Options Backdating Developments: On December 21, 2007, McAfee announced (here) that it had reached a tentative settlement in the pending federal and state derivative lawsuits related to its options practices. The company said that it “has accrued $13.8 million” that amounts “related to expected payments pursuant to the tentative settlement.” The company’s press release does not specify to what specific costs this accrual would be applied.

In a separate development, on December 5, 2007, the United States District Court for the Western District of Washington, applying Delaware law, denied the defendants’ motion to dismiss the plaintiffs’ complaint in the derivative lawsuit shareholders have filed against the Getty Images, as nominal defendant, and certain of its directors and officers. A copy of the court’s opinion can be found here. The court found that the plaintiffs’ allegations were sufficient, at least at the pleading stage, to excuse the demand requirement. The Race to the Bottom blog has a detailed discussion of the decision, here.

I have added these case developments in the McAfee and Getty Images cases to my table of options backdating settlements, dismissals and denials. The table can be accessed here.

Cerberus Wins Right to Walk Out on United Rentals: In an earlier post (here) in which I surveyed litigation arising from busted buyouts, I discussed the lawsuit that United Rentals had filed against Cerberus Capital Management, in which United Rentals sought to compel Cerberus to complete the acquisition of United Rentals, from which Cerberus was trying to walk away. The busted United Rentals transaction was somewhat different than other failed deals, in that Cerberus was not claiming that changed circumstances allowed it to renege on the deal; rather Cerberus claimed that the deal documents themselves allowed Cerberus to terminate the contract upon tender of a $100 million termination fee.

In a December 21, 2007 ruling (here), Delaware Chancellor William B. Chandler III, after a two-day trial, issued a 68-page ruling in favor of Cerberus, ruling that Cerberus could abandon the purchase by paying the $100 million breakup fee.

The outcome of the United Rentals lawsuit, while noteworthy, may have only slight influence on the other lawsuits arising from busted deals, because, unlike the erstwhile suitors in those other cases, Cerberus was not relying on the supposed occurrence of “material adverse effect” from a changed circumstance. Rather, the outcome turned on a specific provision of the United Rental agreement that Chancellor Chandler held to reflect an understanding that Cerberus could call of the deal simply by paying the fee.

The M & A Law Prof Blog has a short, interesting post on the decision here. Professor Larry Ribstein also has an interesting discussion of the decision on his Ideoblog, here. The WSJ.com Law Blog comments here on Chancellor Chandler’s language of and use of classical allusions in the decision.

More About Option ARMs: On November 5, 2007, I wrote here about Option ARM mortgages and asked the question whether they represent the next litigation front in the subprime meltdown, referring specifically to the securities lawsuit shareholders had filed against Washington Mutual. The Wall Street Journal asked many of the same questions in a December 22, 2007 article entitled “Option ARM: Next Weakling” (here), noting that Options ARMs “could be the next wave of trouble for the mortgage industry.” The article cires a Merrill Lynch report stating that Option ARMs are “ticking time bombs” that will start “ticking louder next year.”

Option ARMs give borrowers a choice about how much to pay each month. If borrowers choose to pay only the minimum, the principal amount of their loans can rise – a result known as “negative amortization.” Negative amortization would be an unwelcome development at any time, but it is a particular problem when home prices are falling, as they are now. Many option ARMs carried initial teaser rates that are scheduled to reset in the months ahead. According to sources cited in the Journal article, nearly $156 billion in Options ARMs are scheduled to reset between 2008 and the first quarter of 2012. Perhaps worst of all, most Option ARMs carry stiff prepayment penalties, making the loans into a financing form of an existentialist play.
According to the Journal article, both the Colorado and the Illinois attorneys general have subpoenaed mortgage companies as part of larger investigations into Option ARM sales practices.

The option ARMs are not subprime loans; many of the borrowers on these had good credit. But the prospect of potentially significant interest rate increases could raise, perhaps significantly, the level of the payments required to avoid negative amortization. The prospects for further defaults and foreclosures seems high. Merrill Lynch estimates that losses on Option ARMs could top $100 billion. Those losses would be on top of the estimated losses from subprime mortgages of as much as $400 billion.

On December 21, 2007, NERA Economic Consulting released (here) its 2007 Year-End Update analyzing recent trends in shareholder class actions. The NERA reports notes, as I have discussed in prior reports (most recently here), that securities lawsuit filing activity levels returned to historical levels in the second half of 2007. In addition, the NERA report also notes that in 2007 both average and median class action settlements were at all-time highs.

The NERA report’s key findings are as follows:
  1. “Despite some well-publicized speculation that filings had moved to a permanently lower level,” securities lawsuit filings “increased in 2007 after a marked decline that began in the second half of 205 and continued through 2006.”

  2. The report states that there were 198 securities lawsuits filed through December 15, 2007, and extrapolates a total of 207 lawsuits through year end, which the report notes would be slightly above the 2005 level but still below the 1998-2004 average annual filing level of 234.

  3. The growth in filings was “driven at least in part by litigation related to subprime lending.” The NERA report states that there were 38 subprime related securities filings during 2007.

  4. The average settlement in 207 was $33.2 million, a jump from $22.7 million in 2006, and well above the 2002-2007 average of $24.4 million. (The averages do not include the nine settlements over $1 billion).

  5. In 2007, the annual median settlement also reached an all-time high of $9.6 million, up from $7 million in 2006 and well above the 2002-2007 median of $6.8 million.

  6. The most important factor affecting settlements amount is “investor losses”; the median investor loss for cases settled in 2007 was $310 million. The median investor loss in cases filed in 2007 is $355 million, which the Report states is “a signal that the settlements associated with these new filings might remain high.”

The NERA report’s conclusions about filing levels are directionally consistent with my prior observations on this blog. I do think it is important to note, as I have detailed elsewhere, that while the subprime-related lawsuits are collectively a significant factor in the increase of filings in the second half of 2007, they are only one among many important factors. More to the point, securities filing activity in the second half of 2007 would still be up significantly over the preceding two years even if there were no subprime cases.

In addition, the NERA report’s lawsuit count is quite a bit higher than my own. My count, which consists of data taken from publicly available sources supplemented by tips I get from readers, show only 171 securities class action lawsuits through December 20, 2007. NERA counts 198 through December 15, 2007 and extrapolates 207 through year-end. I doubt that after today we are going to see too many new lawsuits by year end, so the extrapolated number might be high. It is hard to assess NERA’s count of 198 lawsuits though mid-December, without knowing what cases account for the difference between their tally and mine. I am willing to assume that they just have better data than I do, but I sure would be interesting in knowing what cases I supposedly missed.

Finally, I note that NERA’s count of 38 subprime-related class actions differs from my own count of 34 (refer here for my tally). Part of this difference might be definitional, as it is has become more difficult to sharply describe what is and is not subprime-related. If generalized credit issues cause a company’s problems, is the ensuing lawsuit subprime-related or not? I will say this, I have openly listed the lawsuits I have included on my count here. If NERA or anybody else wants to tell me which cases I have omitted, I will add them to my list with alacrity.

In any event, the NERA report closes with a couple of important points with which I completely agree. First, the report notes that “as the crisis in the credit markets continues to deepen and the market for subprime mortgages continues to suffer accordingly, more litigation is likely to follow.” The second is that given the investor losses on the 2007 lawsuits, “the settlements associated with these new filings might remain high.”

So here’s what the weather gauge says: clouds gathering, storms ahead.

CFO.com has a December 21, 2007 article on the NERA report, here. (Full disclosure, I was intereviewed in connection with the CFO.com article.)

The various central banks’ efforts to improve short-term liquidity in the global financial system have dominated the headlines the business pages in recent days, most recently with respect to the news that the European Central Bank has injected an astonishing $501.7 billion of lending capacity into the banking system, an amount that the Wall Street Journal called “the largest sum the central bank has ever lent in a single shot.”

These measures reportedly are calculated to overcome banks’ reluctance to provide each other with short-term loans. What has received less attention is why the banks are reluctant to lend to each other. Closer scrutiny suggests that the banks are wary because they know that many other banks have not yet come clean about the existence of undisclosed losses relating to subprime mortgage problems in the U.S. As one commentator stated in a December 19, 2007 Wall Street Journal article (here),

“Given the degree of uncertainty [and] continuing concerns about where the next losses are and what the next shoe to drop will be, that certainly drives the cautious behavior….It’s a question of grater clarity.” That might not come until next spring, when auditors comb through banks’ financial statements in advance of their annual reports. That process “could prove better disclosure and greater clarity to the market. But it might not.”

The view that the root cause of the banks’ unwillingness to provide each other short-term credit is based on a perception of undisclosed losses was echoed by the Bank of England governor Mervyn King. In a December 19, 2007 Wall Street Journal article entitled “Bank Losses Still Unclear” (here), King is quoted as saying “We need patience now to get through the period where banks have to disclose the losses they’ve made.”

There are several thoughts implicit in these comments. The first is that the banks do in fact have extensive as-yet undisclosed losses. (The banks’ refusal to lend to each other eloquently testifies to the existence of this generalized perception within the banking industry.) The second is that there are banks that will not be disclosing these losses until the banks are compelled to do so by a combination of their reporting obligations and their auditors’ insistence. The overall implication is that these companies have a appointment with truth-telling, scheduled according to their next reporting obligation, presumably to take place sometime in early 2008.

All of this suggests that we should expect a series of bank announcements of losses or significant asset write-downs during the first weeks, perhaps months, of 2008. But the mortgage-backed assets at the center of these losses and write-downs are not held only at banking institutions. Hedge funds, pension funds, insurance companies, mutual funds, REITs and other companies carry these assets as well, and as I have pointed out before (most recently here), this exposure is not limited solely to companies in the financial services sector. There may be a wide variety of companies that have an appointment with truth-telling early in 2008.

Reporting obligations may compel eventual disclosure, but the longer the day of reckoning is delayed, the greater may be the ire of disappointed investors. As I have detailed in my running tally of the subprime-related lawsuits (here), many of the subprime related securities lawsuits have followed dramatic announcements of losses or asset-write downs. With more announcements ahead, further lawsuits seem probable. My depressing assessment is that the worst is yet to come, a conclusion reinforced by the analysis in the following section, below.

Along those lines, it is worth noting that, in connection with the latest big bank write-down announcement – Morgan Stanley’s $9.4 million fourth quarter write-down – that Morgan Stanley employees have already filed a purported class action lawsuit (refer here) on behalf of Morgan Stanley employees in connection with their holdings of company stock in their 401(k) plans.

Why The Losses Will Take Time to Tally: While it is easy to bemoan the truth-telling delay, the reality is that it is going to take time for many of the losses to work their way through the system. These problems are fully illustrated in the December 17, 2007 Wall Street Journal article entitled “CDO Battles: Royal Pain Over Who Gets What” (here), which details the dispute that has arisen as a result of an “event of default” on a single $985 million collateralized debt obligation (CDO) called Sagittarius CDO I Ltd.

Deutsche Bank, the Sagittarius CDO trustee, has filed an interpleader action (view complaint here) to determine whether the CDO’s investors (led in this case by UBS) or the CDO’s credit insurer (a unit of MBIA that entered into a credit default swap) have the right to the remaining payments under the CDO. As the interpleader complaint states, “different Defendants now claim different rights in how the limited fund of Interest Proceeds and Principal Proceeds should be applied.” The interpleader complaint names as defendants “Does 1 though 100, the owners of the beneficial interests” – that is the investors who bought the interests in the CDOs. The MBIA unit claims it has senior rights as a result of provisions in the credit default swap agreement, a position that unnamed investors have, according to the complaint, characterized as “neither reasonable nor correct.” The interpleader action seeks to sort out the competing interests.

There are several interesting things about this dispute. The first is that it shows that as the mortgage-backed investments deteriorate, there are going to be disputes over who gets stuck with the losses or at least who gets which proportion of the losses. The second is that the Sagittarius “event of default” is not an isolated occurrence; according to the Journal article, “about 40 consumer-debt backed CDOs have declared an event of default; their face value is near $45 billion – about 7% of the $640 billion in the CDOs outstanding rated by Moody’s.” Indeed, three CDOs have started liquidation, and JP Morgan projects that by the second quarter, “$40 billion to $50 billion in subprime-mortgage bonds could be sold by distressed CDOs that decide to liquidate.”

The final thing to note about this dispute is who is identified as facing the losses. According to the Journal article, the UBS investors in the Sagittarius CDO are two UBS mutual funds – the UBS Absolute Return Bond Fund and the UBS Global Bond Fund – which bought $1.2 million of the CDO this year. As I noted above, the deteriorating market for asset-backed securities could impact a wide variety of investors, funds and companies. It may take a while for the losses to sort themselves out, but eventually the losses will hit home.

The investors who get hit with these losses are unlikely to take these losses quietly. In addition, many CDO investors (such as hedge funds, pension funds, and mutual funds) in turn have investors of their own that will upset about the fund losses. I have previously noted (here) that there has already been one securities class action lawsuit brought involving subprime-related losses in a mutual bond fund.

The lawsuits against these investment funds may well come from a variety of directions, as illustrated by the action that Barclays filed on December 19, 2007 against the Bear Stearns companies in connection with the subprime-related collapse of two Bear Stearns hedge funds. Barclays was not an investor in the collapsed funds, at least not in the conventional sense; it was rather in the position of lender, supplying borrowed capital, Barclays claims, based on misrepresentation, as part of a complex hedged counterparty relationship. The complaint alleges that Bear Stearns misled Barclays about the nature of the funds’ investments as well as about the condition of the funds as they deteriorated. A December 19, 2007 Wall Street Journal article describing the Barclays suit can be found here. A copy of the Barclays complaint can be found here.
Lawsuits are also likely to follow against the entities that sold the CDO investments in the first place. For example, the Financial Times reports in a December 17, 2007 article entitled “Lehman Faces Australian Lawsuit Threat Over High-Risk Debt Deals” (here), Lehman Brothers faces the threat of legal action by three Australian municipal councils over the sale of CDOs by Lehman’s local subsidiary. The CDOs in which the municipal councils invested are in some cases now marked down to as low as 16 cents on the dollar.

All of which, I think, underscores the point that the losses and lawsuits yet to come will be widespread. The title of this December 19, 2007 Financial Week article (here) says it all: “Lawsuits Linked to Subprime Damage Expected Next Year.” As the article notes, “the other litigation shoe to drop in the CDO implosion will involve legal claims against banks and hedge funds by institutional investors, including other hedge funds and pension funds.”

Hat tip to the WSJ.com Law Blog (here) for the link to the Deutsche Bank interpleader complaint.

Subprime Litigation Wave Hits Huntington Bancshares: According to a December 19, 2007 press release (here), shareholders have initiated a subprime-related securities class action lawsuit against Huntington Bancshares Incorporated in the United States District Court for the Southern District of Ohio. A copy of the complaint can be found here.

According to the press release, the complaint alleges that

Huntington had acquired more than $1.5 billion in exposure to subprime mortgages with its July 2007 acquisition of Sky Financial Group, Inc. (“Sky Financial”). As the real estate and credit markets continued to soften, defendants repeatedly assured Huntington investors that the Company had undertaken significant preparations and implemented defensive measures to weather the deteriorating real estate and credit markets. By the time Huntington closed the merger with Sky Financial, the housing and credit crisis had deepened, yet defendants continued to conceal Huntington’s growing exposure to these problems so as to not acknowledge the acquisition was a debacle so soon after it closed. As a result of defendants’ false statements, Huntington stock traded at an artificially inflated price of approximately $18 per share during much of the Class Period.

Then, on November 16, 2007, Huntington announced its fourth quarter 2007 financial results, stating that as a result of the recently announced actions of Franklin Credit Management Corporation, which had a commercial lending relationship with Sky Financial, and related deterioration in Franklin’s mortgage portfolios, 2007 fourth quarter results for Huntington were expected to include an after-tax charge of up to $300 million, or $0.81 per common share. As a result of this charge, Huntington would report a 2007 fourth quarter net loss.

On this news, Huntington’s stock dropped from $16.08 per share to as low as $14.38 per share, closing at $14.75 per share on November 16, 2007 on volume of over 10 million shares.

I have added the Huntington Bancshares lawsuit to my running tally of subprime-related securities lawsuits, which can be found here. The addition of the Huntington case brings the number of subprime-related lawsuits to 27, not counting the five subprime related securities lawsuits that have been brought against home builders, and the two that have been brought against the credit rating agencies. Adding these categories together brings the total number of subprime-related securities lawsuits to 34. The addition of the list of Morgan Stanley 401(k) lawsuit cited above brings the total number of subprime-related ERISA/401(k) lawsuits to 6.

In recent posts (most recently here), I have discussed the potential difficulties that opt-out actions may present for securities class settlements. As if that were not complication enough, now the government wants to get into the act. As discussed below, the Department of Justice has appeared to object to the pending settlement of the consolidated class action securities lawsuit and derivative litigation involving DHB Industries (known since October 2. 2007 as Point Blank Solutions). The government’s appearance in the case raise some interesting questions.

The securities lawsuit and the shareholder derivative litigation first arose in September 2005, when shareholders sued the company and certain of its directors and officers. Refer here for background regarding the litigation. The shareholders’ amended complaint alleged that the individual defendants inflated the company’s share value then sold substantially all their shares, shortly prior to the company’s announcement of law enforcement officials’ concerns regarding the protective value of the company’s bullet proof vests and of certain issues regarding the company’s financials. The company ultimately withdrew reliance on its financial statements for 2003, 2004 and the first nine months of 2005.

On July 13, 2006, the company announced (here) a joint settlement of the securities lawsuit and the derivative litigation. According to the company’s announcement, the settlement consisted of the company’s agreement to pay $34.9 million in cash, plus 3,184,713 shares of company stock. The derivative case was settled in consideration of the company’s agreement to adopt corporate governance reforms and pay $300,000 of the derivative plaintiffs’ counsel’s fees. $12.9 million of the cash payment is to be paid by the company’s insurers. In addition, the company’s founder, Chairman and CEO, David Brooks, agreed to resign from all positions he held.

The company itself lacked cash to fund the portion of the cash settlement in excess of the insurance. To fund the settlement, the company entered into a transaction with Brooks whereby he would received nonregistered company shares in exchange for cash the company could use to fund the settlement. In return for his agreement to provide financing sufficient to fund the settlement, Brooks required that the company release him from any claims the company might have arising from his conduct as an officer of the company.

The court has held a series of hearings to consider final approval of the settlement, but the settlement has not yet been finally approved.

In a separate but related development, on October 25, 2007, the U.S. Attorney’s Office for the Eastern District of New York filed a superseding criminal indictment (here) charging Brooks and the company’s former Chief Operating Officer with insider trading, fraud, obstruction of justice, and tax evasion. As described here, the indictment alleges that the two officials inflated the company’s stock price by manipulating its financial records to increase earnings, including fraudulent accounts of armor inventory. The two were also charged with cutting themselves company checks for personal gain. Among the personal expenses Brooks is alleged to have charged to the company are $16,000 for a photographer for his son’s Bar Mitzvah and $101,190 for a “belt buckle studded with diamonds, rubies and sapphires.” A scathing commentary on the indictment and the company’s allegedly unsatisfactory role in the provision of body armor to U.S. troops in Iraq can be found here. His daughter’s Bat Mizvah, which allegedly cost $10 million, has also drawn, well, interesting commentary on the Internet.

At the same time as prosecutors commenced the criminal action, the SEC also initiated a civil enforcement action against Brooks (refer here). Among other things, the SEC complaint alleges that Brooks sold $186 million of his personal holdings of DHB stock while in the possession of material nonpublic information. Among other things, the SEC complaint seeks reimbursement by Brooks to DHB of bonuses and profits from stock sales pursuant to Section 304 (the so-called “clawback” provision) of the Sarbanes-Oxley Act.

These developments in the criminal proceeding and the SEC enforcement action became relevant to the securities lawsuit and the derivative lawsuit on November 19, 2007, when the Department of Justice filed its objections to the pending shareholder litigation settlement (here).
The government’s objections to the pending settlement are two-fold: first that the criminal defendants might try to use their release in the proposed settlement “to avoid their obligation, if convicted, to make full restitution.” Second, the government also objects on the ground that the proposed settlement release document purports to release the defendants from Section 304 liability, and to indemnify them for any third party Section 304 claim or settlement.

With respect to the release potentially absolving the defendants of their potential restitution obligation, the government asks for the “addition of a specific provision to the proposed settlement agreement providing that ‘nothing contained in this settlement is intended to limit the United States’ ability to pursue forfeiture, restitution or fines in any criminal, civil or administrative proceeding.'”

With respect to the government’s objections relating to Section 304, the government notes that to allow the defendants to be released and indemnified by the company “would undermine the very purpose behind Congress’ enactment of section 304.” The government “asks the Court not to approve the settlement unless this provision is removed.”

But the government did not stop there. Having had its say about the parts of the settlement that affect the interests of the United States, the government then went on to express its views about other aspects the settlement. As the government put it, “there are several other aspects of the proposed settlement that may warrant specific attention.” In explaining its provision of these additional comments, the government added that it “takes no position” on “whether these aspects of the proposed settlement should preclude a finding that the proposed settlement is fair, adequate and reasonable.”

The government’s extra two cents worth consists of the observation first that “the majority of the Defendants in these actions are [sic] not paying any consideration towards the settlement, but are nonetheless receiving broad releases.” The second is that, because the company’s share price has risen since the settlement was first proposed, the value of the shares Brooks purchased to fund the settlement have appreciated, as a result of which Brooks could “earn a profit of approximately $10 million on those shares, thus reducing his out-of-pocket contribution to the settlement.” Accordingly, the government notes “the Court may therefore want to assess whether Brooks’ contribution to the settlement is appropriate.”

The government is of course not a party to the private securities lawsuit. The bases on which the government made its appearance are under the Class Action Fairness Act of 2005 (pursuant to which the Attorney General must be given notice of class settlement) and 28 U.S.C. Section 517 (which gives the Attorney General the right to send an officer “to attend to the interests of the United States in a suit pending in a court of the United States.”)

While the U.S. government uses its Section 517 authority to appear in a wide variety of cases (refer, for example, here and here), I am not familiar with the government using this authority to intervene in a private securities class action to object to its settlement –I welcome others’ comments if this is more common than I am aware. In any event, it may be that the government resorted to this approach due to the fact that the case settlement preceded the indictment, as a result of which the government was unable to arrange the kind of collaborative settlement, for example, recently announced in connection with the UnitedHealth Group options backdating derivative settlement and SEC settlement.

But the troublesome thing about the government’s objection in the DHB Industries case is that having made its appearance, the government took the liberty of providing its own commentary on the merits of other aspects of the settlement. Section 517 may give the government authority to “attend to the interests of the United States” in pending lawsuits, but even under Section 517, the government’s role is limited to “attending” to the interests of the United States.

Whatever else anybody might want to say about these circumstances, the parties to the lawsuit have the right to negotiate their interests, without concerns of the government providing potentially obtrusive supervision. The class members are fully and appropriately represented under class action procedures, subject to the court’s review. Individual class members retain all of their rights to object to the proposed settlement and in fact some members of the class in fact have done so. What right does the government have to criticize elements of the settlement beyond the government’s interests?

The government’s actions undoubtedly are a reflection of the unique circumstances surrounding the case. But the prospect of the government acting as a kibitzer on class settlements is a concern. The terrain surrounding private securities class action litigation is already challenging enough without the government getting into the act.

Special thanks to Bill Baker of Latham & Watkins for sending along a copy of the government’s objections.

Securities Litigation Filing Trends: In recent posts (most recently here), I have noted that during the second-half of 2007, securities lawsuit filing levels have returned to historical norms after a tw0-year lull. In the most recent issue of InSights, entitled “The Two-Year Lull is Over: Securities Lawsuit Filings Rise” (here), I detail the recent increase in securities lawsuits filing activity and comment on the potential significance of these changes for the D&O insurance marketplace.

Blog Watch: The D & O Diary has recently been reading with interest the postings on the new blog PomTalk (here), a blog on corporate and securities law issues of interest to institutional investors produced by the Pomerantz Haudek Block Grossman & Gross law firm. The blog looks like a worthy addition to the blogosphere, and we look forward to reading future PomTalk posts.
Oil in Hell: Those struggling to understand how so many of the big investment banks have gotten burned so badly on their own holdings in subprime mortgage-backed securities may gain some insight from this excerpt, taken from the Chairman’s Letter in the 1985 Berkshire-Hathaway Annual Report:

You might think that institutions, with their large staffs of highly-paid and experienced investment professionals, would be a force for stability and reason in financial markets. They are not …. Ben Graham told a story 40 years ago that illustrates why investment professionals behave as they do: An oil prospector, moving to his heavenly reward, was met by St. Peter with bad news. “You’re qualified for residence,” said St. Peter, “but, as you can see, the compound reserved for oil men is packed. There’s no way to squeeze you in.” After thinking a moment, the prospector asked if he might say just four words to the present occupants. That seemed harmless to St. Peter, so the prospector cupped his hands and yelled, “Oil discovered in hell.” Immediately the gate to the compound opened and all of the oil men marched out to head for the nether regions. Impressed, St. Peter invited the prospector to move in and make himself comfortable. The prospector paused. “No,” he said, “I think I’ll go along with the rest of the boys. There might be some truth to that rumor after all.”

In a prior post (here), I compared the similarity of the piecemeal way that UBS, Merrill Lynch and Citibank have disclosed their subprime-related asset valuation write-downs. Now UBS has one more thing in common with the other two banks – it has been named as a defendant in a securities class action lawsuit.

According to the plaintiff’s counsel’s December 13, 2007 press release (here), the plaintiffs initiated a securities lawsuits in the Southern District of New York against UBS AG 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

On October 30, 2007, UBS issued a press release announcing its financial results for the third quarter of 2007. In the days following this announcement, the price of UBS stock declined to as low as $49.27 per share. Then, on December 10, 2007, UBS announced writedowns of around $10 billion as a result of its subprime mortgage related positions. Following this announcement, the price of UBS stock declined to $48.78 per share, a 26% decline from the Class Period high. The action purports to be brought on behalf of all shareholders who purchased UBS stock between March 13, 2007 and December 11, 2007.

The complaint quotes at length from an October 12, 2007 Wall Street Journal article entitled “U.S. Investors Face An Age of Murky Pricing” (here) which discusses at length how in March 2007, a hedge-fund unit of UBS (Dillon Read) was slashing its valuations on subprime-related assets at a time when UBS was carrying similar assets at much higher valuations. The article describes tense communications between UBS bankers and the Dillon Read trader, in which they questioned where he was coming up with his valuations, and he questioned the bankers’ valuations at higher levels that he felt were unavailable in the marketplace. UBS closed the hedge fund this summer, but it also did later write down its assets to lower valuations, and more recently to much lower valuations. (I commend this article if you have not yet read it; I re-read it for purposes of writing this blog post and even though it is only two months old it already provides some interesting and useful perspective.)

In addition to the securities class action, according to a separate December 13, 2007 press release (here), separate plaintiffs’ counsel have filed a separate lawsuit in the Southern District of New York, raising similar allegations, on behalf of UBS employees who suffered losses as purchasers of their employers stock in their 401(k) plans.

As I discussed at greater length in my prior post (here), the pattern of piecemeal disclosure of subprime-related losses is one factor contributing to the subprime litigation wave. Unfortunately, the difficulties that many companies are having in valuing assets in a deteriorating environment contributes to this disclosure pattern, and potentially to further subprime-related litigation.

I have added the new UBS lawsuits to my running tally of subprime related litigation (here). With the addition of the UBS action, the current tally of subprime related securities class action lawsuits now stands at 26, not counting the four subprime-related securities lawsuits that have been filed against residential home construction companies and the two subprime-related securities lawsuits that have been filed against the rating agencies. These categories taken together add up to 32 subprime-related securities lawsuits. In addition, the UBS 401(k) lawsuit brings the total of subprime-related ERISA/401(k) lawsuits to five.

Options Backdating-Related Securities Settlement: On December 13, 2007, American Tower announced (here) that it has reached a settlement in principle of the consolidated options backdating-related securities class action lawsuits that had been filed against the company and certain of its directors and officers. Refer here for background regarding the lawsuit. In connection with the settlement, the company will make a $14 million cash payment. The company stated that “it has been and will continue to be in discussions with its insurers concerning the amount of their contribution to the settlement.”

I have added the American Tower settlement to my cumulative table of options backdating-related lawsuit settlements, dismissals, and denials. The table can be accessed here.

Another Target for Subprime Ire: The list of purported scapegoats for the subprime crisis is already lengthy, but a December 13, 2007 Washington Post article entitled “Analysts Late to the Alarm” (here) adds yet another new category of targets to blame. The article notes that securities analysts “did not sound the alarm on the subprime mess,” but asks whether “analysis [should] have seen the meltdown coming?”

The article observes that while there have been much “finger-pointing” at the analysts, there has as yet been “no conclusion.” Among other things, the complexity of the financial instruments involved and the multifaceted nature of the credit issues eluded all but a few analysts. Other contributing factors for the analysis included “the pressure to always be right, the difficulty of going against the tide, and the need to hang onto clients.” The article also examines, without expressing views, whether conflicts of interests could have played a role.

Why the JDS Uniphase Securities Suit Went to Trial: Law.com has a December 13, 2007 article entitled “In-House Lawyers Go for All or Nothing in Securities Case” (here), which gives an inside look at why the JDS Uniphase case went to trial (for background about the trial refer here). The article examines the process that led up to the decision to take the case to trial and the barriers that prevented settlement. The article also gives a look at the pressure the company’s in-house counsel faced as a result of the decision to take the case to trial.

The lawyers involved in this case clearly deserve credit for courage and perseverance. But after reading the account of what they went through, it is hard to imagine may others being willing to make the same decision and to face that kind of pressure. The JDS Uniphase verdict theoretically might embolden others to push a case to trial, but the reality is that very few would be willing to undertake the risk and the pressure.

Among the more disconcerting aspects of the unfolding subprime crisis has been the unseemly spectacle of major financial institutions taking dramatically increased asset value write-downs shortly after having disclosed smaller write-downs on the same assets. UBS became the latest company to follow this pattern earlier this week when it announced (refer here) an increased $10 billion asset write-down, only three weeks after taking a $4.4 billion write-down in connection with the same assets. UBS’s increased write down following the more or less same sequence of events as were involved with write-down disclosures at Merrill Lynch (about which refer here) and Citigroup (about which refer here).

In its December 10, 2007 press release explaining its most recent write-downs (here), UBS said it was making its move “in response to continued deterioration in the U.S. subprime securities market,” as a result of which, the company “revised assumptions and inputs used to value U.S. subprime mortgage related positions.”

Perhaps due to the deterioration in the market for U.S. mortgage-backed securities, but also likely in response to the undesirability of the pattern of piecemeal asset valuation disclosures, SEC Chairman Christopher Cox reportedly said on December 10, 2007 (refer here) that the SEC will be sending letters to approximately two dozen financial service firms, including banks and insurance firms, urging them to disclose “more information about their exposure to potentially problematic loans in light of the massive number of gargantuan write-offs caused by the subprime lending crisis.”

Underlying these developments is the fundamental difficulty companies are facing in valuing many of these mortgage-backed assets. The asset valuation difficulty is apparently of particular concern to the Public Company Accounting Oversight Board (PCAOB), which on December 10, 2007 released an Audit Practice Alert entitled “Matters Related to Auditing Fair Value Measurements of Financial Instruments and the Use of Specialists” (here). The Alert is written in light of the circumstances that may “make it difficult to obtain relevant market information to estimate the fair value of many mortgage-backed securities,” which is likely to “increase audit risk.”

The Alert’s purpose is to draw auditors’ attention to certain areas of the new fair value accounting standards under SFAS No. 157, which is effective for financial statements issued for fiscal years beginning after November 15, 2007, and for interim periods within those fiscal years. In other words, these new standards are about to start applying to many companies for the first time in the reporting period that is currently underway. The PCAOB is clearly worried that there may be problems as the new fair value standards are applied to many mortgage-backed securities.

According to a December 11, 2007 CFO.com article (here), the PCAOB issued the Alert “over concerns that the subprime mortgage crisis will increase the volume of fair value recalculations companies will be forced to make after accounting for losses from the subprime collapse.” At the heart of the Alert is a discussion of the hierarchy of inputs to be used in determining whether a company’s financial statement disclosures are complete, accurate and in compliance with GAAP.
Under SFAS No. 157, as the reliability of the inputs decreases, the company’s disclosure obligations increase. (UBS’s recent increased write-down is in effect a practical example of these principles in action, as the company said that its increased write-down was the result of the results derived from changing the inputs used in its asset valuation.) The Alert observes that this hierarchy creates some obvious, potentially unhealthy incentives: “Because there are different consequences associated with each of the three levels of hierarchy, the auditor should be alert for circumstances in which the company may have an incentive to inappropriately classify fair value measurements within the hierarchy.”

The PCAOB’s encouragement for auditor attentiveness to these issues clearly reflects a concern that in order to avoid certain adverse disclosures, some companies may not come clean. The PCAOB’s alert is obviously intended to ensure that auditors are fully engaged in their critical audit function in assessing the valuations companies assign to mortgage-backed assets. While time will tell how these changing standards and audit processes will play out, the Alert implicitly assumes that auditors may be forced to challenge their clients’ valuation assumptions, which in turn could lead to additional financial statement disclosures (and, potentially, asset valuation write-downs).

These accounting issues not only directly affect financial statement disclosure issues, but they may also be at the heart of future subprime related litigation. Many of the subprime-related lawsuits that have already arisen are built around accounting-related allegations, including, for example, the adequacy of loan loss reserves; the failure to properly account for the allowance for loan repurchase losses; and the failure to properly account for the residual interests in securitizations. But more to the point for purposes of this blog post, many of the subprime-related lawsuits have contained allegations related to the failure to timely write down impaired assets. An excellent, detailed discussion of the accounting issues that have arisen in subprime-related litigation can be found in NERA Economic Consulting’s December 6, 2007 publication “The Subprime Meltdown: Understanding Accounting-Related Allegations” (here).

The piecemeal process by which many companies have disclosed their valuation write-downs on mortgage-backed assets has already engendered litigation. The PCAOB’s alert suggests that it is concerned that in connection with their implementation of SFAS No. 157, auditors may also be called upon to reassess asset valuations, a process that could lead to further disclosure and even write-offs. These circumstances certainly present the possibility for even further subprime-related litigation following adjusted asset valuation disclosures.

One final note is probably worth emphasizing. As I have previously discussed at greater length (here), these asset valuation problems are not restricted to the financial sector. The mortgage-backed assets at the center of these valuations are broadly dispersed in the economy and can found on the balance sheets of a wide variety of entities. The potential exists for the asset valuation issues discussed above to affect some unexpected companies, which, in turn, could further spread the growing subprime litigation wave.

The December 12, 2007 Wall Street Journal has an article entitled “A Subprime Gauge, in Many Ways?” (here), discussing problems that many companies (including, for example, UBS) are having with one of the inputs that might be used in subprime-mortgage backed asset valuations, the ABX index, which tracks the value of securities backed by subprime home loans. The article underscores the difficulties that companies are having in determining the approriate asset valuation inputs.

Mortgage Professionals’ Litigation Exposure: As this blog has noted before (most recently here), the subprime-related litigation wave is likely to hit a wide variety of professionals. Among the professionals that have already become involved in subprime-related litigation have been those in the real estate industry (as discussed here). According to a December 2007 report (here) prepared by reinsurance broker Guy Carpenter, real estate professionals’ susceptibility to litigation may vary by state, depending on a set of possible variables.

According to the report, real estate professionals “may have more cause to worry depending on the states in which they practice,” according to the “convergence of a variety of legal and business conditions” that “create an overall climate of risk.” The report ranks the various states based on an index of factors (such as the percentage of mortgages in foreclosure, the number of litigation attorneys, and the frequency of Truth in Lending lawsuits). States ranked as having a high risk of mortgage professional litigation according to this index includes Alabama, Connecticut, Georgia, and Illinois. The lowest ranking states include Wyoming, Vermont, South Dakota and Oregon.

Chinese companies’ listing debuts are a vital force in the current global IPO marketplace. According to a December 8, 2007 Wall Street Journal chart (here), 195 Chinese companies listed their shares through November, raising $87.3 billion – representing a 26.7% share of the 2007 global IPO volume. By contrast, the IPOs of 174 U.S. domiciled companies raised $38.5 billion, which represents an 11.8% share. In addition, according to a December 3, 2007 Wall Street Journal article entitled “Chinese Firms Will Test Market Appetite for IPOs” (here), “December could see the launch of three issues that, in total, might eventually raise more than $12 billion.” By years’ end, the amount raised in 2007 by Chinese company IPOs could well exceed $100 billion.

Stock exchanges around the world are jockeying for a piece of this action. A December 3, 2007 Financial Times article entitled “Markets Jostle to be China’s IPO Buddy” (here) notes that “Singapore and Hong Kong are falling all over themselves to be the destination of choice for capital hungry mainland companies, while smaller Chinese companies are still attracted to the perceived lighter-touch regulation of London’s Alternative Investment Market.” By the same token, the three anticipated December offerings mentioned above are all scheduled to take place in Hong Kong or Shanghai – not in New York.

In order to try to increase its share of this business, on December 3, Nasdaq opened a Beijing office. The Financial Times article, commenting on the office opening, snipes that the U.S. exchanges “face steep challenges, including the time zone and worries about the country’s litigious environment.” (More about what the litigious environment has meant for Chinese companies below.) But the biggest challenge for the U.S. exchanges is that “Asia is so awash with liquidity that issuers rarely need to look beyond Hong Kong.”

For all that, in 2007, Nasdaq still managed to increase the number of its Chinese listings. According to a December 3, 2007 Wall Street Journal article about the Nasdaq Beijing office opening (here), as of the end of November Nasdaq had 52 listed mainland Chinese companies, with a combined market capitalization of $57 billion, up from 33 Chinese firms with a total capitalization of $25 billion at the end of 2006. The 19 listings by Chinese companies this year are “more than double last year’s total of nine.”

Give the ample liquidity available in Asian financial markets, it is worth asking why Chinese companies would nevertheless be willing to confront U.S regulatory requirements, litigiousness, and time zone differences to list their shares in New York. According to a May 10, 2007 Financial Times article entitled “New York Proves an Attractive Destination” (here), the large privatized Chinese enterprises are attracted to Hong Kong, but maturing small venture-capital backed companies are attracted to New York because “they can still get better valuations and wider analyst coverage in [the high tech and life sciences] sectors than in the resurgent Chinese domestic markets or in the other parts of the world.’ One source is quoted in the article as saying that a New York listing helps the companies to establish their brand internationally, for which “nothing matches a U.S. listing.”

But before we break out the champagne to celebrate Nasdaq’s success in attracting more Chinese companies’ offerings in 2007, it is worth taking a look at what the increased number of Chinese listings has actually wrought. Even a quick look suggests that just because a Chinese company is eager to list its shares does not necessarily mean that the company is ready for the scrutiny that comes with a U.S. listing. Indeed, a more detailed analysis confirms that some of the Chinese companies that have listed their shares on U.S. exchanges may not have been ready for the burdens and responsibilities, to their investors’ disappointment.

The most telling fact is that of the roughly 165 companies that have been sued in securities class action lawsuits in 2007, seven are Chinese companies. Even more significantly, of those seven companies, five completed their IPOs less than 12 months prior to the initial lawsuit filing – including one, Giant Interactive, that debuted on November 1, 2007 and was first sued on November 26. A sixth company, Focus Media Holdings, which was first sued on November 27, 2007, had just completed a secondary offering on November 7, 2007.

A review of the allegations of the lawsuits against the seven companies reinforces the view that at least some of these Chinese companies that the U.S exchanges succeeded in attracting to New York may not have been ready for prime time.

Here is a brief summary of the allegations against the seven companies:

Xinhua Finance Media (first sued on May 22, 2007, refer here): The plaintiffs allege that the Prospectus issued in connection with the company’s March 8, 2007 IPO failed to disclose that the company’s CFO at the time of the offering was simultaneously an investment banker in charge of a securities firm that is the subject of an SEC investigation, and that he was also an investor in two companies that had been sued by the SEC for fraud.

Qiao Xing Universal Telephone (first sued on August 9, 2007, refer here): The lawsuit arises out of the company’s restatement of its financials for the years 2003, 2004 and 2005. The company stated at the time that misstatements resulted from deficiencies in the company’s internal controls over financial reporting.

China Sunergy Company Limited (first sued on September 10, 2007, refer here): The lawsuit alleges that the company’s Prospectus in connection with its May 17, 2007 IPO failed to disclose that the company was having difficulty obtaining a sufficient supply of polysilicon, which forseeably would have a near-term impact on earnings.

LDK Solar Company (first sued on October 9, 2007, refer here): The company was sued after the company’s financial controller resigned, reporting to the SEC and the company’s external auditor that the company lacked internal controls and that the company’s reported polysilicon inventory was 25% overstated.

Fuwei Film (Holdings) Company (first sued on November 19, 2007, refer here): The lawsuit alleges that the Prospectus in connection with the company’s December 19, 2006 offering failed to disclose that the company’s main operating assets were obtained through transactions that may not have been valid under Chinese law. On October 15, 2007, three of the company’s major shareholders, including one director, were arrested on suspicion of legal violations.

Giant Interactive Group (first sued on November 26, 2007, refer here): The lawsuit alleges that the Prospectus released in connection with the company’s November 1, 2007 IPO failed to disclose that the company had experienced a third-quarter 2007 decline in users (i.e., prior to the offering), which it disclosed for the first time on November 19 (less than 3 weeks after the offering).

Focus Media Holding (first sued on November 27, 2007, refer here): The lawsuit alleges that the company’s Prospectus in connection with its November 7, 2007 secondary offering failed to disclose that acquisitions in its Internet advertising division were depressing the division’s gross margins. In the company’s November 19 earning release, it disclosed that its gross margins had declined due to several recent acquisitions.

To be sure, there is nothing uniquely Chinese about these kinds of allegations (except perhaps with respect to the Fuwei Film allegations). But it is the frequency of these allegations relative to the number of listings that is disturbing. Five of these seven companies are listed on Nasdaq (LDK Solar and Giant Interactive are NYSE listed), meaning that these five represent roughly ten percent of the 52 Nasdaq listed Chinese companies. Moreover, four of the seven are among the 19 Chinese companies that debuted on Nasdaq in 2007 – representing roughly 21% of all Chinese companies that listed on Nasdaq this year.

If the U.S. exchanges’ “success” means only that they have attracted companies that stumble out of the blocks, investors may soon lose their sinophilia. This process may already be taking place. A December 7, 2007 Wall Street Journal article entitled “China IPOs Lose Some Allure” (here) noted that two Chinese companies, WSP Holding and VisionChina Media, had to cut their prices to sell shares in their December 6 offerings.

All of this could be interpreted to suggest that in the U.S exchanges’ haste to woo Chinese listings, they may be attracting companies that are not prepared for everything that goes with a U.S. listing. U.S toy retailers learned the hard way that consumers expect to be protected from toys with lead-based paint. The U.S exchanges shouldn’t have to learn this same lesson all over again in the financial marketplace. The measure of the U.S exchanges’ “success” in the global IPO marketplace should not be based on quantity, but on quality, in order for the U.S markets to maintain their reputation for transparency and integrity and to continue to offer superior valuations for companies that can, in fact, withstand the scrutiny. For the sake of the competitiveness of the U.S financial markets, the U.S exchanges themselves must take steps to ensure that foreign issuers continue to perceive that “nothing matches a U.S. listing.”

In an earlier post (here), I noted how the subprime related securities litigation wave has reached the bond insurance sector. The forces creating turmoil for the bond insurers have now reached another company in the credit enhancement business, leading to a further subprime-related litigation.

According to its December 7, 2007 press release (here), the Coughlin Stoia firm filed a securities lawsuit against Security Capital Assurance, a Bermuda-based provider of financial guaranty insurance, reinsurance and other credit enhancement products. A copy of the complaint can be found here. According to the press release, the complaint alleges that in connection with the company’s June 6, 2007 secondary offering, the company’s Prospectus failed to disclose that:

(i) the Company was materially exposed to extremely risky structured financial credit derivatives; and (ii) the Company was materially exposed to residential
mortgage-backed securities relating to sub-prime real estate mortgages.

The lawsuit follows the company’s October 16,2007 announcement (here) that its third-quarter results would be affected by an unrealized mark-to-market loss of $145 million with respect to its credit derivatives portfolio. The lawsuit also follows Fitch’s November 13, 2007 downgrade (here) of two transactions insured by the company and representing $792 million in net par insured. On the date the complaint was filed, the company’s share price was 80% lower than the share price in the secondary offering.

With the addition of the Security Capital Assurance lawsuit, the tally of the subprime-related lawsuits that I am maintaining here now stands at 24, not counting the four residential home construction companies that have been sued in subprime-related lawsuits and the two rating agencies that have been sued in subprime lawsuits. These three categories together represent a total of 30 subprime-related securities lawsuits.

The Thought Bubble Over Gregory Reyes’s Head Says “Whatever Happened to ‘No Harm, No Foul’?”: On August 7, 2007, Gregory Reyes, Brocade Communications’ former CEO was convicted of ten felonies in connection with the company’s stock options practices. The court is now faced with determining Reyes’s sentencing under the federal Sentencing Guidelines. Under the Guidelines, the most significant factor in determining the sentence for the crimes of which Reyes is convicted is the extent of the pecuniary loss attributed to his conduct.

In a November 27, 2007 order (here), Judge Charles Breyer found that the government had failed to “quantify any amount of loss that can be attributed to Reyes’ conduct.” As a result, Judge Breyer calculated Reyes’s recommended sentence to be in the range of 15-21 months, far below the government’s recommended range of 292-365 months.

As discussed at greater length in the Legal Pad blog (here), the court rejected the government’s arguments that the loss could be calculated based on a single-day drop in the company’s market capitalization; based on the amount of the fines and penalties the company paid; based on the shareholders’ “rescissory loss” (because the fluctuating share price was affected by so many factors); or based on Reyes’s own personal gains – because, Judge Breyer concluded, there weren’t any gains that could be proven with clear and convincing evidence.

The date of Reyes’s sentencing is not yet scheduled.

More About the UnitedHealth Derivative Settlement: The record-setting settlement in the UnitedHealth options backdating derivative lawsuit (about which refer here) has continued to provoke commentary.

The Lex column in the December 8, 2007 Financial Times (here), commenting on the fact that William McGuire’s settlement contribution represented the first exercise of the statutory clawback provisions under the Sarbanes Oxley Act, observed that:

By in effect activating Sarbox’s clawback provision, the settlements may spur other shareholder committees to extend their talons in search of reimbursement for backdated options. Companies have long whinged about the onerous requirements imposed on them after the Enron and WorldCom accounting scandals. But here, at least, is an instance where Sarbox seems to have done exactly what it is meant to in protecting shareholders. For once, executives will find it tough to complain and expect any sympathy.

Gretchen Morgenson, writing in the December 9, 2007 New York Times (here), commented that the UnitedHealth settlement demonstrates the importance of special litigation committees. But, she commented, “that the outcome of the UnitedHealth case is so remarkable is a distressing indication of how far shareholders still have to go to hold executives and directors accountable.”

When the dust finally settles and the reports on 2007 class action filings are being written, one development that should be noted as a contributing factor to the increased filings in the second half of 2007 is the emergence of class action lawsuits based on busted buyouts. Disappointed target companies that have become the target of securities lawsuits following busted buyouts include Radian (about which refer to my prior post here), Harman Industries (prior post here) and United Rentals (prior post here).Now plaintiffs’ lawyers have launched a securities lawsuit against Genesco, as a fallout from the busted merger between Genesco and The Finish Line.

Genesco and The Finish Line had announced on June 18, 2007 (here) that The Finish Line would acquire all of Genesco’s stock for $1.5 billion. Problems ensued, and on September 14, 2007, The Finish Line issued a press release (here) announcing that it had received letters from the UBS entities providing the deal financing to the effect that the entities were “extremely concerned about the deteriorating financial position” of Genesco. The UBS entities also noted that they were “not yet satisfied that Genesco has not experienced a Material Adverse Effect.” (A Material Adverse Effect would relieve the acquirer from its obligations under the merger agreement.) The UBS entitles had also asked The Finish Line to “cause Genesco” to provide all financial information required for the entities to “conclude whether a Material Adverse Effect had occurred.”

Thereafter, on September 21, 2007, Genesco announced (here) that it had filed a lawsuit in Tennessee Chancery Court “seeking an order requiring The Finish Line, Inc. to consummate its merger with Genesco and to enforce The Finish Line’s rights against UBS under the Commitment Letter for financing the transaction.”

On September 28, 2007, The Finish Line announced (here) that it had filed an answer, counterclaim and third-party claim for declaratory judgment in the Tennessee action. Among other things, in its September 28 press release, The Finish Line stated that “it has asked Genesco for certain financial and other information as well as access to Genesco’s Chief Financial Offier and financial staff. However, to date Genesco has not responded and refused to comply with these requests.” The announcement also stated that The Finish Line was seeking a declaratory judgment that a Material Adverse Effect had occurred.

In its own response to the lawsuit, UBS not only answered but filed a counterclaim against Genesco for fraud. UBS has also sued both Genesco and The Finish Line in federal court in Manhattan seeking to void its financing commitment letter.

The Tennessee case is scheduled to go to trial on December 10, 2007. A copy of the court’s order identifying the issues for trial can be found here. An exhaustive and interesting analysis of the legal issues in the Tennessee case can be found on the M & A Law Prof blog, here.

Just to provide a cold steel edge to these circumstances, the U.S. attorneys’ office in Manhattan served a subpoena on Genesco. According to Genesco’s November 26, 2007 press release (here), the subpoena “states that the documents are sought in connection with alleged violations of federal fraud statutes.” The press release quotes the company’s Chairman and CEO has saying that the subpoena “come on the heels of the baseless fraud allegations made by UBS ten days ago.”

Circumstances like these were bound to excite the plaintiffs’ lawyers’ interest, and so it comes as no surprise that on December 5, 2007, the Coughlin Stoia firm announced (here) that it had filed a securities lawsuit in federal court in Tennessee against Genesco 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:

During the Class Period, defendants made false and misleading statements oncerning Genesco’s business and prospects. As a result of their representations, Genesco was seen as an attractive acquisition target for Foot Locker, Inc. Foot Locker ultimately made an offer and The Finish Line, Inc. and Headwind, Inc., a wholly owned subsidiary of Finish Line, subsequently made an increased offer, based on Genesco’s purported success. When the truth about Genesco’s results began to be revealed, however, Finish Line indicated it would no longer pursue the acquisition. Then, on November 26, 2007, Genesco received a subpoena from the Office of the U.S. Attorney for the Southern District of New York seeking documents related to its merger agreement and in connection with alleged violations of federal fraud statutes. On this news, Genesco’s stock plunged to $25.44 per share on November 27, 2007, almost a 16% drop from the closing price of $30.17 on November 26, 2007, on volume of 2.4 million shares.

According to the complaint, during the Class Period defendants concealed the following information, which caused their statements to be materially false and misleading: (a) the Company’s stores were not performing well and would not produce the financial results being forecast for the Company; (b) the Journeys stores were performing poorly relative to plan with big same store sales declines; and (c) these poor results would be considered adverse events to potential acquirors, leading to significant share price declines at Genesco.

The Genesco saga clearly has further to run, particularly in light of the Tennessee state court trial that will begin on Monday. But Genesco’s busted deal with The Finish Line is only one of a host of transactions previously announced with great fanfare that are now dead or on life support. The M & A Law Prof blog (which is, by the way, a truly excellent blog) has a comprehensive overview of the status of these busted deals (here), subdivided between the “dead”, the “walking wounded” and the “troubled.” There may be one or more disappointed target companies on this list (or soon to be added to the list) that may find themselves getting a securities lawsuit as a complement to their woes.

As I noted at the outset, these busted deal securities lawsuits are just one more factor driving the increase in securities lawsuits in the second half of 2007. For more about the second-half 2007 securities lawsuit filing increase, refer here.

Another Qwest Opt-Out Settlement: In a recent post (here), I detailed two significant opt-out settlement in connection with the Qwest Communications securities litigation. In the latest of the Qwest opt-out settlements, on December 5, 2007, the Teacher Retirement System of Texas (TRS) announced (here) that it had entered a $61.6 million settlement with Qwest.

In its press release, TRS said that had it remained in the class its recovery would only have been $1.4 million, implying that it had increased its recovery 44 times by opting out. In explaining the reason it opted out, TRS’s executive director said that “we considered the high attorneys’ fees and the insufficient recovery anticipated from the class action lawsuit and decided to seek damages from Qwest on our own.”

A December 6, 2007 Wall Street Journal article entitled “First the Losses, Now Bond-Fund Lawsuits” discussing other lawsuits (other than securities class action lawsuits) can be found here.

As I discussed in my prior post about the Qwest opt-out settlements, Qwest had disclosed in its most recent filing on Form 10-Q that the company had agreed to pay the class action opt-outs a total of $411 million. According to a December 6, 2007 report in the Austin American-Statesman (here), the $411 million amount includes the amount paid in settlement with the Texas fund. As I also noted in my prior post, the $411 million total opt out settlements exceeds the $400 million that Qwest agreed to pay the class.

Subprime Litigation Wave Hits Mutual Fund Family: Add mutual funds to the list of list of kinds of companies that have been hit with the subprime securities litigation wave. According to its December 6, 2007 press release (here), the Lockridge Grindal Nauen law firm has filed a securities class action lawsuit against Morgan Asset Management, Inc., Morgan Keegan & Company, Inc., MK Holding, Inc., Regions Financial Corporation (NYSE:RF), PricewaterhouseCoopers LLP, and certain individuals, officers and directors associated with these entities in the United States District Court for the Western District of Tennessee, on behalf of investors who purchased shares of the Regions Morgan Keegan Select Intermediate Bond Fund (“MKIBX”) and Regions Morgan Keegan Select High Income Fund (“RHIIX”).

The bond funds referenced has been in the news for its losses as a result of some subprime related investments. According to a December 6, 2007 article (here) on the Morningstar website, the Morgan Keegan Select Intermediate Bond Fund has lost 55% of its value this year, which the Morningstar site comments is “a staggering loss for a bond fund.” The site goes on to comment that “The fund lost a bundle on subprime mortgages and then redemptions forced it to sell other holdings under duress, and the net is a horrific loss. It shows that sometimes you really are better off panicking and yanking your money from a troubled fund, because redemptions can make a bad situation even worse.”

I have added the Morgan Keegan/Regions Financial lawsuit to my running tally of subprime-related securities lawsuits, which can be found here. With the addition of this new lawsuit, the tally of subprime securities lawsuits now stands at 23, not counting the four subprime related securities lawsuits that have been filed against home construction companies, and the two rating agencies that have also been sued in subprime related securities lawsuits.
Added together, these various categories total 29 subprime-related securities class action lawsuits, all of which have been filed in 2007.

On December 6, 2007, UnitedHealth Group announced (here) that its Special Litigation Committee had concluded its review of claims relating to the company’s option backdating practices that had been brought against certain of the company’s directors and officers.

The company also announced that its former CEO William McGuire had agreed surrender certain rights and interests which, together with previous repricing of all stock options awarded to McGuire, have a value in excess of $600 million.

Certain other current and former officers also agreed to relinquish certain rights and repay other amounts, which in combination with the repricing of certain stock option, have a value of approximately $300 million.

According to the company’s statement:

The SLC has valued the total amounts to be relinquished pursuant to these settlement agreements, together with the value previously and voluntarily relinquished by current and former executives, through the surrender and repricing of options, to be approximately $900 million.

A December 6, 2007 Bloomberg.com article (here) states that “if approved by a court, the settlement …would be the largest ever in a ‘derivative’ suit…according to data compiled by Bloomberg.”

Separately, the SEC announced on December 6, 2007 (here) that it had reached a $468 million enforcement action settlement with McGuire, which, the SEC said, includes the “largest penalty assessed against an individual in an options backdating case.” The $468 million SEC settlement consists of “a $7 milllion civil penalty and reimbursement to the Minneapolis-based health care company for all incentive- and equity-based compensation he received from 2003 through 2006.”

The SEC’s press release also stated that the McGuire settlement “is the first with an individual under the ‘clawback’ provision (Section 304) of the Sarbanes-Oxley Act to deprive corporate executives of their stock sale profits and bonuses earned while their companies were misleading investors.”

According to UnitedHealth’s press release, McGuire’s settlement consists of the following elements:

  • Surrender to UnitedHealth Group certain stock options to acquire 9,223,360 shares of Company stock, which the SLC has valued at approximately $320 million;

  • Surrender his interest in the Company’s Supplemental Executive Retirement Plan, valued at approximately $91 million;

  • Surrender to the Company approximately $8 million in his Executive Savings Plan Account; and

  • Relinquish claims to other post-employment benefits under his Employment Agreement.

According to the company. these amounts, combined with a previous repricing of all stock options awarded to Dr. McGuire from 1994 to 2002, result in a total value to be relinquished by McGuire in excess of $600 million.

A copy of McGuire’s settlement agreement with the company and the derivative plaintiffs can be found here.

The UnitedHealth press release described the settlement with the company’s former General Counsel, David Lubben, as consisting of the surrender to UnitedHealth Group of his stock options to acquire 273,000 shares of Company stock, which the SLC valued in excess of $3 million; and the repayment to the Company $20.55 million of the compensation realized by him as a result of his March 2007 exercise of stock options.

According to the company, these amounts, combined with a previous repricing of stock options awarded to Lubben, result in a total value relinquished by Lubben of approximately $30 million.

A copy of the settlement agreement between Lubben and the company and the derivative plaintiffs’ counsel can be found here.

The UnitedHealth press release also stated that under the settlement agreement that the company reached with its former director William Spears, “the fair settlement value of the Company’s claims … will be determined by binding arbitration.”

According to the Bloomberg article, current United Health CEO Stephen J. Helmsley had agreed to repay $240 million, although the company apparently says he voluntarily did so months ago.

A copy of the UnitedHealth special litigation committee’s December 6, 2007 report can be found here.

The Wall Street Journal’s December 7, 2007 article discussing the settlement can be found here.

Special thanks to alert reader Kelly Reyher for sending alerting me to this story and sending along the Bloomberg link.

The magnitude of these settlements is obviously arresting. The scale of the settlements is proportionate to the scale of the backdating problems at UnitedHealth, which had forced the company to restate $1.13 billion in earnings over a 12-year period. The scale of these settlements could have a significant impact on at least some of the other pending options backdating derivative cases, particularly where the company has been forced to restate and where top company officials have personally benefited from the backdating.

Readers should note that the table I am maintaining of all options backdating related settlements, dismissals and denials can be accessed here.

From a D & O insurance perspective, it is noteworthy that all or virtually all of the amounts to be paid to the company or to the SEC may be characterized as disgorgement, return of ill-gotten gains, return of compensation to which the individual was not legally entitled, or fines and penalties. Assuming that these are in fact accurate characterizations of the settlement payments, these amounts would not constitute covered loss under the typical D & O insurance policy.