In a development of potentially great significance for climate change disclosure and reporting issues, on August 27, 2008, New York Attorney General Andrew Cuomo announced (here) that Xcel Energy had entered a “binding and enforceable agreement” requiring the company “to disclose the financial risks that climate change poses to investors.” Xcel’s announcement regarding the agreement can be found here.

 

The agreement follows Cuomo’s September 2007 subpoenas to Xcel and four other utilities companies. As I discussed in a post at the time (here), the subpoenas were directed to the companies’ disclosures to shareholders of the financial risks regarding global warming and climate change. In his August 27 press release, Cuomo stated that his investigations of the other four companies (AES Corporation, Dominion Resources, Dynegy and Peabody Energy) are “ongoing.”

 

 

In its agreement, Xcel has undertaken to “provide detailed disclosure of climate change and associated risks” in its annual SEC filing on Form 10-K. Specifically, Xcel will provide “an analysis of financial risks from climate chance,” focused among other things on: 1. “present and probably future climate change regulation”; 2. “climate-change related litigation”; and 3. “physical impacts of climate change.”

 

 

In addition, Xcel also committed to a “broad array of climate change disclosures” including current and projected future increases in carbon emissions (particularly from planned coal-fired plants); company strategies for reducing or managing its global warming and climate change emissions; and corporate governance actions related to climate change, “including whether environmental performance is incorporated into officer compensation.”

 

 

Although Xcel is the only company that is party to the agreement, Cuomo was very explicit in his press release that his believes that the Xcel agreement has managed to “establish a standard,” and third parties are quoted in his press release as saying that the agreement may have created “an enforceable model for climate change disclosure.”

 

 

Perhaps one might imagine that developments involving only Xcel are irrelevant for other companies. However, one could imagine that only by disregarding overwhelming contemporaneous evidence to the contrary. Among other things, Cuomo’s recent auction rate securities settlement, similarly announced to great fanfare, quickly became a model for regulatory settlements with other auction rate securities targets. For that reason, it must be anticipated that the other four companies Cuomo targeted with subpoenas will face enormous pressure to enter similar agreements.

 

 

The more interesting question is whether the Xcel agreement will have a broader impact, and influence disclosures at other companies – and not just in the utilities industry, but in manufacturing, transport, mining and energy production and distribution, agriculture, and even insurance. As I noted in my prior post, virtually contemporaneous with Cuomo’s subpoenas to these utilities, several public interest organizations had petitioned the SEC to adopt specific climate change reporting guidelines. It is entirely possible that the Xcel settlement will increase the pressure, from shareholders as well as from regulators, to disclose their own financial risks from global climate change.

 

 

As I have previously noted, the danger to publicly traded companies is not just that they may face greater disclosure obligations; the danger arises from the fact that companies undertaking greater disclosure commitments, whether voluntarily or as result of compulsion, may be exposed to later allegations that they engaged in “selective disclosure” or “omission” of unfavorable information. It may only be a matter of time before allegations of this type make their way into civil complaints.

 

 

To be sure, a lawsuit must not only allege misrepresentations or omissions, it must also allege causally related damages. In the absence of shareholder losses related to climate change disclosures, plaintiffs’ lawyers would have little incentive to pursue a climate change disclosure lawsuit. But as scrutiny of these issues increases, and as disclosure pressures mount, the opportunity for market moving announcements also increases. To put it another way, as disclosure expectations increase, so do disclosure risks.

 

 

I have previously asserted that directors and officers of public companies face growing climate change-related exposure. Though these views have been greeted with some interest, there has also been skepticism. Indeed, there have, in fact, as yet been no climate change disclosure related D&O claims.

 

 

However, there are too many politicians who see this topic as a way to enhance their stature. There are too many interest groups that are willing to use all means, including litigation, to advance their agenda. And, indeed, there may even be too many financial risks and uncertainties from the underlying issues. Sooner or later, these forces inevitably will come together in a lawsuit (or perhaps many lawsuits) seeking to hold companies and their directors and officers responsible.

 

 

As today’s announcement from the New York Attorney General’s office demonstrates, climate change already is an important governance and disclosure issue. A myriad of forces ensure that its importance will only increase.

 

 

An August 27, 2008 New York Times article discussing the Xcel agreement can be found here.

 

 

Observers outside the D&O insurance industry frequently comment to me that with all the subprime-related litigation, D&O pricing must be skyrocketing. These observers are often puzzled when I respond that the D&O marketplace remains generally competitive and pricing advantageous to buyers. This same conversation recurs with sufficient frequency that if may be worth exploring in greater depth. It may also be worth considering whether or not current marketplace conditions may be vulnerable to abrupt change.

 

With respect to the litigation activity, there have indeed been a significant number of subprime and credit crisis-related lawsuits, as detailed further below.

 

 

Nevertheless, except with respect to certain marketplace segments (such as the financial services industries), D&O insurers generally have not restricted capacity, reduced coverage or raised prices. As IRMI noted in its September 2008 publication The Risk Report (here, subscription required), it may seem “counterintuitive” but “most companies, particularly those outside the financial sector, continue to enjoy ample capacity and relatively advantageous terms and conditions.”

 

 

The most important reason for the competitive marketplace conditions is that historically low securities class action activity levels prevailed during most of the period 2005 through 2007. Insurers’ D&O results for those claim reporting periods undoubtedly appear favorable. At the same time, insurers overall results during that same period were also favorable, due to low levels of catastrophe claims after the hurricane intensive period in 2004 and 2005.

 

 

Insurers’ business-writing capabilities are directly proportionate to their “policyholder surplus” (which is, in simple terms, the insurance company financial reporting equivalent to shareholders’ equity). As a result of insurers’ strong results in recent reporting years, property and casualty insurers’ industry-wide policyholder surplus is at or near record levels. The insurers’ business-writing capability is correspondingly high – and so the marketplace for most lines of insurance, including D&O, is competitive.

 

 

These are of course exactly the conditions that drive the insurance cycle, as ability to write business translates into an appetite for business, with price as the primary means of competition. Eventually, pricing falls below the risk related requirements, results deteriorate, and, when surpluses and redundancies are exhausted, the marketplace corrects.

 

 

The current heightened claim activity level is exactly the kind of circumstance that can lead to deteriorating results, particularly to the extent that there is a mismatch between pricing and the risk exposure. Indeed, IRMI noted in its recent report that if the current litigation wave “produces significant loss payouts, and spreads beyond the financial sector” the current wave could “ultimately affect the larger D&O marketplace.”

 

 

The ultimate outcome will of course only be revealed in the fullness of time. But in addition to policyholder surplus levels, there are a variety of other factors that could be mitigating the impact of the current litigation wave on the D&O insurers.

 

 

First, insurance may not even be involved in many of the highest profile subprime-related claims. Many of the largest banks, for instance, self-insure for their D&O exposure or only carry so-called Side A coverage for nonindemnifiable loss. At least for those banks that have not gone insolvent, these Side A policies are unlikely to be triggered.

 

 

Second, much of the current claims activity may not involve losses to which D&O insurance even applies. For example, the buybacks at the center of the recent high-profile auction rate securities settlements (about which refer here) may not involve insurable losses. To the extent that there are damages paid (for example, if the losses must pay investors’ consequential damages), the losses are likely to be more in the nature of investment bank errors and omissions losses than D&O losses.

 

 

Third, although the subprime and credit crisis-related litigation wave has spread, the vast majority of the lawsuits have been concentrated in the financial services sector. There are certain D&O carriers that are more exposed to this space than others, but many other carriers have long shunned this space. As a result many carriers may not be experiencing the current heightened claims activity levels, and the ones bearing the brunt of the activity arguably are larger and more diversified.

 

 

Fourth, a certain amount of the litigation wave involves companies domiciled (and, most likely, insured) overseas – for example, UBS, Swiss Re, RBS, RBC, Fimalac, Societe Generale, and so on. Losses related to these claims, which represent a significant portion of the subprime related litigation, may not impact the domestic D&O insurance market.

 

 

Fifth, although I have on this blog, and even in this post, referred to the current litigation as a “wave,” one could argue that although the current activity exceeds the claim level of the preceding three years, the current level is not far above historical claims activity levels. I suspect there are senior insurance executives whose D&O unit managers are telling them that current claims activity levels are within expected ranges. (Some of these managers may have different employers three to five years from now.)

 

 

Sixth, but perhaps most importantly, most of these claims are only in their earliest stages. Carriers’ case reserves may not yet be fully developed. There is also the danger that aggregate loss reserve picks are skewed by several years of better than average results. Carriers may feel confident they have a handle on this situation and fully understand their ultimate exposure, and their confidence may be warranted. It will of course be years before they know for sure.

 

 

Earlier on as the subprime litigation wave was just gaining steam, there were a number of dramatic pronouncements (refer, for example, here) about how large the large the potential loss for the insurance industry from the subprime meltdown could be. It has been awhile since anyone has ventured any similar pronouncements, probably because the sky has not yet fallen. But while prognosticators may have become more circumspect, there remains an abiding danger in the current circumstances.

 

 

Despite — or maybe because of — all of the foregoing, the subprime and credit-crisis litigation wave remains highly dangerous for the D&O insurance industry. Among other things, there is the possibility that the most significant danger could be underestimation of its long-run significance.

 

 

Thanks to the several readers with whom I have spoken and corresponded on these topics in recent days. And very special thanks to Bob Bregman at IRMI for permission to quote The Risk Report.

 

 

Another State Court Subprime Class Action Lawsuit: In an earlier post (here), I noted that as part of the current subprime and credit crisis-related litigation wave, plaintiffs’ lawyers have seemed increasingly interested in filing actions under Section 11 of the Securities Act of 1933 in state court. In the latest example of this phenomenon, on August 26, 2008, a plaintiff filed a purported Section 11 class action lawsuit against National City Corporation and several of its directors and officers in Florida (Palm Beach County) Circuit Court. A copy of the complaint can be found here.

 

 

The complaint is brought on behalf of the former shareholders of Fidelity Bankshares who acquired National City stock in connection with National City’s acquisition of Fidelity, which was completed in January 2007. The complaint alleges that the offering documents “concealed billions of dollars of risky construction loans” that National City made to finance residential real estate construction, in Florida and elsewhere.

 

 

Among other things, the complaint alleges that the construction loans were plagued by “bad product design” and were susceptible to “the high likelihood of default and extreme loan loss severity.” Many of the loans “featured the worst qualities of subprime” though National City supposedly represented its loans as “prime” and “conforming.” The complaint also alleges that the offering documents misrepresented other aspects of National City’s financial condition, including its “nonperforming assets” and its loan loss reserves.

 

 

This new lawsuit is merely the latest lawsuit filed against National City regarding subprime-related issues (refer here and here). In any event, I have added this latest lawsuit to my running tally of subprime and credit crisis-related securities lawsuits, which can be accessed here. With the addition of this latest complaint, the current tally of subprime and credit crisis-related securities lawsuits now stands at 109, of which 69 have been filed in 2008.

 

 

Special thanks to Adam Savett of the Securities Litigation Watch for providing a copy of the National City/Fidelity Bankshares complaint.

The 2007 settlement of an Ontario securities class action may suggest the eventual direction of many of the lawsuits in the current subprime and credit crisis-related litigation wave. Even though the lawsuit was filed in a Canadian court and involved a company (FMF Capital Group Ltd.) whose shares traded only on a Canadian exchange, the lawsuit did arise from the early stages of the subprime mortgage meltdown in the U.S. And although the lawsuit preceded the current litigation wave, many of the allegations raised in the lawsuit have also arisen in the more recent U.S. subprime lawsuits.

 

Through an affiliate, FMF offered residential mortgages to subprime borrowers. According to the company (here), FMF originated mortgage loans throughout in 39 of the 50 United States and the District of Columbia. FMF resold packages of these mortgages to institutional buyers.

 

As summarized in a recent memorandum (here) written by NERA Economic Consulting, which served as the Ontario court’s damages expert and settlement consultant, in March 2005, FMF conducted a $197.5 million IPO. Following the offering, the securities issued in the IPO traded on the Toronto Stock Exchange. According to later news reports (here and here), the company apparently sought the Canadian listing as a way to obtain favorable treatment as a Canadian income trust.

 

In November 2005, just eight months after its IPO, FMF announced that it was suspending the monthly distributions due to investors in connection with its publicly traded securities. Within two trading days of the announcement, the company’s securities had declined 76.8% from their preannouncement price.

 

In January 2006, plaintiffs initiated a securities class action in the Ontario Superior Court of Justice against FMF and certain of its directors and officers, the offering underwriters, and FMF’s auditors. Background regarding the lawsuit can be found here.

 

As described in NERA’s memorandum, the plaintiffs alleged that the company "dismantled" its underwriting standards in order to maintain growth in its loan originations, and that the defendants concealed the company’s degraded underwriting standards and poor loan quality. FMF contended that its woes were due to industry-wide factors including interest rates and increased defaults, which undermined its ability to conduct securitizations and finance distributions.

 

According to co-counsel for the class (here), the class action ultimately was settled for over CAN$28 million. US$21 million of the settlement was funded by FMF’s insurers and by FMF’s privately-held affiliate. The remaining CAN$4.55 million of the settlement was to be paid by the IPO offering underwriters and FMF’s auditors.

 

According to NERA, the settlement, which the Court approved on April 11, 2007, is "the largest settlement in a class action securities case in Canadian history."

 

In addition to its status as the largest Canadian securities settlement ever, the settlement may be significant in a number of other respects as well, due to the circumstances surrounding the lawsuit.

 

That is, even though the lawsuit was filed in a Canadian court and involved a Canadian listed company, the lawsuit arose out of the meltdown in the U.S. subprime mortgage market. The claimants’ allegations about the lender’s deteriorating loan underwriting standards and poor loan quality, and the alleged failure to disclose these factors, are substantially similar to the allegations raised in class actions now pending in U.S courts against numerous other mortgage lenders. The company’s attempt to blame macroeconomic factors for its demise also mirrors the response of many defendants in the U.S subprime lawsuits.

 

Indeed, given these similarities, NERA described the FMF case as "the proverbial ‘canary in the coal mine’ for the current credit crisis." The similarities between the FMF case and many of the cases in the current subprime litigation wave suggest that the outcome of the FMF case could be a harbinger of things to come in the current subprime cases.

 

None of the securities lawsuits that have been filed in the current litigation wave have yet been settled, which makes the FMF lawsuit and its settlement at least potentially significant, for what it might indicate about the outcomes of the lawsuits in the current wave.

 

By my analysis at least, the FMF litigation settled for a fairly significant percentage of the company’s market capitalization loss. The company’s IPO raised $197.5 million at $10/share. The company’s share price declined by $5.21/share in the two days following the company’s announcement that it was terminating the income distributions. There undoubtedly are a number of ways the investors’ losses might be quantified, but by any measure, the eventual settlement of more than CAN$28 million appears to represent a significant percentage of alleged investor loss.

 

Because of the FMF lawsuit’s Canadian connection, litigants in the current U.S.-based subprime related litigation wave may or may not consider the case a relevant reference point. But to the extent it is relevant, the magnitude of the settlement as an apparent percentage of investor loss may point toward some very large settlements in the current U.S. subprime lawsuits, where the dollars involved are in many instances significantly greater than in the FMF case. Whether or not the FMF case does have significance for the eventual outcome of the current U.S cases, it is nonetheless interesting because the case has settled and been concluded while most of the recent U.S. cases are only in their earliest stages.

 

A prior post in which I discussed subprime related securities litigation in Canada, including a brief mention of the FMF lawsuit, can be found here.

 

More About Defense Expense and Limits Adequacy: In a prior post (here), I discussed the limits adequacy and program structure implications arising from the threatened depletion — solely as a result of accumulating defense expense — of the Collins & Aikman D&O Insurance program. As noted on the Race to the Bottom blog (here), counsel for one of the individual defendants has now advised the court that the remaining limits in the company’s $50 million D&O insurance program have been completely exhausted.

 

In his blog post, Professor Jay Brown of the University of Denver Law School, spells out what the depletion of the policy’s limits means for one of the minor defendants. The individual, Paul Barnaba, has now petitioned the court for the appointment of a legal aid attorney. Fortunately for Barnaba, it appears that his own counsel, whose fees previously had been paid by the now depleted insurance, is willing to accept the derisory legal aid fee rate. The other defendants may not be so fortunate.

 

The complete exhaustion of $50 million of D&O insurance solely through the accumulation of defense expense is a nightmare scenario for any director or officer. The individual defendants in the Collins & Aikman case, or at least those that are not independently wealthy, must now face serious criminal charges in a complex financial with only legal aid counsel to protect them. In addition, they continue to face significant civil litigation as well, again without any insurance remaining to fund a settlement.

 

As I noted in my prior post about the Collins & Aikman case, these developments may have important implications for traditional notions of limits adequacy. In addition, it is also clear that in order to make sure that individuals are not left to face serious litigation or even criminal charges without insurance, the consideration of alternative insurance structures should be an important part of every D&O insurance transaction.

 

They Stab it With Their Steely Knives, But They Just Can’t Kill the Beast:  The D.C. Circuit  rejected an attack on the constitutionality of SOX (here). OK, now everybody get back to work.

 

In an unpublished August 18, 2008 per curiam opinion (here), the United States Court of Appeals for the Eleventh Circuit has affirmed the district court’s summary judgment ruling in the CNL Resorts case that a Section 11 settlement is not covered "loss" under a D&O insurance policy. The appeals court reversed and remanded the case on other grounds, as discussed below.

 

This coverage action arose out of an underlying securities class action (about which refer here), in which the plaintiffs alleged violations of Section 11 of the Securities Act of 1933. The plaintiffs alleged that they had purchased their CNL shares at an inflated price of $20/share. The plaintiffs sought to recover the $8/share difference between what they had paid and the $12/share valuation that was later placed on the company. CNL settled this shareholder action for $35 million. Details regarding the settlement can be found here.

 

CNL had a $30 million D&O insurance program, arranged in three layers of $10 million each. CNL initiated a declaratory judgment action against the three insurers, seeking a determination of coverage for the settlement as well as related litigation costs and expenses and other amounts. CNL reached a settlement with the primary insurer, but the action proceeded as to CNL’s two excess insurers.

 

As I discussed in a prior post (here), on March 17, 2007, the district court granted partial summary judgment on behalf of the two excess insurers. The district court held that the $35 million settlement represented a disgorgement of CNL’s "ill-gotten gain," which did not constitute a "loss" under the relevant policy language and therefore is not insurable under applicable law.

 

In its August 18 opinion, the Eleventh Circuit affirmed this portion of the district court’s rulings. The Eleventh Circuit said that "because we conclude that the payment to the Purchaser Class was restitutionary in nature, the payment was not covered loss" and the excess carriers are "not liable for payment."

 

CNL had argued on appeal that the $35 million settlement did not represent the return of ill-gotten gains, contending that "without a finding of fraud, it is impossible to conclude that the money was wrongly acquired." The Eleventh Circuit said that "the return of money received through a violation of law, even if the actions of the recipient were innocent, constitutes a restitutionary payment, not a ‘loss’." The Eleventh Circuit also affirmatively held that Section 11 damages are restitutionary in nature.

 

The Eleventh Circuit also rejected CNL’s argument based on the statement in the settlement agreement that the $35 million was not "restitution or disgorgement." The Eleventh Circuit said that the settlement agreement "is not binding on any third party or this Court. The policy, not the settlement agreement, governs our resolution of this appeal."

 

The Eleventh Circuit did reverse a separate summary judgment ruling of the district court. The separate ruling related to the question of coverage for the settlement of the claims of a separate plaintiff class, the so-called Proxy Class, which had alleged misrepresentations in proxy materials. CNL had settled with this separate class in an agreement that, among other things, had resulted in its payment of the Proxy Class counsel’s fees of $5.5 million.

 

The primary insurer, in its separate settlement with CNL, had agreed to reimburse CNL for this $5.5 million settlement. The excess insurers argued, based on language in the primary policy, that the $5.5 million settlement did not represent covered "loss," and therefore the primary policy had not been depleted by payment of covered loss and the excess carriers’ payment obligation had not been triggered. The district court granted summary judgment on this issue for the excess insurers.

 

The Eleventh Circuit reversed this portion of the district court’s ruling. The Eleventh Circuit remanded the case to the district court for further factual proceedings on the question whether the language on which the excess carriers sought to rely properly is a part of the primary policy. The question to be determined is whether or not the relevant policy endorsement form had been filed with the Florida Office of Insurance Regulation, as the form would be void if not so filed.

 

At one level, the Eleventh Circuit’s affirmance of the district court’s ruling on the question of coverage for Section 11 settlements represents a significant development. A federal appellate court’s adoption of the position that a company’s Section 11 settlement is not covered loss under a D&O policy certainly reinforces the developing case authority on this point. The possibility that another court might reach a different conclusion seems increasingly remote.

 

At the same time, there are limitations on the significant of the Eleventh Circuit opinion. The first is that the opinion itself carries the designation "Do Not Publish." This is less of a restriction in the Eleventh Circuit than it might be in other courts; some courts actually prohibit the citation of unpublished opinions. The Eleventh Circuit’s Rule 36-3 (refer here) specifies that "unpublished opinions are not binding precedent, but they may be cited as persuasive authority." Thus, the Eleventh Circuit’s opinion may at least be cited, but it still does not represent binding authority.

 

There is a practical development that also diminishes the significance of the Eleventh Circuit’s opinion. That is, since the time of the district court’s summary judgment ruling on the question of coverage for Section 11 settlements, most D&O carriers have introduced policy endorsements specifying that they will not take the position that there is no coverage under their policies for settlements under Sections 11 and 12 of the ’33 Act. Not all of these endorsements were created equal, and they are all as yet untested in court, but at a minimum they ought to restrain most carriers whose policies have this endorsement from taking the position that a Section 11 or Section 12 settlement does not represent a covered loss under the policy.

 

Of course, not all policies have yet been adapted to this new approach, and there are still many claims pending in which the relevant policy does not have this new language. In connection with these existing policies and claims, it is important to note a couple of things.

 

First of all, even if a company’s Section 11 settlement is not covered under a D&O policy, the company’s expense incurred in defending against the Section 11 claim still ought to be covered.

 

Second, because the settlement of Section 11 claims against individual defendants (as opposed to the company itself) typically would not represent the return of ill-gotten gains, (since typically they would not have received any of the offering proceeds), a D&O policy ought to provide coverage for the settlement of a Section 11 claims against them, as well as their costs of defense, all other things being equal.

 

Very special thanks to a loyal reader for providing me with a copy of the Eleventh Circuit opinion.

 

Auction Rate Settlements: Plaintiffs’ Bar Bummer?: As I noted in a recent post (here), one of the as yet unanswered questions surrounding the high-profile auction rate securities buybacks is what impact these settlements will have on the numerous auction rate securities class action lawsuits (about which generally, refer here).

 

In an August 18, 2008 Legal Week article entitled "Billions Not for the Plaintiffs Bar" (here), Michael Rivera and Erik Frias of the Fried, Frank, Harris, Shriver & Jacobson law firm suggest that these settlements could have a "debilitating impact on the numerous class actions and other private lawsuits filed since the market seized up." The basis on which the authors reach this conclusion is that as a result of the buybacks and other settlement elements, "the losses of individual investors who might be plaintiffs will now be fully compensated, leaving little to no damages to pursue in court."

 

The authors suggest that as a result of the buybacks and other reimbursements incorporated into the settlements, the "bottom line" is that the claimants "will be made whole without assistance from the courts." As they put it, "government and industry have worked cooperatively to craft a solution to the auction-rate securities problem in such a way that private litigation will be largely unnecessary and unavailable." As a result, the authors suggest, there may now be "little opportunity for the plaintiffs bar to profit."

 

The authors may have a point, but I haven’t yet seen the voluntary dismissal of any of the pending auction rate securities lawsuits. The plaintiffs’ lawyers may not go quietly, and one angle I can imagine them trying to work relates to institutional investors, benefits under the various settlements are less defined and less comprehensive.

 

In any event, there are still a host of auction rate securities lawsuits that have been filed against banks and other institutions that have not yet reached a regulatory settlement. To be sure, it may only be a matter of time before the regulators set their sights on these others. In the interim, the existence of the shareholder lawsuits may represent one additional factor pressuring them to reach a regulatory settlement.

 

Finally, as I recently noted (here and here), though the settlements have started to mount, auction rate securities lawsuits continue to accumulate. There apparently are some members of the plaintiffs bar who continue to perceive an opportunity to profit from the auction rate debacle. It will certainly be some time before it is all sorted out.

 

The current securities litigation wave first arose out of the collapse of the residential real estate subprime mortgage market. As I have previously noted (here), the wave long ago ceased to be just about subprime mortgages, as the litigation as expanded to encompass the fallout from a more general credit crisis. As demonstrated in a recent lawsuit, the wave now includes litigation arising from disruptions in major development construction project financing.

 

According to their August 20, 2008 press release (here), plaintiffs’ counsel have initiated a purported securities class action in the United States District Court for the District of Massachusetts against Perini Corp. 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 Perini, a company that offers general contracting, construction management and design-build services to private clients and public agencies worldwide, failed to disclose:

(a) that the developer of Perini’s Las Vegas, Nevada projects, including the CityCenter Project, was experiencing financial problems because it failed to secure financing for the entire project and was dependent upon raising the remainder of the financing from the expected sale of residential units. However, the proceeds from the residential unit sales were based on unrealistic and aggressive prices at a time when the condo market in Las Vegas, Nevada was extremely weak; (b) that the Company’s Las Vegas projects were being delayed, and could possibly be halted; (c) that the developer was in risk of defaulting on its construction loan; (d) that the Company’s future revenue and profit was dependent upon the Las Vegas projects since the projects consisted of approximately 20% of its backlog; and (e) as a result of the foregoing, the Company’s ability to maintain its profit margins was in serious doubt.

Then, on January 17, 2008, the Company issued a press release announcing that Deutsche Bank "delivered a notice of loan default to the developer of the Cosmopolitan Resort and Casino project under construction in Las Vegas, Nevada." In response to this announcement, shares of the Company’s common stock fell $10.05 per share, or 27%, to close at $27.65 per share, on heavy trading volume.

The general economic downturn is now affecting a broad variety of companies in diverse industries. As I have previously noted (most recently here), in all likelihood, in the weeks and months ahead, other companies will be finding that transactions entered in more clement circumstances now appear troubled. As more companies stumble on these troubled transactions, further lawsuits undoubtedly will emerge. And as is the case with the Perini lawsuit, most of these lawsuits will have little to do with subprime mortgages directly.

 

In any event, I have added the Perini lawsuit to my list of subprime and credit crisis-related securities class action lawsuits, which can be accessed here. With the addition of the Perini lawsuit, the current tally of subprime and credit crisis-related securities lawsuits now stands at 108, of which 68 have been filed in 2008.

 

For those who are curious, information about the CityCenter Las Vegas project can be found here. Background about the Cosmopolitan Resort and Casino can be found here.

 

As a result of recent academic research (refer here and here) and other recent developments, Rule 10b5-1 trading plans have attracted critical attention, including SEC scrutiny (refer here). Allegations of alleged misuse of Rule 10b5-1 trading plans have even made their way into shareholder litigation. For example, allegations of Andrew Mozillo’s alleged misuse of his Rule 10b5-1 plans are a central part of the Countrywide shareholders’ derivative complaint (refer here).

 

An August 18, 2008 Latham & Watkins memorandum entitled "Rule 10b5-1 Plans: Recommended Guidelines for Managing Risks in the Current Environment" (here) takes a look at the heightened scrutiny currently surrounding Rule 10b-1 trading plans and presents a set of "better practices to consider" in developing and deploying the plans.

 

Among other things, the authors examine the Rule’s various requirements, and in particular the Rule’s provision specifying that an individual may "in good faith" modify a prior plan, so long as he or she is not aware of material nonpublic information at the time of the modification. The authors correctly note that "the good faith requirement is an important constraining, and problematic, factor because it is inherently subjective. Modifications that do not have a good faith justification will lose the benefit of the affirmative defense. Frequent modifications may be especially hard to justify."

 

The authors review other questions that have been raised in connection with Rule 10b5-1 plan structure and implementation. They suggest that to avoid these kinds of problems or questions companies can adopt certain guidelines to "limit opportunities for their insiders to engage in abusive practices, and more importantly, to avoid the appearance of practices that might be viewed as abusive based on later developments."

 

The authors make a number of good, practical suggestions that should go a long way toward avoiding some of the issues that have raised questions in connection with Rule 10b5-1 plans. The suggestions that appear particularly important in light of recent questions is the authors’ suggestions that "companies should prohibit insiders from entering multiple overlapping 10b5-1 plans," and that companies should promptly disclose insiders’ adoption of Rule 10b5-1 plans through a press release or 8-K filing. The authors also suggest tight restrictions on plan modifications and terminations, as well as on "fast sales," suggesting instead a requirement for a cooling off period.

 

The recent questions surrounding alleged Rule 10b5-1 plan misuse haveraised concerns about the protective value these plans may offer. But as the authors make clear, properly structured plans may continue to provide valuable protection. It is true that insiders who are starting or stopping plans, or running multiple plans, may find themselves unable to rely on the Rule’s safe harbor. But trading plans structured and implemented according to the original intent of the Rule should still afford the protection for which the Rule was designed.

 

Special thanks to Adam Savett of the Securities Litigation Watch blog for providing me with a copy of the Latham & Watkins memorandum.

 

Rating Agencies and Subprime Litigation: As I noted in a prior post (here), the SEC recently released a report critical of rating agencies’ "shortcomings" in connection with their provision of ratings on mortgage-backed securities and other instruments now at the cent of the subprime meltdown. As also discussed in a separate prior post (here), claimants in a recent securities lawsuit have also raised allegations against the rating agencies, alleging conflicts of interest and other alleged misconduct.

 

According to an August 12, 2008 article entitled "Rating Agencies: A New Front in Subprime Litigation" (here), by Larry Ellsworth and Ishan Bhabha of Jenner & Block, the recently filed lawsuit naming rating agency defendants "may just be the tip of the iceberg." The authors suggest that regulatory investigations and other developments may portend further claims against the rating agencies.

 

However, the authors also note that the "agencies are not without defenses." In particular the rating agencies may be able to rely on case authority developed in connection with the Orange County and Enron cases that their rating activities are protected by the First Amendment.

 

The authors question whether the rating agencies will actually be able to rely on these defenses in the circumstances surrounding their rating of the subprime mortgage-backed assets and other related instruments. The authors note that "the agencies only rated those securities for which they were paid, and furthermore had substantial and ongoing involvement with the banks in order to structure the offerings." (For further discussion of the availability of the rating agencies’ potential defenses, refer here.)

 

In addition, the authors also note that "to the extent the rating agencies were actively working with issuers to help them package products in order to get a higher rating the agencies may be especially vulnerable to charges of self-dealing and conflicts of interest, and, if the agencies did not reveal these relationships, these actions might be investigated as material omissions."

 

The authors conclude by noting that these issues are "sure to generate contentious and interesting litigation for years to come."

One of the legacies of the era of corporate scandals earlier in this decade is a heightened awareness of corporate governance issues. This development is most obvious for publicly traded companies in the United States, with the governance requirements embodied in the form of the Sarbanes-Oxley Act. The heightened governance awareness has also had spill-over effects for private companies (refer here) and even non-profit entities (refer here).

 

But there are many other types of non-listed firms, beyond just private companies and non-profit enterprises – including joint ventures and family-owned firms, as well as venture funds, private equity firms and hedge funds. The heightened governance awareness has also affected these other kinds of non-listed firms. But many of the principles and practices developed for publicly traded companies may be ill-suited to these other kinds of non-listed firms.

 

 

In a comprehensive book entitled “Corporate Governance of Non-Listed Companies” (here), Professors Joseph McCahery of the University of Amsterdam and Erik P.M. Vermuelen of Tilberg University take a look at corporate governance principles and practices for these other kinds of non-listed firms.

 

 

The professors begin with observations about current attitudes toward governance, particularly those evolved from the context of publicly traded companies. They note that “it could very well be argued that non-listed companies do not always benefit from the spill-over effect of the application of disproportionate governance rules” and that a “corporate governance framework that is not consistent with the social and economic requirement of non-listed companies will yield imperfections over time.”

 

 

In their book, the authors propose a corporate governance framework for non-listed firms that will “foster strong decision-making, accountability, transparency and ultimately firm performance.”

The authors organize their corporate governance analysis around “three pillars.” The “core pillar” represents “company law, which provides rules and standards for registration and formation, organization and operation.” The second pillar consists of “contractual mechanisms, such as joint venture agreements and shareholder limitations.” The third pillar consists of the non-listed firms “embrace of the corporate governance rules and principles that are tailored to the organization of their publicly held counterparts.”

 

 

The authors’ exhaustive overview of the transjurisdictional development of “company law” demonstrates how various legal norms have evolved in many jurisdictions to address concerns arising from the need to protect investors and creditors from “managerial opportunism.” But these paramount principles of governance for publicly traded firms, whose ownership is widely dispersed and at an informational disadvantage to management, may not be as relevant within the ownership structures of non-listed firms.

 

 

Because of the differing needs and structures of non-listed firms, many of their governance requirements and expectations are highly contractual in nature, and tend to be more focused on protecting one set of owners and shareholders from another set of owners or shareholders. These contractual arrangements tend to address “four fundamental elements – risk of losses, return, control and duration.”

 

 

From the authors’ perspective, the value and importance of these contractual arrangements underscores the limitations of a “one-size-fits-all” approach to corporate governance and also militates against the regulatory imposition of rigid governance mandates on non-listed companies. The authors particularly address these concerns in depth in the context of private equity firms and hedge funds.

 

The third pillar of the authors’ governance framework pertains to non-listed firms’ voluntary adoption of governance measures to improve transparency and accountability. The authors suggest that companies have “strong incentives to adopt or disregard governance recommendations based on a cost-benefit assessment.” Non-listed firms have a “high-powered incentive to comply with corporate governance provisions.” The implementation of appropriate internal control measures, for example can “(1) reduce financial/reporting errors; (2) help firms follow their business practices and performance; (3) assist in tracking inventory; and (4) signal potential weaknesses within the firm.”

 

 

The authors argue for the adoption of an “optimal set of recommendations” that not only would “create a dynamic and sustainable network of business practices and advice tailored to the needs of non-listed companies” but would also “head off legislative pressures.” The “steady and healthy growth” of these kinds of firms, which are so critical to overall economic growth and development, would be advanced by their implementation of mechanisms ensuring that

 

(a) financial statements fairly present the performance of the business; (b) independent and knowledgeable directors and/or supervisors are appointed; (c) audit committees are established; and (d) strong internal control systems and processes reduce business risks and lower costs.

 

The authors’ ultimate point is that “the ‘one-size-fits-all’ and regulatory mentality arguably led to some undesirable spill-over effects to non-listed companies.” They advocate “the introduction of a separate approach” based on the development of guidelines for non-listed firms that are “sufficiently attractive and coherent from a cost-benefit perspective to persuade non-listed companies to opt into a well-tailored framework of legal mechanisms and norms.” The authors conclude that non-listed companies that operate under “well-designed and effective governance structures are likely to perform better and consequently will be more attractive to external investors.”

 

 

The authors’ analysis of the limitations of a one-size-fits-all approach to corporate governance is well-founded, and indeed these concerns may be valid even among listed companies as well as between listed companies and their non-listed counterparts. The authors’ analysis of the possibilities for and limitations of contractual mechanisms for non-listed companies is perceptive, particularly with regard to private equity firms and hedge funds.

 

 

In the end, the implementation of effective governance mechanisms and controls is critical for all firms, regardless of the particular form within which any specific firm operates. The most critical point is that mechanisms adopted must be suited to the form in which any particular firm does business. Mandatory regulatory requirements may not be sufficiently sensitive to the differing needs of different kinds of firms.

 

 

Very special thanks to Professor McCahery for providing me with a copy of this excellent book.

 

 

Olympic Questions:

 

1. Am I the only one that found the opening ceremonies scary?

 

2. Who decided beach volleyball is such a big deal?

 

3. Why does Bob Costas think Cris Collinsworth is so damned funny?

 

4. How did Mark Spitz win seven gold medals without a swim cap or goggles?

 

5. Bela Karolyi. Discuss.  

 

6. Why do so many commercials (including political ads for both Presidential candidates) have images of wind turbines?

 

7. With a 32-year old winning two swimming relay gold medals, a 38-year old winning the women’s marathon, a 33-year old female gymnast winning silver in the vault competition,  and a 41-year old winning two swimming silver medals, is it possible the Chinese are on the wrong track with their prepubescent “women’s” gymnastics team? 

As the subprime litigation wave has churned on, many of the more recently filed lawsuits have been similar to previously filed suits. But amidst the repetition, there has also been some innovation, or at least variation, as a result of which the subprime litigation wave has continued to evolve. Two recently filed subprime and credit crisis- related lawsuits demonstrate both of these elements.

 

Fannie Mae Secondary Offering Litigation: First, on August 7, 2008, plaintiffs filed a purported securities class action under Section 12(a)(2) of the ’33 Act, in the New York (New York County) Supreme Court, in connection with the May 9, 2008 secondary offering of Federal National Mortgage Association (Fannie Mae) A copy of the complaint can be found here.

 

The complaint purports to be filed on behalf of all purchasers who bought Fannie Mae shares in the May 9 offering, in which the company sold approximately 94 million shares at $27.50 a share. (The shares closed today at $7.69.) Interestingly, Fannie Mae itself is not named as a defendant. The plaintiffs have named defendants only the offering underwriters, Lehman Brothers, J.P. Morgan and Citigroup.

 

The complaint alleges that the offering documents failed to disclose a pending change to FAS 140, which change if adopted, the complaint alleges, "could require the Company to raise as much as $46 billion of capital in order to remain in compliance" with its regulatory capital requirements. The complaint alleges that FAS 140 had previously allowed Fannie Mae to account for its liabilities for mortgage-backed securities issued by the company as if the company had sold the securities, even though the company was still obligated to guarantee the securities against defaults in the underlying assets. The supposed pending changes would require Fannie Mae to account on its balance sheet for these now off-balance sheet liabilities.

 

The complaint alleges that the offering documents had stated that upon the successful completion of the offering, the company’s capital requirements would be reduced. The complaint alleges that in July 2008, well after the offering’s completion, an analyst for Lehman Brothers (which was also one of the offering underwriters) issued a report disclosing the pending changes and the supposed impact on the company’s need for as much as $46 billion additional capital. The complaint alleges that in the week following the report, Fannie Mae’s share price dropped from $18.76 per share to $7.07 a share.

 

There are a number of curious things about this complaint. The first is that the complaint names only the offering underwriters as defendants; it does not name Fannie Mae itself. I expect this is because in connection with this firm commitment offering, the offering underwriters were the actual "sellers." (The complaint alleges that the underwriters, who directly bought the shares from the company, were "directly responsible for the offering and sale" of the shares to the market.) This would perhaps explain why the plaintiffs sought to pursue their Section 12 claim only against the underwriters, but it does not clarify why the plaintiffs did not also include in their complaint a Section 11 claim against Fannie Mae or other defendants.

 

UPDATE: Please note the reader comment below explaining that the May offering was an unregistered equity offering, and as such there was no registration statement — hence no Section 11 claim. As an aside, I note that I am always grateful when a reader provides this kind of clarifying information. I hope that all readers will lelt me know when statements on this blog are in need of clarification or correction.  

The other interesting thing is that plaintiffs have chosen to proceed in state court rather than federal court. I have previously noted (here) the apparent interest of some plaintiffs’ lawyers as part of the current litigation wave to pursue ’33 Act claims in state court, and I have also noted that plaintiffs have had some success in having these cases remanded back to state court in opposition to defendants’ efforts to remove them to federal court. Even though this most recent lawsuit asserts claims only under Section 12, it apparently continues the developing trend of plaintiffs pursuing ’33 Act actions (primarily Section 11 actions) in state court.

 

Jurisdiction for ’33 Act actions is concurrent, meaning that plaintiffs have a choice and they are consciously choosing to proceed in state court. I have previously speculated (here) that the decision to proceed in state court represents some form of forum shopping, or perhaps a bid to avoid the requirements of the PSLRA. Whatever the reason, the court selection appears calculated and tactical, much like the decision in this case to assert claims only against the offering underwriters and only under Section 12.

 

Special thanks to Adam Savett of the Securities Litigation Watch for the complaint in this Fannie Mae Secondary Offering lawsuit.

 

Stifel Financial Auction Rate Securities Litigation: The second of these two recent lawsuits is a purported securities class action lawsuit filed in the Eastern District of Missouri on behalf of all persons who purchased auction rate securities from Stifel Financial (or its affiliate, Stifel Nicolaus & Company) between June 11, 2003 and February 13, 2008. A copy of the complaint can be found here.

 

As I have noted (here), there have been many of these auction rate securities class action lawsuits filed. By my count, about which refer below, Stifel and its affiliate are the eighteenth different set of defendants to be separately named in an auction rate securities class action lawsuits.

 

What makes this complaint noteworthy is not its allegations, which are virtually identical to those raised in the earlier auction rate securities lawsuits. Rather, what makes this complaint noteworthy is its timing. There were a flood of these auction rate securities lawsuits filed in March and April 2008, but the filings tapered off after that. The most recent of these auction rate securities class action lawsuits, as near as I can determine, was filed in May 2008.

 

The other interesting element of the lawsuit’s timing is that it comes now, shortly after the largest financial institutions have entered settlements in which the big banks have agreed to massive buy backs of these securities from retail investors (refer here). As I noted in a recent post (here), even though these settlements might have seemed to suggest that the auction rate securities mess was winding wrapping up, the lawsuits relating to the securities continue to accumulate. Notwithstanding the settlements involving the largest banks, problems with these securities continue, and the related lawsuits continue to be filed.

 

A copy of an August 13, 2008 St. Louis Business Journal article relating to the new Stifel Financial lawsuit can be found here.

 

 Run the Numbers: In any event, I have added these two new lawsuits to my running tally of the subprime and credit crisis-related securities lawsuits, which can be accessed here.

 

With the addition of these two new lawsuits, the current tally of the subprime and credit crisis-related securities lawsuits now stands at 105, of which 65 were filed in 2008. As noted above, there have been 18 separate sets of defendants sued in auction rate securities class action lawsuits.

 

Subprime Coverage: Accompanying this litigation wave is the related question of insurance coverage for these lawsuits. Matthew Jacobs, Lorelie Masters and David Weiner of Jenner & Block have written an article in the July/August 2008 issue of Coverage entitled "Insurance Coverage and the Subprime Crisis: A Broad Overview" (here), which provides a comprehensive overview of the subprime litigation and the related insurance issues, from a policyholder perspective. The article is comprehensive and well-written, and raises a number of useful and interesting observations about the subprime-related coverage issues.

 

The heightened susceptibility of life sciences companies to securities class action lawsuits is a phenomenon that I and others have previously noted (refer here). But while life sciences companies may experience greater securities class action claim frequency, many of these lawsuits against life sciences companies are dismissed (as discussed here).

In a case the First Circuit itself called “paradigmatic” of securities cases involving life sciences companies, the appeals court recently affirmed the lower court’s dismissal of the securities lawsuit pending against Biogen Idec and certain of its directors and officers. The court’s analysis is noteworthy because of its emphasis of the issues that contribute to the vulnerability of these kinds of companies to securities lawsuits. But by way of contrast I also discuss below a recent Ninth Circuit opinion reversing the district court’s dismissal of a securities lawsuit involving Gilead Sciences.

 

The First Circuit’s Opinion in the Biogen Idec Case: On August 7, 2008, in an opinion written by Chief Judge Sandra L. Lynch, the First Circuit issued its opinion in New Jersey Carpenters Pension & Annuity Fund v. Biogen Idec (here). The case involves Biogen’s alleged misrepresentations and omissions pertaining to Tysabri, a new drug for multiple sclerosis and other autoimmune disorders.

 

In November 2004, the FDA granted accelerated approval of Tysabri. Less than three months later, on February 18, 2005, continuing clinical trials “revealed that two patients had contracted a type of infection perhaps associated with the drug.” One of the two patients died. On February 25, 2005, the company voluntarily withdrew the drug from the market. Its stock price dropped and several lawsuits were filed.

 

In their amended complaint, the plaintiffs alleged that, in order to facilitate their sale of shares of company stock at inflated prices, the defendants misrepresented the safety and efficacy of the drug. As the First Circuit summarized the case, the “key theme” of the lawsuit is that the defendants were “aware or at least recklessly unaware of greater safety risks with TYSABRI for opportunistic infections, particularly in combination with other MS therapies, than had been announced to the public,” and that defendants “intentionally failed to disclose this information in order to keep the share price high.”

 

The district court dismissed the complaint, finding that while the plaintiffs had alleged material misrepresentations and omissions with appropriate specificity, they had not alleged scienter with appropriate specificity. The plaintiffs appealed.

 

In evaluating the plaintiffs’ allegations, the allegations relating to the timing of defendants’ receipt of information were critical, because, as the First Circuit noted, “defendants cannot have committed fraud if they did not know at the time that the failure to provide additional information was misleading.” In that regard, the First Circuit found that “plaintiffs’ amended complaint fails to allege facts both (1) as to when defendant had information about non-PML opportunistic infection and (2) that the information available sufficiently suggested a causal connection between TYSABRI and non-PML opportunistic infections.”

 

The First Circuit expressed its willingness to consider factual allegations supported only by confidential sources, but the confidential sources’ allegations did not create a strong inference of scienter, because the allegations do not indicate when during the clinical trials information about infections became known.

 

The court also found plaintiffs’ allegations that defendants had fraudulently failed to disclose dangers of use of Tysabri in combination with other drug therapies were insufficient. Plaintiffs’ allegations that defendants had no reasonable basis to say that Tysabri was safe in combination with other drug therapies, the First Circuit found, were “not nearly so compelling as opposing inferences from the undisputed facts in the record.”

 

Because the First Circuit concluded that the plaintiffs had not “sufficiently alleged … that defendants had any reason to know their statements were misleading before February 18, 2005,” the Court disregarded all insider trading prior to that date. Only one insider sale was alleged on or after that date, a February 18 sale by the company’s General Counsel. But the General Counsel was not a defendant to the Section 10(b) claim, and the First Circuit held that based solely on the General Counsel’s trading “a strong inference of scienter on the part of Biogen and other individual defendants cannot be drawn.”

 

The First Circuit found that the plaintiffs’ allegations of scienter were not sufficient to support an alleged violation of Section 10(b), and affirmed the district court.

 

The court’s opinion was informed by its observations of the peculiar characteristics of securities lawsuits filed against companies involved in the drug and device development business:

 

The situation here is paradigmatic of securities fraud cases against drug companies where a promising drug or medical device is approved by the FDA and then later proves to have health risks which affect the market for the drug.

 

The court also noted that disclosures about regulatory developments provide an important context within which sudden stock price changes can occur:

 

The investing public is well aware drug trials are exactly that: trials to determine the safety and efficacy of experimental drugs. And so trading in the shares of companies whose financial fortunes may turn on the outcome of such experimental drug trials inherently carry more risk than some other investments.

 

With these comments, the First Circuit recognized the circumstances that make life sciences companies susceptible to securities lawsuits. These companies have volatile share prices that are vulnerable to sudden shocks due to the uncertainty of the regulatory process or to unexpected safety concerns. All too often these reverses result in securities lawsuits, supported only by allegations that the reverses occurred and therefore company management must have known about the problems from which the reverses arose.

 

The First Circuit’s opinion also evinced an appreciation of the fact that merely because a company has encountered these types of setbacks does not mean that the company has committed securities fraud. The First Circuit’s analysis helps explain why both life sciences may find themselves accused of securities fraud more frequently than other kinds of companies, and also why these cases are frequently dismissed.

 

Ninth Circuit Reverses Dismissal of Gilead Science Case: But while a number of the securities lawsuits filed against life sciences companies may be dismissed, that certainly does not mean that life sciences companies inevitably prevail. Indeed, there have been a number of significant settlements in securities cases involving life sciences companies (particularly large pharmaceutical companies).

 

Life sciences companies also face the same challenges involved in securities claims against any corporate defendant, including the possibility that a victory at the trial court level can be reversed at the appellate level. That is exactly what happened in the securities litigation involved Gilead Sciences. In an opinion dated August 11, 2008 (here), the Ninth Circuit reversed the lower court’s ruling dismissing the case for failure to adequately plead loss causation.

 

Gilead’s flagship produce, Viread, is an agent used with other drugs to treat HIV. The complaint alleges that the company actively marketed the drug for off-label uses, in violation of FDA rules. The company received a Warning Letter from the FDA on this topic, which the company disclosed on August 8, 2003. The company’s share price did not decline in response to this news; in fact, the share price was higher on the following trading days.

 

In order to address the absence of any share price decline, the plaintiffs alleged that it was not until October 28, 2003 that the public “finally realized the impact of the off-label marketing and the Warning Letter.” After market close that day, the company disclosed that Viread sales had fallen below expectations due to wholesaler overstocking during the quarter. Market analysts attributed the sales decline to “lower end-user demand.” The plaintiffs alleged that the reduced demand was “a direct result” of the Warning Letter, which exposed Gilead’s off-label marketing.

 

The district court found that the complaint failed to “connect the chain of events” between the failure to disclose the off-label marketing; that the decline in demand for Viread was due to the Warning Letter; and that the reduced sales caused a decrease in Gilead’s share price. The district court said there were “too many logical and factual gaps.” The district court said it could not make “the unreasonable inference that a public revelation caused a price drop three months later.” The district court dismissed the complaint for failure to adequately plead loss causation.

 

The Ninth Circuit, by contrast, found “the complaint sufficiently alleges a causal relationship between (1) the increase in sales resulting from the off-label marketing, (2) the Warning Letter’s effects on Viread orders, and (3) the Warning Letter’s effect on Gilead’s share price.”

 

The Ninth Circuit went on to observe that “perhaps what truly motivated the dismissal was the district court’s incredulity.” The Ninth Circuit said that a district court ruling on a motion to dismiss “is not sitting as a trier of fact,” and as long as plaintiffs allege a theory that “is not facially implausible, the court’s skepticism is best reserved for later stages … when the plaintiffs’ case can be rejected on evidentiary grounds.” The Ninth Circuit concluded that “a limited temporal gap between the time of the misrepresentation is publicly revealed and the subsequent decline…does not render a plaintiffs’ theory of loss causation per se implausible.”

 

The Ninth Circuit said the market “did react immediately to the corrective disclosure” which the plaintiffs claims to be the October 28 press release, the date on which it is alleged the market had complete information to process the revelations about off-label marketing.

 

It is hardly my place to comment on the merits of a judicial opinion. Suffice it to say that reasonable minds may differ whether the district court was guilty of “incredulity” or the Ninth Circuit of “credulity.” Reasonable minds may also differ whether the three months’ lapse between the disclosure of the Warning Letter and the stock price drop is a “limited temporal gap.” Reasonable minds may also differ whether plaintiffs’ Rube Goldberg explanation for the delayed market reaction “is not facially implausible.”

 

On the other hand, it seems apparent that the allegation of off-label marketing troubled the Ninth Circuit and it is certainly true that a company whose alleged reverses are not due to unexpected regulatory developments or unanticipated clinical outcomes but rather to marketing activities is in a less sympathetic postion. That is obviously why the plaintiffs strained so hard to try to make the stock price drop relate back to the off-label marketing Warning Letter, because that supposed connection put the defendants in a less favorable light. Regardless, I suppose, of whether or not the stock price drop was due to the wholesaler overstocking.

 

The one thing that is clear is that all litigants are susceptible to the vicissitudes of the litigation process, life sciences companies as well as any other kind of company. The plaintiffs in Gilead certainly established the value of continuing to fight, as you never know when an initially disfavored hand might still be just enough to take a trick. Of course, the plaintiffs must now go back to the district court and face a court whose skepticism even the Ninth Circuit acknowledged could justify rejecting plaintiffs’ case later.

 

The SEC Actions Blog has an excellent lawyerly analysis critical of the Ninth Circuit’s opinion in Gilead, here.

 

More Drug News: Biogen Idec’s drug, Tysabri, which the FDA permitted the company to reintroduce to the market in July 2006, was back in the news recently. According to an August 1, 2008 Wall Street Journal article (here), two MS patients treated with the drug have recently contracted a potentially deadly brain infection. The article stated that the company “had no plans to recall the drug or restrict its use.”

 

The WSJ.com Health Blog also has a post (here) discussing this development. The comments following the post make for interesting reading. It is all too easy to consider these legal issues in a vacuum, but there are real patients whose only hope is the use of these kinds of drug therapies. The eloquent pleas of these patients for the drugs to remain available are moving and impressive.

 

But the adverse developments cannot be minimized, and in that regard it should also be noted that Biogen Idec also faces a lawsuit from the estate of one of the deceased patients. Recent procedural developments in the case were also discussed recently on the WSJ.com Health Blog (here).

 

All of that said,  this about business too, and it may come as no surprise that Carl Ichan viewed the stock price drop following Biogen’s recent advserse news as an opportunity to increase his holdings in the company’s shares, perhaps to advance his agenda of getting the company to sell itself, as discussed here.

 

There is a Balm in Gilead: Perhaps I am presuming too much, but for me the name Gilead Sciences evokes Jeremiah, Chapter 8, Verse 22: “Is there no balm in Gilead? Is there no physician there? Why then has the health of my poor people not been restored?” (New Revised Standard Version).

 

This line is memorably recalled in the African-American spiritual, There is a Balm in Gilead, whose refrain captures the soothing power of the song:

There is a balm in Gilead

To make the wounded whole;

There is a balm in Gilead

To heal the sin-sick soul.

The headlines on the business pages have been dominated in recent days by the news of the blockbuster Citigroup and UBS auction rate securities settlements (about which refer here). But as noted in an August 8, 2008 CFO.com article (here), at the same time, a number of other leading banks have been hit with regulatory subpoenas as problems surrounding auction rate securities become “the crisis of the day for the large global financial services companies.”

 

In addition, investor litigation against the banks related to auction rate securities continues to accumulate. For example, on August 6, 2008, STMicroelectronics sued Credit Suisse Group in the Eastern District of New York, alleging that Credit Suisse placed $450 million of the chipmaker’s securities in unauthorized auction rate securities. A copy of the complaint can be found here. An August 7, 2008 Bloomberg article describing the lawsuit can be found here.

 

The complaint’s tone is blistering. The complaint alleges that in August 2007, when the company sought to liquidate what it thought was a portfolio of “liquid, safe and authorized student loan securities,” it discovered that Credit Suisse had actually invested in “illiquid, risky and unsustainable auction rate securities consisting of collateralized debt obligations and credit linked notes, some of which are backed by subprime real estate loans.”

 

Not stopping there, the complaint further alleges that “at least a dozen other multinational corporations are victims of the same scheme,” allegedly carried out by the same Credit Suisse brokers. The complaint alleges that this supposed scheme “involves more than $2 billion of these clients’ money.” The complaint further alleges that Credit Suisse “furthered the fraud by keeping it hidden from victims, governmental authorities and the investing public” and by “refusing to follow instructions to liquidate the assets.”

 

The complaint also alleges that Credit Suisse had an “intentional strategy” reducing its own exposure to auction rate securities and that it accomplished that goal by “dumping into the accounts of unsuspecting clients some of the worst ARS on the market.”

 

According to the complaint, ST has separately filed a FINRA arbitration against Credit Suisse Securities (USA), but because Credit Suisse Group itself is not a member of FINRA, it is not subject to its arbitration requirements, and therefore is not a party to the FINRA action, which remains pending. As a result, the newly filed civil lawsuit presents the spectacle of one Swiss domiciled company suing another Swiss domiciled company in U.S. federal court.

 

With relation to the matters alleged in the ST complaint, it is interesting to note that on July 9, 2008, the Wall Street Journal reported (here) that federal prosecutors in the Eastern District of New York are “investigating whether two former Credit Suisse Group brokers lied to investors about how they placed their money into short-term securities.” Prosecutors are investigating whether investors were “misled about the nature of the auction rate securities they bought.”

 

The July 9 article quotes a statement from Credit Suisse as saying that the two employees, who resigned in September 2007, had “violated their obligations to Credit Suisse and to our clients.” The Credit Suisse statement added that “we promptly notified regulators when this matter arose last year and we have continued to work closely with them”

 

In addition, the Wall Street Journal reported in a front page article on July 31, 2008 (here) that one of the two brokers under investigation, a 35-year old broker named Julian Tzolov, “has left the U.S. and could have fled to his native Bulgaria.” The July 31 article also lists ten overseas companies (including ST Microelectronics) that have initiated arbitration proceedings against Credit Suisse affiliate companies based on auction rate securities companies.

 

On U.S. Market Competitiveness: Consider Departing Foreign Companies: Would-be reformers cite concerns that U.S financial markets are losing out to other countries’ markets due to concerns about U.S regulatory burdens and litigiousness (about which refer here). But if these concerns were as significant as the reformers suggest, you would expect that foreign companies cross-listed on U.S. exchanges would see a positive boost in their share price when they eliminate their U.S. listing. Recent academic suggest the opposite may be true.

 

In an August 2008 paper entitled “Why do Foreign Firms Leave U.S. Equity Markets”  (here), Andrew Korolyi and Rene Stulz of Ohio State and Craig Doidge of the University of Toronto took at look at the 59 foreign companies that chose to deregister their U.S. listings after the SEC enacted Rule 12h-6 in March 2007, making it easier for such companies to do so.

 

Their study produced two essential findings. First, they found that the 59 companies as a group “experienced significantly lower growth and lower stock returns than other U.S-exchange listed foreign firms in the years preceding the decision.” Second, they found that there is only “weak evidence that firms experience negative stock returns when they announce deregistration and stronger evidence that the stock price return is worse for firms with higher growth.”

 

The authors said their finding “support the hypothesis that foreign firms list shares at the lowest cost to finance growth opportunities and that, when those opportunities disappear, a listing become less valuable to corporate insiders so that firms are more likely to deregister and go home.”

 

As discussed here, the authors’ prior research substantiates that overseas firms benefit, through lower cost of capital, when they choose to list their shares on U.S. exchanges, and their shares trade for higher prices than do those of similar companies that do not choose to list here. One theory for this “listing premium” is the “bonding hypothesis,” which speculates that investors put more confidence in companies complying with American disclosure requirements and accounting standards. The authors’ more recent research suggest that the only companies punished for delisting from the U.S. exchanges are those that continued to have growth opportunities and a need to attract American capital. Other companies, who lack those opportunities, delist with impunity.

 

Perhaps ironically, current efforts to make the U.S. markets more competitive arguably may be undercutting the “listing premium,” which might be the U.S. markets’ greatest competitive advantage. As discussed in Floyd Norris’s August 8, 2008 New York Times article entitled “Reasons Some Firms Left the U.S.” (here):

By letting companies walk away easily, the advantage of an American registration is reduced, Mr. Stulz has argued. The S.E.C. is moving to allow foreign companies to use international accounting rules, so any advantage from confidence in U.S. accounting rules will vanish. And the commission is making it much easier for brokers to sell unregistered foreign shares to Americans.

“I think there is a grave risk that the advantage may be lost because of the continued chipping away at the rock,” Mr. Karolyi said. “It just doesn’t seem like the right time or the right place to be engaged in a serious deregulation of financial markets.”