Add corporate debt to the type of lending caught up in the current credit crisis, and add both commercial real estate financing companies and private equity firms (or at least one that recently completed a high profile public offering) to the kinds of companies now ensnared in the current wave of lawsuits. The latest round of lawsuits suggests just how far afield these cases may spread before all is said and done.  

The iStar Lawsuit: The lawsuit filed on April 14, 2008 in the United States District Court for the Southern District of New York against iStar Financial and certain of its directors and officers represents these latest variants in the evolving course credit crisis litigation wave. A copy of the plaintiffs’ lawyers’ press release about the iStar lawsuit can be found here, and the complaint can be found here.

The iStar lawsuit is brought on behalf of shareholders of the company who bought their shares in the company’s December 13, 2007 secondary offering, in which the company raised more that $227 million. According to the complaint, the offering documents failed to disclose that the company was at the time of the offering experiencing negative effects from the credit market turmoil and failed to recognize more that $200 million of losses on its “corporate loan and debt portfolio.”

On February 28, 2008, the company reported (here) a fourth quarter 2007 loss of 478.7 million, due in part to $134.9 million in charges associated with the “the impairment of two credits that are accounted for as held-to-maturity debt securities in its Corporate Loan and Debt portfolio.” and due to the fact that the company had increased its loan loss provisions by $113 million.

The Blackstone Lawsuit: In another example of the far flung effects from the current market turmoil, investors who bought shares of The Blackstone Group, L.P in the firm’s June 25, 2007 IPO have filed a lawsuit in the United States District Court for the Southern District of New York against the company and certain of its directors and officers.

According to the plaintiffs’ lawyers’ April 15, 2007 press release (here), the complaint alleges that the offering documents failed to disclose that Blackstone’s “portfolio companies were not performing well and were of declining value and, as a result, Blackstone’s equity investment was impaired and the Company would not generate anticipated performance fees on those investments or would have fees ‘clawed-back’ by limited partners in its funds.”

The complaint (which can be found here) alleges that in the company’s March 10, 2008 announcement (here)of fourth quarter and year end financial results, the company announced “announced that it was writing down its investment in Financial Guaranty Insurance Company by $122 million.”

Financial Guaranty Insurance Company is a bond insurer that has been struggling due to downgrades of its own credit rating. FGIC’s travails have already resulted in a prior securities class action lawsuit against the company’s other significant investor, The PMI Group. My prior discussion of The PMI Group securities litigation can be found here.

These events and ensuing lawsuits represent the latest extension of the circumstances that originated with the subprime lending meltdown but now are increasingly widespread. I recently highlighted (here) the turmoil (and ensuing litigation) that had affected the student lending sector. The extension of the effects and of the litigation, first to the commercial lending sector and to a commercial real estate financing company, and next to a private equity firm that went public only a short while ago amidst great hoopla and now has been sued for it, are merely the latest developments in what clearly promises to be an increasingly encompassing phenomenon.

As I have noted before, observers who persist in viewing the credit crisis and ensuing litigation as an exclusively “subprime”-related problem will not only fail to comprehend what has already occurred, but will likely underestimate what may lie ahead.

Another Auction Rate Securities Lawsuit: Another related recent development in this area is the lawsuit filed on April 14, 2008 on behalf of auction rate securities investors against Wells Fargo & Co. The plaintiffs’ attorneys’ press release can be found here and a copy of the complaint can be found here.

With the addition of the iStar, Blackstone and Wells Fargo lawsuits, my current tally of credit crisis-related securities lawsuits, which can be accessed here, now stands at 73, 33 of which have been filed in 2008. Thirteen of 73 lawsuits are brought on behalf of auction rate securities investors.

More Suits Against Securitzers: In earlier posts (here and here), I noted the emergence of securities class action lawsuits brought on behalf of investors against the investment banks and related entities that securitized mortgages and other types of debt into financial instruments in which the investors invested and in which they lost money.

The latest of these lawsuits was brought on March 19, 2008 in New York Supreme Court by the City of Ann Arbor Employees’ Retirement System on behalf of investors who purchased Mortgage Pass-Through Certificates as part of a December 12, 2006 offering of the instruments. Named as defendants are Citigroup Mortgage Loan Trust, which organized the offering of certificates backed by pools of mortgages, and 18 mortgage loan trusts, in which the mortgages were held. The defendants have removed the lawsuit to the United States District Court for the Eastern District of New York. Background regarding the lawsuit can be found here. A copy of the removal petition, to which the complaint is attached, can be found here.

The complaint alleges that the offering documents misrepresented the underwriting standards used in connection with the mortgage origination, and also misrepresented the various criteria used to qualify loans and properties. As a result, the complaint alleges, the offering documents misrepresented the risk profile of both the secured assets and the certificates.

The Citigroup lawsuit is substantially similar to the lawsuits previously brought against affiliates of Nomura (about which refer here), Countrywide (refer here) and Wachovia (refer here). This latest complaint is also similar to those prior complaints in that the plaintiffs (who in each case are represented by the Coughlin Stoia firm) sought to initiate each lawsuit in state court. My detailed analysis of the jurisdictional issues involved can be found in the post linked above regarding the Nomura lawsuit.  

Though the defendants have uniformly sought to remove these cases to federal court, in the Countrywide case, the earliest of these cases to be filed, the federal court granted the plaintiffs’ motion to remand the cases to state court. As noted in my discussion of the Countywide remand decision here, the federal court’s remand of the case to state court was based on the grant of concurrent jurisdiction to state courts for ’33 Act liability cases, a jurisdictional grant the federal court found has not been eliminated by subsequent legislation.

I have previously speculated that the plaintiffs’ strategy for pursuing these cases in state court is to avoid the requirements of the PSLRA, an impression that is reinforced by the fact that the plaintiffs’ lawyers did not issue a press release at the time they filed these state court complaints. Whether other defendants’ attempts to remove these lawsuits to federal court will ultimately prove to be successful remains to be seen, but the prospect of significant nationwide securities litigation going forward in state court seems fraught with the potential for uncertainty, opacity and complexity.

You’re Such a Lovely Audience, We’d Like to Take You Home With Us: As your reward for reading this far, I am going to share a wonderful little secret with you. Stanford Law School, which has long maintained its excellent Securities Class Action Clearinghouse (here) has now started the Stanford Global Class Action Clearinghouse (here). The new site is devoted to tracking the development of class action litigation throughout the world. While the site is new and is only just getting started, it already has very interesting materials and shows great promise. We can only hope its sponsors and guardians develop and maintain this new site as well as the predecessor.

Hat Tip to my good friends at the Drug and Device Law Blog (here) for the link to the new site.

A lawsuit filed late last week against First Marblehead Corporation underscores that the current lawsuit onslaught so often referred to as the “subprime” litigation wave is, and really has been for awhile, about so much more than just subprime. Although we are probably stuck with the “subprime” label as a shorthand way to describe these developments, the label encompasses a credit crisis that goes far beyond subprime lending.

First Marblehead is a Massachusetts-based company in the business of underwriting, packaging and securitizing student loans. Operating out of First Marblehead’s offices is a nonprofit organization called The Education Resources Institute (“TERI”) that provides guarantees of student loans that First Marblehead originates. On April 10, 2008, plaintiffs’ lawyers filed a securities class action lawsuit in the United States District Court for the District of Massachusetts against First Marblehead and certain of its directors and officers. A copy of the plaintiffs’ counsel’s April 10 press release can be found here. A copy of the complaint can be found here.

The complaint alleges that during the class period of August 10, 2006 to April 7, 2008, the defendants made material misrepresentations “concerning the performance and quality of First Marblehead’s securitizations, its ability to perform additional securitizations, TERI’s ability to adequately guarantee [First Marblehead’s] student loans, and the Company’s financial results and its ongoing operations.” The complaint alleges that the company “misrepresented the level of default rates in its portfolio,” and “disregarded that TERI was underreserved and unable to adequately insure” the company’s loans. According to the complaint, TERI filed for bankruptcy protection on April 7, 2008, and the company’s stock plunged.

The First Marblehead lawsuit has nothing directly to do with subprime lending itself. Indeed, the occurrence of credit-related litigation essentially unrelated to subprime lending is really nothing new – First Marblehead is not even the student loan company to be sued in a securities class action lawsuit as part of the current litigation wave, given the lawsuit filed in January 2008 against SLM Corporation (“Sallie Mae”), about which refer here.

The student lending cases, like the auction rate securities litigation, are about the secondary and tertiary consequences in the credit marketplace following on the consequences first triggered by the subprime lending meltdown. But the spread of litigation to other types of credit and other kinds of companies underscores the dark possibilities for a crisis that began in the residential real estate lending sector to spread across the entire economy and activate a much broader array of litigation.

It is probably worth noting that the turmoil that has hit the student lending sector is not limited just to the student loan organizations themselves; companies that invested in student loan-backed securities are also experiencing financial and accounting difficulties as a result of their investment in these securities. For example, in a situation that encompasses both the student loan problems and the breakdown of the auction rate securities marketplace, Winnebago, in its March 20, 2008 fiscal second quarter earnings release (here), disclosed that it owned $54.2 million of auction rate securities collateralized by student loans. As a result of the auction rate securities market failure, the company deemed these securities as not currently liquid, and reclassified them on the company’s balance sheet as long-term investments. In its April 9, 2008 10-Q (here), the company recorded a temporary impairment charge to these securities of $3.4 million.

The fact that the student loan turmoil would affect a company as unrelated to the sector as Winnebago demonstrates how far afield the effects of the current crisis have and may yet spread. The essential point here is that as long as observers continue to describe and think about the current developments as merely subprime-related, they will not only fail to appreciate the extent of what has already happened, but also likely underestimate the possibilities of what may lie ahead.

Another Auction Rate Securities Lawsuit: And speaking of auction rate securities, on April 11, 2008, plaintiffs’ lawyers filed yet another lawsuit on behalf of auction rate securities investors against the companies that sold them the investments. As reflected in the plaintiffs’ lawyers’ press release (here), the latest lawsuit involves Oppenheimer Holdings. The Oppenheimer lawsuit is the twelfth of these auction rate securities lawsuits to be filed.

Run the Numbers: Like everyone else, I too am trapped by the now-established convention of referring to the current credit-related lawsuit onslaught as the “subprime” litigation wave, and as a reflection of that convention, I have added the First Marblehead and Oppenheimer lawsuits to my running tally of the “subprime”-related litigation, which can be accessed here. With the addition of these two new lawsuits, the current tally now stands at 70, of which 30 have been filed in 2008. As noted, 12 of these lawsuits involve class action auction rate securities litigation.

Subprime Litigation: The Grandaddy of Them All?: Although the crisis commonly referred to as the “subprime” meltdown is relatively recent, subprime loans have been around for a while. Indeed, problems with subprime loans are also nothing new. Even though the current wave of subprime-related litigation did not get started until February 2007, there were subprime-related lawsuits before that. These earlier lawsuits may provide some interesting perspective on the current round of litigation.

As described in an April 9, 2008 Wall Street Journal article entitled “Subprime Lender’s Failure Sparks Lawsuit against Wall Street Banks” (here), American Business Financial Services was in the subprime loan origination business. It funded its operations through the securitization of loans, but, in addition, it also raised operating cash by selling notes through direct sales to individual investors.

According to the allegations in subsequent litigation, ABFS underestimated the number of its loans that would be paid off early as a result of refinancing, reducing the company’s cash flow, and ultimately leading to the company’s bankruptcy. The noteholders, of which there may have been as many as 22,000, lost millions.

The Journal article describes the Pennsylvania state court lawsuit that the bankruptcy trustee has filed against the Wall Street banks that sponsored ABFS’s securitizations, as well as against the company’s former directors and officers. But this trustee lawsuit follows two earlier lawsuits, one brought by the company’s shareholders and one brought on behalf of the company’s noteholders.

The ABFS shareholder securities litigation, background about which can be found here, was initiated in January 2004, following the company’s disclosure that the Department of Justice was investigating the company’s loan transactions and securitization agreements. The plaintiff shareholders alleged that the company and certain of its directors and officers misrepresented the company’s financial condition by artificially altering the company’s loan default ratio, to understate the level of the company’s troubled loans. In a June 2, 2005 memorandum opinion and order (here), the court granted the defendants’ motion to dismiss, on the ground that the plaintiffs did not adequately allege that the statements at issue materially misleading, nor did the plaintiffs’ allegations create a “strong inference” that the defendants acted with scienter.

The noteholder litigation, by contrast is going forward, albeit in a narrowed state. The background regarding the ABFS noteholder litigation can be found here. The noteholders also claimed that the defendants misrepresented the company’s financial condition. In two orders (here and here), the court dismissed the plaintiffs’ allegations concerning the company’s loan delinquency rates, as well as the plaintiffs’ solicitation claims under Section 12. A much-narrowed case is going forward.

The course of these earlier lawsuits casts an interesting light on the current wave of lawsuits. The ABFS shareholder lawsuit dismissal is a reminder that even a lawsuit involving a bankrupt company that is the subject of a DoJ investigation, and in connection with which shareholders lost substantially all their investment, still has to survive the formidable pleading requirements to which securities lawsuits are subject. Even the noteholders, whose plight may be particularly sympathetic, have seen their petition for redress of grievances substantially narrowed.

The fate of these earlier lawsuits is a reminder that merely because lawsuits are filed, even lawsuits filed in the context of significant financial losses and regulatory investigations, does not mean that the lawsuits will succeed. It may be important to keep in mind as the current wave of lawsuits continues to accumulate that these lawsuits will face the same formidable pleading barriers as did the ABFS lawsuits, and some of these lawsuits, like the ABFS lawsuits, will not survive or will only survive on a greatly narrowed basis.

Tellabs in the Ninth Circuit: Readers interested in following the implementation of the Supreme Court’s Tellabs decision in the lower courts will want to review the April 10, 2008 decision (here) in the Skechers USA securities litigation, in which the Ninth Circuit affirmed the district court’s dismissal of the lawsuit, in reliance on Tellabs.

However, the complications that may yet attend the implementation of the Tellabs decision in the lower courts is also suggested by the dissenting opinion in the Skechers appeal (here), in which the dissenting judge, applying the same Tellabs standard to the same facts, reached the opposite conclusion, finding that the district court’s dismissal ought to be reversed.

In the end however, while the Ninth Circuit’s majority and dissenting opinions in the Skechers case are interesting, they ultimately are of little value to the larger question of how Tellabs may be implemented in the lower courts, because the majority opinion is designated as “Not for Publication,” as a result of which it may not be cited. I have previously (here) decried the truly regrettable practice of courts designating opinions as not for publication or citation. Our entire system of jurisprudence relies on the usefulness of prior decisions to help resolve future cases, and it is fundamentally inconsistent with this arrangement for courts to try to remove decisions from this time-honored tradition and process.

Special thanks to a special friend of The D&O Diary for copies of the Ninth Circuit opinions.

In an April 9, 2008 opinion (here) written by Chief Judge Frank Easterbrook, the Seventh Circuit held that there was no coverage under Arthur Anderson’s fiduciary liability policy for the firm’s settlement of a retiree pension benefits dispute.

The dispute arose after the firm’s Enron-related difficulties undercut the firm’s ability to honor retirees’ demands for lump-sum payment of retirement benefits. Litigation ensued. The retirees claimed, among other things, that the firm had breached its duties under ERISA. The firm retained defense counsel and also (through its broker) provided notice of claim to its fiduciary liability insurer. The plaintiffs then voluntarily dismissed the lawsuits and initiated arbitration proceedings instead. (The full details of the underlying retiree dispute and of the communications between the firm’s representatives and the insurer are set out at length in the district court’s summary judgment opinion, here.)

In November 2002, Arthur Anderson “proposed a compromise to all retirees and wrote to its insurers that it needed at least $75 million from them to fund a settlement.” The firm asked its primary fiduciary liability insurer to tender its full $25 million policy limit. The insurer responded that the arbitration claim did not allege negligence or breach of any fiduciary duty, but rather that it was a “pure contract action” for benefits due, for payment of which coverage is precluded under the terms of its policy. (The relevant policy provisions are set out in the district court opinion linked above.)

In January 2003, the firm settled with most of the retirees for $168 million, and it ultimately settled with the rest of the retirees in 2006 for a further $63 million. In February 2003, the fiduciary liability insurer initiated an action for a judicial declaration that it was not required to defend or indemnify Arthur Anderson.

The district court held (here) that the policy does not require the insurer to fund the settlement but that (as later summarized by the Seventh Circuit), the insurer’s “failure to provide a defense coupled with its delay in filing the declaratory judgment action might require it to pay anyway.” Following a jury trial, the district court entered judgment in the insurer’s favor except to hold that the insurer was liability for $5 million toward the arbitration settlement. Both sides appealed.

The Seventh Circuit affirmed the district court except to reverse as to the $5 million payment required toward the settlement. The Seventh Circuit found first that there was no coverage under the fiduciary liability policy for the retirees’ arbitration claim, because it did not allege negligence or breach of a fiduciary duty, but rather was limited exclusively to an alleged breach of contract. The Seventh Circuit also held that the policy’s “benefits due” exclusion also precluded coverage. Judge Easterbrook commented that “the settlement reflects the present value of the pension promise…rather than damages for anyone’s misconduct,” and he noted further that:

No insurer agrees to cover pension benefits; moral hazard would wipe out the market. As soon as it had purchased a policy, the employer would simply abandon its pension plan and shift the burden to the insurer. Knowing of this incentive, the insurer would set as a premium the policy’s highest indemnity, and no “insurance” would remain. Illinois would not read a policy in a way that made it impossible for people to buy the insurance product they want (here, coverage of negligence and disloyalty by pension fiduciaries).

The Seventh Circuit also found that the firm’s failure to obtain the insurer’s prior consent to the settlement provided another preclusion to coverage. Judge Easterbrook noted that “Arthur Anderson didn’t ask for the consent or even the comments of its insurer; it presented the deal to them as a fait accompli. By cutting [the insurer] out of the process, Arthur Anderson gave up any claim of indemnity.”

Having decided that there was no coverage under the policy, the Seventh Circuit then went on to consider whether Illinois principles of “equitable estoppel” nonetheless barred the insurer from asserting its defenses to coverage, as a result of the insurer’s delay in providing a defense and bringing its declaratory judgment action.

The Seventh Circuit first considered the question of what constitutes “delay,” noting that “treating eight months,” the period of the insurer’s putative delay, “as excessive is questionable.” Judge Easterbrook also noted that had the firm complied with the policy’s advance consent to settlement requirement, the insurer could have filed its declaratory judgment before the settlement.

In the end, the Seventh Circuit concluded that the question whether eight months constitutes delay is irrelevant, since at no point did the firm ever ask the insurer “to send a team of lawyers to represent it”; rather, the firm “made it clear that it would control both the defense and the law firm conducting the defense.” By “not tendering its defense," the firm “gave up and basis for demanding immediate action by the insurer.” Judge Easterbrook noted that:

An insured’s need to have legal assistance for its defense from the outset of a suit is the main justification for the rule that Illinois has adopted. When the insured does not want the insurer to supply a defense (lest the insurer also control the defense), it has no complaint if the insurer takes a while to contemplate the question of indemnity. The urgent need is for a defense to the pending suit; liability for indemnity (the coverage question) can safely be decided later.

Finally, Judge Easterbrook concluded that the insurer did not in the end have a duty to defend as the arbitration complaint was “based on contract and nothing but.”

There are several noteworthy things about Judge Easterbrook’s opinion. The first pertains to his commentary that adverse consequences might follow if the insurer were compelled to fund the settlement. It is the very rare court that is willing to consider not only that in some circumstances compelling the insurer to pay might not only undermine the existence of the market for that type of insurance, but could even constitute a “moral hazard.” Judge Easterbrook’s analysis evinces an unusually developed understanding of the insurance mechanism’s fundamental components.

The court’s analysis of the consent to settlement requirement is also noteworthy; indeed, the Seventh Circuit’s discussion of this issue in many ways mirrors the analysis of the recent New York Court of Appeals opinion (discussed here) in which the New York court also enforced the consent to settlement opinion strictly according to its terms. These two holdings underscore not only that the provision means what it says but also that it will be enforced according to its terms. These rulings unmistakably highlight that policyholders who fail to follow the policy’s requirement for advance consent to settlement do so at peril to their insurance coverage.

There is a further important lesson from this case, one that is similar to the lesson of the prior New York case, and that is that nothing good comes from a policyholder’s failure to keep the insurer in the loop. Indeed, if there is one common element in almost every litigated coverage dispute, it is that at some point preceding the litigation, there was some breakdown in communications between the policyholder and the insurer.

There are no guarantees that carriers will respond appropriately even when they are provided with full information. But the single most important way for policyholders to reduce the possibility of a litigated dispute with their insurer is to maintain full and professional communications with their insurer. Indeed, point number on in my list of “Seven Ways Counsel Can Help Clients with D&O Claims” (here) is to “Keep the Carrier Informed.”

Finally, I note that the Seventh Circuit’s discussion of the “benefits due” exclusion is an important accompaniment to my analysis (here) of the insurance implications of the U.S. Supreme Court’s opinion in the LaRue case. As Judge Easterbrook’s opinion makes clear, these policies are not intended to provide a substitute funding mechanism for companies’ benefit obligations to their employees. However, the policies are intended to provide companies with indemnity protection when an insured’s alleged or actual negligence or breach of a fiduciary duty harms a plan participant’s interests. For that reason, it is analytically consistent for insurers to offer, as some now do, an endorsement to their policies to carve out from the benefits due exclusion an agreement to cover a plan participant’s claim of harm to their individual plan investment interests, of the kind recognized in the LaRue decision.

Special thanks to a loyal reader for providing me with a copy of the Seventh Circuit’s opinion.

On April 8, 2008, PricewaterhouseCoopers released its 2007 Securities Litigation Study, which can be found here. The PwC study follows prior reports from NERA Economic Consulting (refer here) and Cornerstone Research (refer here and here). The PwC study differs from the other studies in certain details but the studies are all directionally consistent.

The PwC study observes that “after a two-year decline and a sluggish start to the year, total federal class actions filed in 2007 against foreign and domestic companies increased once more, reversing the previous downturn.” The PwC has some interesting thoughts about the prior downturn and the causes of the reversal; the study speculates that “much of the decrease in the 2006 numbers” was due to “the preoccupation of the plaintiffs’ bar with stock options matters filed primarily as derivative matters.” The study also observes that the upswing in 2007 “comes as no surprise” given that “the stock options matters appear mostly to have dissipated.”

The report also notes that the deterrent effect of Sarbanes Oxley “may have led to a lower number of overall cases” but adds that the economy may also have been a factor and “during hard times, the increased pressure to produce good financial results is more likely to lead to bad behavior which could result in higher levels of litigation” as a result of which “over the next few years” we could see “above the recent average number of filings.”

The study has a number of interesting observations about the role of accounting issues in securities lawsuits. Among other things, the study notes that while there have been a “burgeoning number of restatements in recent years,” the number of restatements associated with federal securities class actions is “relatively small” – the report notes that in 2007, the number of securities lawsuits associated with restatements fell to 29, from 47 in 2006. The report notes that this analysis supports the view that “market reaction to restatements is declining” and also supports the view that “the market does not react to all restatements.”

Somewhat differently than the recently released Cornerstone Research settlement analysis (here), the PwC study finds that the total value of settlements did not significantly change between 2006 and 2007. The PwC study also reports an average 2007 settlement of $56.3 million, compared to an average settlement of $57.5 million in 2006. Due to the few number of billon dollar settlements in 2007, if settlements greater than $2.5 billion are excluded, the average 2007 settlement was $28.3 million, compared to $57.5 million in 2006. 

The study includes commentary on a number of interesting topics, including the growth of subprime-related litigation and the growing importance of institutional investors in securities class action litigation. The study also includes interesting commentary on the increased prominence of hedge funds, about which the study notes:

As the subprime fallout continues into 2008, this will be one area to watch. Not only could litigation against hedge funds by investors increase, but large institutional investors such as pension funds – which have added hedge funds to their portfolios over recent years and which are increasingly active in shareholder lawsuits – may also begin to focus with similar activism on hedge funds in order to recover losses associated with the subprime crisis.

The PwC also has extended discussion of the issue of the growing importance of Foreign Corrupt Practices Act investigations and enforcement proceedings, a topic on which I have frequently commented on this blog (most recently here).

The study also has an interesting discussion of concerns facing foreign issuers. Among other things, the study notes that “the number of foreign IPOs climbed to 55 in 2007, surpassing the record of 34 IPOs set in 2006.” China “accounted for 55% of the foreign IPOs.” With these foreign listings has come litigation activity. According to the study, the number of 2007 securities lawsuits against foreign issuers increased by 93%, to 27 cases, in 2007, from 14 cases in 2006 (but short of the 30 cases filed in the record year of 2004). The report states that ten of these cases were against Chinese companies, of which five involved IPO-related allegations. My prior post discussing Chinese IPOs can be found here.

The report also has an interesting discussion of the growth of “global class actions,” involving both securities lawsuits in the US involving foreign domiciled companies, as well as the increasing number of lawsuits now being filed outside the U.S.

One concluding observation about the PwC’s settlement analysis. The study’s analysis of class action settlement data is interesting and useful, but I am concerned that as a result of trends in opt-out litigation and settlements, the study of class action settlements alone may no longer be sufficient to understand the full extent of companies’ potential loss severity exposure. To refer to but one example, in connection with the Qwest securities litigation, the aggregate value of the individual opt out settlements actually exceeded the amount of the class action settlement. (see my prior analysis of the Qwest opt out settlements here).

While the emergence of class action opt outs as a material issue is relatively reason, and for that reason still relatively uncertain, consideration of possible opt out litigation appears to be an increasingly indispensible part of the analysis of potential litigation exposure and of the total cost of securities litigation. My discussion of the emergence of opt out issues can be found here.

In a powerful affirmation of the rule of law, two justices of the U.K.’s High Court of Justice ruled in an April 10, 2008 opinion (here) that the British Serious Fraud Office (SFO) must reconsider its decision to discontinue its bribery investigation into the award of a weapons contract between Saudi Arabia and BAE Systems plc. My prior post regarding the BAE investigation can be found here.

The SFO announced its decision to discontinue the investigation in December 14, 2006. The investigation had been ongoing for some time and had even withstood a prior attempt in October 2005 to have the investigation stopped. However, in July 2006, apparently when the SFO was about to obtain access to certain Swiss bank accounts, the British government received “an explicit threat made with the intent of halting the investigation.”

In the proceedings before the court, the government refused to characterize the threat, but the opinion quotes news reports that what happened was that Prince Bandar bin Sultan bin Abdul Aziz of al-Saud “went to Number 10” and told the Prime Minister’s Chief of Staff to “get it stopped” or the military weapons contract ‘was going to be stopped and intelligence and diplomatic relations would be pulled.” (Prince Bandar, the Saudi ambassador to the United States from 1983 to 2005, is now and in 2006 was the Secretary-General of the Saudi National Security Council.)

Following the July 2006 threat, an internal governmental review process unfolded, including high level consultations with the British ambassador to Saudi Arabia and others, culminating in a previously confidential December 8, 2006 memorandum by then-Prime Minister Tony Blair to his Attorney General Peter Goldsmith that “developments” had “given rise to the real and immediate risk of the collapse of UK/Saudi security, intelligence and diplomatic cooperation.” This, the Prime Minister said, would “have seriously negative consequences for the UK public interest in terms of both national security and our highest priority foreign policy objectives in the Middle East.” The government was particularly concerned with the Saudis continued counter-terrorism support, without which, it was feared, British lives could be in danger.

According to news reports (here), in August 2006 (that is, one month after Prince Bandar’s visit to “Number 10”), BAE won a $8.7 billion order from the Saudi government for 72 Eurofighter Typhoon warplanes, purportedly the latest component of the Al Yamamah arms deal, which dates back to 1985 and is the largest British export contract ever.  

The legal challenge to the decision to terminate the investigation was presented by two public interest groups, Corner House Research and the Campaign Against Arms Trade. They challenged the SFO’s decision to accede to the threat as “contrary to the constitutional principle of the rule of law,” as well as on other grounds. By contrast, the government argued, as the court summarized, that “the law is powerless to resist the specific, and as it turns out, successful attempt by a foreign government to pervert the course of justice in the United Kingdom.” (The court said of this argument that “so bleak a picture of the impotence of the law invites at least dismay, if not outrage.”)

The April 10 opinion was written by Lord Justice Alan Moses. After a detailed review of the background to the SFO’s decision to terminate the investigation, the Court considered the claimants’ challenge, which Lord Justice Moses said did not question the government’s assessment of the national security risk. The threat that was the basis of the decision to terminate the investigation “was not simply directed at the company’s commercial, diplomatic and security interests, it was aimed at its legal system.”

The threat was made “with the specific intention of interfering with the course of the investigation.” The court noted that “had such a threat been made by one who was the subject of the criminal law of this country, he would risk being charged with an attempt to pervert the course of justice.” Surrender to such threats “merely encourages those with power, in a position of strategic and political importance, to repeat such threats.” The court concluded that “in yielding to the threat, the [SFO director] ceased to exercise the power to make the independent judgment conferred on him by Parliament.” As a result, the court concluded that the submission to the threat was “unlawful.”

The court’s opinion reviews a host of other considerations, including in particular the U.K’s obligations as a signatory Organization for Economic Cooperation and Development’s Convention on Combating Bribery of Foreign Public Officials in International Business Transactions (which specifies that investigations “shall not be influenced by considerations of national economic interest, the potential effect upon relations with another State or the identity of the natural or legal persons involved.”). But the court’s essential conclusion is that the decision to terminate the investigation was contrary to the principles of the rule of law. “It is difficult,” the court said,” to identify any integrity on the role of the courts to uphold the rule of law if the courts are to abdicate in response to a threat from a foreign power.”

The full opinion is lengthy but it is well worth the read. The details surrounding the government’s consideration of how to respond to the threat are fascinating, and the court’s analysis of the legal considerations involved is thought-provoking, particularly its consideration of how imminent a threat of loss of life must be before a court might consider yielding. The inherent tension in the court’s decision arises from the fact that this case tests the limits of what any government might be willing to risk in resisting corruption; the lesson the court rejected is that if the corrupt forces are rich and powerful enough, they have nothing to fear from the force of law.

It remains to be seen, however, whether the investigation will go forward in the end; the court did not rule that the investigation must proceed, only that the December 2006 decision to terminate the investigation was unlawful. According to an April 11, 2008 article in The Guardian (here), “the high court will reconvene in a fortnight to decide what remedy to award the two groups of anti-corruption campaigners who brought the judicial review of the Serious Fraud Office decision to end the inquiry.”

As I have noted in a number of prior posts, most recently here, many governments around the world (including the U.S. government) are increasingly committed to enforcing anti-corruption laws. BAE is also being investigated in the U.S. and in Switzerland, and is only one of several current high-profile corruption investigations. The April 10 opinion underscores the seriousness of the issues involved, as well as the stakes. Courts will continue to grapple with the challenges these cases present, but it is important for companies to understand that the risks involved with corrupt practices include the threat of civil litigation, as I discussed here. BEA is in fact already the target of a shareholders’ derivative lawsuit in the United States. The growing threat of this type of litigation suggests why corrupt activity may represent the “next corporate scandal.”

Press coverage of the April 10 decision can be found here and here. The FCPA Blog’s post on the decision can be found here.

Subprime Litigation Webcast: On Friday April 11, 2008, at 11:00 a.m., I will be a panelist on a webcast sponsored by Risk Metrics on the topic “Subprime Litigation and Liability.” The panel will be moderated by Adam Savett, author of the Securities Litigation Watch blog, and will include defense attorney Darryl Rains, of the Morrison and Foerester firm, and plaintiffs’ attorney Mark Lebovitch, of the firm Bernstein, Litowits, Berger & Grossman. Registration for the webcast (which is free) can be accessed here. Further information, including links to background papers by Risk Metrics, can be accessed on the Securities Litigation Watch, here.  

In two recent federal district court decisions, two options backdating-related securities class action lawsuits – one involving Witness Systems and one involving Jabil Circuit – were dismissed.

First, in the Witness Systems case, on March 31, 2008, Judge Clarence Cooper of the United States District Court for the Northern District of Georgia granted the defendants’ motion to dismiss, with prejudice. A copy of the Order can be found here. Background regarding the case can be found here.

The complaint alleged that seven options grants in 2000 and 2001 were backdated and that four grants in 2004 were springloaded. Oddly, the plaintiff alleged that he company’s financial statements during the period April 23, 2004 to August 11, 206 were misleading because of the 2000-2001 backdating. The allegedly misleading statements allegedly began earlier and continued through the class period.

Judge Cooper found that

Plaintiff has failed to allege sufficient, particularized facts to support a “cogent and compelling” inference of scienter as to Witness or as to each Individual Defendant. Although the [amended complaint] is lengthy, the details contained therein are simply insufficient to support a strong inference of scienter. Specifically, the allegations are in the nature of a theory that Defendants must have known that the 2004 and 2005 financial statements were misstated due to backdating that occurred in 2000 and 2001. The [amended complaint] never explains when, or how, any or all Defendants learned about the circumstances pertaining to any backdated option grants. (Citations omitted.)

Judge Cooper went on to observe that “nothing is alleged that would demonstrate that these individuals had any knowledge that disclosures during the class period might require further adjustments based on options grants made in 2000 and 2001.”

Judge Cooper further found that the defendants’ stock sales did not support an inference of scienter. Judge Cooper specifically found that the defendants’ “pattern of regular dispostions was inconsistent with allegations of scienter, and the two defendants who sold significant share percentages only joined the company as a result of a merger after the alleged backdating. Judge Cooper also found that the plaintiffs had not adequately pled loss causation.

In the Jabil Circuit case, on April 9, 2008, Judge Steven Merryday of the United States District Court for the Middle District of Florida granted defendants’ motion to dismiss, but with leave to amend. Plaintiffs have until May 12, 2008 to file an amended complaint. A copy of the April 9 order can be found here. Background regarding the Jabil Circuit case can be found here.

The Jabil Circuit case may be of some interest because the company was one of the several companies whose option grants were reflected in the charts that accompanied the  original March 18, 2006 Wall Street Journal article entitled “The Perfect Payday” (here) that launched the options backdating scandal.

The crux of Judge Merryday’s decision is his conclusion that the plaintiffs’ allegations failed to establish that any grant was backdated. Judge Merryday said:

Although the complaint specifies the offending statement and identifies when and where the defendants issued the statement, the complaint includes deficient allegations concerning the falsity of the statement. The plaintiffs purport to allege repeated instances of backdating by stating the dates of “suspiciously timed” option grants and the individual defendants who received the grants. However, the plaintiffs never allege the any specific grant of stock to any specific individual defendant was backdated. The issuance of suspiciously timed options fails to convert the [company’s compensation policy] representation into a false and misleading statement.

Having found that the complaint did not adequately allege backdating, Judge Merryday was able to dispose of plaintiffs’ allegations that the company had not properly accounted for the option grant or made misrepresentations when company officials later denied that there had been backdating.

Judge Merryday also found that the plaintiffs’ scienter allegations were insufficient because the complaints’ allegations of “knowledge of non-public information fails to raise an inference of scienter with respect to any defendant.” The insider trading allegations were insufficient because the complaint failed to allege the percentage of total shares sold or to compare the share sales to sales before and after the class period. The defendants’ alleged receipt of option grants was also found insufficient.

Judge Merryday also found that the complaint’s allegations of GAAP, IRS and SEC violations were insufficient “because the complaint fails to adequately allege a basis for the claim of backdating.” Similarly, with respect to the issue of loss causation, Judge Merryday found that “having failed to adequately allege the falsity of the backdating-related statements, the plaintiffs fail to sufficiently plead loss causation as to those statements.” Judge Merryday also rejected plaintiffs’ claims of proxy misstatements based on the plaintiffs’ failure to adequately allege backdating.

I have added these two dismissals to my table of options backdating lawsuit settlements, dismissals and denials, which can be accessed here. These two dismissals may be noteworthy because they appear to be the first options backdating securities lawsuit dismissals outside of the Ninth Circuit. They are also the first dismissals granted in an options backdating securities lawsuit in several months. But while some of these options backdating securities suits have now been resolved, many more remain pending.

As reflected on my running tally of the options backdating lawsuit filings (which can be found here), there were a total of 36 options backdating-related securities class action lawsuits filed. And as reflected in my table of options backdating lawsuit case dispositions (linked above), of these 36 cases, eight have settled, six have had their motions to dismiss denied, and five have been dismissed (albeit some with leave to amend). That leave 17 cases on which no action has yet been taken, and with the six dismissal denials, 23 cases that remain pending – not to mention the cases on which amended pleadings or appeals may give new life.

These cases appear to have a very long way to run yet. But the high degree of skepticism shown in these two opinions is striking, and would not bode well for these cases were this general view to become widespread.

Special thanks to an alert reader who prefer anonymity for providing copies of the two opinions.

Another Subprime-Related D&O Loss Estimate: On April 9, 2008, Fitch’s Ratings released a report entitled “Subprime Mortgage Exposure for Property/Casualty Insurers.” A link to the repor can be found in this Business Insurance article (here), but registration is required for access to the report.

The report repeats prior estimates of industry-wide insured subprime-related losses in the range of $3 to $4 billion (although also noting that estimates have ranged as high as $9 billion). The report states that “Fitch believes that the majority of these losses will be borne by the larges writers of primary and excess D&O.”

The report also states that “Fitch believes that the near-term impact from the subprime issues will have a stabilizing or modestly positive effect on professional liability rates, especially within the financial services sector, but are unlikely to result in broad hardening.” The report warns though that “if the credit contagion spreads into sectors not directly tied to the subprime mortgage market or if the weakening economy leads to increased bankruptcies, current loss estimates will prove to be inadequate and there could be adverse reserve development that could have a larger impact on rates going forward.”

Fitch’s estimates and comments are largely in line with prior D&O loss estimate, about which I previously commented here.

Regular readers know that I have been tracking subprime-related class-action lawsuits (here). In a recent post, I noted my interest in trying to develop a similar list of subprime-related derivative lawsuits. In response to my request, a number of readers supplied helpful information, and as a result I have been able to develop a list of subprime-related derivative lawsuits, which can be accessed here.

The list is accurate but it may not be complete. Readers aware of any other subprime-related derivative lawsuits are encouraged to let me know, so that I can address any omissions. I will update the list as new lawsuits come in or as new information becomes available.

The table of cases I have compiled lists the companies that have been named as nominal defendants in shareholders’ derivative lawsuits. Some of the companies listed actually have been sued in multiple derivative suits, and some companies have been sued in multiple jurisdictions. However, where the allegations relate to substantially similar allegations, each company has only been listed once, regardless of the number of actual derivative lawsuits pending. Where I have been able to supply relevant links (in most cases to the actual complaint), the link pertains to the first filed suit.

As the list reflects, a total of 20 companies have been sued as nominal defendants in subprime-related derivative lawsuits. The derivative suits against seven of these companies were first filed in 2008, the rest in 2007. Most (but not all) of the companies named in the derivative suits have also been named in subprime-related securities class action lawsuits. Most of the companies sued in the derivative lawsuits are in the lending and banking industries, but the list also includes insurance companies, home builders, and REITs, among other.

Special thanks to Adam Savett of the Securities Litigation Watch (here) for providing information and links to several of the lawsuits, and thanks to all readers who provided information and suggestions in response to my inquiry.

Another Auction Rate Securities Lawsuit: On April 8. 2008, plaintiffs’ lawyers filed another purported securities class action lawsuit on behalf of auction rate securities investors against the companies that allegedly sold them the securities, in this case Raymond James Financial. A copy of the plaintiffs’ lawyers’ April 8 press release can be found here, and a copy of the complaint can be found here.

This brings the total number of auction rate securities lawsuits to eleven. My prior post discussing the auction rate securities lawsuits can be found here. I have been tracking the auction rate securities lawsuits as part of my running tally of subprime-related class action lawsuits, about which more below.

Adjusting the Subprime-Related Class Action Litigation Tally: Also as a result of my efforts to build the list of subprime-related derivative lawsuits, I received additional information regarding three previously filed securities class action lawsuits. In the past, I had determined that these three lawsuits were not appropriately categorized as subprime-related. However, upon further inquiry and based on conversations with some readers, I have now added these three additional lawsuits to my running tally of subprime-related securities class action lawsuits. The three added lawsuits related to Municipal Mortgage & Equity (about which refer here), WSB Financial Corp. (refer here), and CBRE Realty Finance (refer here).

With the addition of these three lawsuits, and with the addition of the Raymond James auction rate securities lawsuit referenced above, my running tally of subprime-related lawsuits now stands at 68. One unfortunate consequence of my decision to add these three cases is that now my running tally may no longer agree with others’ tallies, such as the Stanford Law School Securities Class Action website (here). There is an inherent categorization problem in trying to track the subprime lawsuits. Reasonable minds will disagree about whether a case is or is not appropriately categorized as subprime related. There are almost always going to be some disagreements at the margins.

Many thanks to the readers who supplied the information and commentary about the three class action lawsuits.

Subprime ERISA Lawsuit Update: As most readers know, I have also been tracking subprime-related ERISA lawsuits (here). As a result of my research and inquiries regarding subprime derivative lawsuits, I identified three additional subprime-related ERISA lawsuits of which I previously had been unaware. These three additional ERISA lawsuits pertain to Huntington Bankshares (refer here), National City Corp. (refer here), and Impac Mortgage (refer here).

With the addition of these three suits to my list, the number of subprime-related ERISA lawsuits now stands at 14, five of which have been filed in 2008, and the remainder of which were filed in 2007.

Two Options Backdating Case Developments: Two courts recently issued rulings on motions to dismiss in options backdating-related lawsuits.

First, on March 31, 2008, in the Juniper Networks option backdating-related securities litigation (about which refer here), Judge James Ware of the United States District Court for the Northern District of California largely denied the defendants’ motion to dismiss, except that he granted the motion (with leave to amend) as to one individual defendants, and he granted the motion to dismiss all alleged misrepresentations that took place prior to July 14, 2001, as time barrred. A copy of the March 31 order in the Juniper Networks case can be found here.

Second, and also on March 31, 2008, in the Microtune options-backdating related derivative litigation, Judge Richard Schiff of the United States District Court for the Eastern District of Texas granted the defendants’ motion to dismiss, albeit with leave to amend as to certain individuals on certain claims. A copy of the Microtune opinion can be found here. Judge Schell first concluded the Congress had not created a private right of action under Section 304 of the Sarbanes-Oxley Act, and dismissed that claim. Judge Schell also granted the dismissal with prejudice of claims of allegedly misleading proxy statements as to the individual defendants who were not on the board at the time of the proxy. The proxy allegations were dismissed without prejudice as to the remaining individual defendants. Similarly, the plaintiffs’ claims based on Section 10(b) were also all dismissed, but with prejudice as to some defendants and without prejudice as to others. The court declined to exercise jurisdiction over the plaintiffs’ state law claims.

I have added these two decisions to my table of options backdating related case dispositions, which can be accessed here. Readers are encouraged to let me know about case dispositions of which they become aware so that I can add them to the list.

Special thanks to Nick Even of the Haynes and Boone firm for the link to the Microtune decision.

New Century Updated: In an earlier post (here), I noted that the court had granted (with leave to amend) the defendants’ motion to dismiss in the first-filed subprime related securities class action lawsuit, involving New Century Financial Corporation. On March 24, 2008, the plaintiffs filed their amended complaint (here), which names as defendants not only certain former directors and officers of the company, but also the company’s former auditor, KPMG, and the company’s offering underwriters.

Readers will recall that in connection with the New Century bankruptcy proceeding, the bankruptcy examiner recently released a detailed report (about which refer here) in which, among other things, the examiner reviewed the question of the auditors’ and the company’s directors and officers’ potential responsibility for certain accounting practices and statements at the company. In light of the bank examiner’s report, the plaintiffs sought (and the defendants’ agreed not to oppose) leave to file a second amended complaint, which the court granted. The plaintiffs’ must file their second amended complaint by April 30, 2008. The court also set a briefing schedule for the anticipated motion to dismiss, to be argued September 8, 2008. A copy of the court’s order granting leave and setting the scheduling can be found here.

A German Securities Trial?: The Securities Litigation Watch has an interesting post (here) about the apparent mass securities lawsuits trial that has commenced in Germany involving Deutsche Telecom. An April 7, 2008 Business Week article discussing the trial can be found here.

Add E*Trade and SunTrust Bank to the growing list of companies that have been sued in purported class action lawsuits on behalf of auction rate securities investors against companies that sold them the instruments. The plaintiffs’ attorney’s April 2, 2008 press release regarding the E*Trade auction rate securities lawsuit can be found here, and the complaint can be found here. The plaintiffs’ attorneys’ April 2, 2008 press release regarding the SunTrust lawsuit can be found here and the SunTrust complaint can be found here. With the addition of these two new suits, there have now been a total of ten companies sued in these auction rate securities class action lawsuits.

The auction rate lawsuits are interesting. Clearly the plaintiffs’ lawyers think they are worth pursing. And if the intensity of the auction rate securities investors’ anger is an accurate gauge, then the plaintiffs’ lawyers filing of these lawsuits ultimately could be justified. As a result of prior posts on this blog (here and here) about auction rate securities, I have received numerous emails and inquiries from upset auction rate securities investors. Notwithstanding the investor anger, it is probably worth noting that so far as I can tell the leading plaintiffs’ securities firms are not (at least not yet) active in this space. Most of the auction rate securities class action lawsuits thus far have been filed by two plaintiffs’ firms (refer here and here).

The allegations in these auction rate securities class action lawsuits are largely identical. Essentially the plaintiffs contend that the defendants failed to disclose material facts about the instruments. In particular, the defendants are alleged to have failed to disclose that the auction rate securities were not cash alternatives, but rather that there were only liquid at the time of auction. More to the point, the complaints allege that the defendants failed to disclose that the auction rate securities would become illiquid as soon as the broker-dealers stopped maintaining the auction market.

In each of these class action lawsuits, the complaint names as defendants a specific financial institution and its broker-dealer affiliate. No individual defendants are named. While each complaint contains substantially identical generalized allegations of misrepresentations or omissions, the complaints contain virtually no allegations about specific statements the particular defendants companies are alleged to have made.

And even though the complaints purport to allege breaches of Section 10(b) of the ’34 Act, the complaints’ only basis for alleging scienter are generalized allegations of knowing falsity; there are no allegations of insider trading, and no particularized factual allegations supporting the general allegations of knowing falsity. The complaints similarly depend on the failure of the auction rate market itself as satisfying the loss causation requirement, rather than referring to any alleged curative disclosures or anything else in particular about the specific securities in which the class members invested.

The defendants undoubtedly will argue that these generalized allegations are insufficient to meet the threshold pleading requirements, in reliance in particular on Tellabs and Dura Pharmaceuticals. But while the defendants may seek to have the actions dismissed, the plaintiffs’ lawyers clearly intend to keep filing these actions.

The lawsuits potentially may also raise some interesting D & O liability insurance coverage issues. Because the complaints do not name any individuals as defendants, the sole potential coverage under the typical D & O policy that these claims might trigger is the so-called “entity coverage” found in most policies. In most public company D & O policies, the entity coverage is strictly limited to “securities claims.” While the auction rate securities lawsuits purport to raise claims under the securities laws, these allegations may or may not trigger the potentially applicable entity coverage, depending on how the term “securities claim” is defined in the applicable policy.

There are two general variants of the “securities claim” definition. One variant defines the term “securities claim” by reference to the securities laws themselves, including within the definition claims that assert breaches of federal or state securities laws or their equivalent. The other definitional variation defines “securities claim” by reference to the claimants and securities allegation with respect to which would be recognized as a securities claim. For example, this latter category might limit a “securities claim” to claims brought by holders of the company’s securities, or alternatively, might limit a securities claim to alleged breaches in connection with trading of the company’s own securities.

Clearly this definitional distinction could make a difference in connection with these recently filed auction rate securities lawsuits, as these claims might assert a “securities claim” and trigger the entity coverage in policies that use the former variants, but may or may not trigger the entity coverage in the policies that have the latter variant.

It is probably also worth noting that a number of the companies (for example, E*Trade) that have been sued in these auction rate securities class actions have also separately been sued in securities class action lawsuits by the companies’ own shareholders. These companies’ available insurance coverage may be under significant pressure already.

With the accumulation of these lawsuits, whose numbers are likely to continue to grow, it may well be time for these lawsuits to be broken out into their own separate statistical category, much as the IPO laddering cases were when the were filed in 2001. The auction rate securities lawsuits clearly represent a litigation category distinct from the more typical securities class action brought by public company shareholders.

But with the addition of the two latest lawsuits, the total number of subprime related lawsuits, as reflected on my running subprime lawsuit tally (which may be accessed here), now stands at 64, of which 26 have been filed in 2008. As noted above ten of these 64 lawsuits represent lawsuits brought by auction rate securities investors. Two of the 64 were brought by asset-backed securities investors against the investment banks who created the instruments. Two of the 64 were brought by mutual fund investors against the fund companies and fund managers. The remaining lawsuits were brought by public company shareholders.

Subprime Derivative Lawsuits: In addition to securities lawsuits, some shareholders have also filed subprime-related shareholders’ derivative lawsuits against company management alleging breach of fiduciary duty and other legal breaches. The latest of these subprime-related derivative lawsuits was filed on April 1, 2008 in the United States District Court for the District of Maryland against Municipal Mortgage & Equity (“Muni Mae”) , as nominal defendant, and certain of its directors and officers (complaint here). Muni Mae has previously been sued in a subprime-related securities lawsuit (refer here).

The derivative suit against Muni Mae joins other subprime-related derivative lawsuits that previously have been filed against, among others, Countrywide, American International Group, Regions Financial, and Bear Stearns. I have not been separately tracking the subprime-related derivative lawsuits, basically because I failed to anticipate that shareholders would file as many subprime-related derivative actions as they have. In response to readers’ inquiries, I will now endeavor to track the subprime-related derivative suits.

Unfortunately, because I am coming at this task belatedly, I may fail to account for derivative lawsuits that were filed previously and of which I am unaware. I would be grateful if readers would let me know of any pending subprime-related derivative lawsuits of which they are aware, so that I can add them to my tally and the list will be as complete as possible.

Subprime Litigation Overview: The field of subprime-related litigation has continued to grow and expand, to the point where it is difficult to get an organized sense of the range of issues and litigants involved. An April 1, 2008 memorandum from the Gibson Dunn law firm entitled “Subprime-Related Securities Litigation: Where Do We Go From Here?” (here) provides a top-level overview of current exposures facing companies involved in subprime-related businesses. The paper identifies early trends and key defenses, takes a brief look at likely D & O insurance issues, and describes the factors that are likely to affect the likely future direction of this litigation.

A Canadian Backdating Lawsuit: Though the backdating scandal now seems like ancient history, it seems that the lawsuits are still continuing to come in, although the most recent instance involves a Canadian company sued in a Canadian court.

According to news reports (here), a shareholder of Savanna Energy Services Corp. has filed an action in Alberta’s Court of Queen’s Bench against eleven current or former directors and officers of the company, alleging that the defendants manipulated the company’s stock options in order to profit personally. The lawsuit seeks damages equal to the defendants’ ill-gotten gains and a ban on issuing options to the company’s executives. The plaintiffs’ complaint relies on an affidavit from Eric Lie, the University of Iowa professor whose research initially triggered the options backdating scandal. Lie’s affidavit reports “a high statistical probability” that individuals at Savanna backdated options between 2004 and 2007.

Because Savanna is a Canadian company whose shares trade only on the Toronto Stock Exchange and because it has been sued in Canadian court under Canadian law, I have not tried to shoehorn the case into my running tally of options backdating lawsuits (which may be accessed here). The Savanna lawsuit may represent its own unique category of one.

Delaware Corporate Law Update: Francis Pileggi has posted on his Delaware Corporate and Commerical Litigation Blog (here) an interesting series of posts (here, here and here) reporting on the proceedings at Tulane University’s Corporate Law Institute, which took place this past week. The posts include a number of interesting commentaries from members of the Delaware judiciary. Francis’s post (here) about Delaware law regarding the sale of companies is particularly noteworthy and interesting, particularly Vice Chancellor Strine’s remarks about the duties of boards of companies in the process of the sale of a company.

Death by Blogging?: Readers who may not appreciate how stressful it can be to maintain a blog may want to review the April 6, 2008 New York Times article entitled “In Web World of 24/7 Stress, Writers Blog Till They Drop” (here), which surveys the toll that blogging is taking on some authors.

While no one here at The D & O Diary seems to be in any immediate danger, maintaining the blog is unquestionably stressful. The authors described in the Times article are (or rather, were) at least getting paid for their troubles, whereas The D & O Diary lacks even that consolation. Our blogging efforts defy Samuel Johnson’s sage words that “No man but a blockhead ever wrote except for money” — words that we frequently contemplate to our distress. Yet on we blog, as if by compulsion. A blog is indeed a harsh mistress.

On April 1, 2008, the Wilmer Hale law firm released a report entitled “West Coast Securities Litigation & Enforcement” (here), in which the law firm reports, among other things, that “investors sued 44 public companies in the West in 2007, a striking 56 percent increase over 2006, reversing what some had hoped was a permanent post-Enron decline in securities class actions.” A copy of the law firm’s April 1 press release about the report can be found here.

The report attributes the “surge” in filings against West Coast companies to the “subprime crisis” which “precipitated lawsuits.” The report also attributes the apparent “upswing in filings” to the “increased capacity of the dozen-plus law firms that bring most of these class actions.”

The report notes that while there were more lawsuits filed, there were also more lawsuits dismissed (29) than settled (18) in the Ninth Circuit during 2007, from which the report happily concludes that “last year’s spike in filings was the product of opportunistic lawyers filing in a falling stock market, and not an indication that corporate malfeasance is on the rise.”

The report also considers 2007 settlement developments and concludes that “it has become cheaper to settle in the Ninth Circuit,” based on the fact that in 2007, the median West Coast settlement was $6 million, the “lowest point since 2004” and 40% below the national median of $9.6. The report concludes because of the lower settlement figures that “the recent wave of California cases appears weaker than those filed in New York and elsewhere and –as in the past – negotiated settlements reflect the financial condition of the defendant issuer or the magnitude of the market loss.” The report also notes that “favorable dismissal rates may have – indeed, should have – encouraged plaintiffs’ lawyers to scale back their expectations.”

The report also has a number of interesting observations about the backlog of pending options backdating cases. The Ninth Circuit courts have been “far less receptive to those cases than have courts in the other regions.” In addition, West Coast issuers “have successfully defended a large number of [options backdating-related] derivative actions; by year end, courts had dismissed 14 such cases and allowed only two to proceed.” The report notes that West Coast courts have thrown out a number of options backdating-related securities lawsuits, while courts in other jurisdictions have permitted these cases to go forward.

The report concludes with a number of observations about the activities of the SEC’s West Coast enforcement offices, which offices apparently remain active.

The law firm’s report is interesting, but many of the report’s statistical observations consist of numerators yearning for denominators to give their existence meaning.

First, while the number of lawsuits against companies based in the Ninth Circuit may well have increased 56% percent between 2006 and 2007, lawsuits overall increased 43% (going from 116 lawsuits in 2006 to 166 in 2007, according to Cornerstone, here). The report’s feature stat would be significantly less compelling had the report more accurately stated that increase in the number of lawsuits on the West Coast in 2007 was 13% greater than the increase nationwide.

Second, the methodology used to conclude that California companies were 63% likelier to be sued than companies elsewhere in not revealed. For example, is report saying that the ratio of California companies sued to the total number of companies in California is 63% higher than the same ratio for all other states? Or is the report just making some comparison about the raw numbers of 2007 lawsuits against companies inside and outside California? It would have been helpful for the report to specify its methodology, because this particular conclusion is, well, challenging, given that 52 of the 166 securities lawsuits in 2007 were filed in the Southern District of New York, far more than any other federal district. (Refer here for my full analysis of the 2007 lawsuit filings.)

Third, the report seems to imply that the West Coast companies are being sued because they are located on the West Coast.. The report is written by the law firm’s West Coast office and is clearly intended for West Coast companies, and the statistical analysis is clearly intended to convey meaning for those companies as West Coast companies.

But if plaintiffs’ lawyers really were targeting West Coast companies as West Coast companies in 2007, you would expect the lawsuits against the West Coast firms to have continued in 2008. Actually, the exact opposite has happened. While West Coast companies arguably were sued frequently in 2007, they have been sued infrequently in 2008. Through the first quarter of 2008, only six companies located in the Ninth Circuit have been sued in securities lawsuits, even though the number of filings overall in the first quarter  (52) was up compared the number of filings in 2006 and 2007, as I detailed in yesterday’s post.

The increased number of lawsuits against West Coast companies in 2007 can only have meaning for those companies as West Coast companies if the reduced number of lawsuits against West Coast companies so far in 2008 also has meaning for the companies as West Coast companies. The strong suggestion is that something other than geography alone explains both ends of this equation.

(As an aside, the potential role of geography in predicting securities lawsuit frequency was a recurring statistical question in my former life as a D & O underwriter. Brokers in the Midwest contended that Midwestern companies were less likely to be sued, and therefore all Midwestern companies should receive a D & O insurance premium discount. We could never prove that geography alone was an accurate predictor of securities litigation frequency; rather, what we found was that geography coincided with some other factor – usually industry – that was the true frequency predictor. An esteemed former colleague who taught me everything I know on this topic referred to this phenomenon as “multicollinearity “.)

The report also strains when it attempts to use the 2007 dismissals and settlements to analyze the 2007 filings.

Obviously, the cases that were dismissed or settled in 2007 were mostly filed before 2007. The fact that cases filed before 2007 were dismissed in 2007 really doesn’t tell you whether or not the cases filed in 2007 are meritorious or if “corporate malfeasance” is or is not “on the rise.” It is likely that the cases dismissed or settled in 2007 were actually filed over the course of several calendar years, so the raw numbers of dismissals, settlements and filings in a single calendar year may have little or no meaningful interrelationship, and further data (such as, for example, the total number and filing dates of pending cases) is required to make any useful comparisons or even to try to conclude, for example,  that West Coast courts have become "less receptive."  

The fact that median settlements in 2007 in the Ninth Circuit were lower than prior years’ median settlements tells you only that the median was lower. It does not tell you whether or not the 2007 settlements were “cheaper” than settlements in prior years in the Ninth Circuit or than 2007 settlements elsewhere, as these kinds of comparisons require not only the dollar figure at which the cases settled, but also the amount of investor loss that was at stake for each case category compared. Without further information, there is no way to know whether or not the lower 2007 median is simply due to smaller cases being settled in 2007 than in prior years in the Ninth Circuit, or in 2007 elsewhere. There is certainly nothing about the lower 2007 median alone that analytically supports the view that 2007 cases filed in California are “weaker than those filed in New York and elsewhere.”

The report’s commentary about the options backdating cases is interesting, and the most useful addition I can make to the report’s analysis about option backdating case dispositions is to refer readers to my running list of options backdating settlements, dismissals and denials, which can be accessed here.

And finally, because I can’t seem to write a concluding paragraph for this post without discretion making me hit the delete button, that’s a wrap.

Driven by the growing wave of subprime-related litigation (particularly a spate of auction rate securities lawsuits), the number of new securities class action lawsuit filings surged in March 2008. The total number of new securities class action lawsuit filings — 25 – matches the number of new filings in November 2007, which in turn represented the highest monthly total of new filings since January 2005.

The 25 new securities lawsuits in March included 14 new subprime-related suits, taking account the new auction rate securities filed against J.P. Morgan Chase on March 31, 2008 (about which refer here). Of the 14 subprime-related suits, eight (including the new J.P. Morgan Chase lawsuit) were brought on behalf of auction rate securities investors against the companies that sold them the instruments. The remaining lawsuits (both those that are subprime-related and those that are not) were brought on behalf of public company shareholders against the companies and their directors and officers, other than one lawsuit brought on behalf of mutual fund investors.  

Largely because of the subprime-related litigation, many of the March lawsuits were filed in the United States District Court for the Southern District of New York – a total of 11 of March’s 25 new securities lawsuits were filed in the S.D.N.Y. Six of the new securities lawsuits filed in March involved companies domiciled overseas.

With the addition of the 25 new lawsuits in March, the total number of new securities lawsuits filed in the first quarter of 2008 totaled 52, of which 24 are subprime-related. All of the auction rate securities lawsuits were filed in March. (A complete list of the subprime-related lawsuits can be found on my running tally of subprime lawsuits, which may be accessed here.)

The 52 new securities class action filings in the first quarter of 2008, if extrapolated across four quarters, imply an annual filing rate of 208 new securities class action lawsuits, which is consistent with historical norms. (According to Cornerstone’s year-end 2007 securities analysis, here, the average number of securities class action filings during the period 1997 to 2006 is 1994). However, while this filing rate is consistent with historical levels, it is well above the annual levels seen in the most recent years, particularly 2006 (116) and 2007 (166).

Again, largely due to the number of subprime-related filings, the S.D.N.Y had the largest number of first quarter filings, with 21. The federal district with the next highest numbers of filings, D.Mass., had only five.

The companies sued in new securities lawsuits in the first quarter represented 31 different Standard Industrial Classification (SIC) Code categories, which might suggest that a broad diversity of companies were sued, but in most of those 31 categories only a single company was sued. The SIC Code categories with the largest numbers of companies sued were SIC Code category 6211 (Security Brokers and Dealers), with 7 companies sued, and 6021 (National Commercial Banks), with 6 companies sued. In all 29 companies in the 6000 SIC Code series (Finance, Insurance and Real Estate) were sued in the first quarter.

Nine of the companies sued for the first time in the first quarter of 2008 were domiciled overseas, representing eight different countries (including Switzerland, in which two of the companies are domiciled; the other seven countries had only one each.)

Six on the companies sued for the first time in the first quarter of 2008 had completed an initial public offering less than 12 months before the date of the first-filed lawsuit.

A final word about my lawsuit count: I am largely dependent on publicly available sources for my information about securities class action filings, although I have been able to supplement my information with data and links supplied by readers. (I am always grateful when readers bring information to my attention). I have compared my count to the information available on the Stanford Law School Securities Class Action Clearinghouse website (here) and have elected to omit certain cases that the Stanford site has included, largely because at least three of the cases listed on the Stanford site do not involved publicly traded companies. I will say that the diversity and variation of cases that have arisen in the last few months have created some very difficult categorization issues, and reasonable minds clearly could differ as to whether any particular case should or should not be “counted.”

While the securities class action lawsuit filing rate has fluctuated since mid-2007, the evidence remains consistent that the "lull" in filings that occured between mid-2005 and mid-2007 is over. It does remain to be seen if the filings will continue at their current rate, especially whethter factors such as the auction rate securities crisis will continue to drive litigation. On the other hand, the litigation activity is being driven by so many different aspects of the current crisis, it seems probable that subprime and other credit-related litigation will continue to accumulate. The more interesting question may be the extent to whcih the credit crisis litigation will spread beyond the financial sector.

A Further Thought about Securities Class Action Settlements: Earlier today I posted about the new Cornerstone report on 2007 class action settlements. The report is interesting and includes useful analysis and information. But upon reflection, it occurred to me that it is increasingly the case that class action settlement data alone may not provide all of the information necessary to understand the costs involved in resolving securities lawsuits. As I have noted in numerous prior posts (refer here), class opt outs are an increasingly important part of securities lawsuit resolution, a development that gained considerable momentum during 2007. Indeed, as I note here, the aggregate amount required to settle the Qwest opt-out actions actually exceeded the amount of the class settlement, and the amount paid in settlement of other opt actions is also very substantial.

For that reason, any assessment of the total costs involved in securities case resolution cannot be limited to class action settlements alone. The costs involved with separate opt-out actions must also be considered.