 144. My list of all of the subprime and credit crisis securities cases can be accessed here.

 

Special thanks to Adam Savett of the Securities Litigation Watch for providing a copy of the WaMu complaint.

 

More about Social Networking: In a recent post, I revealed my New Year’s resolution to become more familiar with and involved in the various professional social networking sites, including LinkedIn and Twitter. The prior post elicited a promising initial response, but because I suspect that many readers may not have seen my prior note, I am reprising the message here.

 

Many readers may be interested to know that between the times when I enter new blog posts, I often add quick notes and links on Twitter. My Twitter site can be accessed here. It is relatively simple to register.

 

I also remain interested in trying to better develop my LinkedIn network. The LinkedIn button in the right hand margin above will take you to my LinkedIn profile. I am interested in trying to bring readers of this blog into my LinkedIn network, so please let me know if you would like to "connect." I am still learning what I might be able to accomplish with the network, but I proceeding on the theory that the only way to figure it out is to plunge in and try to make it work.

 

We are barely into the New Year, but all signs are that two of the critical securities litigation trends of 2008 – the subprime/credit crisis related litigation wave and the Madoff-related litigation wave – remain significant factors and apparently will continue to drive new lawsuit filings as we head into 2009, as the recent lawsuit filings discussed below suggest.

 

The New RBS Lawsuit

First, with respect to the credit crisis litigation, on January 12, 2009, plaintiffs’ lawyers issued a press release (here) stating that they had initiated a securities class action lawsuit in the Southern District of New York on behalf of purchasers of Series S American Depositary Shares (ADSs) of the Royal Bank of Scotland Group and related entities and certain directors and officers. The complaint also names as defendants the offering underwriters that conducted the June 2007 offering of the shares.

 

The Complaint (which can be found here) alleges misrepresentations and omissions in the offering documents, which incorporated the Company’s 2004, 2005 and 2006 financial statements. The Complaint alleges that the company "ultimately announced huge multi-billion pound impairment charges associated with its exposure to debt securities, including mortgage-related securities tied to the U.S. real estate markets, causing the price of RBS’s Series S ADSs issued in the Offering to decline." The ADSs, which were originally offered at $25/share, now trade around $10/share.

 

According to the Complaint, the offering documents omitted that:

 

(a) defendants’ portfolio of debt securities was impaired to a much larger extent than the Company had disclosed; (b) defendants failed to properly record losses for impaired assets; (c) the Company’s internal controls were inadequate to prevent the Company from improperly reporting its debt securities; (d) the Company’s participation in the consortium which acquired ABN AMRO would have disastrous results on the Company’s capital position and overall operations; and (e) the Company’s capital base was not adequate enough to withstand the significant deterioration in the subprime market and, as a result, RBS would be forced to raise significant amounts of additional capital.

 

RBS is actually the second company from the ill-fated consortium that was the "successful" bidder in the ABN AMRO buyout to get dragged into U.S. securities litigation.

 

As I noted here, another consortium member, Fortis, was also hit with a securities class action lawsuit in October 2008. As I noted in that prior post, "it is one more of those amazing things about the current circumstances that, despite the size of the ABN AMRO calamity, it is effectively just background noise in the larger cataclysm." (An abridge version of the ABN AMRO debacle can be found here.) Both RBS and Fortis have also been the recipients of massive bailout efforts from their respective governments.

 

The ABN AMRO losses to RBS continue to amount. For example, on January 12, 2009, Bloomberg reported (here) that, as a result of loans RBS acquired as part of the ABN AMRO deal, RBS is the biggest lender to bankrupt U.S. chemical maker Lyondell Chemical Co., and may face losses on its $3.47 billion of loans. The loans were part of the $20.5 billion raised to finance Bassell AF’s 2007 leveraged buyout of Lyondell.

 

More Madoff Litigation

According to their release (here), on January 12, 2009, plaintiff’s counsel initiated another Madoff-related securities class action lawsuit in the Southern District of New York on behalf of investors in the Herald USA Fund, Herald Luxemburg Fund, Primeo Select Funds, and Thema International Funds, against the Funds, Medici Bank, Bank Austria Creditianstait, Unicredit S.A., Pioneer Alternative Investments, HSBC Holdings plc and Ernst & Young LLP, as well as Medici Bank’s founder Sonja Kohn and its former CEO Peter Scheithauer. A copy of the complaint in the case can be found here.

 

Austrian regulators took control of Bank Medici after the bank revealed that it had invested as much as $3.2 billion in funds managed by Bernard Madoff and his firm. Bank of Medici is 25% owned by Unicredit. As reported here, one of the Bank’s largest customers was Unicredit’s Pioneer Investments, which invested as much as €805 with the Funds. Further background can be found here.

 

According to the press release, the Complaint alleges defendants caused the Funds "to concentrate almost 100% of their investment capital with entities that participated in the massive, fraudulent scheme perpetrated" by Madoff and his firm.

 

Run the Numbers: With the addition of the RBS case, the total number of subprime and credit crisis-related securities lawsuits going back to 2007 now stands at 143, of which two have been filed already in 2009. My updated tally of the subprime and credit crisis-related cases can be accessed here.

 

The new lawsuit on behalf of the Bank Medici Funds investors brings the total of Madoff-related securities class action lawsuits to eight, as reflected on my running tally of the cases, which can be accessed here.

 

Keeping Count: In my analysis (here) of the recently released Cornerstone/Stanford Clearinghouse report regarding the 2008 securities litigation, I noted that the report’s count of new 210 securities lawsuit filings through December 15, 2008 contrasted with my own count of 224 securities lawsuits through December 31, 2008. As I noted in my analysis, the additional lawsuits filed between December 15 and December 31 were critically important in understanding fully 2008 filing trends, as they significantly affect relative and absolute filing numbers during the year.

 

The Stanford Law School Securities Class Action Clearinghouse website has now updated its count through year’s end, bringing their 2008 tally to 226. The Stanford website can be accessed here.

 

On further review of their figures, my account appropriately should be adjusted from 224 to 226.

 

Investors whose fortunes were tied to Bernard Madoff and his firm have already been counting (and mourning) their losses. But for the insurers that provided coverage for financial firms targeted in the Madoff-related litigation, the losses have only just begun to accumulate.

 

How high the insurance losses ultimately may run remains to be seen, but early estimates suggest that that the insurance losses, even just for defense expenses, could be significant.

 

A January 9, 2008 Bloomberg article (here) reports that Madoff-related claims "may cost insurers who cover financial institutions more than $1 billion as they pay legal costs for investment managers who gave client money to Madoff." Indeed one respected industry participant is quoted as saying that a total of $1 billion "feels a little low to me."
 

 

The losses could well affect not only D&O insurers, but also insurers offering"error and omissions" E&O insurance. For many of the kinds of investment firms involved in these cases so far, the type of insurance protection they would most likely purchase provides both coverages within a single package.

 

The article correctly points out that how large the insurance losses ultimately turn out to be depends on how many of the Madoff "feeder funds" and other litigation targets actually have purchased these kinds of insurance. As one observer quoted in the article notes, hedge funds and other investment vehicles "often don’t buy coverage."

 

There are a variety of other factors that also could affect the total cost to insurers of the Madoff-related claims. The first is the question of who is insured under the policies. In many of these Madoff-related lawsuits (a complete list of which can be accessed here), the plaintiffs have named a laundry list of related defendants, often including not only investment managers and advisors, but also investment funds, offshore entities, and a squadron of associated individuals.

 

These claims are going to stress-test the insurance policies involved. The policyholders will find out how well put together the policies were, in light of the entities’ related structures and operations. There may well be instances where the entire family of advisors, managers and funds were not fully yoked together under the coverage umbrella.

 

But an even more important set of issues that potentially could affect the scope of insurance losses are the potential coverage defenses the carriers may seek to assert. In particular, insurers will be looking closely to see whether the allegations raised in these lawsuits trigger one of more of the standard conduct exclusions, particularly the personal profit and the fraud exclusions.

 

The conduct exclusions typically are written on an after adjudication basis, meaning that the only apply to preclude coverage only after an adjudicated determination that the prohibited conduct actually took place (as I recently noted in my discussion of the potential coverage insurance issues arising in connection with the Satyam scandal, here).

 

Moreover, at this point the fraud involved appears to involve misconduct of Madoff himself, rather than the feeder funds, although obviously investigators are probing the potential complicity of a wide variety and number of persons associated with Madoff.

 

The personal profit exclusion may prove to be the more relevant. A typical exclusion precludes coverage for loss "based upon, arising from, or in consequence of … an Insured having gained any profit, remuneration or advantage to which such Insured as not legally entitled, if a judgment or final adjudication in any proceeding establishes the gaining of such remuneration or advantage."

 

Investors have already claimed that the feeder funds inappropriately exacted management fees or other compensation without conducting appropriate due diligence or otherwise earning their fees. However, an adjudicated determination of these allegations would be required for the profit exclusion to preclude coverage.

 

Although there is currently no reported reason to suggest that the "feeder funds" were aware of Madoff’s scheme, insurers will also be looking closely at who know what and when, looking for possible bases to rescind coverage based on alleged misrepresentations in the policy application.

 

Yet another factor that could restrict the total insurance losses is the limitation on the amount of insurance potentially involved. In my experience, many investment advisory firms and hedge funds buy relatively lower limits of insurance coverage. Thus, in many cases, the available insurance involved could be relatively slight and could quickly be exhausted by defense costs alone. As a result, a portion of the potential defense expense and the amount of some settlements could wind up being uninsured.

 

I suspect that as a result of the Madoff-related events, many investment advisory firms, hedge funds and other financial firms will now need far less persuading of the value of this type of insurance or that more than just minimal limits could well be advised. Unfortunately, for the firms acquiring this insight for the first time now, this type of coverage could well become much more expensive even if otherwise available.

 

As noted in a December 31, 2008 publication of the Lloyd’s insurance market entitled "Madoff Scandal Poses Challenges for Directors" (here), the "sheer scale of the fallout from Madoff could seriously affect the financial insurance market’s dynamics, affecting the availability and cost of both professional indemnity and directors and officers coverage." The article quotes one source as stating with respect to this type of coverage that "prices are going to increase and cover will be restricted."

 

More Madoff Lawsuits: Meanwhile, the Madoff-related lawsuits continue to flood in. For example, on January 8, 2009, Pacific West Health Medical Center, Inc. Employees Retirement Trust sued Fairfield Greenwich Group and related entities and individuals in the Southern District of New York on behalf of all persons who purchased shares of the Fairfield Sentry funds, alleging that the defendants breached their fiduciary duties. The defendants are also accused of negligence, unjust enrichment and breach of contract.

 

A copy of the Pacific West complaint can be found here. A copy of a January 9, 2009 Bloomberg article describing the complaint can be found here.

 

It also looks as if overseas investors are about to get involved in Madoff litigation, which may be unsurprising give that, as the Financial Times reports (here), as much as half of the Madoff losses have been borne by non-U.S. investors.

 

According to a January 8, 2009 Reuters story (here), investment activist group Deminor is readying to sue UBS, HSBC, Hyposwiss and others in courts in Luxembourg and Ireland in connection with the Madoff scandal. The charge is that the defendant banks acts as depositories for sponsored funds that invested clients’ money in Madoff-related vehicles. The allegation is that the depository banks were responsible for the sponsored funds and negligently failed to check what was inside the clients’ portfolios.

 

According to an earlier Financial Times article (here), UBS at least sought to exculpate itself from any responsibility for clients’ assets through the subscription documents it used.

 

In any event, I have updated my running tally of the Madoff-related litigation, which can be accessed here.

 

Special thanks to David Demurjian for the link to the Bloomberg article, and to a loyal reader who prefers anonymity for the Reuters and Financial Times articles.

 

Can Madoff Losses Be Recovered?: In addition to all of the factors noted above that could diminish the aggregate Madoff-related insurance losses, there is also the question whether the investors’ claims are meritorious. That is, do the claimants actually have a legitimate basis upon which to try to recover their losses from the Madoff "feeder funds" and others?

 

These questions will be addressed in a webinar entitled "Madoff Litigation: Can the Lost Billions Be Recovered?" to be hosted by Securities Docket on January 14, 2009 at 2:00 P.M. The speakers include Gerald Silk of the Bernstein Litowitz firm, Brad Friedman of Milberg LLP, and Fred Dunbar of NERA Economic Consulting. Further background regarding the webinar can be found here. Registration for the webinar can be accessed here.

 

A replay of a prior Securities Docket webinar entitled "2008: A Year in Review" can be accessed here. (I was one of the speakers at this prior session.)

 

"Hitler Previews the Cubs’ Winter Meeting": This video is in questionable taste, contains foul language, and is very very funny, at least for those having some acquaintance with the Chicago Cubs. (The humor is more accessible if, for example, you know who Kerry Wood is.) Special thanks to a loyal reader for sending along a link to this video.

 

https://youtube.com/watch?v=Rs7OagOu8ok%26hl%3Den%26fs%3D1

Seventh Circuit Weighs In on State Court ’33 Act Jurisdiction and Removal: A January 5, 2009 Seventh Circuit decision in the Katz v. Gerardi case (here) may make it more difficult for plaintiffs to pursue ’33 Act litigation in state court, at least in the Seventh Circuit — and possibly elsewhere, too.

 

As I detailed in a recent post (here), plaintiffs’ lawyers have proven keenly interested in pursing subprime and credit crisis-related litigation in state court, apparently for forum shopping type reasons. Defendants generally have sought to remove these cases to federal court, relying, among other things on the Class Action Fairness Act of 2005 (CAFA) and the Securities Litigation Uniform Standards Act of 1998 (SLUSA).

 

However, this past summer, the Ninth Circuit held in the Luther v. Countrywide case that the nonremoval provision in Section 22 of the ’33 Act (which provides concurrent state and federal court jurisdiction for ’33 Act cases) effectively trumps the more recently enacted SLUSA and CAFA because it more specifically relates to securities lawsuits. My discussion of the Luther v. Countrywide case can be found here.

 

An October decision in the Second Circuit in the New Jersey Carpenters’ Fund v. Harborview Mortgage case had refused to remand to state court a ’33 Act case, as is more fully discussed on the 10b-5 Daily blog (here). The Harborview decision was primarily based on the fact that the underlying securities lawsuit did not involve "covered securities" for which SLUSA created an explicit removal exception; because the exception did not apply, the case could appropriately be removed to federal court notwithstanding the nonremoval provision in Section 22.

 

In the recent Seventh Circuit opinion, Judge Frank Easterbrook wrote that the provisions of the more recently enacted statutes, particularly CAFA, trump Section 22. Judge Easterbrook expressly rejected Luther v. Countrywide’s conclusion that the more specific securities statute prevailed. However, Judge Easterbrook’s opinion, like the Second Circuit opinion in Harborview, also depended in part on the fact that the investment instruments involved are not "covered securities" (i.e., do not trade on a national exchange), and therefore did not come within one of CAFA’s removal exceptions.

 

In addition, Judge Easterbrook’s opinion does seem to have been influenced significantly by the fact that the plaintiff in the case was really a seller of the investments involved, rather than a buyer, and therefore lacked a legal basis to assert a ’33 Act claim. Although the opinion nevertheless examined the removal/jurisdictional issues as if the plaintiff had a legal right to assert the claim, the opinion’s starting point arguably influenced the outcome of its analysis.

 

In any event, the Seventh Circuit’s recent opinion, together with the Second Circuit’s Harborview opinion, clearly could create substantial jurisdictional hurdles (at least outside the Ninth Circuit) for the numerous plaintiffs now seeking to pursue ’33 Act claims in state court. Many (if not all) of the various subprime and credit crisis-related cases filed in state court related to investment instruments that are not traded on national exchanges and therefore are not "covered securities." Accordingly, contrary to the title of one of my prior posts, Section 11 cases may not be "coming soon to a state court near you" after all.

 

A January 12, 2009 Law.com article discussing the Seventh Circuit opinion can be found here.

 

Collins & Aikman Defendants Criminal Charges Dropped: On January 9, 2009, prosecutors dropped securities fraud and other criminal charges against former Collins & Aikman CEO David Stockman and three others. As reported in the January 10, 2009 Wall Street Journal (here), the U.S. Attorney’s office said further prosecution "wouldn’t be in the ‘interests of justice’ following a renewed assessment of the case."

 

While the individuals involved undoubtedly are relieved to have the prosecutorial threat removed, the government’s action comes only after the now-defunct company’s directors and officers insurance was entirely exhausted by defense fees, as I discussed at length in a prior post (here). Unfortunately for these individuals, they continue to face SEC enforcement proceedings as well as civil litigation (about which refer here), now without any further insurance available to fund their defense in these proceedings, not to mention any settlements or judgments that may follow.

 

A criminal prosecution has such an enormous potential to cause harm. On the one hand, it is commendable that the government was willing to reassess the case and to drop it before any further harm was done. On the other hand, even though the prosecution is over, it has done material damage to the individuals who were unfortunate to be subject to a prosecution that lacked an adequate basis. It is extremely regrettable when the government uses its enormous power when it is unwarranted. In this instance the government can drop the case and walk away without so much as an apology, but the unfortunate consequences of an unjustified prosecution continue for the individuals involved.

 

University of Denver law professor Jay Brown has extensively covered the Collins & Aikman criminal prosecution on the Race to the Bottom blog (here), including in particular his discussion (here) of how the criminal prosecution exhausted the company’s D&O insurance. The SEC Actions blog has a good summary description (here) of the criminal case and raises the question whether the SEC will proceed with the civil enforcement proceeding in light of the discontinuance of the criminal case. All of the key pleadings in the criminal case can be found on the University of Denver Law School’s corporate governance website, here.

 

2008 Delaware Case Law in Review: Francis Pileggi of the Delaware Corporate and Commercial Litigation Blog has released the2008 installment of his annual review of key Delaware opinions. Pileggi’s report, which is must reading for anyone who wants an overview of important legal developments in Delaware’s court’s during 2008, is entitled "Selected Key Corporate and Commercial Delaware Decisions in 2008" and can be accessed here.