On January 15, 2008, in a 5-3 majority opinion (here) written by Justice Kennedy (pictured to the left), the U.S. Supreme Court affirmed the Eighth Circuit in the Stonridge Investment Partners, LLC v Scientific Atlanta case. The Court concluded that the implied right of action under Section 10(b) did not reach the respondent companies’ conduct because the investor claimants did not rely on the alleged deceptive conduct. Justice Stevens, joined by Justices Souter and Ginsberg, dissented. Justice Breyer, as previously disclosed, did not take part in the case.

As discussed in a prior post (here), the investors claimed that Scientific Atlanta and Motorola had helped Charter Communications make its revenue targets through an arrangement whereby Charter overpaid its vendors for set-top cable boxes and the vendors agreed to return the overpayment by buying advertising from Charter. The vendors treated the two transactions as a wash sale, but Charter accounted for the transactions so that they favorably (and, the investors alleged, improperly) impacted its revenue and permitted the company to meet its revenue targets. Charter later restated is revenue to reclassify the revenue from the set-top deal.

Charter’s investors separately sued Charter and its accountant in a case that later settled, but the investors also sued the vendors, alleging that the vendors knowingly entered the transaction in order to permit Charter to achieve a desired accounting outcome. The investors alleged that the vendors falsified documents and backdated contracts to facilitate the outcome.

The district court granted the vendors’ motion to dismiss and the Eighth Circuit affirmed, holding that "any defendant who does not make or affirmatively cause to be made a fraudulent misstatement or omission …is at most guilty of aiding and abetting and cannot be held liable under Section 10(b)."

The U.S. Supreme Court affirmed the Eighth Circuit, holding that the case against the vendors was properly dismissed. But the Supreme Court did not adopt the Eighth Circuit’s reasoning; rather, the Court says, with respect to the Eighth Circuit’s statement that Section 10(b) reaches only misstatements or omissions by one with a duty to disclose, that "if this conclusion were read to suggest that there must be a specific oral or written statement before there could be liability under Section 10(b) or Rule 10b-5, it would be erroneous." The Court would on to note explicitly that "conduct itself can be deceptive."

While the Supreme Court disclaimed the Eighth Circuit’s reasoning, it still affirmed the Eighth Circuit’s holding because the vendors’ "acts or statements were not relied upon by the investors and that as a result liability cannot be imputed."

Thus the Court’s decision turns on the absence of "reliance." The Court did note that there is a "rebuttable presumption of reliance" under two circumstances; first, if "there is a duty to disclose" and second, "under the fraud-on-the-market" doctrine, by which reliance is presumed when the statement at issue becomes public. The Court held with respect to these presumptions of reliance that

Neither presumption applies here. Respondents had no duty to disclose; and their deceptive acts were not communicated to the public. No member of the investing public had knowledge, either actual or presumed, of respondents’ deceptive acts during the relevant time. Petitioner, as a result, cannot show reliance upon any of respondents’ actions except in an indirect chain that we find too remote for liability..

The investors sought to overcome these considerations by urging that that respondents engaged in a scheme, contending that the vendors had "engaged in conduct with the purpose and effect of creating a false appearance of material fact to further a scheme to misrepresent" and that Charter’s release of false financial statements "was a natural and expected consequence of" the vendors’ deceptive acts.

The court rejected these "scheme liability" allegations, saying that the vendors’ "deceptive acts, which were not disclosed to the investing public, are too remote to satisfy the requirement of reliance. It was Charter, not respondents, that misled its auditor and filed fraudulent financial statements; nothing respondents did made it necessary or inevitable for Charter to record the transaction as it did."

The majority opinion noted a number of additional considerations that it found militated against the investors’ position; the Court found that:

1. Investors’ position seeks to apply Section 10(b) "beyond the securities markets–the realm of financing business – to purchase and supply contracts – the realm of ordinary business."

2. Recognizing the position urged by the investors "would revive in substance the implied cause of action against all aiders and abettors except those who committed no deceptive act in the process of facilitating the fraud."

3. In enacting the PSLRA, Congress recognized an SEC enforcement cause of action for aiding and abetting, but did not recognize a private right of action for aiding and abetting. The Court said "we give weight to Congress’ amendment to the Act restoring aiding and abetting liability in certain cases but not others."

4. Adopting the position urged by the investors "would expose a new class of defendants to these risks" who might "find it necessary to protect against these threats, raising the cost of doing business."

5. If the Court adopted investors’ position, "overseas firms" would be "deterred from doing business here," and could "raise the costs of being a publicly traded company under our law and shift securities offerings away from domestic capital markets."

6. The implied right of action under Section 10(b) "should not be further expanded beyond its present boundaries." The Court said that its holdings is "consistent with the narrow dimensions we must give to a right of action Congress did not authorize when it first enacted the statute and did not expand it when it revised the law."

7. The SEC’s enforcement power "is not toothless" and "both parties agree that criminal penalties are a strong deterrent." Moreover, there is an "express private right of action against accountants and underwriters under certain circumstances" and the "implied right of action in Section 10(b) continues to cover secondary actors who commit primary violations."

The dissent argues that the Court, having found that the Eighth Circuit’s reasoning was incorrect, should at a minimum have remanded the case for further proceedings on the reliance issue. The dissent also faults the majority’s "fraud on the market" analysis, saying that the doctrine does not require investors to be aware of the specific deceptive act to rely on the doctrine to establish reliance. Justice Stevens also argued that because the vendors’ actions were undertaken with the expectation that Charter would rely on them in making fraudulent statements, the causal connection between their allegedly improper action was sufficient to support a finding of reliance.
The dissent also rejects the majority’s finding regarding Congressional intent, arguing that Congress’ actions (or rather, inactions) cannot be read to bestow immunity on an undefined class of actors from liability under Section 10(b). Finally, the dissent conclude with a lengthy affirmation of the right of court’s to imply remedies, even in the absence of legislative action.

At its most basic level, the outcome of this case is unsurprising. The justices arrayed themselves just as I had speculated in my prior post. That is, the three justices still on the Court who were in the majority in Central Bank (Kennedy, Scalia and Thomas) were joined by the two recent appointees (Roberts and Alito), while the three justices who had been in the dissent in Central Bank (Stevens, Souter and Ginsberg) were also in the dissent on Stoneridge.

The majority’s opinion also, again perhaps unsurprisingly, essentially adopts the position advocated by the Solicitor General on behalf of the U.S. Department of Justice (in his amicus brief, here); that is, as I noted in my prior post, the Solicitor General urged that, while the Eighth Circuit concededly erred in concluding that conduct itself could not satisfy the statute’s deception requirement, the Supreme Court could nevertheless affirm the Eighth Circuit because the investors had not shown reliance – which was of course exactly what the majority held.

One aspect of the majority’s opinion that is striking is that the opinion does suggest an awareness of, and perhaps even the influence of, arguably extrajudicial considerations such as the potential impact the investors’ position might have had on the overall business environment or the relative competitiveness of U.S financial markets. These considerations, while undeniably important, arguably are irrelevant to whether or not these claimants have a remedy under the statute.

While the majority rejected the investors’ "scheme liability" theories, the Court did not hold that "secondary actors" can never be liable. To the contrary, and consistent with Central Bank, the Court held that any person who employs a manipulative device may held as a primary violator, assuming all the requirements of Section 10(b) are met. And in any event , the SEC still has statutory authority to pursue enforcement actions based on "aiding and abetting" allegations.

The Court is certainly correct when it says that were investors’ position recognized, then companies would seek to protect against the threats, which would raise the cost of doing business. Indeed, if companies had to procure insurance to protect against not only the securities liability arising from their own conduct but also with respect to every company with respect to whom they are a customer or vendor, the cost of liability insurance would have soared. (As an aside, the burden of trying to underwrite this exposure would have been enormous as well, not to mention extremely challenging.) These same points could also be made with respect to liability insurance for third-party professionals as well. The position that the investors urged, if successful, would have had a dramatic impact on the cost of liability insurance.
These practical considerations support the view that the Stoneridge case is a defense victory and represents a rejection of an expanded reading of Section 10(b). But the more expansive possibilities may never really have been in the cards, given the lineup of the court. Yes, the decision could have changed things, but in the end, it did not. In effect, Stoneridge represents a 5-3 vote for the status quo. So while a decision for the investors could have increased the cost of insurance, the actual outcome on behalf of the venors is unlikely to impact the cost of insurance.
News coverage of the decision can be found here and here. The Blog of the Legal Times reports a number of different reactions to the decision here.

On January 11, 2008, MBIA became the latest bond insurer to be named as a defendant in a subprime-related securities class action lawsuit. Bond insurers ACA Capital Holdings (about which refer here), Security Capital Assurance (refer here) and Radian Group (refer here) have previously been named in subprime-related securities lawsuits. MBIA is one of the leading triple-A rated bond insurers, and the company’s difficulties may represent among the more significant developments arising from the subprime meltdown. A copy of the plaintiffs’ lawyers January 11, 2008 press release regarding the MBIA securities lawsuit can be found here, and a copy of the securities lawsuit complaint, which also names MBIA’s CEO and CFO as defendants, can be found here.

In addition to the securities lawsuit, MBIA’s benefit plan fiduciaries were also hit with a lawsuit under ERISA, filed on behalf of MBIA employees in connection with company stock held in the employees’ 401(k) plan. The plaintiffs’ counsel’s January 11, 2008 press release about the ERISA lawsuit can be found here. The company also disclosed on January 8, 2008 (here) that the SEC and the New York Insurance Department have started informal inquiries into the company’s recent disclosures and a deal the company struck with Warburg Pincus.

The centerpiece of the securities lawsuit complaint is the company’s December 19, 2007 detailed accounting (here) of its exposures to collateralized debt obligations, a disclosure that contained information the complaint describes as a "bombshell." According to the complaint, in the December 19 release, the company "disclosed for the first time that it faced $8.1 billion of exposure from insuring some of the riskiest securities in the marketplace – collateralized debt obligations (CDOs) comprised of other CDOs (so-called "CDOs squared" securities) whose underlying collateral included residential mortgage backed securities (RMBS)." The complaint alleges that "with this disclosure, investors learned for the first time that Defendants had placed their triple-A rating in jeopardy."

The company’s December 20, 2007 press release (here) attempted to respond to the market criticism and reaction that followed the December 19 disclosure. Nevertheless, the company later came under further pressure when it announced on January 9, 2008 (here) that the company actually held $9 billion of the CDO squared securities, rather than the $8.1 disclosed just weeks before and that, according to the complaint, "nearly 60% of these securities were originated in 2006 or later (which was material because recent vintages are defaulting with greater consistency) and that the portfolio had already caused a $200 million impairment."

The MBIA securities lawsuit is the first subprime-related securities lawsuit of 2008. In light of the magnitude and recency of the events involved in the lawsuit, it seems likely that there will be further developments, both with respect to the company itself and in general. While it is obviously still quite early, the MBIA lawsuit does at least suggest that the 2007 subprime-related securities litigation wave was not, as some have suggested, a one-time event.

I have in any event added the MBIA lawsuit to my running tally of subprime-related securities lawsuits, which may be found here. With the addition of the MBIA lawsuit, the current tally (including subprime-related securities lawsuits pending against the credit rating agencies and against residential home construction companies) stands at 38. With the addition of the MBIA ERISA lawsuit, the number of subprime-related ERISA lawsuits stands at 9.

My prior discussion of bond insurers’ exposure to subprime risk, including a detailed discussion of the securities lawsuit that has been filed against ACA Capital Holding, can be found here.

CDOs Squared: I have previously noted (most recently here) that among the contributing factors to the subprime meltdown are the complicated investment instruments into which mortgage loans were repackaged and sold in the global financial marketplace. The MBIA complaint’s allegations about CDOs squared underscore this point rather impressively. MBIA (and other bond insurers) played a particularly critical role in the viability of these instruments, since MBIA’s willingness to provide insurance against the instruments’ default enabled the instruments to carry MBIA’s AAA rating making them acceptable even to conservative investors.

Readers who like me do not feely fully briefed on CDOs squared may want to review this 2005 Nomura Securities publication (here), which explains that a CDO squared security is a type of collateralized debt obligation where the underlying portfolio consists of other types of CDOs.

According to the article,

Synthetic CDOs-squared offer investors higher spreads than single-layer CDOs but also may present additional risks. These two-layer structures somewhat increase exposures to certain risks by creating performance "cliffs." That is, seemingly small changes in the performance of underlying reference credits can cause larger changes in the performance of a CDO-squared.

Of particular interest to bond insurers (and investors in a bond insurer that happens to insure CDOs squared) is that CDOs squared "display particular sensitivity" to "frequency of defaults." Based on a very detailed analysis, the Nomura article concludes that "higher default rates affect a CDO-squared tranche much more dramatically than the underlying CDO tranche." The report goes on to state, among other things that, that "for example, the probability of a [CDO squared] tranche wipeout goes from 0.6% to 41.2% as the [CDO tranche] default rate goes from 1.0% to 1.5%."

Snakes and Ladders: The Nomura article’s discussion of the risks involved with CDOs squared brings to mind Warren Buffett’s frequent diatribes against derivative securities. For example, in his letter to shareholders in the 2002 Berkshire Hathaway Annual Report (here), Buffett referred to derivatives as "time bombs" and as "financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal." (Full disclosure: I own Class B Berkshire shares, although not nearly as many as I wish I did.)

I have struggled over the years to understand the vehemence of Buffett’s condemnation of derivatives, but I gained fresh insight recently when I read Roger Lowenstein’s excellent book When Genius Failed, which recounts the formation, growth and dramatic collapse of Long-Term Capital Management. The events described in the book took place a decade ago, but many of the same events, circumstances, complications, and even many of the same people, were involved then as are involved in the current subprime meltdown.

LTCM’s story is far more complicated than can easily be recounted here, but the most critical facts are that at the beginning of 1998, the firm had equity of $4.72 billion, but as a result of leverage, carried balance sheet assets of around $129 billion. Even more astonishing were the firm’s off-balance sheet derivative positions, which had a notional value of $1.25 trillion. Adverse global financial circumstances in August and September 1998 put LTCM on the wrong side of a huge number of arbitrage bets, and put the firm in a position where it had to liquidate positions, only to find that there were no willing buyers. Lack of liquidity and the firm’s highly leveraged position not only threatened the firm with failure, but, owing to LTCM’s massive indebtedness, threatened a constellation of financial institutions with enormous losses. The Federal Reserve became concerned that the ensuing fallout could cause panic and damage the financial markets.

The scramble to protect the financial markets from an LTCM meltdown involved a veritable who’s who of the financial world, including the redoubtable Mr. Buffett. Reading about Buffett’s role in the LTCM crisis gave me some insight into his loathing of derivative securities.

First, the book makes it clear that in connection with Berkshire’s then-pending acquisition of General Reinsurance Corporation (which ultimately closed in December 1998), Buffett was worried about Gen Re’s involvement in certain LTCM investments on which Gen Re had counterparty exposure or for which Gen Re had provided financing. (Full disclosure: At the time, I was an employee of a Gen Re operating subsidiary.)

In addition, Buffett was also deeply involved in a Goldman Sachs-led proposed buyout of LTCM, that would have given the acquirers control of LTCM’s assets for $250 million, a small fraction of the assets’ putative (and as events turned out, ultimate) value. The potential buyout did not come off, in part because of Buffett’s inaccessibility at critical moments while he was vacationing in the Pacific Northwest with Bill Gates.

As a result of these events, Buffett apparently had a window into LTCM’s portfolio and apparently came away with an unfavorable view of derivative securities. Indeed, Buffett specifically references LTCM’s near meltdown and disparages some of LTCM’s derivative investments ( particularly "total return swaps") in the 2002 Berkshire shareholders letter linked above.

As an aside, it is worth noting that Buffett is only one of a host of people now prominent in the subprime crisis who played one role or another in the LTCM bailout. For example, John Thain, recently given the assignment of turning around Merrill Lynch, was deeply involved in the LTCM bailout efforts as CFO of Goldman Sachs. Jon Corzine, now the democratic governor of New Jersey, was also involved in many of the discussions. James Cayne, who just this past week resigned as head of Bear Stearns as a result of that company’s subprime woes, played a significant although not particularly constructive role in the LTCM bailout as well.

Although Lowenstein’s book refers to events from ten years ago, it rewards reading now, because it shows how some of the same recurring behaviors drive occasional excesses and trigger periodic crises in the financial markets. Indeed, the recurrence of many of the same circumstances and names today gives the impression that the global financial marketplace represents nothing more than an elaborate game of Snakes and Ladders, where the same money, investments and people slide around in certain prescribed paths and wind up ahead or behind as the game unfolds.

There is also a certain symmetry between the events surrounding LTCM’s near-demise and the current subprime crisis; once again, for example, Buffett is cast in the role of potential rescuer, in particular now with respect to bond insurers (about which refer here). But the more important connection between the two sets of circumstances is the role of complicated derivative securities in contributing to the respective crises. Indeed, given the role that these immensely complicated derivative securities, such as CDOs squared , are playing in the current subprime crisis, Buffett’s comments in the 2002 shareholders letter about the dangers of derivative securities may be required reading for anyone who wants to understand what is going on today.

 

A Reflection on Winter in the Suburbs: Am I the only one who thinks the very idea of "decorative cabbages" is ridiculous?

More About Foreign Claimants, Foreign Companies: In earlier posts (here and here), I discussed issues arising as a result of foreign litigants suing foreign domiciled companies in securities class action lawsuits in U.S. courts. These issues were involved in a recent opinion in a case pending in the Southern District of New York. In a January 8, 2008 ruling (here), U.S. District Court Judge Denny Chin appointed Luxembourg-based investment company Axxion S.A. Luxembourg as lead plaintiff in the consolidated securities lawsuit pending against GPC Biotech AG, a biotechnology company based in Munich, Germany.

Three sets of plaintiffs had sought to serve as lead plaintiffs. Judge Chin selected Axxion, which through its Akrobat Fund-Value investment fund had spend $3.9 million purchasing 150,000 GPC Biotech shares and which claimed losses of $1.8 million, as having the “largest financial interest in the relief sought.” Judge Chin rejected the arguments of the other claimants, who had resisted Axxion’s petition on the grounds that its fund had purchased the shares on the German exchanges. (GPC Biotech’s shares trade both on the Nasdaq and on the Deutsche Bourse.)

In effect, the competing claimants argued that Axxiom’s petition should be rejected because Axxion is an “f-cubed claimant” (a foreign claimant suing a foreign company whose shares the claimant purchased on a foreign exchange.) Judge Chin found (citing the Nortel Networks case) that other courts in the District had previously selected foreign litigants as lead plaintiff to represent both foreign and U.S. investors. He also noted that while the defendants might raise a subject matter jurisdiction defense as to Axxiom, “such a defense would not appear ‘unique’ to Axxiom, as it would appear that many (if not most) of the class members would be foreign investors.”

Judge Chin further noted that there is no reason to doubt” the ability of Axxiom to respond to a motion to dismiss raising the subject matter jurisdiction defense. Judge Chin also commented “without prejudicing the issue” that “plaintiffs have alleged individual acts in the United States in furtherance of the alleged fraud.” As discussed at length in my prior post (here), the presence of substantial acts in the United States has been held by some other courts to be a sufficient basis to support the exercise of subject matter jurisdiction.

As I noted in my recent analysis of the 2007 securities lawsuits (here), there were 26 securities lawsuits filed in U.S. courts in 2007 against foreign domiciled companies, 21 of them in the Southern District of New York. As a result, the issues surrounding foreign litigants’ claims against foreign domiciled companies is likely to be the subject of a great deal of scrutiny and discussion in the months ahead, particularly in the Southern District. The subject matter jurisdiction issue will also receive a great deal of attention. As I noted in a prior post (here), the jurisdictional issue is also squarely raised in a case now pending before the Second Circuit.

Finally, although Judge Chin did not address the issue in his recent opinion, the presence of a significant number of foreign claimants who purchased their shares on foreign exchanges may raise significant class certification issues. In the Vivendi case (about which refer here), the court excluded certain foreign claimants from the class while including others, and, as discussed here, in the recent Royal Dutch Shell decision (refer here), the court (for reasons based on facts perhaps specific to that case) excluded non-U.S. purchasers from the class and dismissed their claims based on the lack of subject matter jurisdiction. These class certification issues will also be important in the new wave of securities claims filed against foreign domiciled companies.

In any event, it appears that even if foreign jurisdictions have not warmed to U.S. style class action litigation, foreign institutions increasingly are drawn to U.S. courts to attempt to recoup investment losses, even against foreign-domiciled companies. These institutions’ willingness to resort to U.S. courts and to rely about remedies available under U.S. law potentially could drive legal reforms in their own countries, as these foreign seek local alternatives to hold company management responsible. These overseas firms’ willingness to employ U.S. litigation suggests that the U.S. approach to litigation, usually portrayed as a disadvantage to the U.S. in the global financial market competition, may actually have a more complicated impact on U.S competitiveness than some would-be reformers assume.

One final observation about the GPC Biotech case is that it embodies a number of important 2007 litigation trends. First, as noted above, a significant factor in the 2007 uptick in securities lawsuit filings is the increased incidence of lawsuits in the Southern District of New York against foreign-domiciled companies, of which the GPC Biotech lawsuit is one example. Second, GPC Biotech is in the 2834 SIC Code (Pharmaceutical Preparations), which as I noted here was one of the SIC Code categories with the greatest number of 2007 filings.

In many ways, the GPC Biotech lawsuit is emblematic of a number of important trends that emerged in 2007, in particular because the case does not in any way relate to the subprime meltdown. As I have noted before, even though the subprime litigation wave was clearly an important 2007 development in connection with securities litigation, it was only one of several important factors at work during the year.

Tracking Subprime Lawsuits: In discussing (here) the 2007 year-end securities lawsuits analysis of NERA Economic Consulting, I noted that NERA’s count of 2007 subprime-related securities lawsuits filings and my own count (here) diverged. I have now had the opportunity to confer and compare notes with NERA, as a result of which I was able to identify the differences between our tallies. Based on these discussions, I have added three additional subprime-related securities class action lawsuits to my running tally: BankAtlantic Bancorp (here), First Home Builders of Florida (here), and Merrill Lynch/First Republic (here).

As a result of these additions, my current tally of subprime-related securities lawsuits (including lawsuits against the credit rating agencies and subprime-related lawsuits against residential construction companies) now stands at 37.

Very special thank to NERA, and especially to Svetlana Starykh, for the willingness to confer and to share information.

Accounting Discipline: According to a January 9, 2008 CFO.com article (here), the International Helsinki Federation of Human Rights must shut down as a result of its finance manager’s six-year embezzlement of $1.8 million. The finance manager apparently embezzled the funds to “support his mistress.”

The Federation’s mission had been “to protect and strengthen civil society groups that monitor and report on human rights issues from a non-partisan perspective.” Unfortunately, the Federation’s funds were put to some decidedly different uses. According to the news reports, “the mistress reportedly gambled away up to $7,000 a week at poker and told the finance executive she needed $44,000 to open a hair salon. She also spent some of the money for breast augmentation and a nose job.”

The finance manager told the court that he would not have agreed to finance the woman’s operations had he known about them ahead of time. (The news reports do not reveal what he thought about them afterwards, though.)

Apparently the finance manager regarded these transfers of cash as a loan transaction; he told the court that the woman had promised him she would pay him back from a large inheritance she expected.

The finance manager, age 43, has been sentenced to three years in jail; the woman, age 31, was sentenced to two years.

All of which is just a reminder of the importance of internal accounting controls for entitles of all sizes and types. It is perhaps an idle thought, but I do wonder how much financial fraud has its origins in some kind of marital infidelity or sexual indiscretion. Admittedly, it would be a difficult thing to try to underwrite…

What He Said: During the time that I have been blogging, I have felt within me an essay developing that would describe what it is like to blog and what the advantages and disadvantages are. My friend Mark Herrmann, who is one of the co-authors of the Drug and Device Law Blog (here), has gone ahead and delivered himself of the very essay I might have written, if I were as articulate as Mark. The essay, published in the National Law Journal, can be found here. He wrote it, now I don’t have to.
By the way, if you have any involvement with life sciences companies, the Drug and Device Law Blog is indispensible.
Hat tip to the Delaware Corporate and Commercial Litigation Blog (here) for the link to the NLJ article.

Last Chance: The early registration discount for the 2008 PLUS D & O Symposium expires January 11, 2008 at 5:00 p.m. CST. The registration materials and schedule can be found here. As I have previously noted, I will be co-chairing this year’s Symposium with Chris Duca from Navigators Pro. We are proud of the program we have put together. The speakers include former SEC Chairman William Donaldson, who will be the keynote speaker, and the panelists include, among many luminaries, SEC Enforcement Division Director Linda Chatman Thomsen.

In prior posts (most recently here), I have written about the increasing importance of opt-out settlements in the context of securities class action litigation. Along the way, numerous readers have inquired whether I am aware of a publicly available resource that is tracking the securities lawsuit opt-out settlements. I am not aware of any public resource, but because there clearly is an interest in having this information available, I have gone ahead and compiled all of the opt-out settlement information of which I am aware. My list of the opt-out settlements can be found here.

Readers should understand that the opt-out information I have compiled is necessarily limited to the settlements of which I am aware and is limited to publicly available information. The information is also limited to recent prominent securities lawsuit opt out settlements; there may well be earlier or other cases that had opt out settlements of which I am simply unaware. As a result, the information on the linked document is undoubtedly incomplete. I welcome any additional information that any readers would be willing to provide, and I will endeavor to keep the data updated as new or additional information becomes available.

My most recent comprehensive overview of the opt-out settlements generally can be found here. My recent post detailing the Qwest opt-out settlements can be found here. Readers should be further aware that virtually all of the opt-out settlements identified in the linked document have been described or at least mentioned in prior posts on this blog, and these prior discussions can be retrieved by using the search box in the upper left hand corner of the blog home page.

Options Backdating Settlement: On January 4, 2008, Nabors Industries announced (here) that it had entered a settlement agreement in connection with the consolidated options backdating-related shareholders derivative lawsuit that had been filed against the company and certain of its directors and officers in the Southern District of Texas. In connection with the settlement, Nabors Industries agreed to "certain corporate governance reforms, a new equity award policy, and a modified Compensation Committee Charter." The company and its insurer also agree to pay up to $2.85 million to plaintiffs’ counsel for the plaintiffs’ attorneys’ fees and expenses.

I have added the Nabors Industries settlement to my list of options backdating lawsuit dismissals, denials and settlements, which can be accessed here.
International Corporate Governance: Over at the Race to the Bottom blog, an excellent blog that I follow regularly, University of Denver Professor J. Robert Brown is running a series of blog posts (beginning here) taking a look at corporate goverance standards and issues in countries other than the United States, drawing on student research. So far, the blog series has featured posts on Norway and Board Diversity (here), and the first part of a two-part post on Corporate Governance and the United Kingdom (here). This series promises to be very informative and we look forward to following its progress.

In prior posts (most recently here), I noted that even during the two-year lull in securities lawsuits filings that prevailed between mid-2005 and mid-2007, filings against life sciences companies – and pharmaceutical companies in particular – continued more or less unabated. More recently I noted (here) that pharmaceutical companies in the Standard Industrial Classification Code category 2834 represented one of the two most frequently sued categories of companies among the 2007 securities lawsuits. Because of this heightened lawsuit frequency involving life sciences companies, it seems worthwhile to take a closer look at the 2007 life sciences securities lawsuits.

First a word about categorization. For purposes of this post, I am including under the heading "life sciences" any company in either SIC Code series 283 (Drugs) or SIC Code series 384 (Surgical, Medical and Dental Instruments and Supplies). Reasonable minds might differ about whether additional categories should be included, but I decided to go for simplicity here.

Companies within the SIC Code series 283 were particularly hard hit in 2007, especially companies in the 2834 SIC Code (Pharmaceutical Preparations), within which 14 companies were sued in 2007. In addition, two companies in SIC Code 2836 (Biological Products) and one company in SIC Code 2833 (Medicinal Chemical and Botanical Products) were also sued, bringing the total number of companies sued in 2007 from SIC Code Series 283 to 17. These 17 lawsuits compare to eight lawsuits in the SIC Code Series 283 among the 2006 securities lawsuits.

There were four companies sued in SIC Code series 384, including two within SIC Code 3841 (Surgical and Medical Instruments) and two within SIC Code 3845 (Electromedical and Electrotherapeutic Apparatus).

The 21 total lawsuits against companies in these two SIC Code series categories means that lawsuits against life sciences companies represent roughly 12% of the 172 securities lawsuits filed in 2007. (Refer to my prior post here for a description of the data I am using in my analysis). This compares to 34, or slightly less than 20%, of the 2007 securities lawsuits related to the subprime meltdown. As I have said before, the subprime lawsuits were an important factor but by no means the only important factor in the increase of securities lawsuit filings in 2007.

The 2007 securities lawsuits against life sciences companies involved a wide variety of allegations. By far the most common contention is the allegation of unexpected or undisclosed set-backs in the regulatory or clinical trial process, which was raised against nine of the 21 life sciences companies sued. The next most prevalent type of allegation was related to disclosures surrounding product safety (five companies).

Other allegations included slowing sales or missed projections (two companies), misrepresentations regarding product efficacy (one company), disclosure of a criminal investigation (one company), failure to disclose merger-related information (one company), misrepresentations or omissions regarding sales practices (one company), and misrepresentations regarding the status of regulatory approvals (one company).

Of the 21 life sciences companies sued in securities lawsuits in 2007, five are foreign-domiciled, including two from France, and one each from Germany, Switzerland and the U.K.

As I noted in my prior posts regarding pharmaceutical company lawsuits (here), while life sciences companies have proved to be popular targets for plaintiffs’ lawyers, they have not always proved to be easy targets. Many of the past securities lawsuits against pharmaceutical companies have been dismissed. The dismissal levels may have something to do with the prevalence of allegations regarding regulatory or clinical trial setbacks. While these setbacks may indeed rock the companies’ stock prices, these kinds of setbacks are an almost inevitable attribute of the regulatory and scientific environment in which these companies operate. These risks are often comprehensively disclosed, creating a particular challenge for plaintiffs’ attorneys.

While it is far too early to tell how the 2007 securities lawsuits against life sciences companies will fare, it will be interesting to monitor these cases to see how many go forward beyond the motion to dismiss stage.

The Return of the "Club Deal" Antitrust Case: According to news reports (here), plaintiffs’ lawyers have filed an antitrust lawsuits against the leading private equity firms and investment banks, alleging that the 13 defendants conspired to fix prices in connection with seven specific private equity "club deals" between 2004 and 2007. In fall 2006, a different set of plaintiffs lawyers had originally filed a complaint in the Southern District of New York raising substantially similar allegations, but they withdrew their complaint after the U.S. Supreme Court handed down its May 2007 opinion, specifying a heightened pleading standard for antitrust cases, in Bell Atlantic v. Twombley. The new plaintiffs’ counsel apparently feels they can meet the Twombley standard.

The new complaint, which can be found here, was filed in the District of Massachusetts, and alleges that the large buyout firms conspired to keep acquisition prices low by "clubbing together" rather than competing on large buyout deals. The private equity firm defendants include, for example, Bain Capital, Blackstone Group, KKR, and Thomas H. Lee Partners. The seven specific deals referenced in the complaint include Kinder Morgan, HCA and Freescale Semiconductor. The lawsuit also targets investment banks for the conflicted role they allegedly sometimes play as both advisers to the target companies and as lenders (or even co-investors) to or with the acquirers.

Special thanks to Ned Kirk of the Sedgwick Detert firm for a link to the news reports and for a copy of the Complaint.

Need for Speed: If you not yet seen it, you have to read the Wired Magazine article entitled "The Pedal-to-the-Metal, Totally Illegal, Cross-Country Spring for Glory" (here), which tells the tale of Alex Roy, who is consumed by a passion to recreate Cannonball Run and set the speed record for driving between Manhattan and Santa Monica (a feat Roy accomplished in an astonishing 31 hours and 4 minutes). You have to read it to believe it.

Special thanks to new reader Michael Barker the link to the article.

On January 3, 2008, State Street Corporation announced (here) that for the fourth quarter of 2007, it will be establishing a reserve of $618 million, on a pre-tax basis, "to address legal exposure and other costs associated with the underperformance of … fixed-income strategies managed by… the company’s investment management arm." The net charge to the company, "after taking into account the tax effect of the reserve and associated lower incentive compensation cost" will be $279 million.

In its January 3 press release, the company did not identify the specific litigation to which the reserve will relate; rather, the company referenced only "customer concerns as to whether the execution of [the fixed-income strategies] was consistent with the customers’ investment intent." The press release goes on to state that the strategies "were adversely impacted by exposure to, and the lack of liquidity in, subprime mortgage markets."

A January 4, 2007 New York Times article entitled "State Street Corp. Is Sued Over Pension Losses" (here) states that State Street decided to create the reserve "after five clients sued it, claiming they had lost tens of millions of dollars in State Street funds they were told would be invested in risk-free debt like Treasuries." The Times article briefly identifies four of the claimants, but adds that "it was unclear who brought the fifth suit."

Because of the possibility that, as stated in the Times article, that State Street’s litigation and related reserve "highlight the legal challenges that lie ahead for financial firms," it would appear to be worthwhile to review here the five State Street lawsuits. The value of this exercise is underscored by the perception (which I share) voiced by one commentator quoted in the Times article that "there could be many, many more" lawsuits like those against State Street.

The first of the five lawsuits was brought on October 1, 2007 by Prudential Retirement Insurance and Annuity Company. (I previously posted about the Prudential lawsuit here.) A copy of the Prudential complaint can be found here. According to Prudential Financial’s October 1, 2007 filing on Form 8-K (here), the action "seeks, among other relief, restitution of certain losses attributable to certain investment funds" sold by State Street’s investment management arm, and alleges that State Street "failed to exercise prudent investment management." The specific legal basis of Prudential’s claim is that State Street and its investment arm violated the Employee Retirement Income Security Act of 1974 (ERISA).

The complaint alleges that the defendants "radically altered" the investment strategies of two bond funds, the Intermediate Bond Fund and the Government Credit Bond Fund. The complaint alleges that the funds "took undisclosed, highly leveraged positions in mortgage-related financial derivatives" and thereby "exposed" the funds to "an inappropriate level of risk" that during the summer of 2007 "produced catastrophic results." The complaint further alleges that as these events unfolded the defendants provided "untimely, incomplete and misleading information."

The Prudential complaint alleges that the defendants caused losses of "roughly $80 million" to assets held by about 165 retirement plans for which Prudential is responsible, affecting approximately 28,000 plan participants. The complaint seeks restitution and compensation for the investor losses (which Prudential has, according to an October 2, 2007 Wall Street Journal article, here, already reimbursed). The complaint also seeks recovery of fees and other amounts the defendants’ received, as well as recovery of the plaintiff’s attorneys’ fees.

Of the five lawsuits against State Street in connection with which the company established its litigation reserve, three others (in addition to the Prudential lawsuit) allege violations of ERISA. The first of these three other ERISA lawsuits was brought on October 17, 2007 by Unisystems and the trustee of the Unisystems Employees’ Profit Sharing Plan. A copy of the Unisystems amended complaint can be found here. (My prior post about the Unisystems complaint can be found here.)

The second of the three other ERISA lawsuits was brought on October 24, 2007 by the Composite Pension Trust of Nashua Corporation. A copy of the Nashua complaint can be found here.

The third of the three other ERISA lawsuits (and the fourth of the five total lawsuits brought against State Street) was brought on October 31, 2007 by the plan administrator and the trustee of the Employees’ Savings and Profit Sharing Plan of the Andover Companies. A copy of the amended Andover Complaint can be found here.

The fifth of the five lawsuits against State Street (which is also the lawsuit which the Times was unable to identify) was brought on November 5, 2007 in Harris County, Texas, District Court by Memorial Hermann Healthcare System. On December 3, 2007, the defendants removed the Memorial Hermann complaint to the Southern District of Texas. A copy of the removal petition, to which the initial state court complaint is attached, can be found here. Unlike the four other State Street lawsuits, the Memorial Hermann complaint does not allege a violation of ERISA. Instead, the complaint asserts against the State Street defendants a variety of state law claims, including breach of contract, fraud and negligent misrepresentation.

The Memorial Hermann complaint essentially alleges that the State Street defendants breached an "Agreement of Trust" to serve as trustee of nearly $91 million in the plaintiff’s assets. The assets allegedly were invested in the State Street Limited Duration Bond Fund, which the complaint alleges lost 37 percent of its value during three weeks in August 2007, and 42 percent of its value for the 2007 year. The losses allegedly were the result of "unjustified investments in mortgage securities without diversification and using derivatives, all contrary to the stated Investment Objectives and representations."

UPDATE: In a later post, I discuss (here) a sixth lawsuit that has been filed against State Street.

The State Street lawsuits are significant in and of themselves, but also for what they might foreshadow. As I noted above, these lawsuits may well represent the kinds of legal problems that other financial services companies may face, particularly as the mortgages backing many of these investment funds and investment securities continue to detiorate.

There are a number of other important implications from the State Street lawsuits. The first relates to the identity of the claimants – these are very large institutions suing other very large institutions. These lawsuits are not the kind of lawyer-driven stock drop lawsuits that have drawn so much ire from would be reformers. These are conservative business litigants using plaintiffs’ tools seeking to recoup significant losses. These sophisticated litigants may be unlikely to accept quick compromises, and, mindful of their own fiduciary obligations, may well be unwilling to accept any compromise that does not represent a very significant percentage of the losses.

The second important implication of the State Street lawsuits is the sheer magnitude of the dollars involved, as demonstrated by State Street’s pre-tax set aside of $618 million for cases that are only in their earliest stages. The State Street litigation reserve underscores the staggering exposures that these cases and others like it represent. The stakes in these cases are enormous.

The third implication derives directly from the enormity of the financial exposures involved; that is, these cases clearly have very serious repercussions for liability insurers, a consideration discussed in a January 4, 2008 Dow Jones newswire article entitled "Subprime Litigation May Dent D & O Insurers Like Chubb, AIG" (here). The article’s overall conclusion – that the subprime litigation wave may represent a significant concern for D & O insurers – is a valid point that I have in fact previously considered in a prior post (here). However, while I generally agree with the Dow Jones article’s overall thrust, I do disagree with some the article’s premises.

The most egregious of the article’s faulty premises is that the State Street lawsuits represent a D & O insurance exposure. The article disregards the fact that four of the five State Street lawsuits are brought under ERISA. The typical D & O policy contains an ERISA exclusion, primarily because exposures under ERISA are covered under a separate fiduciary liability policy, not a D & O policy.

In addition, none of the five complaints name as a defendant any individuals; there are no director or officer defendants in any of these complaints (although there are John Doe defendants named without further identification in several of the complaints). The entity coverage under the typical D & O policy provide coverage only for securities claims against insured entities, and none of the five complaints raise securities law allegations.

So, contrary to the Dow Jones article’s presumption, the State Street complaints do not themselves appear to embody any particular D & O insurance threat, as in their current forms at least, they would not appear implicate the typical D & O insurance policy. To be sure, the complaints may represent serious threats to fiduciary liability insurers and perhaps even to investment management errors and omissions (E & O) insurers, and to that extent the implication would seem to be that the subprime litigation wave represents a much more extensive threat to the insurance industry beyond just D & O. All of which does indeed suggest that the subprime litigation wave is a potentially complex and serious threat to insurers generally. To that extent, at least, the Dow Jones article is correct when it states that State Street’s reserve "has increased concern that insurers offering policies covering such exposures could be hit with big claims from the credit crisis."

In any event, I do agree that the subprime litigation wave represents a threat to the D & O insurers, even if the State Street lawsuits themselves may not. My prior blog posts on the potential impact on D & O insurers from the subprime meltdown can be found here and here; even though I wrote these posts months age, the analysis still appears more or less valid.

It should also be noted that there have been a number of other subprime related lawsuits brought under ERISA, primarily by employees raising allegations relating to company stock held in the 401(k) plans. A list of these employee ERISA lawsuits may be found in my running tally of subprime-related litigation, here.

The January 6, 2007 New York Times has an article entitled "Testing Investors’ Faith in State Street" (here) that examines the market’s curious reaction to State Street’s announcement concerning its litigation reserve — its stock price went up, hitting a 52-week high, a response that Times columnist Gretchen Morgenson is at a loss to explain.

Now This: The American Dialect Society has chosen (here) "subprime" as the 2007 Word of the Year. Pondering this development, I was moved to reflect that the subprime meltdown has moved beyond a mere financial event; it has become a cultural, social, and even political phenomenon.

Like all important phenomena, the subprime meltdown has deep roots, which arguably go back to the early 80s when the market for mortgage securities was more or less invented at Salomon Brothers, as entertainingly retold in Michael Lewis’s classic, Liar’s Poker. Though the events described in Lewis’s book took place over twenty years ago, they resonate now with irony and sometimes even ominous portent, although much of the current resonance was perhaps unintended when the words were originally written.

The most portentous segments detail the creation in the mid-80s of the recently eventful mortgage security, the collateralized mortgage obligation (CMO), about which Lewis notes, in words that contemporary investors in Norway, Japan, Australia and the U.K might now rue, that "CMOs opened the ways for international investors who thought American homeowners were a good bet." Lewis also notes, in an observation that seems particularly ironic today, that that as a result of the innovation of CMOs, "investors now had a new, firm idea of what the price of a mortgage bond should be." Lewis goes on to describe how the Wall Street Bankers "found a seemingly limitless number of ways to slice and dice home mortgages."

Space constraints prevent doing full justice to Lewis’s account, so fraught with significance in light of today’s circumstances. Suffice it to say that given recent events, Liar’s Poker merits and rewards a re-reading. It is as entertaining as it ever was, but the description of the invention of the market for mortgage bonds seems to matter in ways that it did not previously.

Special thanks to loyal reader Matt Rossman, who pointed out Liar’s Poker’s newly relevant historical value some time ago – I only recently got around to following up on Matt’s suggestion to re-read the book.

Chinese Checkered: In an earlier post (here), I reviewed the recent checkered track record of Chinese companies listed on the U.S. securities exchanges, including in particular Chinese IPOs. A December 2007 Dewey & LeBoeuf article entitled “China’s Top Ten at the Corporate Governance Bottom” (here) sounds many of the same themes as my prior post.

The article notes that “the ten largest Chinese companies trading in the U.S. rate poorly when it comes to corporate governance.” The article cites research showing that the ten companies have “an average rating of 0.5 stars for corporate governance, with five being the highest rating and three being average.” Five of the companies received “0” ratings for corporate governance.

Among the reasons for the low ratings is a NYSE guideline allowing “foreign private issuers” to follow their home country governance rules. Because China does not require that a majority of directors to be independent, “Chinese companies listed on the NYSE are allowed to stack the board with inside directors.”

In addition, that article notes, “lack of strong outside oversight” can lead to problems “when it comes to transfer pricing, related-party transactions, intergroup guarantees, tax rates, and the valuation of contingent liabilties.” The control role of the Chinese government in these companies’ ownership and operation can “lead to considerable pressure,” because “these large companies are instruments of state policy.”

There may be a view that the exchanges’ allowances for Chinese companies are indispensable if the U.S. financial markets are to attract these and other overseas listings. And it may well be argued that the governance concerns, which reflect the biases of U.S. expectations, are merely components of the market information that should be taken in to account in the companies’ valuations.

At a minimum, these considerations certainly do argue in favor of a more cautious approach to Chinese companies, both for investors and D & O underwriters alike. As I noted in my prior post, a disproportionate number of Chinese companies have become involved in securities litigation in the U.S.. a fact that may not be unrelated to the governance concerns.

Changing Environment for Climate Change Disclosure: In prior posts (here and here), I have reviewed the changing circumstances surrounding environmental disclosures, particularly as relates to global climate change. A January 2008 McKenna, Long & Aldridge article entitled “The SEC is Getting Hot and Bothered Over Climate Change” (here) takes a detailed look at the current and proposed requirements that potentially could affect public companies’ disclosure obligations relating to global climate change.

The article’s conclusions are that “publicly traded companies can expect scrutiny of their SEC filings to increase” and that “companies that have yet to squarely confront the question should consider taking a closer look at future filings.”

Apollo Group Securities Lawsuit Trial Wrapping Up: In recent posts (most recently here), I discussed the JDS Uniphase securities lawsuit trial, which, on November 27, 2007, resulted in a jury verdict in the defendants’ favor. The JDSU trial was noteworthy because trials in securities cases are so rare. But as I also noted that there was, coincidentally, another securities trial, involving Apollo Group, going on at the same time.

Adam Savett reports on his Securities Litigation Watch blog (here) that the plaintiffs in the Apollo Group trial rested their case on December 12, 2007, and the court subsequently denied the defendants’ motion for directed verdict. Closing arguments in the case apparently are scheduled to take place on January 9, 2008. Savett predicts a jury verdict on January 10.

In any event, we won’t have long to wait to find out the outcome of yet another civil securities lawsuit trial. It is probably a worthy topic for another day to consider why this flurry of trial activity is taking place now and what it may mean. Certainly, if the Apollo Group trial results in another defense verdict, it would further discourage other plaintiffs from hazarding a jury, and perhaps further encourage settlement.

Readers my be interested to note that the Securities Litigation Watch blog is also maintaining (here) a list of all post-PSLRA securities class action lawsuits that have gone to trial.

Finally, readers interested in details of the trial may want to read this December 7, 2007 Arizona Republic article (here) describing the trial testimony of Apollo Group’s former CFO.

Busted Buyout Lawsuit Reaches the Finish Line: In an earlier post (here) I discussed the litigation arising out of Finish Line’s bid to walk away from its planned $1.5 billion acquisition of Genesco. In case you missed the news over the holidays, on December 27, 2007, the Tennessee court (here) rejected Finish Line’s contention that there had been a “materially adverse effect” sufficient to permit Finish Line to invoke the termination procedures in the agreement. The court ordered Finish Line to complete the transaction.

However, as noted in the December 28, 2007 CFO.com article (here) discussing the ruling, there is still a second action pending in New York, that could affect whether or not the transaction ultimately is completed. UBS, which had committed to finance the transaction, contends that the merger will result in an insolvent entity. The Tennessee court has said that if that is the case, the court would “halt the agreement.”

Finally, the WSJ.com Law Blog notes (here) that though the court has issued its ruling in the Genesco case, there are still plenty of other busted deals to fuel additional litigation for the foreseeable future in the New Year.

PLUS D & O Symposium: The 2008 Professional Liability Underwriting Society (PLUS) D & O Symposium will take place on February 6 and 7, 2008 in New York. I will be co-chairing the Symposium again this year, with my good friend Chris Duca of Navigators Pro. We are very proud of this year’s agenda, which includes former SEC Chairman William Donaldson as the keynote speaker and features a stellar lineup of panelists, including SEC Enforcement Division Director Linda Chatman Thomsen. The entire schedule is available at the PLUS website, here.

Readers will be interested to know that the early registration discount is available only until January 11, 2008, so you will want to be sure to register before the end of this week.

As the latest of the year-end 2007 securities lawsuit reports (including my own, here), Cornerstone Research has released (here) its 2007 report on securities class action filings. Cornerstone’s January 3, 2008 press release describing the report can be found here. The numbers in the Cornerstone report differ from those in the previously released year-end report of NERA Economic Consulting (here), but the numbers are directionally consistent. The Cornerstone report does make some additional observations about the 2007 securities lawsuit filings, and also adds some interesting analysis.

The Cornerstone report notes the following findings:

1. Cornerstone reports that there were 166 securities class action lawsuit filings in 2007, which represents a 43% increase over the 116 filings in 2006. The 2007 yearly total is, however, 14 percent below the average for the ten-year period ending in December 2006.
2. Stock market volatility is important in explaining the number of filings. The increase in filings in the second half of 2007 coincided with an increase in volatility in the U.S. stock market from the historically low levels that prevailed in 2006 and the first half of 2007.
3. Securities lawsuit filings as a percentage of the total number of publicly traded companies increased in 2007. 2.19% of publicly traded companies were sued in securities lawsuits in 207, compared to only 1.57% in 2006, and by contrast to the 2.27% ten-year average from 1997-2006.
4. For cases filed in 2007, the drop in market capitalization both from the beginning to the end of the class period and from the class period high to the end of the class period increased, largely driven by several large case filings in the fourth quarter of 2007.
5. Of the 2,646 cases in Cornerstone’s database, 81 percent have been resolved. Of the resolved cases, 41 percent were dismissed and 59 percent settled. For the cases filed from 1996 to 2001, almost all of which have been resolved, the median time to resolution is 33 months. The median time to dismissal is 25 months, and the median time to settlement is 36 months. Cases with larger shareholder losses are likely to take longer to resolve.
6. The Finance sector had the largest amount of litigation activity, with 47 Finance cases in 2007, driven by the subprime crisis.
7. The top three Circuits in terms of the number of 2007 filings were the Second Circuit, with 58 filings; the Ninth Circuit, with 39 filings; and the Eleventh Circuit, with 18 filings.
8. Cornerstone counted 32 cases attributable to the subprime crisis (by contrast to my own count of 34 cases, here). The report notes that the subprime filings reflect a shift in emphasis from allegations related to traditional income statement line items to allegations related to balance sheet components.

In attempting to discern the significance of the 2007 filing levels, the Cornerstone report revisits the analytic framework Cornerstone first postulated in its mid-year 2007 report (here). The mid-year report raised two alternative theories for the lull in litigation activity from mid-2005 to mid-2007, the "less fraud" hypothesis and the "lower volatility" hypothesis. The "less fraud" theory, associated with Stanford Law Professor Joseph Grundfest, involved the theory that as a result of corporate reforms, there is less fraud and hence less litigation. (Professor Grundfest went further and speculated that perhaps, as a result of the reforms, there had been a "permanent shift" to a lower litigation level.) The "lower volatility" theory noted that the period of lower litigation activity coincided with historically low stock market volatility, and speculated that litigation activity might return to historical norms if volatility returned.

The year-end Cornerstone report expressly attributes the increased litigation activity in the second-half of 2007 to the heightened level of stock market volatility during that period. Nevertheless, the report also states that "the ‘less fraud’ theory suggests a significant and permanent shift in the class action landscape" that is "not inconsistent with the recent increase in filing." The report finds this possibility because of the significant amount of 2007 litigation activity that was directly associated with the subprime crisis, which the Cornerstone report describes as "a likely ‘one time’ event," that "may not be indicative of future filing activity."

To support this analysis, the report suggests that there is an identifiable "core litigation rate," which is a statistical construct based on historical filings from which "one time events" like "backdating, subprime cases [and] IPO Allocation filings are excluded." Using this construct, the report finds that "litigation activity remains well below historical norms." Professor Grundfest describes this "core litigation rate" as "the litigation rate observed net of one-time systemic shocks."

I cannot disagree with the report’s overall conclusion that more data is needed before the "less fraud" hypothesis can be conclusively rejected. Indeed, only time will tell. But for a number of reasons, I disagree with the Cornerstone Report’s analysis of the 2007 filings, and in particular with the report’s conclusions about the significance of the 2007 filing activity.

First, the Cornerstone report treats the 2007 subprime litigation activity as if it consists of a single, uniform phenomenon, limited in scope and duration. But my own view is that even though the subprime meltdown is still relatively recent, the litigation activity has already evolved into a highly diverse set of circumstances, lawsuits and litigants. As I detail at greater length here, the subprime litigation wave already involves a wide variety of kinds of companies and allegations. Moreover, it is likely to continue to evolve in the months ahead. To isolate the subprime cases as if they represent a narrow or contained phenomenon minimizes the potential of the ongoing subprime litigation wave to drive litigation activity for months and perhaps years to come, and disregards the very real possibility that the wave will expand to encompass a far wider variety of litigants and allegations.

Second, even if the subprime litigation wave can fairly be characterized as a "one-time" event, that is hardly sufficient to marginalize its continuing significance. The fact is the world of D & O liability has experienced a steady progression of "one time events" in recent years — the bursting of the Internet bubble, the telecom crash, the IPO Allocation cases, the corporate scandals, the options backdating cases, and now the subprime crisis. Indeed, the joke among D & O insurance industry professionals at the recent PLUS International Conference was that subprime is "just a one time event" – the joke being that in the D & O industry, there is a one time event every year, and that results are driven by the constant recurrence of supposed "one time events." When one time events become the norm, they are not extraneous, they are the very essence of the risk exposure.

The reality is that the claims experience in the D & O arena is characterized by a succession of one time events. Indeed, no D & O insurance manager who wished to retain his credibility with senior insurance company management would attempt to try to marginalize the subprime litigation wave by describing it as a one time event, simply because there have been too many supposed one time events in recent years for the phrase to retain any meaning. D & O claims are and for years have been driven by these kinds of events. There perhaps may be a statistical construct by which to postulate a "core litigation rate," but the construct would be disregarded by insurance professionals as lacking credibility and unlikely to provide adequate predictive power to describe likely future events. The practical reality is that it must be assumed that there will always be one time events – not as unusual occurrences, but in the ordinary course.

Finally, as I have documented elsewhere (here and here), subprime litigation is only one of a number of important factors driving the recently increased litigation activity. Even without the subprime cases, the uptick in litigation activity is significant.

To be sure, only time will tell whether the increased litigation activity in the second-half of 2007 is indicative of future activity levels. But as I previously stated (here), I think there is already a sufficient basis upon which to declare that the two-year lull in securities lawsuit filings is over, and to state that there does not appear to have been a "permanent shift" to lower securities lawsuit filing levels.

The first of the 2007 year-end securities class action reports has already appeared (refer here), with others soon to follow. As I have noted elsewhere (most recently here), the most important securities trend during 2007 was the return of lawsuit filing activity to historical levels, after a two-year lull. But there were numerous other important securities lawsuit trends in 2007, as discussed below.

First, a word about data. My observations about the 2007 securities lawsuits are based on my own tally of the 172 securities lawsuits, which I derived from publicly available data plus information from readers. My tally differs from the numbers that appeared in NERA Economic Consulting’s 2007 year-end report (here). NERA counted 198 securities lawsuits through mid-December, and projected 207 lawsuits by year-end. The projected number was not borne out, but NERA’s actual year-end number around 200 is materially higher than my own count of 172. NERA undoubtedly has superior data; readers should be aware that I have used my own data for purposes of this post.

The year-end tally of 172 new securities class action lawsuits includes 103 new securities lawsuits that were first filed in the second-half of 2007. This half-year total is virtually identical to the six-month average of 101 that Cornerstone Research noted in its mid-year 2007 securities litigation report (here) for the period from the second half of 1996 through the first half of 2005. In addition, the year-end total of 172 lawsuits represents an increase of 56 cases over the 2006 year-end total of 116, an increase of 48 per cent.

The companies named in securities lawsuits in 2007 represent 80 different Standard Industrial Classification (SIC) Code categories. In a year in which subprime lawsuits were such a significant factor (refer here for my analysis of the 2007 subprime lawsuits), it is hardly surprising that one of the SIC Code categories with the highest number of new lawsuits is SIC Code 6798 (Real Estate Investment Trusts), which had 14 new lawsuits. But SIC Code 2834 (Pharmaceutical Preparations) also had 14 new lawsuits, which is entirely consistent with my frequent observation that while subprime lawsuits are an important part of the 2007 securities lawsuit trends, the subprime lawsuits represent only one of several important trends.

Other SIC Code categories that had significant activity unrelated to the subprime mess include SIC Code category 3674 (Semiconductors), which had seven lawsuits; SIC Code category 3663 (Radio and Telephone Equipment), which had six lawsuits; SIC Code category 7372 (Prepackaged Software), which had five lawsuits; and SIC Code category 4899 (Communications Services) which also had five lawsuits.
26 of the 172 securities lawsuits that were filed in 2007 involved companies domiciled outside the United States. These 26 companies are based in 12 different countries, including China (seven companies); Switzerland (three companies); Bermuda, Canada, France, Hong Kong, Israel and the U.K (each of which had two companies each); and Germany, South Korea, Sweden and Taiwan (each of which had one company each). My detailed analsysis of the securities lawsuits involving Chinese companies can be found here.

Many of the 2007 securities lawsuits involved allegations of misrepresentations in connection with the defendant company’s IPO within twelve months of the lawsuit. 29 of the 172 new lawsuits involved IPO allegations. Interestingly, 20 of the 29 lawsuits against IPO companies were filed in the second-half of 2007, which suggests that an increase in the number of cases involving IPO companies was an important part of the increased level of securities litigation activity in the second-half of 2007. In addition, nine of the 29 IPO company lawsuits involved foreign-domiciled companies, so the level of IPO-related activity and the level of foreign-domiciled company activity appears to be correlated to a certain extent.

The 2007 securities lawsuits were filed in 52 different federal district courts. By far the largest numbers of lawsuits were filed in the Southern District of New York, where a whopping 52 of the 172 lawsuits (or about 30%) were filed. The court with the next highest total, the Central District of California, had only 18. Indeed, if the lawsuits filed in the Central, Southern and Northern Districts of California are combined, the total of 32 cases is still far short of the S.D.N.Y. total.

The high number of filings in the S.D.N.Y. is in part attributable to the number of financial services companies that have been sued in Manhattan as a result of the subprime mess. But another important factor in the number of S.D.N.Y. lawsuits is the significant number of lawsuits against foreign domiciled companies. 21 of the 26 foreign-domiciled companies sued in securities lawsuits in 2007 were sued in the S.D.N.Y.

Other courts that had a significant number of securities lawsuits in 2007 include the Southern District of Florida (10); Eastern District of Pennsylvania (6); Northern District of Texas (5); and the Western District of Washington (5).

I have noted elsewhere (here) the significance of the number of 2007 securities lawsuits. Another important attribute of the 2007 securities lawsuits is their diversity. More specifically, the increase in 2007 securities litigation activity clearly was driven by a number of factors, not just the litigation activity surrounding the subprime meltdown. Indeed, even if the 34 subprime-related lawsuits (listed here) were withdrawn from the 2007 total, the resulting 138 lawsuits would still represent a material increase over the 116 lawsuits that were filed in 2006. The fact that there were significant numbers of cases aggregated in categories completely isolated from subprime-related issues demonstrates that the story of the renewed securities litigation activity involves far more than just the subprime meltdown.

Finally, one of the other many factors contributing to the renewed level of securities lawsuit activity in 2007 is the outbreak of lawsuits arising from busted buyouts, which I discuss at greater lenghth here.

In its 2007 year-end study of securities class action trends (here), NERA Economic Consulting noted that the "sharp increase" in 2007 securities lawsuit filings was "driven in part by litigation related to subprime lending," an observation I have also noted elsewhere. Given the importance of the subprime lawsuit filings to the overall 2007 securities lawsuit picture, it is worth taking a closer look at the 2007 subprime-related securities lawsuits.

As a preliminary matter, it should be noted that I have counted 34 subprime-related securities lawsuits during 2007 (as detailed here), whereas in its year-end report NERA stated that there were 38 subprime-related lawsuits. The difference may be merely definitional, as it became harder to classify cases as the year progressed. NERA may also have superior information, a not unlikely possibility given that my data are derived solely from publicly available sources. In any event, readers should be aware that the analysis in this post is limited to the 34 lawsuits in my tally.

The 34 companies sued in the subprime-related lawsuits represent 15 different Standard Industrial Classification (SIC) Codes. The largest concentration of cases is in the 6798 SEC Code (Real Estate Investment Trusts), which accounted for 11 of the34 cases. Fully 30 of the 34 companies sued fall within the 6000 SIC Code Series (Finance, Insurance and Real Estate).

Another way to look at the companies is by industry, rather than by SIC Code. As might be expected, there are more companies is in the banking/mortgage lending business than any other industry; this group accounted for 12 of the companies sued. Other industry groups with multiple companies represented included residential home builders (5), REITs (5), Bond Insurers (3) and Credit Rating Agencies (2). Other industries represented with one company each include mortgage investment companies, mutual funds, and savings and loans. (The list of companies also includes Freddie Mac, which as a government sponsored entity is hard to classify.)

The subprime-related lawsuits were filed in 15 different federal district courts, with the largest number filed in the Southern District of New York (11). Other courts with multiple filings include the Central District of California (6), Eastern District of Pennsylvania (3) and the Northern District of California (2).

The list of companies sued includes two that are domiciled overseas: UBS (Switzerland) and Security Capital Assurance (Bermuda). One of the subprime-cases – the one involving Security Capital Assurance – involves IPO-related allegations.

The 34 subprime-related lawsuits were filed between February and December 2007, with at least one lawsuit filed in each month during that period. There were two in February, four in March, two in July, eight in August, four in September, two in October, five in November, and four in December.

In other words, the subprime-related lawsuits, while concentrated in the Finance, Insurance and Real Estate SIC Codes, represent a number of different industries. The lawsuits have been filed in a number of different courts, but with a concentration in New York and Los Angeles. The lawsuit filings were spread (albeit somewhat unevenly) throughout the year. These observations seem relevant to any analysis of what the cases might represent within the larger context of securities filing trends.

Mortgage Investigations Face Challenges: A December 27, 2007 Washington Post article entitled "Mortgage Probes Face Big Hurdles" (here) notes that as problems have emerged following the subprime mortgage meltdown, "government subpoenas are flying, investor lawsuits are mounting, and in the nastiest cases, businesses are pointing the finger of blame at one another. "

But despite the almost irrepressible urge to find scapegoats, investigators could face significant hurdles due to the "tangled system" of regulatory authority and oversight. In addition, another consideration that could stymie investigators, and that could be a factor in the many investor lawsuits, is that "many of the assets that tumbled were explicitly marketed as involving borrowers with trouble credit histories, alerting investors that they were high-risk bets."

White Collar Fraud is Not Just Wrong, It’s Insane!: Regular readers may recall my prior post (here) about former Crazy Eddie CFO (and convicted felon) Sam E. Antar, who is now making a name for himself warning others about how to spot fraud. A lengthy December 25, 2007 Fortune Magazine article entitled "Takes One to Know One" (here) takes a closer look at Antar. and his current campaign to combat fraud.

The detailed article reviews the Crazy Eddie fraud in depth and explains how Antar has become a roving lecturer on accounting fraud. The article summarizes Antar’s strategy for finding fraud as "sustained and disciplined paranoia." He also says that the only safeguards against accounting fraud that work are "stringent disclosure rules for companies and better fraud training for auditors."

Interested readers may want to check out Antar’s blog, White Collar Fraud (here), for further commentary from Antar, who signs his blog posts as follows: "Respectfully, Sam E. Antar (former Crazy Eddie CFO and convicted felon)."