Strangely, the Judge Couldn’t Be Found Inside the Mailbox at the UPS Store: According to the February 12, 2009 Atlanta Constitution (here), Fulton County deputies have yet to serve suit papers filed on December 12, 2008 against a Fulton County Superior Court Judge, even though the deputies and the Judge all work in the same courthouse building and even though the summons was addressed to the Judge at the courthouse. However, the deputies did attempt to serve the Judge at his campaign headquarters mailbox at a UPS store.  (Map courtesy of Fulton County deputies.)

 

Hell: According to a February 10, 2009 Minneapolis Star Tribune article (here), local police in Texas have seized 22 urine-soaked dogs found with their owner inside a locked station wagon. The ammonia level inside the car was measured as 23 parts per million. Humans reportedly start experiencing health issues at 12 parts per million. The article does not explain the simultaneous combination of owner, dogs, urine and locked station wagon.

 

Her Whole World Came to an End in an Instant: You might say, she broke a nail, big deal, right? However, Lee Redmond of Salt Lake City has not cut her nails since 1979. The total length of her nails in 2008 was over 28 feet, including a right thumbnail that measured nearly 3 feet long. She has appeared in the Guiness Book of World Records. The Associated Press reports (here) that she broke her nails after she was thrown from an SUV in a vehicle collision. She was hospitalized for serious injuries that are not considered life threatening – unless of course your life consists of being famous for having long fingernails. Everyone here at The D&O Diary hopes for the best for Ms. Redmond.

 

I Wonder, Did They Check Bernie Madoff’s Shoes?: According to a February 11, 2009 San Jose Mercury News article (here), a mortgage fraud suspect stopped at the Canadian border had $70,000 stuffed in his boots. (Don’t ask, of course they were cowboy boots.) He also had $1 million in Swiss bank certificates and four ounces of platinum valued at $1,420 an ounce. What an idiot. With the global economy in the tank, he probably could have written off the value of the certificates and gotten a tax loss carry forward for the next five years, and with commodities prices what they are, he was probably carrying the platinum at a loss too.

 

A Strange World, Indeed, Mr. Mum:  Ordinarily, I find material for my blog posts basically by roaming around the Internet and after a while someting worth writing about just kind of shows up. For whatever reason, last night, all I could find was a bunch of really weird stories. After a while, it occured to me, when life hands you lemons, or whatever, you basically just have to make a blog post out of it.

 

The hardest part was figuring out how to categorize this post. Categorization is a mandatory publication prerequisite within the blog software I use. I finally decided to put this post in the "SOX (Generally)"  category, because, after all, what is more absurd than the word "SOX"? 

 

All of this reminds me of the old comic strip, written by Irving Phillips, entitled "The Strange World of Mr. Mum." As shown in these examples, Mr. Mum was a silent but observant witness to all of the world’s absurdities. Many of the strips ended with Mr. Mum in a bar, contemplatively drinking a glass of carrot juice. (I just hope his dogs weren’t locked in the car outside.)

 

 When the Madoff scandal news first broke, I thought it would be like so many other fraud controversies, dominating the headlines briefly and then fading into the background – as seemingly has happened with the Marc Dreier debacle. But perhaps as a result of the scale and breadth of the harm caused, the Madoff scandal story just seems to keep escalating.

 

Today’s headline revelation is the widely reported news (refer here), that Ruth Madoff, Bernard Madoff’s wife, allegedly withdrew a total of $15.5 million from a brokerage account just prior to Mr. Madoff’s now-famous confession to his sons and subsequent arrest.

 

This allegation first arose in a footnote of a complaint filed on February 11, 2009 by Massachusetts Secretary of State William F. Galvin to revoke the broker-dealer registration of Cohmad Securities Corporation. The complaint and related exhibits can be found here.

 

The Enforcement Section of the Massachusetts Securities Division of the Officer of the Secretary of the Commonwealth had "sought to determine whether the businesses of Cohmad and Madoff Investments were so intertwined that they could be viewed as a common enterprise, and not as separate entities, for purposes of imputing liability and obtaining investor relief." The complaint alleges that Madoff was one of Cohmad’s co-founders and directors.

 

As detailed in the complaint, Galvan contends that Cohmad "categorically refuses to discuss its actions with regulators" and therefore "has no right to continue to engage in the securities business in the The Commonwealth of Massachusetts."

 

As part of the complaint’s contention that Cohmad and Madoff’s securities firm are "so intertwined that they could be viewed as a common enterprise," Galvin cites, among other things (in footnote 4, on page 25 of the complaint) wire transfer records showing the "flow of funds" between the two enterprises, referring specifically to documents showing that "Ruth Madoff withdrew [from Madoff-related accounts at Cohmad] $5,500,000 on November 25, 2008 and withdrew $10,000,0000 on December 10,2008." Madoff was arrested on December 11, 2008.

 

The documents reflecting these two wire transfers can be found on the last two pages of Exhibit 16 (refer to pages 51 and 52, here).

 

A news wire story (here) quotes a spokesman from Galvin’s office as saying "We’re not accusing her of anything wrong." The spokesman added "Now, what someone in New York or the feds may think of it may be entirely different."

 

A Painful Situation: And under the general heading of marital complications related to the Madoff scandal, I reference the difficulties facing Steven Simkin, formerly married to Laura Blank. On February 3, 2008, Simkin filed a complaint in New York State (New York County) Supreme Court (here) against his former wife in connection with the Madoff-related investment the couple had maintained prior to their divorce.

 

According to the complaint, the couple entered a June 27, 2006 agreement providing for the division of their marital assets. The couple "mistakenly believed" that their largest asset was their account with Madoff Investment Securities, which they believed to be valued at $5.4 million. As part of the agreement, Simkin agreed to pay Blank half of the assumed account value in cash. (Ouch.)

 

The account is now "worthless, literally not worth the paper on which the parties’ valuation rested." Simkin’s complaint alleges that

 

As a result of the parties’ clear mistake of fact, Steven paid Laura millions of dollars believing, as did Laura, that it represented her share in the "Account" (as the parties understood it to be) and retained the "Account" as a portion of his equitable share of the couple’s assets. As a result, Laura obtained a windfall and Steven did not receive an equitable share of the couple’s joint assets. Accordingly, by this action, Steven seeks to reform the Agreement, which is grounded upon a material and mutual mistake respecting the couple’s assets at the time …and recover from Laura so as to accomplish the goal the parties intended by executing the Agreement.

 

Mr. Simkin, you have my sympathy.

 

Special thanks to the several readers who send me links to the Massachusetts Secretary of State’s complaint and to Jon Jacobson for help in finding the Simkin complaint. I have added the two complaints to my register of Madoff-related litigation, which can be accessed here.

 

A Clawshank Redemption?: And under the general heading of trying to recover previously paid out amounts, one issue that has gained a great deal of attention is whether the trustee in the Madoff liquidation proceeding can recover ("clawback") amounts paid out to fund investors who cashed out before the scandal was revealed. The Securities Docket has a post on the topic (here), discussing efforts that some of the investors who redeemed their shares to change the claims bar date in the Madoff liquidation proceeding out of concern for anticipated clawback efforts. .

 

In a February 2009 memorandum entitled "How Long and Strong is Trustee Piccard’s Claw?" (here), the Seyfarth Shaw law firm takes a detailed look at the trustees’ powers, and reviews the similar clawback efforts undertake in the Bayou funds scandal.

 

The memo concludes that the trustee’s ability to clawback redemption payments is "not unbridled" and that there are "powerful defenses that can and will be advanced, including the good faith defense that protected many redeeming investors in the Bayou case." The memo also notes that "additional defenses also are likely to be developed as the facts surrounding what Madoff did come into sharper focus."

 

Meanwhile, in Europe:  According to press reports (here), European investor rights group Deminor has initiated a legal proceeding in a Luxembourg court in order to compel two Luxembourg units of UBS to provide informatoin and materials relating to the entities’ role in steering clients to Madoff-related investmens.

 

The action, which Deminor initiated on February 11, 2009, is filed against UBS S.A. and UBS Fund Services, as well as against the Luxalpha SICAV Fund, Luxembourg Third Party Management Company SA and Access Management Luxembourg SA.

 

According to the news reports, the action seeks information regarding contracts between the UBS units, Madoff, and Luxalpha, an investment fund that UBS allegedly promoted. Regulators closed Luxalpha last week for not complying with regulatory requirements. The action also seeks to obtain audit reports of the fund, prepared by Ernst & Young.

 

Deminor claims that it represents individual and institutional investors that had lost over $1.3 billion as a result of the Madoff scheme.

 

I would be very grateful to any reader who might be able to provide me with a copy of the new Luxembourg complaint.

 

Gender Issues: A February 11, 2009 Washington Post article entitled "In Banking Crisis, Guys Get the Blame" (here) raises the question whether the current global economic crisis is a result of the fact that the financial industry and its regulators are "overwhelmingly male-dominated."

 

The article quotes one commentator as saying that "you can argue that the men have made a right mess of it, and now the ladies should have a go." Another commentator observes that "maybe if we had some more women in the boardrooms, we may not have seen as much risk-taking behavior."

 

Finally, one commentator with an odd notion of human anatomy, commenting on London’s top financial sector officials, observed that "there are quite a lot of alpha males with testosterone steaming out their ears."

 

At least when it comes to relying on women to clean things up, Iceland "is leading the way," having appointed a female prime minister as well as two women to lead two of its major banks. The prime minister’s spokesperson is quoted as saying "Men, especially young men, made a mess of things. There is a strong discussion that women would have taken a more cautious approach in the financial sector."

 

And Finally: I have added a Twitter button in the right hand column. Readers interested in receiving Twitter updates (or "tweets" as they are known) between blog posts will want to click on the Twitter button and register to become a "follower" of my Twitter site. I also add "tweets" when I have added new blog posts. I have come to appreciate that there are many web denizens who prefer to receive their information as "tweets", so that is why this blog now has a Twitter button.

 

The New York Times has a nice February 11, 2009 article (here) with a good overview of what Twitter is all about.

I have previously tried to anticipate the future direction of the credit crisis litigation wave (refer, for example, here), but what I failed to foresee is that as the credit crisis itself has entered the remedial phase – or what we all hope turns out to be the remedial phase – there also would be litigation arising from the administration of the remedies. A recent securities lawsuit demonstrates how circumstances surrounding the government’s bailout efforts can lead to litigation.

 

As reflected in their February 9, 2009 press release (here), plaintiffs’ lawyers have filed a securities class action lawsuit in the Middle District of Alabama against Colonial BancGroup and certain of its officers. Colonial is a bank holding company that operates Colonial Bank, N.A., which has 347 bank branches in Florida, Alabama, Georgia, Nevada and Texas, and over $26 billion in assets.

 

The lawsuit relates to Colonial’s efforts to obtain TARP money, and in particular to the company’s December 2, 2008 and January 27, 2009 press releases discussing the company’s TARP-related efforts. A copy of the complaint can be found here. Special thanks to Courthouse News Service for the complaint.

 

In its December 2, 2008 press release entitled "Colonial BancGroup Received Preliminary Approval from the U.S. Treasury for $550 Million in Capital" (here), Colonial announced that it had "received preliminary approval" to participate in the Treasury Department’s capital purchase program, pursuant to which Colonial "will receive $550 million from the Emergency Economic Stabilization Act of 2008."

 

In the December 2 press release, Colonial also stated that in exchange for its investment, the Treasury was to receive preferred shares paying a 5% dividend for the first five years. If the preferred shares are not redeemed within five years, the dividend rate increases to 9%. The press release also stated that the Treasury will also receive warrants to purchase shares of Colonial.

 

According to the plaintiffs’ lawyers’ February 9 press release, in response to Colonial’s December 2 announcement, Colonial’s share price "surged over 50 percent from its $2 per share close on December 1, 2008 to close at $3.08 per share on December 2, 2008."

 

However, the complaint alleges that the defendants failed to disclose that "Colonial would be required to raise additional outside capital of $300 million before it could receive the $550 million in TARP funding." The complaint further alleges that Colonial "belatedly disclosed" this requirement after the markets closed on January 27, 2009. The complaint alleges that in response to the company’s January 27 announcement, Colonial’s share price declined 45%, from $1.58 per share to $0.85 per share.

 

Colonial’s January 27, 2009 press release, which can be found here, stated that Colonial’s participation in TARP is "subject to Colonial’s increasing equity by $300 million." The January 27 press release also states that Colonial is "actively pursuing a variety of capital raising alternatives to increase equity by $300 million, which should satisfy this condition of the TARP preliminary approval."

 

As discussed in a February 6, 2009 Birmingham Business Journal article (here), Colonial’s announcement that it must raise $300 million of additional funds to qualify for TARP "is raising eyebrows among some banking analysts and banking experts." The article quotes one commentator as saying that this item represents "a pretty significant omission" on Colonial’s part in its announcement of the TARP funding. The article also quotes an analyst as saying she felt "deceived" by the bank because it "withheld important information."

 

The Colonial lawsuit is far from the first credit crisis-related securities lawsuit in which governmental intervention of one sort or another is involved. For example, the government’s role in brokering Bank of America’s acquisition of Merrill Lynch features prominently in the securities lawsuit recently filed against BofA (about which refer here). The need for governmental rescues has also featured in a number of other credit crisis-related securities lawsuits, including for example, the lawsuits filed against Fortis (refer here), ING (refer here), and the Royal Bank of Scotland (refer here). But so far as I know, the Colonial case is the first securities lawsuit where the allegations are tied directly to the TARP funding program.

 

I supposed that after more than two years of credit crisis litigation, as well as massive governmental involvement in the financial markets, it should come as little surprise that we have reached the point where lawsuits relating to the bailout efforts themselves are starting to arise. I suppose we should start getting ready now for the inevitable stimulus-related lawsuits which undoubtedly will follow not long after Congress finishes its current efforts.

 

The Colonial lawsuit does raise an interesting categorization issue, which is whether the case properly should be counted as credit crisis-related and grouped with the previously filed credit crisis-related securities lawsuits. After reviewing Colonial’s press releases and considering the reasons why the company needed TARP money in the first place, I have concluded that the lawsuit is related to the ongoing credit crisis and therefore it belongs in my running tally of credit crisis related securities lawsuits.

 

My running tally of the subprime and credit crisis-related securities lawsuits can be accessed here. With the addition of the Colonial lawsuit, the tally of subprime and credit crisis-related securities lawsuits that have been filed during the period 2007 through 2009 now stands at 156, of which 15 have been filed in 2009. A spreadsheet showing the 2009 credit crisis related securities lawsuits can be accessed here.

 

One final note about TARP — the Bank Lawyer’s Blog reports (here) that some banks in the Dallas area are advertising the fact that they haven’t taken TARP money because they don’t need to. That line of analysis could get awfully murky under the Treasury department’s proposed updated bailout approach, under which banks will be "stress tested" and only the likeliest to survive will receive aid.

 

Madoff Update: Regular readers know that in addition to my running tally of the subprime and credit crisis-related securities lawsuits, I have also been maintaining a separate tally of Madoff-related litigation. The Madoff-related litigation register, which can be accessed here, is subdivided into multiple tables, reflecting the various types of litigation that has arisen out of the Madoff scandal.

 

I recently updated the Madoff lawsuit register by adding a number of new Madoff lawsuits, based on excellent information, materials and links provided by several readers, including in particular Jon Jacobson of the Greenberg Traurig law firm. My special thanks to all for the contributions.

 

And Finally: Describing it as "the beginning of a long process," the SEC Actions blog has a post (here) discussing the partial settlement that Bernard Madoff has reached with the SEC. The WSJ.com Law Blog also has a post here describing the partial settlement. A link to the SEC’s litigation release regarding the partial settlement can be found here.

 

Even though Madoff victims previously filed a securities class action lawsuit against Banco Santander and other parties in the Southern District of Florida (as discussed here), a different group of claimants has now filed a separate lawsuit in the Southern District of New York against substantially the same set of defendants. However, the new lawsuit purports to represent a different approach, and also presents specific allegations pertaining to Banco Santander’s public offer (here) to compromise the Madoff-related claims.

 

On February 4, 2009, plaintiffs filed a purported class action lawsuit in the Southern District of New York "on behalf of all persons or entities who owned shares of Optimal Strategic U.S. Equity Ltd. on December 10, 2008." The defendants include Banco Santander S.A. and related entities; Optimal Investment Services; PricewaterhouseCoopers; several HSBC-related entities; and several individual defendants. A copy of the complaint can be found here.

 

Both the purported class and cast of defendants named in this new lawsuit are similar to the class and defendants named in the previously filed Southern District of Florida lawsuit (about which refer here). However, unlike the prior lawsuit, the most recent lawsuit does not assert any claims under the federal securities laws.

 

Even though the new lawsuit purports to involve a class action, it asserts, rather than alleged violations of the federal securities laws, common law claims against all defendants for negligent misrepresentation, breach of fiduciary duty, and unjust enrichment. The complaint also asserts a claim for aiding and abetting a breach of fiduciary duty claim against PricewaterhouseCoopers. In addition, the complaint asserts a claim against all defendants under Section 349 of the New York General Business Law.

 

What makes this class action complaint’s lack of securities law allegations noteworthy is that it was filed by one of the leading plaintiffs’ securities class action law firms. A number of possibilities suggest themselves as to the reasons for the omission of a claim based on the firm’s area of specialty.

 

The first is the possibility that the firm hopes to maintain its own lawsuit separately and without consolidation with the previously filed lawsuits.

 

Another more interesting possibility is that the law firm wants to avoid the discovery stay under the PSLRA. Indeed, press reports (here) relating to the lawsuit expressly noted that "unlike other Madoff-related cases, the suit does not contain a securities claim, meaning plaintiffs can receive relevant information about the case before any trial that could bring to light previously unknown details on the case."

 

A leading plaintiffs’ securities firm’s use common law claims as a tactical way to insert a discovery tentacle, possibly to support later amended securities claims, is a disturbing possibility that would represent a circumvention of the PSLRA’s intended protections. Of course, there is always the possibility that the plaintiff lawyers in fact intend to pursue the common law claims without later adding securities claims, which would represent an interesting development in and of itself.

 

Yet another reason the plaintiffs’ lawyers may have dispensed with a federal securities claim is suggested in the claim asserted against PricewaterhouseCoopers. Under Stoneridge, the plaintiffs have no aiding and abetting claim against the audit firm under the securities laws. The complaint nevertheless asserts an aiding and abetting claim against the audit firm, but for fiduciary duty violations, not Securities law violations, suggesting an attempt to avoid Stoneridge’s limitations.

 

The new complaint in any event expressly references Banco Santander’s public offer to compromise the Madoff-related claims (about which refer here). Among other things, the complaint describes Santander’s offer as "woefully inadequate," citing the fact that the offer "does not compensate Class members for any interest or gain their money would have earned," and asserting that the preferred stock Banco Santander is offering would be substantially discounted in the open market.

 

For their part, the plaintiffs in the action previously filed in the Southern District of Florida have filed an "emergency motion" to enjoin Banco Santander from contacting putative class members to try to secure a release from them of their claims. In the memorandum filed in support of the motion (a copy of which can be found here), the plaintiffs allege that Santander "has launched a misleading and coercive campaign to pick off class members one by one, by pressuring them to release their claims based on incomplete and misleading information."

 

The memorandum cites Santander’s supposed use of closed door meetings, in which class members are presented with "onerous conditions and take-it-or-leave-it terms with quick expiration dates." The memorandum also references Santander’s "failure" to inform the putative class members of the existence of the lawsuit that "seeks recovery in excess of the compensation proposed."

 

The motion seeks to enjoin Santander from contacting class members, in order to prevent an "end-run around the Court’s jurisdiction and power to preside over this Class Action."

 

Whatever else may be said about the multidirectional litigation, it seems fairly certain that Banco Santander is getting a quick indoctrination into the battlefield tactics of the U.S. plaintiffs’ bar.

 

I have in any event added the new lawsuit to my running tally of the Madoff-related litigation, which can be accessed here. The new lawsuit appears in Table IV, in which I have identified "additional lawsuits against related defendants" and that are distinct from the federal securities class action lawsuits separately listed in the document.

 

Special thanks to Adam Savett of the Securities Litigation Watch blog for a copy of the complaint of the new lawsuit.

 

More Bank Closures: The expanding wave of bank failures swelled again this past Friday night when the FDIC announced the closure of three more banks, bringing the number of 2009 year-to-date closures to nine.

 

The three latest bank closures are Alliance Bank, previously a $1.14 billion asset bank in Culver City, CA (about which refer here); County Bank, previously a $1.3 billion bank in Merced, California (refer here); and First Bank Financial, previously a $279 million asset bank in McDonough, Georgia (refer here). The FDIC’s complete list of failed banks can be found here.

 

The closure of nine banks already in 2009, including in particular the closure of six banks in just the last two weeks, is extraordinary in and of itself. It is also noteworthy in context, as the number of bank closures just in the opening weeks of this year already exceeds the total number of all bank closures during the four years between January 1, 2003 and January 1, 2007. Indeed, during the period January 1, 2000 to January 1, 2008, only one year (2002, with 11 closures) had more bank closures than the nine already in the first six weeks of the year.

 

As I recently noted (here), the increasing number of bank closures is a difficult and disturbing trend, Unfortunately, all signs are that the number of bank closures will continue to grow as the year progresses.

 

Event Registration Update: If you are planning on attending the PLUS D&O Symposium on February 25 and 26, 2009 at the Marriott Marquis hotel in New York but you have not yet registered, you may want to get your registration in at your earliest opportunity. Event registration is rapidly filling, and so you may want to register now before it is too late. Registration 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.

 

The numbers are unambiguous – there were more securities lawsuits filed in the second half of 2008 than there were in the first half. Nevertheless commentators and observers continue to repeat the mistaken conclusion that there were fewer lawsuits filed in the second half, and even to try to discern some significance from a decline that never, in fact, occurred.

 

Here are the facts. As reflected on the Stanford Law School Clearinghouse Securities Class Action Clearinghouse website, which helpfully indexes the securities class action filings by quarter (here), there were 112 securities lawsuits filed in the first half of 2008 and 114 in the second half.

Not only were there more lawsuits filed in the second half of the year, but there were more lawsuits filed in the fourth quarter (65) than any other quarter during the year. Indeed, there were more lawsuits filed in December (30) than any other month during the year.

 

 

Clearly, the fact that securities lawsuit filings in fact accelerated at the end of 2008 potentially has far different implications for the future than the mistaken impression that lawsuit filings were declining.

 

 

The source of the impression that there were fewer lawsuits in the second half of 2008 is the year-end securities lawsuit filing Report jointly published by the Stanford Law School Clearinghouse and Cornerstone Research. The Report, which can be found here, considered only lawsuit filings through December 15, 2008. As I noted at the time the Report was first published (here), by omitting the last two weeks’ lawsuit filings, the Report not only excluded at least 12 lawsuit filings from its analysis, but it also reached a conclusion, inconsistent with the actual aggregate year-end data, that lawsuit filings had declined in the year’s second half. When lawsuit filing data through December 31 are considered, it is clear that the number of filings did not decline in the year’s second half.

 

 

What difference does it make whether or not lawsuit filings declined in the second half? Well, a discussion of the reasons for a lawsuit filing decline is a far different conversation that a debate over the reasons why lawsuit filings accelerated in the year’s final quarter and month. The repetition of the impression that lawsuit filings were declining when in fact they were accelerating not only perpetuates a misunderstanding of what actually happened, but it also allows the possibility that decisions could be made or conclusions reached based on a faulty premise.

 

 

Unfortunately the conclusion that securities lawsuit filings declined in the second half of 2008 continues to be repeated. As reflected in a February 9, 2009 Business Insurance article (here), industry observers continue to distract themselves and perhaps others as well debating the reasons for a lawsuit filing decline that never happened, when in fact the actual discussion ought to be the reason why lawsuit filings actually accelerated at the end of the year.

 

 

The danger from this mistaken conclusion is apparent in the remarks of one leading industry observer at a recent conference. As quoted in the Business Insurance article, the observer noted, in apparent reliance on the Cornerstone report, that “in this last quarter, there were actually fewer cases filed. It got better, not worse at the end of the year.” The world certainly looks a lot different if you think things recently “got better”; unfortunately, they didn’t get better, they got worse.

 

 

The D&O insurance industry has a hard enough time behaving rationally and making sense of what has actually happened. It would be extremely unfortunate if the industry were to become even further confused by a conclusion that unsupported by full-year data.

 

 

I entreat readers to do everything they can to make sure that the misimpression about securities lawsuit filing activity levels is not perpetuated. The industry faces too many other challenges to have to deal with the added burden of laboring under misimpressions.

 

 

The credit-crisis securities litigation wave, which began with the filing of the first subprime mortgage-related lawsuits in early February 2007, is about to enter its third year. Though the wave has evolved during the intervening period, it shows no sign of slowing down. The more interesting question going forward will be whether the litigation, which up until now has largely been concentrated in the financial sector, will spread to encompass companies in the wider economy.

The Wave’s History – So Far

The current subprime and credit crisis-related securities litigation wave began on February 8, 2007, with the filing of a securities lawsuit against New Century Financial Corporation and certain of its directors and officers. (Refer here for my most recent post on the New Century case.) Two years later, there have been 152 separate subprime or credit crisis-related lawsuits filed against companies and other entities, as reflected in my running tally of the suit, which can be accessed here.

The initial cases during 2007 were largely filed against subprime loan originators, banks, mortgages companies, home builders and residential real estate investment trusts. However, by year end 2007, a number of lawsuits had also been filed against investment banks, investment advisors, and rating agencies.

During 2007, there were a total of 40 subprime-related securities lawsuits filed.

In 2008, the lawsuits against banks and other mortgage originators continued to mount, but the litigation activity spread beyond just residential mortgage and real estate issues. The litigation also involved student lenders, commercial construction companies, commercial real estate investment trusts, bond insurers, and mortgage guaranty insurers. As I noted at the time (refer here), by early 2008, the litigation activity was no longer just about the subprime meltdown but had by that time become a credit crisis litigation wave.

The litigation wave also picked up considerable momentum during 2008, driven in part by the onslaught of cases involving auction rate securities. A total of 21 separate auction rate securities lawsuits were filed in 2008, against broker dealers, security issuers and mutual funds, among others. There were also a significant number of separate securities lawsuits filed on behalf of preferred shareholders and subordinated debtholders, which represents a relatively unusual securities litigation development, as discussed here.

The crisis in the global financial markets during fall 2008 also significantly affected the litigation wave. As I noted here, as a result of the financial market turmoil, the litigation wave reached an "inflection point" during the third quarter of 2008, where companies began to find themselves exposed to litigation not because of their own direct vulnerability to the credit crisis, but because of the companies’ exposure to other companies that were experiencing credit crisis-related issues.

During 2008, a total of 101 subprime and credit crisis-related securities lawsuits were filed.

As 2009 has begun, the litigation wave has shown no sign of slowing down. Indeed, during January 2009 alone, there were eleven new credit crisis-related securities lawsuits. A spreadsheet of the 2009 cases can be found here.

One important consequence of the litigation wave’s evolution over time is that it has become increasingly difficult to maintain absolute definitional clarity about what should be included in the category. This challenge has become even more difficult now that the financial crisis basically encompasses the entire global economy. It has become progressively tricky to determine whether or not newly filed lawsuits logically ought to be group together with the earlier suits, or whether they represent something entirely different. This categorization challenge has made simply "counting" the subprime and credit crisis-related lawsuits increasingly more difficult over time.

Financial Sector Concentration

Though the litigation has evolved and become more diverse, the litigation activity has largely been concentrated in the financial sector. Of the 152 subprime and credit crisis-related securities lawsuits that have been filed as of February 4, 2009 and that involved companies or other entities that have assigned standard industrial classification codes (SIC Codes), fully 117 of them have involved companies or other entities with SIC Codes in the 6000 series (Finance, Insurance and Real Estate).

Moreover, the 18 entities that have been sued but that have no SIC Code designated are also almost exclusive concentrated in the financial sector. These entities include mutual funds, private equity firms, hedge funds, and foreign firms whose shares do not trade on U.S. exchanges (e.g., Fortis and Société Générale).

Of the financial companies, the SIC Code categories with the largest number of lawsuits were SIC Code 6021 (National Commercial Banks) and SIC Code 6798 (Real Estate Investment Trusts), both of which had 16 lawsuits. Other categories with a significant number of securities lawsuits include SIC Code 6211 (Security Broker Dealers), which had 13 lawsuits; SIC Code 6189 (Asset Backed Securities), which had 12 lawsuits; and SIC Code 6035 (Savings Institutions, Federally Chartered), which had 11 lawsuits.

Has the Wave Entered a New Phase?

But while the litigation activity has largely been concentrated in the financial sector, there has more recently been a "new wave" of credit crisis lawsuits, as discussed at greater length here. These new wave lawsuits involved companies exposed to some of the credit crisis casualties (Lehman Brothers, Fannie Mae, Freddie Mac, Washington Mutual, American International Group, etc); that made wrong-way bets on commodities or currencies; and companies outside the financial sector whose balance sheets are laden with auction rate securities or other troubled assets.

The interesting question these new wave cases present is how far outside the financial sector these kinds of cases will spread as we go forward.

How are the Cases Faring?

Even though the subprime and credit crisis-securities litigation wave is about to enter its third year, most of the cases are still only in their earliest stages. There has really been only one significant settlement, the recent massive $550 million settlement involving Merrill Lynch (about which refer here). The few other settlements have been considerably more modest (refer here).

Only a handful of these cases have even reached the motion to dismiss stage. Among the cases where dismissal motions actually have been addressed, there have been several notable cases in which the dismissal motions were denied – for example, the New Century case (refer here) and the Countrywide case (refer here).

On the other hand, there have also been a handful of cases in which the motions to dismiss have been granted, and at least some courts have seemed skeptical that the target companies financial woes were the result of fraud (about which refer here).

My complete list of subprime and credit crisis-related securities lawsuit settlements, dismissals and dismissal denials can be found here.

Looking Ahead

Even though the litigation wave is about to enter its third year, it is clear that we have still only just begun. With the cases already filed only in their earliest stages and with new lawsuits continuing to pour in, the subprime and credit crisis-related litigation wave is likely to continue to remain an important feature of the litigation landscape for years and years to come.

 

The 2008 securities lawsuit filings were dominated by new lawsuits filed against companies in the financial sector, as has been well-documented elsewhere (refer here). But while lawsuits against financial companies were the most prominent feature of the 2008 securities filings, there were also a significant number of lawsuits filed against companies outside the financial sector. In particular, life sciences companies, which historically have experienced a heightened level of securities litigation exposure, suffered a significant level of litigation activity once again in 2008.

 

For purposes of this post, I am including under the heading "life sciences" companies any company either in SIC Code series 283 (Drugs) or in SIC Code series 384 (Surgical, Medical and Dental Instruments and Supplies). Reasonable minds could differ about whether additional categories should also be included within life sciences companies, but the interests of simplicity and consistency with my own prior analyses support this categorical definition.

 

A review of the 2008 securities lawsuit filings shows that, notwithstanding the primacy of litigation involving financial companies during the year, heightened securities litigation activity involving life sciences companies continued in 2008.

 

According to my analyses, during 2008, there were 15 new securities lawsuits filed against companies in the 283 SIC Code series, including nine in the 2834 SIC Code category (Pharmaceutical Preparations). There were also eight securities lawsuits filed against companies in the 384 SIC Code category, including five in the 3845 SIC Code category (Electromedical Apparatus).

 

The fact that there were 23 new securities lawsuits filed against life sciences companies in 2008 is quite remarkable given the predominance of the credit crisis litigation wave.

 

The total number of life sciences lawsuits is significant in relative terms as well. By way of comparison to the 23 new securities lawsuits filed against life sciences companies in 2008, there were 21 securities lawsuits filed against life sciences companies in 2007. (My detailed analysis of the 2007 life sciences securities lawsuits can be found here.)

 

The fact that the number of lawsuits filed against life sciences companies actually increased in 2008 is extraordinary in light of the extent of the surging credit crisis litigation wave.

 

The 23 securities lawsuits filed against life sciences companies in 2008 represents approximately 10% of the total of 226 new securities lawsuits overall that were filed in 2008, which is comparable to the 12% that life sciences lawsuits represented of 2007 securities lawsuit filings.

 

That this significant of a percentage of securities litigation activity is unrelated to the credit crisis litigation wave underscores a point I have previously emphasized (for example, here), that while the subprime and credit crisis-related litigation wave is a significant factor driving securities lawsuits filing activity, it is by no means the sole factor.

 

The lawsuits filed against life sciences companies in 2008 involved a wide variety of allegations. The most common allegation, asserted in five of the lawsuits, is that the defendant company misrepresented the results or progress of one or more of its clinical trials. Lawsuits filed against four companies alleged financial misstatements or improper revenue recognition.

 

Other lawsuits involved allegations relating to disclosures about product efficacy; manufacturing deficiencies or controls; merger integration issues; misrepresentations about an officer’s credentials; intellectual property concerns; and product commercial viability.

 

The attributes of these companies that most frequently attract litigation is the combination of their susceptibility to disruptive events and the vulnerability of their share prices. These kinds of setbacks are an almost inevitable attribute of the regulatory and scientific environment in which these companies operate. However, these kinds of risks are also often comprehensively disclosed.

 

As a result, though life sciences companies are frequently sued, they have not proven to be easy targets. As I noted here and here, lawsuits filed against life sciences companies are frequently dismissed. Nevertheless, life sciences companies continue to attract the unwanted attention of the plaintiffs’ lawyers.

 

Securities Litigation Survey: Readers interested in securities litigation topics under the year-in- review heading will want to take a look at  the January 2009 memorandum by the Skadden law firm entitled "Securities Litigation 2008 – Noteworthy Decisions" (here). The memorandum does a particularly good job briefly summarizing the eleven decisions discussed as well as identifying the significance of the decisions.

 

Early Registration Deadline Approaching: The early registration deadline for the C5 D&O Liability Insurance Conference is approaching. The Conference is scheduled to take place March 24 and 25, 2009 in London. As reflected in the program brochure, which can be accessed here, the program has a number of interesting speakers and will be addressing many of the current hot topics in D&O insurance. I will be participating in a panel entitled "Current Litigation Trends in Europe and the US: Are Class Actions on the Horizon?"

 

The early registration deadline for this conference is February 9, 2009, after which the registration fee becomes considerably more expense.

 

The growing problems surrounding option adjustable-rate mortgages (Option ARMs) are a concern I have previously noted (here). But it now appears that the problems may be far worse even than previously feared. These problems not only represent a growing threat to borrowers and lenders alike, but the also present the increasing likelihood for further shareholder litigation.

According to a January 30, 2009 Wall Street Journal article entitled “Option ARMs See Rising Defaults” (here), nearly $750 billion in Option ARMs were issued from 2004 to 2007. Unfortunately, as of December 2008, 28% of Option ARMs were in default or foreclosure, and an additional 7% involved properties that have already been take back by lenders. A chart accompanying the Journal article shows that the Option ARM default rate is already far greater now than was the subprime default rate at the beginning of 2008.

Borrowers holding Option ARM mortgages now find themselves having to play a particularly unattractive hand. In particular, as a result of the way these loans are structured, borrowers that have been paying only the minimum have likely seen their principal amount due increase as a result of so-called “negative amortization.”

At the same time, housing values around the country have declined. The Journal article reports that more than 55% of borrowers with Option ARMs owe more than the current value of their homes.

Think that sounds bad? Things are about to get worse. A lot worse.

As detailed in a lengthy January 4, 2009 post on the Seeking Alpha blog (here), the interest rates on billions of dollars are due to reset in 2009 and 2010. The problems that likely will ensue “are expected to be more pronounced than the subprime crisis since the economy is already nearing its trough, the consumer confidence has slumped to an all time recent history low and financial markets are in a gridlock.”

In explaining why the problems associated with the Option ARM resets could be so bad, the Seeking Alpha blog post goes through a detailed analysis of the timing and likely magnitude of the resets. In explaining the problems that could follow, the author notes:

The potential average payment increase on the loans recast is 63%, representing an additional $1,053 due each month on top of the current average payment of $1,672. These large payment increases could cause delinquencies to increase, and increase dramatically, after the recast. The fact that only 65% of borrowers have elected (or are able) to make only minimum payments underscores the magnitude of the potential problem. The potential payment shock combined with the continuous deteriorating outlook for home prices and lack of refinancing opportunities could be a negative cause of concern for investors in Option ARM securities. Even more ominous, is pall cast upon the banks that hold these assets and are additionally exposed to other forms of consumer credit, ie. HELOCs, credit card debt and other unsecured loans.

As a result of these problems and possibilities, sources quoted in the Journal article estimate that more than half of all option ARMs outstanding will default, and that nearly 61% of options ARMs originated in 2007 will eventually default.

These looming problems not only represent a threat to borrowers, investors and lenders, but they also present the possibility for even further litigation.

Problems arising from Option ARM mortgages have already been the source of considerable securities litigation. The most recent lawsuit involves Triad Guaranty, which provides private mortgage insurance products to residential mortgage lenders and investors in the United States.

As reflected in their January 29, 2009 press release (here), plaintiffs’ attorneys have filed a securities class action lawsuit in the Middle District of North Carolina against Triad and certain of its directors and officers. According to the press release, the complaint (which can be found here), alleges that

beginning in late August 2007 and continuing throughout 2008, Triad began to acknowledge serious issues surrounding its exposure to anticipated losses and defaults related to its book of business for its Alt-A and pay-option adjustable rate mortgage (“ARM”) products written in 2006 and 2007 due to a failure to engage in proper underwriting practices, resulting in a decline in Triad’s stock price. Then, on November 10, 2008, Triad issued its financial results for the third quarter of 2008, reporting a net loss for the quarter ended September 30, 2008 of $160.1 million. On this news, Triad’s stock price dropped $0.11 per share to close at $0.70 per share on November 11, 2008.

The complaint further alleges that the defendants concealed from the investing public that:

(a) the Company was not adequately accounting for its loss reserves in violation of Generally Accepted Accounting Principles, causing its financial results to be materially misstated; (b) the Company failed to engage in proper underwriting practices for its book of business related to insurance written in 2006 and 2007, including the insurance related to its Alt-A and pay-option ARM products; (c) the Company had far greater exposure to anticipated losses and defaults related to its book of business related to insurance written in 2006 and 2007, including its Alt-A and pay-option ARM portfolios, than it had previously disclosed; (d) the Company lacked effective internal controls to detect fraud and misrepresentations in the underwriting process; and (e) the Company failed to disclose the true risks associated with its ability to continue to write new business and, given rating downgrades and capital limitations, the Company would be forced to liquidate its Canadian subsidiary and stop writing new insurance policies and transition the business to run-off.

Even before this recent lawsuit was filed against Triad, there had already been a number of securities lawsuits raising allegations concerning Option ARMs, including for example cases filed against Wachovia (refer here), Washington Mutual (refer here) and Downey Financial (refer here).

All of those prior lawsuits involved either companies that issued the Option ARMs or the issuers’ successors in interest. Triad, by contrast, is not an issuer but rather is a mortgage insurer. Triad’s involvement in a securities lawsuit raising Option ARM-related allegations highlights the potential for extensive further litigation, involving not just the issuers themselves but other types of companies as well.

I have in any event added Triad to my running tally of subprime and credit crisis-related securities litigation, which can be accessed here. With the addition of the Triad lawsuit, the current tally of subprime and credit crisis related securities litigation filed during the period 2007 through 2009 now stands at 150, of which eight have been filed in 2009. A spreadsheet reflecting the 2009 lawsuits can be found here.

As detailed in a recent post (here), one of the more worrisome trends in an economic environment full of thing to worry about is the increasing number of bank failures involving community banks. This trend continued this past Friday night when the FDIC closed three more banks, brining the 2009 bank closure tally up to six.

 

The three banks closed on Friday were MagnetBank of Salt Lake City, Utah, which has assets of $292.9 million (and the details about which can be found here); the Suburban Federal Savings Bank of Crofton, Maryland, with assets of $360 million (refer here); and Ocala National Bank of Ocala, Florida, with assets of $223.5 million (refer here).

 

 

A particularly troublesome note regarding the Utah bank’s closure is that the FDIC was unable to find a buyer for the bank’s assets or deposits, which the Wall Street Journal described (here) as a “rare event and an ominous sign for regulators.” According to news reports (here), this is the first time in over five years that the FDIC has been unable to find a buyer for a failed bank’s assets. In the absence of a buyer, the FDIC will issue checks to the bank’s depositors, increasing the impact on the FDIC insurance fund.

 

 

The failure of the Suburban Federal Savings Bank was the first bank failure in Maryland since 1992. As detailed in the Washington Post (here), the bank’s failure was precipitated by mounting losses in the bank’s mortgage loan portfolio.

 

 

Perhaps even more noteworthy than the fact that the total number of bank failures in 2009 is already up to six banks is the fact that the total number of bank failures in the seven month period between July 1, 2008 and January 31, 2009 is 27. (The FDIC’s complete list of failed banks for the period October 2000 through the present can be found here.) That is a huge number and all signs are that these numbers will continue to grow as 2009 progresses. The Journal article specifically observed that regulators are “bracing for dozens of more lenders to collapse in the coming months.”

 

 

Along those lines, it is worth noting that in the FDIC’s Quarterly Banking Profile for the Third Quarter of 2008 (here), which is the FDIC’s most recent quarterly profile, the number of institutions on the FDIC’s problem list increased from 117 to 171, and the assets of the “problem institutions” rose from $78.3 billion to $115.6 billion. This is the first time since 1994 that assets from problem institutions have exceeded $100 billion.

 

 

The FDIC’s next quarterly banking profile, for the quarter ending December 31, 2008, will not be released until later in February (the reports are issued 55 days after each quarter end). It will be interesting to see how significant the deterioration was in the fourth quarter.

 

 

As I detailed in my prior post, both historically and more recently, an increase in the number of failed banks has meant an increase in failed bank litigation. As the bank failures continue to mount, the threat of increased bank related litigation will also continue to grow.

 

The recent news about the eleventh hour award of nearly $4 billion in bonuses to Merrill Lynch employees is only the latest in a series of events exciting enthusiasm for "clawbacks" of allegedly excessive or undeserved Wall Street bonuses. Reports that New York City financial firms disbursed $18.4 billion in cash bonuses is 2008 added further fuel to the fire.

 

Senator Chris Dodd stated, with particular reference to executives receiving bonuses from financial institutions benefiting from government bailouts, "I’m going to look at every possible legal means to get that money back," adding "I’m going to be urging – in fact not urging, demanding—that the Treasury Department figures some way to get the money back."

 

President Obama, for his part, referred to the award of bonuses during a recession and while financial companies are seeking financial help to be "shameful" and the "height of irresponsibility."

 

The idea of compelling executives to disgorge compensation has been a recurring part of the public discussion surrounding the current economic crisis. The suggestion that the government should clawback financiers’ prior compensation has been a rallying cry for academics (here) and commentators (here) alike.

 

Indeed, the Dealbook blog reports (here) from Davos that a discussion of the topic of executive compensation turned a conference session into " a bit of a lynch mob, Davos-style" in response to a proposal to force those financiers who benefitted from the boom to "disgorge some of the money they ‘earned’ in bonuses based on profits that have since vanished."

 

This lynch mob mentality is familiar to those who recall the public outcry that accompanied the last era of corporate scandals. In fact, the perceived compensation excesses at Enron and Tyco, among others, resulted in a statutory provision specifically designed for the purpose of clawing back unwarranted compensation, Section 304 of the Sarbanes Oxley Act.

 

Section 304 has in fact been used to recover executive compensation, in the noteworthy options backdating settlement involving UnitedHealth Group (about which refer here). However, the fact that over six years’ after the enactment of the statutory clawback provision that there is only one noteworthy example of its utilization underscores the provision’s limited usefulness.

 

Simply put, and as discussed in detail here, Section 304 has several critical limitations: the provision lacks a private right of action; the provision’s language is poorly written; and it can only be used against the CEO and the CFO, limiting its use against other executives.

 

Moreover, as discussed in a December 24, 2008 CFO.com article (here), a federal district court recently ruled that the provision cannot be enforced against a company’s CEO or CFO if the company did not restate its financial results, even if the company had accounting discrepancies. The restriction clearly could further limit the provision’s usefulness and could constrain the government’s attempt to use the provision to recover the recent controversial bonus payments.

 

There are, however, other legal avenues that litigants might pursue to try to recover executive compensation, as discussed in the January 29, 2009 New York Law Journal article entitled "Limiting, Clawing Back Executive Pay in the Wake of the Financial Bailout" (here) by David Pitofsky and Matthew Tulchin of the Goodwin Proctor law firm.

 

The authors note that while the business judgment rule traditionally has shielded compensation decisions "shareholders seeking equitable rescission and restitution via derivative suits have been successful in recovering ill-gotten gains, even in the absence of compelling proof of personal impropriety." The authors cite as an example the recovery of $40 million in bonuses from HealthSouth CEO Richard Scrushy.

 

The authors also reference the mixed results presented in recent attempts to use state corporate governance laws to recoup executive compensation. On the one hand, they note the unsuccessful regulatory efforts to recoup a $187 million compensation package from former NYSE Chairman Richard Grasso (about which refer here).

 

On the other hand, the authors also note the more recent and successful use of New York’s fraudulent conveyance laws by current New York Attorney General Andrew Cuomo, who obtained AIG’s agreement, in response to the Attorney General’s demand letter, to freeze salaries and eliminate bonuses for certain former top AIG executives. (An October 15, 2008 New York Times article discussing Cuomo’s letter can be found here.)

 

University of California law professor Jesse Fried, among others, suggests (here) that the New York fraudulent conveyance laws, upon which Cuomo relied in his efforts involving AIG, might be used to recover unwarranted bonuses. Fried points out that the statute applies to all firms in New York, even those that have not applied for bankruptcy, and gives creditors the right to recover payments made to insiders under certain circumstances.

 

Provisions regarding executive pay were in fact a part of the federal bailout bill enacted by Congress last fall. However, amendments specify that the provision only applies to firms that receive government bailout funds by selling assets to the government in an auction. Because the bailout funds have not been deployed as originally intended to buy assets, the compensation recoupment provision may prove "toothless," as discussed in a December 18, 2008 Washington Post article (here).

 

Nevertheless, the lynch mob mentality in evidence at Davos is likely to continue to arise elsewhere, and in all likelihood, popular interest in recouping executive compensation will continue as a prominent topic while Congress continues to grapple with the current economic crisis.

 

Among other things, we can also expect continued discussion on whether or not Congress should enact a legislative limit on executive pay, as discussed in Robert Frank’s January 3, 3009 New York Times column (here).

 

In addition we can expect increasing pressure on companies to adopt their own clawback provisions, either as part of their incentive compensation plan, as governance policy, or as a statement of intent. My prior post discussing corporate clawback policies can be found here.

 

Whenever the issue of possible litigation against corporate officials comes up, the question arises concerning who will bear the costs. Obviously, the amounts of any compensation clawed back or disgorged would not be covered by the typical D&O policy. However, under the wording of the typical policy, a corporate official that is the target of a compensation clawback lawsuit would have substantial grounds on which to argue that his or her costs of defending against the suit should be covered.

 

To the extent that current popular sentiment for compensation recoupment translates into litigation, the resulting defense expense could become yet another area of growing claims expense for increasingly beleaguered insurers.

 

The Heat is On: Banco Santander started it, with its offer to make good on its clients’ Madoff related losses. The word is out now, and at least some other banks have gotten the message.

 

As reported in the January 29, 2009 Financial Times (here), the National Bank of Kuwait has fully reimbursed all of its clients that lost money on the Madoff-related Ponzi scheme — full reimbursement meaning both the clients initial investment as well as "the gains, thought to be ficticious, that they thought they had made."

 

As the Financial TImes article notes, the NBK move "puts pressure on other banks and fund managers whose clients lost money in Mr. Madoff’s alleged fraud." (I wonder why the FT found it necessary to add the work "alleged.") The article goes on to note that NBK had the advantage of relatiively small losses to cover

 

Proud to Be a ‘KM Pick’: Knowledge Mosaic, the online subscription information service for attorneys, regulators, journalists and academics, offers a number of excellent services, including a weekly newsletter entitled Wired Mosaic. A feature of the newsletter is the KM Pick, in which the newsletter highlights a legal-oriented blog.

 

I am proud to report that in the January 29, 2009 issue of the newsletter (here), The D&O Diary is featured as the KM Pick. Modesty prevents me from reciting here the blush-inducing words of the newsletter’s glowing encomium, but suffice it to say that I sure hope everyone will take a look at the item (right hand column, scroll down).