Questions surrounding the susceptibility of foreign domiciled companies to U.S. securities laws and to the jurisdiction of U.S. court are frequently recurring issues, as I noted most recently here. However, a new case filed in Ontario under Ontario’s securities laws presents an interesting variation on these questions.

 

The Ontario Action Against AIG

According to its November 13, 2008 press release (here), the Siskinds law firm has filed a class action application and accompanying statement of claim in the Ontario Superior Court of Justice under the Ontario Securities Act against American International Group, American International Group Financial Products, and ten current or former AIG directors and officers. According to the press release, the claim is brought on behalf of Canadian investors who bought AIG securities between November 10, 2006 and September 16, 2008.

 

A copy of the application and statement of claim can be found here. According to the press release, the statement of claim alleges as follows:

 

The AIG class action arises out of AIGFP’s credit default swaps and the crippling decline in AIG’s stock price when the true effect of those credit default swaps became known to the investing public. The AIG disclosures out of which the class action arises are currently the subject of investigation by law enforcement authorities, and are alleged in the class action to have caused massive losses to Canadian investors.

 

The Ontario Securities Act

The action is brought under the investor protection provisions in Part XXIII.1 of the Ontario Securities Act. (Refer here for the provision of the Act.) The statutory provision specifies the liability standards in connection with "secondary market disclosure."

 

Section 138.3 of the statute provides a cause of action for damages on behalf of persons who trade in a company’s security — "without regard to whether the person or company relied on the misrepresentation" — where "a responsible issuer or a person or company with actual, implied or apparent authority to act on behalf of a responsible issuer releases a document that contains a misrepresentation."

 

The persons against whom the action may be brought are specified to include, among others, the issuer, "responsible" directors and officers, as well as persons who "knowingly influenced" the issuer or responsible persons.

 

Jurisdictional Issues

The plaintiff’s statement of claim takes great pains to emphasize that the action has "a real and substantial connection with Ontario." Indeed, in paragraph 155, the statement of claim alleges that the financial disclosures that are the basis of the action were "disseminated in Ontario"; that "a substantial proportion of the Class Members reside in Ontario"; that AIG "carries on business in Ontario"; that AIG considers its Canadian revenue as "domestic" for accounting purposes"; that "key AIG personnel charged with oversight of the above conduct were domiciled in Ontario and undertook part of that effort from Ontario."

 

The pains taken in the statement of claim to specify the claim’s connection to Ontario suggests an anticipation of a question whether the case properly belongs in Ontario courts. AIG is, after all, domiciled outside of Canada, and its shares do not trade on Canadian securities exchanges (or at least the plaintiff does not so allege). The alleged misstatements were prepared and issued outside of Canada.

 

On the other hand, the statement of claim does allege misconduct, harm and damages within Ontario. Without presuming the outcome, allegations of this type are of the kind that at least some U.S. courts have found a sufficient basis for the exercise of jurisdiction and the application of U.S. securities laws on companies domiciled outside the U.S.

 

Discussion

Setting aside these subject matter jurisdiction issues, and disregarding potential personal jurisdiction issues, there are some larger questions about this case. AIG faces extensive litigation in the U.S. on similar or related issues. Should any particular jurisdiction’s court have priority? Should courts defer to another jurisdiction’s courts?

 

These kinds of questions have come up before, for example, in connection with the Royal Dutch Shell cases, where there were also parallel proceedings in different countries (refer here). The way that these proceedings should coordinate is very much an evolving issue. But the noteworthy difference between that prior example and this instance is that here the target company is a U.S.-based company. It will be interesting to see whether that distinction makes a difference and how the respective cases unfold.

 

I also have these vague, unformed questions whether or not it makes a difference that AIG is now effectively owned by U.S. taxpayers. The taxpayers’ highest priority right now is getting repaid for the astonishing obligations to the U.S. treasury that AIG has recently undertaken. I haven’t worked it all out yet, but there does seem to be something inconsistent with the U.S. taxpayers’ interest in having the company’s limited resources siphoned off to defend and possibly to pay damages in a foreign jurisdiction. Canadian investors probably don’t care much about that, I suppose.

 

Of course, it might be argued that U.S. courts have been doing similar things to other countries’ companies (including Canadian companies) for some time now. Indeed, the plaintiff’s lawyers’ press release quotes one of the plaintiff’s attorneys as saying:

 

for many years, Canadian corporations have had to confront the long arm of America’s justice system. But with the enactment of Part XXIII.1 of the Ontario Securities Act, Canadian investors can finally pursue remedies in our own Courts against American corporations that fail to respect Canada’s securities laws. Canadian investors are entitled to have Canadian Courts hear their claims.

 

The one thing that is clear is that a class action under the Ontario securities laws is a serious matter. As I noted in a prior post (here), a prior class under the Ontario securities laws against FMF Capital recently settled for over CAN$28 million. This settlement apparently represents the largest securities class action settlement in Canada, and while the amount may seem small compared to some of the massive U.S. settlements, the amount did represent a very significant percentage of the investors’ claimed investment loss.

 

At a minimum, the FMF Capital settlement suggests that a claim under the Ontario securities laws represents a serious potential liability exposure. Along those lines, it should be noted that the press release states that the plaintiff class seeks damages of $550 million. (The press release does not state whether or not those are U.S. or Canadian dollars.)

 

UPDATE: Dimitri Lascaris of the Siskinds law firm has written a guest column on the Securities Docket blog (here), in which he explains the basis of jurisdiction in Ontario for the AIG lawsuit, as well as the operation and effects of the Ontario securities laws.

 

Two Final Observations

First, this new lawsuit represents yet another demonstration that the threat of securities litigation outside the United States continues to grow.

 

Second, this new lawsuit presents an interesting and potential dangerous expansion of this growing threat, which is the possibility that U.S. domiciled companies could find themselves the target of securities litigation in other jurisdiction’s courts under other jurisdiction’s laws.

 

To the extent it proves to be successful, the Ontario plaintiff’s new lawsuit against AIG could represent a very unwelcome and potentially complicated expansion of the liability exposures of U.S companies and their directors and officers.

 

Special thanks to Adam Savett of the Securities Litigation Watch blog (here) for providing a copy of the Ontario court application and statement of claim.

 

Now This: In this time of financial turmoil, it pays to be resourceful. And so, The D&O Diary is giving serious consideration to converting itself into a bank holding company, in order to be able to join other leading American business enterprises and participate in the bailout process.

 

While there might be those who would contend that we are not "too big to fail," we certainly are feeling the effects of the economic downturn, and recent 401(k) statements suggest that radical measures may be required. Capital infusions would be particularly welcome here.

 

On November 13, 2008, I participated on a panel at a seminar sponsored by the Pennsylvania Bar Institute in Philadelphia, Pa. The topic of the panel was "Blogging for Lawyers." Appearing with me on the panel was Francis Pileggi, the author of the Delaware Corporate and Commercial Litigation Blog (here). In connection with the panel, I delivered a paper, which is reproduced in a slightly modified form below. Francis has also posted his paper on his blog, which can be accessed here.

 

I would like to thank Francis for inviting me to participate in this panel, which was a fascinating experience. Clearly, many lawyers (and perhaps others, too) are interested in knowing more about blogging. Here is my paper:

 

The First Amendment to the U.S. Constitution enshrines freedom "of the press" as one of our nation’s most hallowed rights. Historically, at least, only the few fortunate enough to own a printing press could actually benefit from this constitutional protection.

 

Until now.

 

As a result of technological innovation, it is now possible for everyone in effect to have their own printing press in the form of a blog and to publish their views to the entire world via the Internet. This new medium is both powerful and flexible, and represents and extraordinary new means for personal expression, for the exchange of ideas, and for the advancement of economic interests.

 

The Benefits of Blogging

Perhaps many of the benefits of blogging may seem self-evident, but my own experience has included many unforeseen and unanticipated benefits that have contributed significantly to the overall value of the enterprise.

 

1. A Larger Stage: As a professional based in suburban Cleveland, I could be susceptible to isolation, obscurity and even irrelevance. The blog not only facilitates a connection with my immediate professional community, but also with a larger national and even international audience, far beyond the relatively narrow scope of my day to day professional activities.

 

One of the more interesting and gratifying developments from the blog has been the links my blog has enabled me to form with academics, regulators, journalists, and attorneys from an incredibly diverse variety of contexts and jurisdictions. The resulting dialog has not only been intellectually enriching, it has also helped to raise my professional profile far more than any other professional development activity I have ever undertaken.

 

2. Recognition: Simply by virtue of having a blog on a topic, others assume you are an expert. Whether or not this is actually the case, I have been quoted, as a supposed expert, in national and international publications, including The Wall Street Journal, The New York Times, Bloomberg, The Los Angeles Times, The San Francisco Chronicle, among many others.

 

I have been invited to speak at or even moderate a wide variety of conferences and other events. I have been asked to lecture at law schools. I have been invited by law firms to speak to their clients. I have been asked by investment banks to share my thoughts about industry trends with their clients. I have been retained by consulting firms, accounting firms and actuarial firms. I have been asked to contribute written work to numerous publications. Virtually all of these opportunities have come my way as a result of the blog.

 

3. A Voice in the Dialog: In my field as in many others, there is an ongoing dialog about issues and developments. The blog ensures not only that my voice is heard in this ongoing dialog, but it also allows me the means to try to set the agenda. While I would not be so immodest as to claim that the blog has allowed me to be influential, it has at least assured that my voice is heard. Whatever else might be said about my contributions, as a result of the blog, I am not irrelevant, despite being based in Beachwood, Ohio (which, by the way, is a pretty nice place).

 

4. An Audience is a Great Thing: A blog is a medium of expression. It is also a medium of communication, and many audience members will communicate with a blog’s author. This has proven to be one of the most important parts of my blogging experience, as audience members constantly provide me with ideas, suggestions and questions that have immeasurably enriched my blog. Indeed, I have gotten many of my best ideas from readers and I truly love it when readers communicate with me about my blog.

 

If there is any downside, it is that it takes time to respond to reader inquiries and comments. I also wish that readers would feel freer to post their comments directly on my blog. It is fine for readers to tell me that they disagree with me, but it would be so much better if they would tell everyone. All of that said, a strong and active readership is one of the important parts and one of the most important benefits of a successful blog.

 

5. Trend Watching Begets Trend Knowledge: There is an unexpected side-benefit from making a practice of observing, thinking about and commenting on trends and developments. That is, these practices ensure that I am aware of and have thought about all of the latest trends and developments. This has a direct payback for my professional practice, which is that I am fully prepared to speak knowledgeably about most topics that are likely to arise in the typical business setting. This is a substantial asset in many professional and business meetings.

 

6. The Blogosphere: Another significant benefit from blogging consists of the links I have developed with fellow bloggers. The blogosphere is a congenial and mutually supportive place. Bloggers show each other courtesy and respect. Fellow bloggers helped support and publicize my blog in its early days, and have continued to supply me with information and commentary all along the way. The blogosphere’s conviviality adds a measure of satisfaction and enjoyment to the blogging experience.

 

The Burdens of Blogging

As a practical matter, just about anything anyone would need to have a successful blog is available for free on the Internet. But even if blogging might be free, that does not mean that it is without its costs. A blog is a harsh mistress, and the demands required ought to be fully considered by anyone contemplating blogging.

 

1. Time: I am frequently asked how much time I spend on my blog. I usually try to laugh off the question with a joke. The reality is not very funny. I actually spend a lot more time on the blog that I think anyone could possibly imagine. It helps to be a closet insomniac. I spend many, many hours on my blog, hours stolen from time in which I would otherwise be relaxing, enjoying my family, or sleeping. The blog takes an insane amount of time.

 

2.Blogging is a Lot Harder Than it Looks: I think every blogger starts their blog in a burst of optimism, with a backlog of things they are yearning to express. The early enthusiasm and reservoir of ideas carry the blog for a time. But the real challenge is sustaining the blog after the initial enthusiasm fades and the backlog of ideas is depleted. During the time I have been blogging, there have been many promising new blogs that have dazzlingly burst out, generated truly interesting and impressive content, and then quietly blinked out of existence. Sustaining a blog for the long haul is difficult.

 

Finding things to write about and finding the time to write them is hard work that requires serious commitment. I have found myself blogging in airports, hotels, coffee shops, beach houses, trains, basements, attics, and spare bedrooms. I have worked on my blog in London, Cologne, Montreal, Quebec City, San Diego, Dallas, Dubuque, Omaha, Tampa, and just about everyplace in between; I have posted blogs from laptops, libraries, Internet Cafes, and hotel business centers, and just about any other location where the Internet can be accessed. I have blogged on my birthday, Christmas Day, my anniversary, on vacation, during the Super Bowl, during rainstorms, during snowstorms, and even on beautiful sunny days.

 

I think writing a blog is a possibility that everyone ought to consider, but at the same time it should also recognized that not everyone will want to do everything that is required to sustain a blog over time.

 

3. The Benefits Are Indirect: There may be bloggers whose blogs produce direct economic benefits commensurate with the time and effort required. But for most bloggers, the most identifiable economic benefits are indirect. To be sure, I have developed revenue-producing client contacts directly as a result of the blog. But these developments are the exception, not the rule.

 

There is of course substantial reputation-enhancing power in having blog. I think the heightened professional profile my blog has helped me to raise will in the long run translate into significant revenue generating opportunities. But others might conclude that there are shorter, more sure-fire paths to business development.

 

4. Conflicts: A constant blogging concern is remaining sufficiently mindful of the possibility that the views I express on my blog potentially could conflict with the interests of my current or future clients. I try as hard as I can to be circumspect. But I can imagine that this concern about potential conflicts might well discourage some professionals who might otherwise be inclined to blog.

 

Three Things Potential Bloggers Should Know

1. Technology: It is easy to set up a blog. About two minutes on Blogger.com is enough to get started. But to get a blog set up the way you want and to deal with all of the problems that inevitably arise, a willingness to futz around with technology is indispensible. Fee-based services such as LexBlog reduce – but do not eliminate – the need to directly confront the technological beast. I would not recommend blogging to anyone who is uncomfortable troubleshooting technological issues.

 

2. The Downside of Owning a Printing Press: I made the analogy above comparing a blog to a printing press. The analogy is far more apt than might appear at first blush. As a blogger, you are in fact in the publishing business. For example, you have subscribers, who will expect you to address delivery problems, subscription questions and complaints, as well as delivery interruption and cancellation issues. Addressing subscriber concerns and questions is an ongoing challenge.

 

In addition, a blogger has editorial responsibilities. I am frequently called upon to address such issues as faulty or missing hyperlinks, misspellings, and erroneous references. These kinds of concerns can not only be time-consuming, they can also be disheartening. Without editors or fact-checkers, a blogger almost inevitably encounters these kinds of concerns, especially given the time pressure inherent in the blogging medium. Remedying these kinds of concerns is an indispensible but underappreciated part of the blogging process.

 

3. Plagiarism Happens: I recently participated in a business competition where our team presented directly after one of our competitors. One of the questions the prospect asked in our meeting directly quoted information the competitor had provided to the prospect in the preceding meeting. The information consisted of original research I personally conducted and about which I had written on my blog. I was astonished and appalled not only that a competitor would brazenly plagiarize my original work, but even more astonished that the competitor would even think about attempting to use the information to compete against me.

 

Call me naïve. I work very hard on my blog to make sure that I credit my sources. Given my own personal practices and standards, the idea that someone would simply plagiarize my work never occurred to me. For the first time, I have experienced serious reservations about the wisdom of sharing my original work with the whole world. I still have misgivings which I have not entirely reconciled. All I can say is that would-be bloggers should be more aware of this issue than I have been.

 

Conclusion

Some of my remarks here might discourage some potential bloggers. I do not intend to be discouraging, merely realistic. That said, all of the burdens, challenges and concerns notwithstanding, I have found blogging to be enormously satisfying on both a personal and professional level. In the end, while there might be a host of good professional reasons for me to have a blog, I have found the enterprise worthwhile simply because I have found it satisfying. If I didn’t enjoy doing it so much, I wouldn’t do it.

 

A blog is a wonderful platform for self-expression. The opportunity to express my views knowing they will be read by a wide variety of persons around the world is stimulating and gratifying. I am constantly reminded of the power of the Internet. The idea that I can have my own little corner of the Web that thousands of people voluntarily and repeatedly choose to visit is just so inexpressibly cool. It never ceases to amaze me.

 

Afterword

Based on the questions at today’s seminar, I realize that there many additional topics about blogging that I should attempt to address, beyond the issues I discussed above.  Topics that came up today included: 

How do you get started blogging? 

How is the blogging medium different from mainstream media, and why does it matter? 

How should a busy professional sort, access and use law blogs? 

Time and space do not allow me to address these issues here. But these are all worthy topics, which I hope to try to address in forthcoming posts in the next few weeks.

In the interim, I very much welcome readers questions and comments about blogging. I am very interested in sharing my thoughts and knowing more about readers’ thoughts on this topic.

 

On November 11, 2008, Citigroup (here) and Fannie Mae and Freddie Mac (here) announced plans to modify existing home loans in an attempt to help borrowers avoid further foreclosures.

 

These mortgage relief efforts unquestionably are constructive, even praiseworthy. But as noted on the Real Time Economics blog (here), these efforts represent only a “drop in the bucket.” Among other concerns is that these relief initiatives can only reach “whole loans,” those that have not been broken up and sold into complex debt instruments. Apparently only 20% of troubled loans are whole loans.

 

 

As a result, for example, the Citigroup program addresses only mortgages the company itself still holds. With respect to the mortgages that Citigroup services but does not own, Citigroup says that it “will work diligently with investors to secure their approval to expand the program.”

 

 

The complications that could arise from investors’ interests in the loans that have been sold is becoming apparent in the wake of  the Bank of America’s earlier relief efforts on the mortgage loans it acquired in the Countrywide acquisition. If the upshot from those efforts is any indication, changes to the underlying mortgages made without investors’ assent could well lead to controversy and even litigation.

 

 

Background

 

On October 6, 2008, Bank of America announced (here) a “proactive home retention program that will systematically modify troubled mortgages.” The program, which included up to $8.4 billion in interest rate and principal reductions for nearly 400,000 customers of Countrywide Financial Corporation, was hailed at the time as a “good framework” for similar arrangements with other mortgage companies.

 

 

The program was part of a deal Bank of America reached with the attorneys general of several states to settle claims brought regarding risky loans that Countrywide had originated. The press coverage at the time (refer here) noted that the deal would impact investors that own securities composed of mortgages originated by Countrywide, and that investors’ approval of the deal was required.

 

 

Investor’ Concerns

 

According to a November 10, 2008 Charlotte Observer article (here), it appears that investors may be balking at the Countrywide mortgage deal, and some may be considering suing.

The article cites a white paper (here) prepared by the New York law firm of Grais & Ellsworth, which paper asserts with respect to the deal that “even though Countrywide’s own conduct (or misconduct)” necessitated the deal,

 

 

Countrywide plans to pay not a cent of its own (or, rather, of its parent Bank of America) toward the $8.4 billion. Instead, it plans to impose the cost of its settlement on the trusts into which the to-be-modified loans were securitized, and thereby onto holders of certificates in those trusts. In our view, Countrywide’s plan will violate the agreements that govern those trusts.

 

 

The Charlotte Observer article quotes Bruce Boisture of Grais & Ellsworth as saying that as the deal reduces mortgage interest rates and principal balances, less cash will be paid into the mortgage trusts, as a result of which the trusts will note have enough cash to pay the trusts’ obligations. Boisture estimates that “385 trusts, representing hundreds of investors and outstanding debt originally worth $465 billion, could be eligible for a lawsuit.”

 

 

The white paper asserts that Countrywide had a “hopeless conflict of interest” between its obligations as the mortgage servicer under the securitization documents and as the originating lender that had allegedly engaged in predatory lending. Countrywide’s agreement as the mortgage servicer to modify the mortgages might extinguish the Countrywide’s liability as the loan originator, but, the white paper asserts, the agreements violate Countrywide’s obligations as the loan servicer under the securitization documents.

 

 

The white paper concludes by arguing that:

 

 

Countrywide and B of A must be assuming that the $8.4 billion will be spread over enough certificateholders that none will think it worth the trouble to protest. By working together for their mutual protection, certificateholders can disabuse Countrywide and B of A of this unfortunate assumption.

 

 

According to its website (here), the law firm is hosting a November 18, 2008 webcast “to brief investors” on Countrywide’s plan. The website states that the firm and several investors “are now organizing a coalition to contest Countrywide’s plan through demands on the trustees, and, if necessary, litigation.”

 

 

Discussion

The questions being raised on behalf of the investors in the securities backed by the Countrywide mortgages underscores how difficult it could be to try to provide relief to borrowers whose mortgages were broken up and sold. As the white paper contends, mortgage restructuring potentially could violate the rights of investors owning securities backed by the mortgages.

 

The dispersion of the Countrywide mortgages amongst as many as 385 trusts and many more investors demonstrates how daunting it could be to secure investors’ consent to the mortgage adjustments. While one might argue that investors would be better of if there are fewer foreclosures, obtaining the assent of investors, who may or may not agree, could prove challenging.

 

 

It may be worth noting that mortgage restructuring may not only arguably harm the interests of the investors directly involved, but it could also undermine the appetite of potential future investors for similar investments. If future investors cannot be confident that their interests will not be altered, efforts to reinvigorate the securitization process (and by extension, the home lending process) could be impeded.

 

 

The investors’ objections to the Bank of America mortgage workout deal and the prospect of litigation on the investors’ behalf highlights how challenging it may be to come up with solutions that address the predicament of all of the mortgage borrowers.

 

 

In each of bailouts and workouts that have flowed across the front pages of the nations’ newspapers in recent days, there have been constituencies that have been aided but there are also constituencies that have been harmed. Equity interests have been diluted or wiped out, debt interests have been subordinated or extinguished, and other interested parties have similarly been disadvantaged..

 

 

Some of these disadvantaged parties have sued. For example, AIG shareholders have initiated an action in the Delaware courts seeking to assert their rights to vote on the (original) AIG bailout. There undoubtedly will be others of these disadvantaged constituencies that will bring their grievances to the courts. Including, perhaps, the investors that purchased securities backed by the Countrywide mortgages.

 

 

More ERISA Lawsuits: It may be argued that the aggrieved constituencies include, at least in some instances, the employees of the bailed out companies. That appears to be the position of the plaintiffs’ attorneys who, according to their  November 10, 2008 press release (here), have filed a class action against Fannie Mae under ERISA on behalf of Fannie Mae employees who participated in the Fannie Mae ESOP between April 17, 2007 and the present and whose accounts included Fannie Mae common stock.

 

 

There may well be employees of other companies that have been affected by the recent financial market turmoil that similarly file actions under ERISA. For example, the Milberg firm issued a November 10, 2008 press release (here) that it is “investigating illegal conduct” by the Hartford Financial Group and certain fiduciaries of the Hartford Investment and Savings Plan. The purported investigation involves supposed violations of ERISA.

 

 

The new Fannie Mae ERISA action is merely the latest in a series of actions that have been filed under ERISA as part of the subprime meltdown and the current financial crisis. Since the beginning of the subprime meltdown I have been tallying these ERISA lawsuits here. With the addition of the Fannie Mae lawsuit, the current tally now stands at 19.

 

On November 10, 2008, NERA Economic Consulting released a report entitled "SEC Settlements: A New Era Post-Sox" (here) that details trends in the number of SEC settlements and of SEC settlement values in the six years since the enactment of the Sarbanes-Oxley Act.

 

The Report has a number of interesting findings, including the observation that prior to SOX’s enactment, the largest SEC enforcement action penalty was the April 2002 penalty of $10 million imposed against Xerox. However, the Report notes, after SOX, "the SEC has imposed penalties of $10 million against 115 parties, include 14 that were penalized at least $100 million." The Report includes a "top ten" settlements list, which is headed by AIG’s 2006 settlement of $800 million.

 

The Report also contains an analysis of the five most frequent allegations. Topping the list is microcap fraud (such as broker room operations or pump-and-dump schemes), followed by misstatement/omissions (including options backdating), and misappropriation of investor funds. The majority of cases against publicly traded companies involve allegations of misrepresentations or omissions.

 

The Report note that the SEC is on pace to reach 739 settlements in 2008, which would represent an increase in the number of settlements for the second straight year. The increase is driven largely by an increase in the number of individual settlements. The number of company settlements, by contrast, is declining. The number of company settlements is on pace to reach 171, which would represent the lowest number of company settlements since SOX was enacted.

 

The median 2008 company settlement through the end of the third quarter is $1.0 million, which is up from the 2007 median of $700,000, but well below the annual medians during the years 2004-2006, when the medians ranged from $1.1 to $1.5 million. The median individual settlement throughout the post-SOX era has been approximately $100,000.

 

Median settlements for public company misstatement cases have declined from a 2006 high of $50 million to a 2008 median (through the end of the third quarter) of $12.0 million. The report speculates that this decline may be due to the 2007 institution of a requirement for Commission approval prior to beginning negotiations in public company cases. (It is also probably worth noting that three of the top ten settlements took place in 2006, whereas none of the top ten has yet taken place in 2008.) The majority of public company misstatement cases settle for less than 1% of market capitalization.

 

The Report did note that of 197 companies the study identified as having settled SEC enforcement proceedings related to company misrepresentations or omissions, 181 had announced the existence of an investigation. The average time from the investigation announcement to the settlement for these 181 companies was 2.3 years.

 

The report also found that forty-three percent of company payments have been in the form of disgorgement, with 57% representing penalties. With respect to individual settlements, disgorgement represents 88% of payment amounts.

 

Relation Between SEC Settlements and Securities Class Action Lawsuits?:  The Report anticipated a question that formed in my mind as I read its analysis, which is the relation, if any, between SEC settlements and private securities class action litigation. The Report notes "it might be tempting to draw a comparison" between the number of class action filings, which increased in 2007, and the increase in the number of SEC settlements in 2007 compared to 2006. The Report notes that this comparison would be "misleading" in two respects:

 

First, the filing of a securities class action represents the first stage of class action legal proceedings, whereas SEC settlements are part of the last stage of the legal process. Because the SEC does not announce its investigations publicly, it is generally not possible to track the beginning of investigations. Instead this paper tracks settlements, which are often the first public information about an SEC matter. Second, most SEC settlements do not parallel shareholder class actions. In 2007, only 22% of SEC settlements were with public companies or their employees and related to misstatements, and were therefore closely comparable to shareholder class actions.

 

SEC Settlements and D&O Insurance, Briefly Noted: It is probably worth emphasizing that very little if any of the amounts involved in these settlements would have been insured under a typical D&O insurance policy. Most policies exclude from their definition of insured "Loss" such items as "fines and penalties" and disgorgements of amounts are typically excluded or do not otherwise represent insurable loss. However, in many instances, defense fees incurred in connection with the enforcement proceedings would be covered, depending on the applicable policy’s definition of the term "Claim."

 

New NERA Website: In addition to its Report, NERA also announced on November 10 the launch of its new website entitled "Securities Litigation Trends" (here) where NERA will be centralizing its own securities litigation analysis and also collecting other useful links (including related blogs).

 

Special thanks to Ben Seggerson at NERA for providing links to the NERA study and to the new web page.

 

This past week, in conjunction with the PLUS International Conference in San Francisco, the insurance information firm Advisen issued an updated forecast of insurance losses likely to arise from the credit crisis. As reflected in its November 5, 2008 press release (here), Advisen is now estimating aggregate D&O and E&O losses of $9.6 billion, up from the firm’s February 2008 $3.6 billion forecast. The firm also issued separate reports detailing its analysis of D&O losses (refer to report here) and E&O losses (report here).

 

Advisen has not only increased its estimate since February, it has widened the scope of what it is estimating. Thus, for example, the earlier estimate referred only to projected losses from securities class action lawsuits. The most recent estimate includes anticipated losses from derivative lawsuits, governmental investigations and other matters. The more recent forecast includes other items not incorporated into the prior estimate, such as an estimate for defense fees incurred on dismissed claims. For these and other reasons, some caution is advised in comparing the two estimates, as the overall increase in part reflects differences in the estimation process.

 

In addition, Advisen’s aggregate $9.6 billion forecast falls within a broader range of estimated combined D&O and E&O losses of from $6.8 billion to $12.1 billion. The sheer breadth of this range (reflecting a potential swing of as much as $5.3 billion) underscores the continuing difficulty of attempting to quantify the insurance industry’s potential credit crisis-related losses.

 

There are several considerations that make any current attempt to quantify the insurance industry’s credit crisis related exposure particularly challenging.

 

1. What are We Measuring?: Both the credit crisis and the associated litigation have expanded and evolved since the started to emerge in early 2007. Moreover, as a result of the dramatic events that shook the global financial markets in September and October 2008, what began as a subprime meltdown has now become a more generalized downturn affecting the broader economy. As I have emphasized in recent posts (refer here and here), the broader economic turmoil has produced its own associated litigation, and further litigation seems highly likely.

 

Because of these recent developments, it has become increasingly difficult to define with precision what is and what is not "credit crisis-related." The lines defining the category have blurred to the point that it may be difficult to say with any certainty what is being measured. The absence of definitional clarity makes both descriptions and predictions particularly precarious. The very attempt to quantify credit crisis related losses implies a categorical precision that may no longer exist.

 

 

2. Measurement Distortions: Most attempts to describe the credit crisis exposure reference the total number of securities lawsuits. While this total is important, the reality is that the number of lawsuits is greater than the number of companies sued. Several companies have been sued multiple times on behalf of different sets of putative claimants, as the Advisen report duly notes. To the extent the successive lawsuits hit the same insurance program, they are less likely to increase the insurance industry’s overall losses.

 

Moreover, as I discussed here, early returns suggest that the courts have proved skeptical that investor losses in the context of a marketwide meltdown are the result of fraud. It is far too early to generalize from these early returns, but to the extent the courts remain skeptical, the overall potential impact of this litigation could be diminished.

 

In addition, the insurance losses on any particular claim will vary widely depending not only based upon the issues affecting the underlying liability exposure, but also affecting the extent of insurance coverage triggered. Issues such as retentions, program structure, limits availability, as well as overall terms and conditions, could significantly affect the extent to which the payment of insurance proceeds is triggered in any particular claim.

 

As the Advisen report notes, these issues are particularly relevant for claims against companies in the financial sector, as many of these companies carry very large self-insured retentions or have limited their insurance coverage protection solely to Side-A only protection. These coverage-related issues could substantially determine the extent of insured losses in many claims, which in turn could substantially affect the insurance industry’s aggregate exposure.

 

3. The Uncertainty of Events to Come: Any estimate of the insurance industry’s overall credit crisis-related exposure necessarily encompasses not only projections about the lawsuits that have already been filed, but also incorporates assumptions about the number and seriousness of lawsuits yet to be filed. In addition, the estimate also includes certain assumptions about how much longer the new lawsuits will continue to emerge.

 

Advisen suggests that the losses will spread into 2009, reflecting an apparent presumption that the accumulation of lawsuits will run only through 2009. My crystal ball is no better than any one else’s, but my own view is that lawsuits associated with the current economic crisis will continue to emerge for some time to come, and more specifically will continue well beyond the end of 2009. But the critical issues here is that any attempt to estimate the insurance losses entails certain assumptions about the lawsuits yet to come, and the magnitude of the losses estimated will vary materially depending on the assumptions used.

 

The foregoing analysis suggests a number of competing considerations, some of which might imply larger overall insurance losses, some of which cut the other way, and some of which that will have an uncertain impact. For that reason, I think it is particularly difficult to try to estimate the insurance industry’s overall exposure from the credit crisis related litigation. As a result, I have no opinion one way or the other about the accuracy of Advisen’s estimate.

 

That said, I agree with Advisen that the insurance industry’s overall losses are going to be very large, and that whatever the loss projection might have been in February 2008, developments since that time suggest that the number almost certainly has increased. Moreover, as a result of the events in the financial marketplace during September and October 2008, there are increased prospects for further significant losses to continue to accumulate across a wide variety of companies and across a wide variety of industries. There is every possibility that Advisen will find it necessary to increase its estimate in the future.

 

I think the most recent developments in the financial markets may be particularly significant for the insurance industry’s ultimate losses. These events included some enormously significant events, including, for example, the largest bank failure in U.S. history, the bankruptcy of one of the largest investment banks, and the government’s bailout of the largest insurance company. At the same time, commodity prices and currency exchange rates changed direction abruptly and significantly. These and other developments will continue to reverberate through the global economy for months and perhaps years.

 

One of the direct consequences from these developments is that there will be significant additional litigation, and this additional litigation will emerge for some time – as I noted above, the litigation could well continue to emerge beyond the end of 2009. Because of the turmoil in the global financial market, this litigation is widely dispersed across the entire economy. That is, unlike the litigation exposure that prevailed in the early stages of the subprime meltdown and credit crisis, which was concentrated in the financial and real estate sectors, the litigation exposure now ranges across most industries and many companies.

 

Is the D&O Insurance Industry Headed for a Hard Market?: The insurance industry in general has not yet reacted fully to these developments. To be sure, and as fully noted in the Advisen report, companies in the financial sector are now seeing D&O insurance price increases and a more challenging underwriting environment. The Advisen report also suggests, correctly in my view, that there are a variety of factors that potentially could lead to a hardening market ahead, including in particular the losses associated with Hurricane Ike and other catastrophic events, as well as the marketplace disruptions involving AIG and the investment losses that have accumulated at other leading carriers.

 

All of that said, other than with respect to companies in the financial sector, there is little present evidence of a market turn. For most companies, conditions remain competitive, and both pricing and available terms and conditions remain attractive.

 

A harder market may well lie ahead, as Advisen suggests. The question is how far ahead. I doubt companies generally will experience a hard D&O insurance market until insurers are reporting substantial calendar year losses across their D&O portfolio.

 

The Advisen report suggests that the credit crisis-related losses will be spread "across 2007, 2008 and 2009." However a close reading of the Advisen reports reveals that Advisen is referencing "accident years" not "calendar years." Losses associated with claims in a particular accident year may not be fully developed until years later. An insurer recognizes a loss only when the claim is paid or a reserve against the ultimate amount is finally established. The calendar year in which the loss is finally recognized may be years after the accident year in which the claim first arose. The lag time to the ultimate loss in the professional liability insurance lines can be as long as three years or more. The lag time creates a risk (all too often realized) of loss underreporting.

 

Another danger of the lag time is the possibility that carriers may misunderstand their own loss experience, which could produce a mismatch between the risks assumed and the pricing charged. Exacerbating this concern is the insurers’ delayed recognition that the litigation threat from the evolving credit crisis has spread to the larger economy. Simply put, current pricing may not reflect the existing litigation exposure.

 

The interaction of these factors suggests the possibility that the arrival of the harder market could be delayed but could be even more disruptive when it arrives. The carriers that are the slowest to recognize the changed circumstances will be the ones that experience the most disruptive impact.

 

Of course, to the extent that AIG’s travails and other carrier’s investment portfolio woes produce a shortage of insurance capacity, the hard market’s arrival could be accelerated. But my own view is that predictions of a hard market for D&O insurance could be premature until the insurers begin to recognize serious calendar year losses in the professional liability lines.

 

More Bank Closures: In what has become a regular Friday night ritual, after the close of business on Friday November 7, 2008, the FDIC announced the closure of two more banks.

 

First, the FDIC announced (here) that state regulators had seized and the FDIC had been appointed the receiver of Franklin Bank of Houston Texas. Second, the FDIC also announced (here) that it had been appointed receiver of Security Pacific Bank of Los Angeles, California, after the bank was closed by state banking authorities.

 

These two bank closures represent respectively the eighteenth and nineteenth bank closures so far during 2008. The FDIC’s complete list of bank closures during the period October 1, 2000 through the present can be found here. Of the 19 bank closures year to date, thirteen have occurred since July 1, 2008. Moreover, after the close of business for the past four Fridays in a row, the FDIC has announced at least one bank closure.

 

The year to date number of bank closures already represents that highest annual total since 1993, at the tail end of the last era of failed banks. More to the point, the pace of bank closures, which has increased in the second half of 2008, has accelerated over the past four weeks.

 

For anyone who remembers the last era of failed banks, these bank closures represent a particularly ominous sign. They also represent one more reason why I believe that the turmoil from the credit crisis, and associated litigation, will continue for some time to come.

 

One of the more distressing side effects of the recent dramatic events in the global financial markets has been the sudden and unexpected reversal of fortune on any number of financial transactions and positions, particularly with respect to commodities and currencies. These developments have proven to be particularly troublesome for market participants that sought to protect themselves from commodities or currency exposure through financial hedges, only to find themselves suddenly stuck in wrong way bets as commodities prices or currency exchange rates moved quickly in unexpected directions.

 

At least in connection with several companies, the consequences from these adverse hedge transaction developments have included the arrival of securities class action lawsuits.

 

The most recent of these lawsuits have both involved foreign domiciled companies. Sadia, S.A. is a Brazilian meat products and processing company whose shares trade on the Brazilian exchange and whose ADRs trade on the NYSE. According to their November 5, 2008 press release (here), plaintiffs’ lawyers have initiated a securities class action lawsuit against Sadia and certain of its directors and officers in the Southern District of New York, on behalf of persons who bought both shares and ADRs of Sadia between April 30, 2008 and September 26, 2008. A copy of the complaint can be found here.

 

According to the press release, the complaint alleges that during the class period:

 

Sadia entered into undisclosed currency derivative contracts to purportedly hedge against the Company’s U.S. dollar exposure. The Company characterized the amounts of these contracts as "nominal." However, these contracts violated Company policy in that they were far larger than necessary to hedge normal business operations and resulted in a loss of $365 million. As a result of Defendants’ admission of violating Company policy regarding currency hedging, the American Depository Receipts of Sadia S.A. closed at $9.50 per share, down from the previous day’s close of $15.27, a decline of 38%.

 

The second of these recent lawsuits involved Britannia Bulk Holdings, a U.K.-based drybulk shipping and maritime logistics services company that conducted a $116.2 million IPO on June 17, 2008. According to their November 6, 2008 press release (here), plaintiffs’ lawyers have initiated a securities class action in the Southern District of New York against the company and certain of its directors and officers, as well as against its offering underwriters. A copy of the complaint can be found here.

 

According to the press release,

 

on October 28, 2008, Britannia Bulk issued a press release announcing that the Company expected a significant net loss for the third quarter of 2008 compared to the net income achieved during the second quarter of 2008. The loss was due to problems with hedges the Company had entered into earlier in the year. In addition, the Company announced it would not pay a dividend on its common shares for the quarter ended September 30, 2008, or for the foreseeable future.

Following this disclosure, the Company’s stock collapsed to $0.16 per share. The following day, the Company disclosed that it had been notified by its lenders that they were accelerating all of its subsidiary’s obligations under a $170 million lending facility. This would ultimately result in the subsidiary being placed into administration under U.K. insolvency laws.

According to the complaint, the Registration Statement failed to disclose the problems in the Company’s activities in the forward freight agreements ("FFAs") market. Specifically, the Registration Statement concealed that the Company failed to institute and enforce controls that would prevent Company personnel from buying FFAs not purchased to hedge identifiable ship or cargo positions. FFAs were represented to only be used as a hedge for work Britannia Bulk’s ships engaged in. However, in fact, FFAs were used outside of these guidelines, exposing the Company to significant risks. Moreover, the Company had not entered into appropriate fixed price contracts given the dramatic fluctuation in crude oil and bunker fuels.

Add to these two the securities lawsuit recently filed against Pilgrim’s Pride (about which I previously wrote here), which also included allegations of an ill-timed hedge designed to control price increases for its feed materials, that hurt the company when feed prices unexpectedly plunged.

 

While the companies and specific transactions involved are very diverse, the common thread among these cases is that in each case the company was harmed as a result of a wrong-way bet on commodities or currencies. In each case, the sudden and dramatic events in the financial markets during September and October 2008 produced a magnified impact on financial condition of these companies. To be sure, in the Sadia and Brittania Bulk cases, the circumstances appear to have been exacerbated by allegedly unauthorized trading, but nevertheless in all three cases the financial harm resulted from hedging or hedge related activities that suddenly and unexpectedly went very wrong.

 

These companies are far from the only companies that attempted to protect themselves from rising commodities prices or currency exposures through hedge transactions, and that are also likely far from the only companies that found themselves in wrong-way bets when the commodities and currency markets moved unexpectedly and materially in unexpected directions in recent weeks.

 

Indeed, a November 6, 2008 Wall Street Journal article (here) described the steep losses some investors (including several large companies) have incurred in connection with their investment in a relatively new derivative investment called an "accumulator, which obligates the investor to buy a fixed quantity of a security, commodity or currency at a fixed price and at regular intervals. This approach works when prices are rising, but can be devastating when prices fall. The article specifically mentions VeraSun, which recently filed for bankruptcy, and which experienced huge losses on accumulator contracts for the price of corn. The article also mentions Citic Pacific, which recently experience losses of as much as $2 billion on an accumulator contract linked to the Australian dollar.

 

Another common thread among these companies is that most of them are not involved in the financial services industries. Each of these company’s circumstances represents an example of the ways that the turmoil in the global financial markets during September and October 2008 has altered the prior wave of subprime and credit crisis-related litigation, which before that time had been largely been confined to the financial services and real estate industries, to spread into the larger economic and financial marketplace.

 

The fallout from the disruptive events of the past few weeks has already included significant litigation activity outside the financial sector. While it still remains to be seen how extensive the litigation activity beyond the financial sector ultimately will prove to be, at this point it seems increasingly likely that a diverse range of companies could become involved.

 

In making this observation, I am not limiting my prognostication just to companies that have engaged in hedging transactions, but rather I am contemplating the entire universe of companies that have experienced a significant reversal of fortune due to the this fall’s disruptive events. So, in addition to companies that have experienced unexpected reversals on wrong-way bets on commodities or currencies, there are companies that were adversely affected by Lehman Brothers’ failure (refer here) or by the sudden seizing up of the credit markets that followed (refer here). In the days to come, there will be an increasing number of companies reporting problems due to these and other concerns. While not every company reporting these problems will sustain a securities class action lawsuit, a significant number will, and many of them, like the companies mentioned above, will be outside of the financial sector.

 

With the sentencing of the last two defendants in the criminal investigation of the Milberg law firm and several of its former partners, it may be time to ask what the impact has been on the plaintiffs’ securities bar and what the future may be for securities litigation. There are also interesting questions about what the impact may be on securities litigation as a result of  Barack Obama’s election to the White House and the augmentation of the Democrats’ control of Congress.

 

These questions were the focus of a November 5, 2008 panel at the PLUS International Conference in San Francisco. The panel, which was moderated by Edwards Angell Palmer & Dodge partner John McCarrick, included Boris Feldman of the Wilson Sonsini firm; Professor Joseph Grundfest of Stanford Law School; Keith Fleischman of the Grant & Eisenhofer firm; and Judge Vaughn Walker of the Northern District of California.

 

The session was preceded with a fascinating video created for the event entitled "The Rise and Fall of William Lerach," which detailed the career and criminal prosecution of former plaintiffs’ securities bar titan Bill Lerach. The video also included an interview of Lerach that had been taped before Lerach began his incarceration.

 

The video included a detailed history of the circumstances underlying the criminal investigation of the Milberg firm, including the fascinating story of how a lovers’ quarrel in Cleveland and the discovery of stolen paintings in a public storage warehouse led to Lerach’s indictment and eventually to the entry of guilty pleas by Lerach and others. (I detailed these events behind the criminal indictments, including pictures of the stolen paintings and how they related to the overall story, here).

 

The video contained some extraordinary footage, including a vintage video clip of Lerach in a 2003 speech about supposedly corrupt corporate officials, quoting the Bible (refer to text here) as saying, "What profit a man if he gain the whole world but lose his own soul?" – adding parenthetically on his own, "or his freedom." The video also quoted Lerach as saying several times in an apparent attempt to defend the kickback payments that led to his conviction that "it was an industry practice" and that his firm did it "because we had to" in order to "meet competition. "

 

Following the video, the panelists turned to the question of the current state of the plaintiff securities bar and what may lie ahead.

 

The discussion focused initially on the question whether the leading plaintiffs’ lawyers’ demise has opened the door for other plaintiffs’ firms. Boris Feldman observed that the level of talent in the plaintiffs’ has proven to be both deep and broad. He added, however, that in his view that the more significant development is that the power of the securities class action cases seems to have shifted from an individual lawyer, like a Lerach or a Mel Weiss, to institutional investors. Keith Fleishman agreed that institutional investors are in greater control of these cases.

 

Judge Walker expressed a contrary view, commenting that from his perspective the cases "largely have not changed." He said that the involvement of a sophisticated institutional investor that "rides herd" occurs "in relatively few cases." In the vast majority of cases, he said, "things have not changed." He said that in his view, plaintiffs’ lawyers are "still very much in the drivers’ seat."

 

He went on to note that the problems with the system are not confined to the conduct to which Lerach plead guilty, noting that Lerach had plenty of what Walker called "accessories." Among the "accessories" Walker identified are the judges who have not "ridden herd" to scrutinize settlements, fee awards and claim administration. He also identified the defense bar as among the "accessories," who present settlements without having obtained the facts but instead "locking arms" with the plaintiffs’ counsel at settlement hearings, as a result of which there is no "adversary presentation" of the kind on which courts depend.

 

Judge Walker expressed concern that there is little monitoring or participation in the strategic process, and "frankly not enough discipline" in the system "to weed out the cases" that should not be pursued.

 

Keith Fleischman disagreed with Judge Walker and said that in his experience, courts were very much engaged in the supervision of cases and their settlements, and required a process in which the developments were "highly scrutinized."

 

Professor Grundfest offered the view that perhaps both Judge Walker’s and Fleischman’s viewpoints were correct because the cases are "bifurcated" between the larger cases in which institutional investors are actively involved and the smaller cases where smaller plaintiffs’ firms and investors with smaller interests are involved. Grundfest observed that the vast majority of cases either are dismissed or settle for under $10 million, and the institutional investors are not involved in these smaller cases.

 

Boris Feldman observed that some of these smaller plaintiffs may include small Taft-Hartley funds whose involvement may represent a "version 2.0" of the activities that led to the problems of which Lerach was convicted. He raised the question about the small union locals that are repeatedly involved in securities cases in which they actively seek lead plaintiff status, which, Feldman suggests, raises questions about what is really in it for the local funds and whether there are favors of one kind or another that that motivates these small funds.

 

An interesting related question that came up in the panel discussion is whether or not the institutional investors’ involvement in securities litigation could lead to an increase in the number of securities cases that go to trial. Fleischman first raised this, suggesting that expectations on both sides of these cases have changed, which could lead to more cases going to trial.

 

Feldman came back to this topic later, suggesting that the dynamic has changed in cases in which politicians are involved, such as where the lead plaintiff is a large public pension fund. Feldman observed that the specialized lawyers who have handled these cases generally know what a case is worth, and generally know about where a case will settle. Politicians may have other motivations, and may well believe that a trial victory would be more valuable to them than a settlement.

 

Professor Grundfest also suggested that plaintiffs’ firms, managing a portfolio of cases almost in the same way a hedge fund manages its investments, may find it expedient to take cases to trial as one way to try to maximize returns across their entire portfolio. Grundfest agreed that we are probably going to see more trials.

 

The panel discussed a number of other topics, including the way in which plaintiffs’ plead damages in the class action complaint. Judge Walker observed that insufficient attention is paid to whether the theory of damages alleged makes sense. He noted that not enough attention is paid to demonstrating the way that the defendant company’s stock price moved with respect to the alleged misrepresentations.

 

The panelists also discussed the way in which e-discovery has changed these cases. Feldman observed that e-discovery has been a "goldmine" for the plaintiffs’ lawyers, and because of the expense involved, the "big loser" has been the insurance companies. Grundfest noted that he tells his students that "e-mail" stands for "evidence mail" because it "captures and creates smoking guns." Judge Walker noted that these documents can sometimes assume an importance all out of proportion to the case as well.

 

What the Election Means for the Plaintiffs’ Bar: The panel concluded with the panelists making predictions about what Tuesday’s election may signify for securities litigation. Grundfest opened the discussion by stating that as a result of the Democrats’ sweeping electoral victory, the headline is that "Christmas comes early" for the plaintiffs’ bar, and the only question is "what’s in the boxes and what’s under the tree." Grundfest suggested that the plaintiffs’ bar may succeed in having Congress legislatively reverse Stoneridge and Central Bank.

 

Grundfest also suggested that Congress might move toward revising the pleading standard in securities cases, moving from the currently more restrictive standard to one where the case could survive a motion to dismiss if there were the "mild aroma" of fraud. Grundfest also suggested that as the likely changes could "dramatically increase the exposure" for the insurers, because the potential securities litigation exposure is "likely to go up in the future."

 

Feldman agreed that, after a period in which conditions may have been relatively advantageous for defendants, we could have entered "a bad period from a claims perspective for insurance companies." Feldman suggested that Obama’s judicial appointees are likely to be more receptive to class actions, and to favor the "interests of the little man." He agreed that the plaintiffs’ priorities are likely to get through Congress and also that Central Bank is likely to be legislatively reversed. He also said that the current credit crisis will feed into this processes, as excesses unearthed as part of the credit crisis will become the "poster children" to justify the legislative changes.

 

Judge Walker concluded the discussion with an observation of the irony that we now find ourselves in a period of the greatest upheaval of our generation yet two of the most talented plaintiffs’ lawyers are "out of action."

 

At first glance, poultry producer and processor Pilgrim’s Pride and shopping center REIT General Growth Properties would seem to have little in common. But while they may be in different business sectors they share a remarkable number of common woes.

 

Both are laboring under crushing debt obligations associated with recent acquisitions, and both face potentially insurmountable problems servicing or restructuring their debt. The problems facing both companies are further exacerbated by the economic downturn. In each case, the founding families may lose control of the companies, or perhaps even their entire investment. Both companies have also seen their share prices plummet.

 

And now, both companies have been hit with securities class action lawsuits.

 

While these two new lawsuits at one level are the result of these two companies’ particular challenges, the underlying debt issues and complications arising from the current credit crisis could affect legions of other companies, and possible spark even further securities litigation.

 

Pilgrim’s Pride: As detailed in a front-page October 17, 2008 Wall Street Journal article entitled "Debt Woes, Feed Costs Come Home to Roost at Pilgrim’s" (here), Pilgrim’s Pride is struggling under the burden of debt associated with its 2007 acquisition of rival Gold Kist, making Pilgrim’s Pride the "world’s largest chicken company."

 

As noted in a subsequent Journal article (here), in addition to an "increasingly untenable debt load," the company has been "hammered by rising prices for feed, bad bets in the grain market, [and] falling prices for chicken." The October 17 Journal article details an ill-timed hedge the company had entered, fixing its grain feed costs when prices had peaked, locking the company into a costly contract just before prices began to decline.

 

Pilgrim Pride’s financial challenges have been "exacerbated" by the economic downturn, as a result of which fewer consumers are dining out, reducing demand for chicken.

 

Due to these circumstances, Pilgrim Pride’s share price has declined 97 percent this year. On October 30, 2008, press reports (here) speculated that the company, which faces pending interest payments it may not be able to fulfill, is a "likely" candidate for bankruptcy.

 

In addition, and also on October 30, 2008, plaintiffs’ lawyers issued a press release (here), announcing that they have filed a securities lawsuit in the Eastern District of Texas against Pilgrim’s Pride and certain of its directors and officers. A copy of the complaint can be found here.

 

According to the press release, the complaint alleges that the defendants "misrepresented the Company’s financial condition and concealed the impact of the Company’s capital problems on its business and prospects." The Complaint specifically references the company’s September 24, 2008 press release (here), in which it announced that it had "notified its lenders that it expected to report a significant loss" in its fiscal period ending September 27, "due to high feed-ingredient costs, continued weak pricing and demand for breast meat, and the significant impact of hedged grain positions during the quarter."

 

According to the press release, the complaint alleges that the defendants failed to disclose that:

 

(a) the Company’s hedges to protect it from adverse changes in costs were not working and in fact were harming the Company’s results more than helping; (b) the Company’s inability to continue to use illegal workers would adversely affect its margins; (c) the Company’s financial results were continuing to deteriorate rather than improve, such that the Company’s capital structure was threatened; (d) the Company was in a much worse position than its competitors due to its inability to raise prices for customers sufficient to offset cost increases, whereas its competitors were able to raise prices to offset higher costs affecting the industry; and (e) the Company had not made sufficient changes to its business model to succeed in the more difficult industry conditions.

 

General Growth Properties: As detailed in Wall Street Journal articles dated October 20, 2008 (here), and October 28, 2008 (here), the "aggressive mortgage financed acquisition strategy" of General Growth Properties, the second-largest U.S. mall owner, "has left the company with little ability to pay debt coming due amid the credit crisis."

 

As detailed in an October 27, 2008 Bloomberg article (here), General Growth’s shares have declined over 95 percent this year "on concern that the company won’t be able to refinance about $1.2 billion of debt this year." The debt stems in part form the company’s 2004 $11.3 billion acquisition of Rouse companies.

 

Compounding the company’s difficulties are the departures of three of the company’s senior executives (refer here), on reports that the executives had obtained loans from a trust associated with the company’s founding family, in order to pay of margin debt the executives had incurred to acquire stock in the company.

 

The company had earlier sought to raise capital through the sale of preferred stock, but these efforts "fizzled", as reported in the October 28 Journal article. The company is now seeking to sell three massive Las Vegas luxury malls, to try to address the company’s "most pressing problem," which is $900 million in mortgage acquisition costs coming due on November 28. The October 28 Journal article reports that "without an extension or new funding, General Growth doesn’t have cash on hand to pay the debt."

 

General Growth is burdened not only with the heavy load of debt that financed its acquisition strategy and difficulty in obtaining credit or additional capital, but it is also challenged by falling real estate values and increasing vacancy rates, driven by the declining economy.

 

On October 31, 2008, plaintiffs’ counsel issued a press release (here) announcing that they had initiated a securities class action lawsuit in the Northern District of Illinois against General Growth and certain of its directors and officers. A copy of the complaint can be found here.

 

According to the press release, the Complaint alleges that the defendants "made false and misleading statements about General Growth’s access to financing," in particular that the company "had the ability to refinance billions of dollars of debt that was coming due in the fall of 2008 and the spring of 2009, on acceptable terms." The complaint further alleges that the company failed to disclose that "the Company’s President/Chief Operating Officer had received loans from the Chief Executive Officer’s family trust in violation of the Company’s own Code of Business Conduct and Ethics."

 

Discussion: Pilgrim’s Pride and General Growth are far from the only companies burdened with debt incurred as a result of acquisitions fueled by the easy credit during an earlier era. Nor are they the only companies laden with debt they may not be able to refinance or repay while also facing the adverse effects of the general economic downturn.

 

Just this past week, the U.S.’s second largest ethanol producer, VeraSun, filed for bankruptcy; VeriSun also fell victim of wrong way hedges on corn supplies (refer here). Well-known retailers Mervyn’s, Linens ‘N Things, and Shoe Pavilion are already in liquidation (refer here). The financial difficulties have also spread to some unexpected places, as described, for example in the October 29, 2008 Wall Street Journal article entitled " Cash-Poor Biotech Firms Cut Research, Seek Aid" (here).

 

One particular area of concern involves the numerous companies acquired as part of debt-financed leverage buyout. As detailed in a November 2, 2008 New York Times article entitled "Debt Linked to Buyout Tighten the Economic Vise" (here),  "many of the loans used to finance the deal are coming due at the worst possible time." The article quotes a Harvard Business School professor as saying that "The big question is how apocalyptic it will be." 

 

 

In the weeks and months ahead, there will be other companies – perhaps many other companies – faced with precisely the same dismal circumstances as these two companies. In the current economic downturn, all companies will suffer, and weaker companies will struggle. Highly leveraged companies may not survive.

 

As other companies toil with these challenges amid the difficult financial conditions, many of them may also become the target of securities litigation. Indeed, as I noted in recent posts (here and here), the "bad economic vibe" could result in further securities litigation.

 

While the arrival of additional securities lawsuits seems likely, it remains to be seen how many of these cases succeed. As I noted in a recent post discussing the subprime-related securities litigation (here), courts increasingly appear skeptical of allegations that a company’s collapse in the current challenging economic circumstances, even if the result of aggressive or even sloppy business practices, is the result of fraud.

 

An additional question these cases present is whether they are sufficiently credit-crisis related to be included in my running tally of subprime and credit crisis-related securities litigation (which can be accessed here). While I could certainly come up with arguments for including these cases, in the end I don’t think they belong on the list. These cases are more the result of generalized business conditions rather than the specific phenomenon I have been trying to capture in my lawsuit tracking. But regardless of how they are categorized, these cases certainly do suggest we are and will remain in a period of heightened litigation activity.

 

One final note about these cases is that they involved companies outside of the residential real estate and financial services industries. Whether or not these cases are credit crisis related for purposes of categorization and tracking, they are definitely indicative of the way in which deteriorating financial and economic conditions — that originated in the subprime arena but quickly spread more broadly — threaten to extend the current litigation wave beyond the financial sector to the general marketplace.

 

The subprime and credit crisis litigation wave may well have been contained to a relatively narrow segment of industries, but as economic conditions continue to deteriorate, the litigation thread will become more generalized and widespread.

 

Another Failed Bank: After the close of business on Friday October 31, 2008, state banking regulators closed Freedom Bank of Bradenton, Florida, and the FDIC was named as a received. An FDIC press release describing the closure can be found here. According to the FDIC’s Failed Bank List (here), the closure of Freedom Bank is the 17th U.S. bank seized by regulators so far in 2008.

 

As reflected in a November 1, 2008 Bloomberg article (here) reporting about Freedom Bank, the number of bank closures in 2008 year-to-date represents the highest number of bank failures since 1993, which was of course at the tail and of the last significant era of failed banks.

 

The Bloomberg article also reports that Freedom Bank had lost $258 million in the last two quarters from rising losses on real estate loans. Freedom is the second bank failure in Bradenton this year; in August, regulators closed First Priority Bank of Bradenton (about which refer here).

 

Contagion: The November 1, 2008 New York Times article entitled "From Midwest to M.T.A., Pain from Global Gamble" (here) describes how market place participants as diverse as Wisconsin school systems and New York’s Metropolitan Transit Authority were ensnared in the financial difficulties of formerly high-flying Irish bank Depfa, which in October 2007 merged into German bank Hypo Real Estate. The consequences for Hypo have proved to be dire, as the company recently required a massive bailout from the German government.

 

The consequences for the Wisconsin schools have also been calamitous, as detailed in the article. The article does not mention that the Wisconsin schools have already launched a lawsuit against the broker/dealer and investment bank responsible for the schools’ CDO investment. My prior post discussing the Wisconsin schools’ lawsuit can be found here.

 

PLUS Week: This upcoming week, I will be in San Francisco attending the PLUS International Conference. As a result, The D&O Diary will likely not maintain its usual publication schedule. If you see me at the conference, I hope you will take a moment to introduce yourself, particularly if we have not previously met. See you in San Francisco.

 

At what point can we declare that the subprime securities lawsuits are not doing particularly well in the courts? It may not yet be time, but there unquestionably are growing numbers of subprime lawsuits that have failed to survive motions to dismiss, at least as a preliminary matter.

 

The latest evidence of this phenomenon involves the securities lawsuit filed against Fremont General and certain of its directors and officers. As detailed here, Fremont plaintiffs first initiated the securities suit in June 2007. The 175-page Amended Consolidated Complaint in the case can be found here.

 

The plaintiffs allege that Fremont, a subprime mortgage lender, misrepresented the "quality of Fremont’s underwriting, loan quality and loan performance," and also that misrepresentations in Fremont’s financial statements "resulted in a material deception of the investing public." It was, the plaintiffs alleged, "only a matter of time before the Company’s extremely loose lending practices – driven by aggressive volume targets and financial incentives – would result in substantially increased mortgage delinquencies and material losses for Fremont investors."

 

Fremont filed for bankruptcy on July 9, 2008. The securities lawsuit was stayed as to the company but proceeded against the individual defendants. The defendants moved to dismiss the plaintiffs’ complaint.

 

In an October 28, 2008 order (here), Central District of California Judge Florence-Marie Cooper granted the defendants’ motion to dismiss, but allowed the plaintiffs 45 days in which to file a further amended complaint.

 

In their motions, the defendants had contended that the plaintiffs had failed to allege sufficient facts to satisfy the material misrepresentation and scienter pleading requirements for a 10b-5 claim.

 

Judge Cooper began her analysis of the motions with a commentary on the "disjointed nature of the allegations" in the Amended Complaint, noting that "nearly 100 pages" of the pleading "are dedicated to recounting of the history of the company, allegations of flaws in the company’s underwriting practices, and allegations of misstatements in various financial statements." She noted that she had "scoured" the Amended complaint "in an effort to link Lead Plaintiff’s allegations of specific statements with the alleged reason(s) those statements are misleading." She observed that "the internal cross references…fail to substantiate Lead Plaintiffs’ conclusory allegations that the statements were false and, in nearly all cases, they fail to illuminate why or how the falsity was material."

 

The Court also noted that while the complaint has "numerous references to representations by or knowledge of ‘Defendants’" these references "collectively do not facilitate a reasoned assessment of the statements and knowledge attributable to the Individual Defendants."

 

Finally, Judge Cooper also noted that "more often than not, the cross-referenced allegations intended to evidence the falsity of the alleged misrepresentations fail to adequately plead scienter in connection with those statements."

 

Because she concluded that the plaintiffs’ allegations "do not clearly articulate the basis of Lead Plaintiff’s Section 10-b and Rule 10b-5 claims against the Individual Defendants," Judge Cooper granted the motion to dismiss, with leave to amend.

 

It of course remains to be seen whether the plaintiffs will be able to address the court’s concerns in their amended complaint; to the extent they can, their case may go forward. But though Judge Cooper’s dismissal ruling is merely provisional, it is the latest in a series of similar rulings where courts have proven unreceptive to similar allegations raised against companies caught up in the subprime meltdown.

 

As I noted in prior posts concerning dismissals in the IMPAC Mortgage case (refer here), NovaStar Financial case (here), the Standard Pacific case (here) and First Florida Home Builders of Florida case (here), courts have proven demanding in their expectations regarding the specificity of the allegations required in the claims against these participants in the subprime marketplace. The courts clearly want to see more than that the companies engaged in aggressive business practices before their residential lending portfolio collapsed.

 

To be sure, there have been cases in which the plaintiffs’ allegations have proven sufficient to survive a motion to dismiss, as for example in the Toll Brothers case (refer here). But several courts now have made it clear they expect to see more than the existence of a mess left from the subprime meltdown. Generalized allegations that the lending institutions were aggressive or even that they failed to follow their own loan underwriting guidelines apparently may not be enough.

 

The subprime litigation wave is still in its earliest stages, and for that reason it may be premature to start making any generalizations. Nevertheless, it is at least interesting to note that a growing (and arguably significant) number of the earliest filed subprime securities cases are finding it difficult to survive the preliminary motions. Some of the cases may yet go forward following the amended pleading stage. But at least based on the most recent preliminary rulings, the question does arise whether the general economic turmoil has made courts skeptical of generalized allegations of fraud.

 

There will of course be further developments in the weeks and months to come. I will be tracking the results on my table of subprime and credit crisis-related case dispositions, which can be accessed here.

 

Namesake: Fremont General’s name doubtlessly derives from that of John C. Frémont, the 19th century American explorer, military commander and politician. Frèmont is known as "The Great Pathfinder" for his surveys of the Oregon Trail, the Oregon Territory, the Great Basin, and the Sierra Mountains in California.

 

Frèmont was one of the two first Senators from California in 1850. Frèmont was also the Republican party’s first candidate for President in 1856 and he was the first major party Presidential candidate to run in opposition to slavery. He had the dubious distinction of losing to James Buchanan. He did at least draw more votes than Millard Fillmore.

 

Frèmont’s name lives on as the moniker for numerous counties, cities and civic buildings, in California and elsewhere. And, until it went bankrupt earlier this year, there was also a subprime mortgage lender named after him as well.

 

Observations on the Blogosphere: Congratulations to the Drug & Device Law Blog (here), which is celebrating the second anniversary of its blogging existence. In a post today, the blog’s authors pose this question, with following commentary:

 

We have a question for someone with access to the data: What percentage of legal bloggers stop publishing within 12 months of launching a new blog?

We don’t know the answer to that, but we bet it’s like small businesses — most fail within a year.

Why?

First, as we’ve said before, blogging is hard, hard work. It’s not easy to maintain an active legal practice by day and find time at night for massive "recreational" writing. Try writing five or six shorts articles a week (which is what we’ve averaged) for just one week. Think about what that would feel like for three months. And now imagine what we’re celebrating today — two years cranking out posts at that pace.

   

The authors are absolutely correct about how difficult it is for a fully occupied professional to maintain a blog over time. The authors supply their own reasons why they continue to blog despite the enormous burdens and effort required. I concur with their views, particularly as respects interaction with the audience and the ability to influence the dialog.

 

Andrew Sullivan, the author of The Daily Dish blog (here) has a more detailed answer in a November 2008 Atlantic Monthly article entitled "Why I Blog" (here). Sullivan eloquently captures what makes blogging so exhilarating — and excruciating. He notes that "for bloggers, the deadline is always now. Blogging is therefore to writing what extreme sports are to athletics: more free-form, more accident prone, less formal, more alive. It is, in many ways, writing out loud."

 

One particularly distinctive aspect of the blogging experience is the immediacy of the connection between author and reader. Readers can (and do) easily post comments or send emails with corrections and criticisms. As a result, Sullivan notes, "the blogger can get away less and afford fewer pretensions of authority." Some of those who send comments, Sullivan adds,

 

unsurprisingly, know more about a subject than the blogger does. They will send links, stories, and facts, challenging the blogger’s view of the world, sometimes outright refuting it, but more frequently adding context and nuance and complexity to an idea. The role of a blogger is not to defend against this but to embrace it. He is similar in this way to the host of a dinner party. He can provoke discussion or take a position, even passionately, but he also must create an atmosphere in which others want to participate.

 

As Sullivan notes, this interaction is "an integral part of the blog itself." He is absolutely correct when he observes that "you’d be surprised by what comes unsolicited into the inbox, and how helpful it often is."

 

But while I agree with Sullivan’s essay on many points, I also think his concept of the blogosphere is peculiarly narrow and as a result his analysis is impoverished. Sullivan apparently presumes that all blogs and blogging lives resemble his own. However, Sullivan inhabits a rarified and privileged corner of the blogosphere, one that only an infinitesimally small number of bloggers enjoy. He is, for example, able to blog full–time. In addition, he has "an assistant and interns to scour the Web for links to stories and photographs." These are assets and advantages about which most bloggers can only fantasize.

 

Because he is blind to the varieties of blogging experience, Sullivan overlooks the diversity of blogging philosophy and goals that coexist with his own. To use but one very concrete example, his essay completely fails to take account of the numerous excellent law blogs in the blawging community (of which the Drug and Device Law blog is a superb example.)

 

Were Sullivan to encompass these kinds of blogs in his descriptions, he could not assert that "the blog has remained a superficial medium" or that blog readers are unwilling to read more detailed essays. His blog may be superficial, and his readers may have short little spans of attention, but those characteristics are not universal, either as to blogs or as to blog readers.

 

Sullivan also seemingly overlooks the challenge and pain (duly noted on the Drug and Device Law blog) that many bloggers experience trying to juggle our blogging addiction with the demands of our day jobs. Though Sullivan’s essay nowhere recognizes these challenges, I am confident that for many working bloggers these elements define the essence of their blogging experience. Bloggers with the luxury of blogging fulltime are spared these challenges.

 

Some day I will unburden myself of the longer essay on blogging that burns within me. Whenever that day comes, I will attempt to fill some of the critical voids in Sullivan’s essay. The most important point is the role that that blogs can play in a specific professional community — for the exchange of ideas, for the development of connections, and for the passing events to be noted. Over time, a blog can also become a reference source for an entire industry (a point that the authors of the Drug and Device Law blog also note in their second anniversary post).

 

Until the day comes when I finally write my own essay on blogging, I will have to let it suffice to quote with approval one remark in Sullivan’s essay, in which he says "there are times, in fact, when a blogger feels less like a writer than an online disk jockey, mixing samples of tunes and generating new melodies through mashups, while making his own music."

 

Ultimately, as Sullivan writes in explanation of how he got hooked on blogging, "the simple experience of being able to directly broadcast my own words to readers was an exhilarating literary liberation."

 

Hat tip to the FCPA Blog (here) for the link to Sullivan’s essay.

 

The credit crisis recently entered a dark new phase, and this new darker phase has also already produced its own distinctive round of lawsuits. Like the ominous economic circumstances, the new litigation phase also seems darker and more threatening.

 

In the latest issue of InSights (here) — entitled "Has the Credit Crisis Litigation Wave Reached an Inflection Point?" – I briefly review the subprime litigation wave as it developed over the past two years and then examine the dramatic events that occurred in the financial marketplace beginning in September 2008. The article then examines the recent wave of litigation surrounding these events and concludes with an assessment of what these developments may signify going forward.

 

No Avalanche After All?: Following the U.S. Supreme Court’s February 2008 decision in the LaRue case (about which I wrote here), in which the court recognized an individual’s right to pursue a breach of fiduciary duty claims for mismanagement of their 401(k) plan, there was significant speculation that the decision could unleash an avalanche of lawsuits. The avalanche may yet materialize. But in the meantime it is worth noting that despite his victory in the Supreme Court, LaRue himself has voluntarily dismissed his case in the district court, where the case was on remand after the Supreme Court’s decision.

 

As reflected in the October 21, 2008 Consent Order of Dismissal in the case (here),LaRue withdrew his complaint after he "decided that it is not financially feasible to continue to pursue his claim."

 

As Professor Paul Secunda noted on the Workplace Law Prof Blog (here), LaRue’s withdrawal of his case shows that "these types of claims are still extremely difficult for plaintiffs to prevail upon" and "all the doomsday prognostications to the contrary seem just a tad off."

 

Just In Case Those Bank Lawsuits Do Materialize: In a recent post (here), I speculated that we may be entering a new phase of litigation involving failed banks. Apparently I am not the only one who anticipates that we may be seeing more failed bank litigation. In an October 23, 2008 memorandum entitled "Failed Financial Institution Litigation: Remember When" (here), the Willkie Farr & Gallagher law firm observes that the recent dramatic financial institution failures "are likely to fan the flames for myriad government agencies to pursue litigation against all parties associated with the financial institutions."

 

The Willkie Farr memorandum takes a comprehensive look at the potential failed financial institution litigation that may emerge, referring to the litigation that unfolded during the S&L crisis as a guide. The memo examines likely litigants, including in particular the probable defendants. The memo also reviews the factual and legal issues that are likely to arise, including some issues that may be different in the current era than previously– for example, with respect to circumstances involving credit default swaps.

 

The memorandum also briefly reviews the D&O insurance issues that are likely to arise in connection with claims against the directors and officers of the failed financial institutions. Among other issues, the memorandum review issues in connection with the regulatory exclusion (about which I previously wrote here), and in connection with the insured vs. insured exclusion (which I wrote about here).

 

The Willkie Farr memorandum is thorough and comprehensive, and is a good resource to keep at hand in the event the "dead bank" litigation does in fact materialize.

 

An Insurance Professional Takes A Look Back: It may surprise those outside the industry, but the insurance business really is full of a wide assortment of interesting, amusing and entertaining people. Many of their stories are humorously retold by industry veteran Larry Goanos in his new book Claims Made and Reported: A Journey Through D&O, E&O and Other Lines of Insurance (here). Larry’s book examines the careers of some of the luminaries of professional lines insurance industry and provides valuable insights for business success.

 

While writing the book, Larry apparently interviewed over 400 people, some of whom started in the industry back in the 1940s and 1950s. Many of the stories Larry recounts have become legendary in the industry, such as the tale of the broker whose suit was seemingly in flames during a meeting while he continued to talk or the mid-level executive who bought a Rolls Royce as his company car –on his lunch hour. The book is written with in the same spirit of friendship and good humor that characterizes the best side of our industry, and will be enjoyable for anyone who is a part of or is interested in the industry.

 

Congrats to Larry on his book. He obviously had a lot of fun writing it, and a lot of people are going to have fun reading it. It is worth noting that Larry intends to split the proceeds from the book’s sales among four charities, including the PLUS Foundation and Grateful Nation Montana.

 

What the Hell is the Point of 36 Watches — Or, For That Matter, Three Mirrored Disco Balls?: In an October 29, 2008 Wall Street Journal article (here) describing unexpected challenges facing lenders that foreclosed on properties, the article details issues arising in connection with Indianapolis developer Christopher T. White and his business, Premier Properties USA:

 

Indianapolis prosecutors charged Mr. White in June with theft and fraud for writing a $500,000 check to Premier for payroll purposes on a nearly empty account. Mr. White’s defense attorney counters that the developer believed money was arriving to cover the check. A lender seized Mr. White’s personal property and in August auctioned items including five Vespa scooters, 15 flat-panel televisions, 36 watches and three mirrored disco balls.

 

"Where the Hell is Matt?": If you have not yet seen this latest viral Internet video, you have to take four minutes and watch it right now. Absolutely guaranteed to make you smile. Matt really does seem to have visited (and danced in) all the places depicted, which kind of makes you wonder how long it took to make this video. While he was dancing, the rest of us were sitting at our desks doing much more productive things…

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