Ever since “entity coverage” (sometimes called “Side C coverage”) became a part of the standard D & O policy in the mid-90’s, bankruptcy courts have wrestled with the issue whether or not the D & O policy proceeds are property of the estate under Bankruptcy Code Section 541(a) and subject to the automatic stay under Bankruptcy Code Section 362. The directors and officers of the bankrupt company want access to the insurance proceeds to fund defense expense or settlements, but the bankruptcy trustee wants the proceeds preserved so they are available to satisfy the trustee’s own claims, and so the trustee seeks to subject payment of the proceeds to the bankruptcy stay.

A recent decision in the federal bankruptcy court in Delaware arising out of the bankruptcy of World Health Alternatives addressed the issue whether the directors and officers could access the proceeds of the bankrupt company’s D & O policy to settle separate shareholders litigation pending against them.

World Health Alternatives filed for bankruptcy in February 2006. However, prior to the bankruptcy filing, the company and several of its directors and officers had been sued in federal court in Pennsylvania in a securities class action lawsuit (refer here), and in October 2005, plaintiffs filed a separate derivative action. The cases were later consolidated. After the company filed its bankruptcy petition, it was dropped as a defendant from the shareholder litigation. In August 2006, the parties settled the consolidated shareholder action and in November 2006 filed a settlement agreement with the court.

The consolidated shareholder litigation settlement provides for the payment of $1.7 million (the remaining limits under the company’s D & O policy). In addition, the company’s former CEO agreed to transfer 435,000 shares of stock in three other organizations, and the company’s former accounting firm agreed to pay $1 million. The settlement proceeds were tendered into escrow, and the final settlement hearing was scheduled for June 11, 2007.

On May 21, 2007, the trustee in bankruptcy initiated an adversary proceeding in federal bankruptcy court in Delaware against the company’s former directors and officers, alleging, among other things, breaches of fiduciary duty and unjust enrichment. The trustee petitioned the bankruptcy court to enjoin the approval of the shareholder litigation settlement agreement and to direct the transfer of the proceeds of the D & O policy to the trustee.

In an June 8, 2007 opinion (here), Bankruptcy Judge Kevin Gross considered “whether a debtor’s creditors have priority over the debtor’s shareholders in the proceeds of an insurance policy to which both claim entitlement.” The court said that the threshold issue in the petition for a preliminary injunction is whether there is a “reasonable probability that the Trustee will win on the merits of his claim of priority to the proceeds of the policy,” which turns on “whether the proceeds are property of the estate.”

The question the court faced was complicated by the fact that the company’s D & O policy (like most current D & O policies) contained Side A coverage protecting the individuals, as well as Side B coverage providing the company with reimbursement coverage of amounts for which the company indemnified the individual directors and officers, and Side C “entity coverage” protecting the company from its own securities claim liability.

Typically, when a liability policy provides coverage to a debtor, the proceeds of the policy are property of the bankrupt estate. The court said that

When a policy covers the debtor and its directors and officers, and there is risk that payment of the proceeds to the directors and officers will result in insufficient coverage of the debtor, then the proceeds are property of the estate and any attempts to obtain the proceeds are prohibited under the automatic stay.

Judge Gross found, however, that under the circumstances “it appears that the proceeds of the Debtor’s insurance policy are not the property of the estate.” He reached this conclusion because “the policy proceeds which are being used to fund the settlement…are from the Policy’s Coverage A,” and the Trustee “has no right to any Coverage A proceeds.” The court said, quoting with approval from In re Allied Digital Technologies Corp., 306 B.R. 505, 512 (Bankr. D. Del. 2004):

The Trustees’s real concern is that payment of defense costs may affect his rights as a plaintiff seeking to recover from the D & O Policy rather than as a potential defendant seeking to be protected by the D & O Policy. In this way, Trustee is no different than any third party plaintiff suing defendants covered by a wasting Policy.

Because the court found that “there is no reasonable probability that the Trustee would succeed on the merits,” he denied the petition for a preliminary injunction.

On June 11, 2007, the court in the shareholders’ class action in Pennsylvania approved the shareholders’ action settlement and entered final judgment.

Judge Gross noted that there were numerous “other impediments” to the trustee’s recovery under the Policy, including the fact that the trustee did not even file the adversary proceeding against the company’s former directors and officers until after the claims-made D & O policy had lapsed. (As an aside, this fact alone would have been sufficient to dispense with the entire matter, since there would be no coverage in any event under the policy for the trustees’s claim, but the court chose a different line of analysis.)

Judge Gross also noted that the D & O Policy had a “Priority of Payments” provision “which requires that payments first be made to Coverage A insureds.” But while noting that the policy had a priority of payments provision, Judge Gross did not affirmatively conclude that the provision would defeat the trustee’s claims that the policy proceeds are property of the estate.

Though the court in the World Health Alternatives bankruptcy held that the trustee could not prevent the company’s former directors and officers from using the D & O policy proceeds to settle claims against them, there is a split of authority whether D & O policy proceeds are part of the debtor company’s estate and subject to the automatic stay. A priority of payments clause is one approach that some companies have used to try to avoid the assertion that the policy proceeds are part of the estate.

Another way to provide against the adverse effects that could follow in the event that the standard D & O policy (containing entity coverage) is subject to the stay in bankruptcy is to structure the company’s D & O insurance program to include a separate Side A policy that provides coverage solely for the individual directors and officers. Because these policies protect only the individuals, the policies’ proceeds are unlikely to be held part of a debtor company’s estate and therefore would not be subject to the stay in bankruptcy. Excess Side A policies providing so-called “drop down” protection in the event the standard D & O policy is subject to the bankruptcy stay may be the most cost effective protection against this possibility.

A good, brief summary of the issues surrounding the proceeds of the D & O policy in the context of bankruptcy by Kimberly Melvin of the Wiley Rein law firm can be found here.

Special thanks to Adam Savett of the Securities Litigation Watch (here) for the link to the bankruptcy court’s opinion.

Photo Sharing and Video Hosting at Photobucket In prior posts (most recently here), I described various attempts to shift the blame for alleged option grant manipulations to company gatekeepers. In the latest development, Vitesse Semiconductor announced on June 13, 2007 (here) that it has sued KPMG, its former auditing firm, seeking $100 million in damages and alleging that the firm failed to properly provide auditing and other services to the company.

On December 19, 2006, Vitesse announced (here) the results of a review conducted by a special committee of its board of directors that had been organized to look into allegations of possible options grant manipulations. The special committee “found evidence that members of Vitesse’s former senior management team backdated and manipulated the grant dates of stock options issued over a number of years, utilized improper accounting practices primarily related to revenue recognition and inventory, and prepared or altered financial records to conceal those practices.” The special committee estimated that the total additional expense to Vitesse from the stock grant manipulation is approximately $120 million since 1995.

The special committee identified a number of accounting issues, some of which “appear to have been used on certain occasions to manipulate revenues for accounting periods in consideration of Wall Street expectations.” Among the practices identified were: the failure to properly account for returned inventory; use of false sales invoices to increase revenue; and improper revenue recognition practices, including channel stuffing and improper recognition of consignment sales.

The company’s December 19, 2006 press release also stated that Vitesse’s board had “dismissed KPMG LLP based on its lack of independence.” However, in a December 22, 2006 press release (here), Vitesse clarified its prior statement about KPMG’s dismissal, noting that “the dismissal was as a result of Vitesse’s consideration of potential claims it may have with respect to KPMG, which would impair its independence, rather than any finding that KPMG lacked independence with respect to Vitesse prior to the date of the Special Committee’s report.” A CFO.com article regarding the clarifying press release can be found here.

The Vitesse lawsuit against KPMG follows the lawsuit that another former KPMG client recently filed against the firm. KPMG was named, along with PricewaterhouseCoopers, as a defendant in a lawsuit that Collins & Aikman Corp. filed against its former CEO, David Stockman, and other former company executives. The Collins & Aikman lawsuit (about which refer here) alleges that the accountants “turned a blind eye to accounting improprieties” at the company.

The Vitesse and Collins & Aikman lawsuits are only the most recent of KPMG’s litigation woes. KPMG also was targeted in the Department of Justice’s investigation of tax shelters KPMG developed and sold between 1996 and 2002 (refer here), in settlement of which KPMG agreed to make payments totaling $456 million.

Vitesse itself and several of its former directors and officers face securities class action litigation (here) based on allegations of stock option manipulations. At least one of the securities class action complaints filed against Vitesse (here) also named KPMG as a defendant.

Vitesse is not the first company having uncovered options backdating to sue its former auditor. As discussed in an earlier post (here), Micrel sued its former auditor, Deloitte and Touche, for allegedly faulty advice regarding the company’s options practices. Deloitte settled the case for a payment of $15.5 million.

French Accent: “Vitesse” is of course the French word for “speed. ” The D & O Diary associates the word with the French TGV trains (“train � grande vitesse”) which SNCF, the French rail company, operates. The TGV Eurostar train goes through the Chunnel from Paris to London. On April 4, 2007 (refer here), a modified TGV train set the conventional train speed record, clocking in at 357.2 mph. (To my knowledge, Vitesse Semiconductor has nothing to do with the TGV.)

Photo Sharing and Video Hosting at Photobucket In an earlier post (here), I examined the risk characteristics surrounding Private Investment in Public Equity (PIPEs) financing, and argued that PIPEs are an increasingly important part of small public company financing, and that companies should not be viewed as suspect merely because they have resorted to PIPEs financing. Since the time of my prior post, PIPEs have continued to increase in importance. According to CFO.com (here), in the first quarter of 2007 alone, there were 302 PIPEs transactions totaling $10.92 billion in equity raised, which represents a 48 percent increase over the amount raised in the first quarter of 2006.

In a PIPE, accredited investors (usually hedge funds) acquire company securities in a private offering as a discount to the securities’ market value. The issuer undertakes to register the shares with the SEC, usually within 90 to 120 days of the private offering closing. My earlier post reviewed the benefits of PIPEs to issuers and investors.

A June 9, 2007 article by William K. Sjostrom, Jr. of Northern Kentucky University Law School entitled simply "PIPEs" (here) takes a closer look at PIPEs financing, reviews why hedge funds invest in these offerings, examines the regulatory issues (including the SEC enforcement actions) in which hedge funds get involved, and critiques the SEC’s current regulatory stance on PIPEs.

The article emphasizes that PIPEs are an important funding source for small companies, Approximately 90% of 2006 PIPEs transactions involved companies with market caps below $250 million, generally because they have no financing alternatives. More than 84% of PIPEs issuers have negative operating cash flows and a majority would run out of cash without the PIPE.

Under the circumstances, it might well be asked who would invest in a PIPE; the answer is hedge funds.

Hedge funds constitute nearly 80% of the investors in microcap PIPEs, and the hedge funds invest in PIPEs because of the returns they can achieve. By using a strategy whereby they sell short the issuer’s common stock promptly after the PIPE deal is disclosed, they are able to lock in the deal purchase discount (which, all in, ranges from 14.3% to 34.7%), as either a rise or fall in the issuer’s share price after the PIPE would cause an increase in value of either the long or short position and a decrease in the complementary position.

To execute this strategy, the hedge fund must be able to borrow the shares to cover their short position. But since the stock of many PIPEs issuers is very thinly traded, the hedge fund may not have shares to cover the short position – a so-called "naked short," which while not illegal per se, may constitute illegal stock manipulation. (An SEC enforcement action against a hedge fund investor that engaged in a naked short in connection with a PIPE transaction can be found here.) A June 14, 2007 New York Times article about naked short selling can be found here.

Because of the popularity of PIPEs investments, as well as the fact that (as Professor Sjostrom puts it) some hedge funds "routinely push the legal envelope with their trading strategies," the SEC has stepped up its enforcement activities in this area and "has brought at least eleven enforcement actions relating to PIPEs deals."

The SEC has, for example, alleged that hedge funds have engaged in illegal insider trading by shorting the issuer companies’ stock prior to the announcement of the PIPE transaction (refer here for a case example) and that the hedge fund investor has violated Section 5 of the Securities Act of 1933 by using the shares the hedge fund bought in the PIPE private placement to cover their open short position (refer here for a case example). The SEC’s position is that the hedge fund should use shares purchased on the open market to cover the open short position. (A prior D & O Diary post discussing these enforcement actions can be found here.)

The SEC’s regulatory response to tighten its control over PIPEs has been to declare that PIPEs deals involving more than 33% of an "issuer’s float" constitutes a "primary" offering, which would render investors (such as hedge funds) in a PIPE of more than 33% of float into "underwriters" and therefore subject them to potential liability under Section 11 of the ’33 Act. A December 27, 2006 Wall Street Journal article discussing the SEC’s position can be found here (subscription required). The SEC’s position was stated more recently in a January 27, 2007 speech (summarized here) by David Lynn, at the time the SEC’s Chief Counsel of the Division of Corporate Finance. (Lynn recently left the SEC and joined the CorporateCounsel.net team, refer here.)

According to another recent article (here) discussing the SEC’s new cap and commenting on the possibility that under the SEC’s new guidelines PIPEs investors might take on underwriter liability exposure under Section 11,

Most PIPE investors are unwilling to … accept such liability. PIPE investors who might be willing to accept liability as underwriters certainly would require the full panoply of the underwriter’s traditional protections: representations and warranties, indemnity, conflict letters, opinions, and extensive due diligence. The speed and efficiency associated with PIPEs would be lost.

Professor Sjostrom’s article points out that this constraint effectively puts a cap on the size of PIPEs deals, and that the lower the dollar value of a company’s public float, the less money it will be able to raise through a PIPE transaction. As the author notes, the SEC’s cap "hits small companies the hardest, the very companies that have few, if any, other financing options." The author calls on the SEC to take into account the effect its regulation has on the PIPEs financing market, "considering that it represents the sole financing option for many small public companies." The author concludes that "a more measured and transparent SEC approach to PIPE regulation is in order."

A very good and detailed (albeit more technical) discussion of the regulatory issues, including the practical implications of the SEC’s screening process under the new guidelines, can be found here.

As I discussed in my prior post, PIPEs are likely to remain an important part of the financial landscape, in part because, as Professor Sjostrom argues, companies that engage in PIPEs often have no other financing alternatives. There are, as I previously pointed out, some PIPEs elements that characterize riskier PIPEs deals, but a transaction should not be suspect simply because it is a PIPE. That is, a PIPE should be viewed , and, as Professor Sjostrom argues, regulated, with a more "measured" approach, and the focus should be on the riskier deals (such as the so-called "structured PIPEs") that represent the relatively greater risk to issuers and investors.

Do Activist Investors Hurt Bondholders?: While I’m on the subject of hedge funds, I should reference the June 13, 2007 CFO.com article (here) about a recent Moody’s study showing that demands of "short-term shareholder activists" (read: hedge funds) are "generally negative for credit quality." This can be caused by the actions responsive to activist investor pressures, such as the company’s sale of significant assets with the proceeds passed to shareholders; increases in dividends or share buybacks; or a more leveraged financial strategy. These activities have "the potential to change the company’s credit profile over the short to medium term." The short-term activists also "distract management from running the business to deal with their demand, eating up corporate resources and wealth."

There are, however, a "minority of cases" where following activist intervention "a company embarks on a more focused strategy…and makes significant improvement to practices, including disciplined capital allocation."

A Full Disclosure Endnote: The full name of the Northern Kentucky University Law School is the Salmon P. Chase College of Law. The school’s name refers to the 19th century Ohio Senator and Governor who served in Lincoln’s cabinet as Secretary of the Treasury and who also served as Chief Justice of the United States Supreme Court from 1864 until his death in 1873 (refer here for more detail). While serving as Chief Justice, Chase presided at the impeachment trial of Andrew Johnson. In addition to the Law School, Chase Manhattan Bank (now part of JP Morgan Chase) is also named after the former Chief Justice.

 

Photo Sharing and Video Hosting at Photobucket In the options backdating related derivative case pending in Delaware Chancery Court involving Sycamore Networks as nominal defendant, Vice Chancellor Leo E. Strine, Jr. granted the defendants’ motion to dismiss, in an opinion (here) that carefully distinguished the earlier Delaware Chancery Court dismissal denials in the Ryan v Gifford (Maxim Integrated Products) case and the Tyson Foods case. (Refer here for my post regarding the prior cases.) In addition to holding that the Sycamore Networks plaintiff lacked standing to challenge option grants that occurred before the plaintiff acquired his shares, Vice Chancellor Strine also held that the plaintiff had not established demand futility.

The Sycamore Networks plaintiff’s allegations involved three categories of grants, Employee Grants, Officer Grants and Outside Director Grants. With respect to the Employee Grants, the Vice Chancellor held that “because the complaint is devoid of any facts suggesting a rational inference that any members of Sycamore’s board, much less a majority, knew about the backdated Employee Grants, [the plaintiff] has failed to create a reasonable doubt about the Sycamore board’s ability to impartially consider a demand as to this category of claim.”

The Officer Grant allegation involved not only options backdating allegations but “the more subtle issues raised by “springloading and bullet-dodging as well. The Court held with respect to these allegations that the plaintiff had failed to show that there was not a disinterested majority of the board available to consider the allegations. In making this finding, Vice Chancellor Strine specifically distinguished the earlier decision in the Tyson case, which contained detailed allegations of multi-year concealments, by contrast to the Sycamore Networks complaint, which alleged only “weak allegations about a single alleged instance of spring loading involving information that did not even clearly affect the company’s stock trading price.”

Vice Chancellor Strine found in connection with the third category of backdated grants, the Outside Director Grants, that because the directors in fact received the disputed grants, it would be “difficult to find them independent.” However, the Vice Chancellor found that the disputed options were made pursuant to a shareholder approved plan that expressly permitted below-market grants, and no adverse inferences could be drawn from the fact that the awards followed adverse news disclosures. Chancellor Strine specifically noted that by contrast to the plaintiff in the Ryan v. Gifford (Maxim Integrated Products) case, the Sycamore Network plaintiff “has pled no facts to suggest even the hint of a culpable state of mind of any director.”

The Vice Chancellor also drew a contrast between the detailed allegations in the Tyson case, which built upon the fruits of a prior books and records request, and the Sycamore Networks plaintiff, who “rushed in to court, making generalized charges unaccompanied by fact pleading about the involvement of the directors in the improprieties he contends occurred.”

The 77-page Sycamore Networks opinion not only reflects a detailed analysis of the case before the Court, but also contains a painstaking comparison between the Sycamore Networks allegations and the allegations in the Maxim Integrated Products case and the Tyson Foods case. The Sycamore Networks case on the one hand and the two prior cases on the other hand now present opposite outcomes under Delaware law on options backdating derivative case dismissal motions, and represent contrasting precedents from which parties in future cases will attempt to argue. Certainly, Vice Chancellor Strine’s distinction between the Sycamore Networks complaint and the allegations in the prior two cases will present a road map from which defendants can attempt to argue their dismissal motions.

The Sycamore Networks opinion also contains a lengthy discussion of the important differences between backdating, on the one hand, and sprinloading and bullet dodging on the other hand, as well as a broad discussion of boards’ duties and potential liabilities generally.

The Sycamore Networks plaintiff relied heavily on the allegations contained in the separate complaint of a former Sycamore Networks employee who claimed that his employment contract was terminated because he complained about the company’s stock option practices. A July 12, 2006 Wall Street Journal article describing the complaint and the backdating allegations can be found here, subscription required.

Professor Larry Ribstein has an interesting discussion of the Sycamore Networks case on his Ideoblog (here). Hat tip to the Delaware Corporate and Commercial Litigation Blog (here) for the link to the opinion.

Zoran Backdating Case Survives Motion to Dismiss: The Sycamore Networks case and several other options backdating related derivative cases (refer here) have been dismissed due to the plaintiffs’ failure to establish that a demand on the board to address the alleged misconduct would be futile. However, on June 5, 2007, Judge William Alsup denied the defendants’ motion to dismiss in the Zoran backdating derivative litigation, specifically holding that the plaintiffs had established demand futility. A copy of the Zoran opinion can be found here.

The basis of the Court’s finding of demand futility is the plaintiffs’ allegation that each board member (including even two who were not named as defendants) had received backdated stock options. Based on this allegation, Judge Alsup concluded that that the directors are “interested” in the dispute, stating:

a decision now to correct the grant dates would have a detrimental impact on the directors by removing the financial benefit of the backdating. The director may be required to pay back the difference in price between the true grant date and the purported grant date. The directors may even face legal exposure. Accordingly, if plaintiffs can plead with particularity that the directors received backdated grants, those directors will be considered interested.

Judge Alsup specifically cited the Ryan v Gifford (Maxim Integrated Products) case. The Zoran opinion preceded the Sycamore Networks case, and so Judge Alsop’s analysis does not consider the distinguishing factors to which Vice Chancellor Strine referred in concluding that the Sycamore Network directors were not “interested” despite having received challenged options.

A press release discussing the Zoran decision can be found here. My prior post discussing the Zoran lawsuit can be found here.

Alleged Sharp Practices: If you have not read Judge James M. Rosenbaum’s denial of the defendants’ motion to dismiss in the United Health Group options backdating related securities class action lawsuit, you will definitely want to take a moment and read the brief opinion here.

The fate of the dismissal motions was definitely tipped when the court characterized the defendants’ motions as “expending forests of trees and millions of electrons.” Of the plaintiffs’ allegations, the court said, “if plaintiffs are correct, this case is incredibly simple. Plaintiffs claim defendants were playing with a stacked deck. When awarded options, with deliberately selected grant dates which were already in the money, defendants were playing a game they knew they could not lose; and unsurprisingly, defendants won.”

Having started with the “stacked deck” card playing analogy, Judge Rosenbaum switches his comparison to horse racing, and compares the defendants’ alleged scheme to the plot of the 1973 Academy Award-winning movie The Sting, in which the lead characters revenge themselves by a “scheme involving ‘past-posting,’ or betting on horse races after the results are known.” The Court’s conclusion? Motion denied, with a note that “the Court commends The Sting to all parties.”

While the Court settled on the horse racing analogy, I have myself preferred the card-playing comparison, as I noted in my comment (here) early in the unfolding of the backdating scandal, where I quoted Talleyrand’s remarks about the baleful effects of cheating at cards.

Hat tip to Adam Savett of the Securities Litigation Watch (here) for the link to the United Health Group opinion.

Anyone who was around when The Sting first came out will undoubtedly recall the film’s score, inspired by the music of Scott Joplin, including the movie theme based on Joplin’s song , The Entertainer, a sound file for which can be found here.

An inspired updated video mash up based on The Sting can be found here:

As the number and magnitude of buyout deals has continued to grow, shareholders have become increasingly restive. Shareholders seem increasingly inclined to demand, and in some cases successfully compel, a larger acquisition price for the target company. For example, Biomet shareholders successfully compelled the company’s would-be private equity acquirers to increase their $10.9 billion buyout bid by $500 million (refer here).

Some shareholders are upset about more than the buyout price alone. In some instances, shareholders are employing lawsuits on the grounds that a proposed buyout is fundamentally unfair. A June 7, 2007 Washington Post article entitled “Lifting the Lid: Investors Sue Over Cozy Deals” (here) reports that shareholders have filed “a string of lawsuits claiming that the deals are unfair to investors and sometimes only serve to enrich top executives.” In these cases the shareholders argue that “managers accept low ball offers because they have cut lucrative deals for themselves with the buyers that might allow them to continue running the company.” The article specifically mentions lawsuits filed in connection with buyouts at Lear, Topps and Ceridian.

But while lawsuits surrounding buyout transactions have proliferated, the more interesting question may be whether a second round of litigation may lie ahead, as some of the recent buyout deals start to strain and threaten to fail. A June 8, 2007 Wall Street Journal article entitled “Boom Aside, Not All LBOs Look So Hot” (here) reports that “a number of recent high profile deals are already showing signs of strain.” Significant debt fueled many of the buyout deals “potentially causing problems as bond yields climb and the U.S. economy runs into new obstacles.” While none of the deals mentioned in the Journal article have failed altogether, the article notes that “it is striking how quickly a few deals have run into problems.”

A default or other failure could trigger a wave of recriminations, from bondholders, lenders, creditors or fund investors, against the buyout firms or company management. The extraordinarily generous terms of the debt instruments (for example, the absence of any kinds of covenants) could lead to accusations against the banks that structured the deals, or by investors whose portfolio managers invested in the debt.

While my crystal ball is no better than anyone else’s, the number of high-profile merger failures in the recent past (think AOL Time Warner and Daimler Chryser) suggests that the inevitable end of the current buyout boom may involve at least a few significant casualties. If the buyout funds or debt investors lose money, which would be hard to avoid in the event of a significant default, the recriminations will follow as day follows night. Ironically, the current push to drive up buyout prices could set the stage for later problems, as the higher buyout prices necessitate increased debt, leading to a smaller margin for error. Some deals may end in tears – and lawsuits.

For prior D & O Diary posts discussing buyout related lawsuits and D & O claims, refer here and here.

Conflict Control: An interesting effort to control the conflicts that can arise in a management-led buyout is reflected in a June 7, 2007 “Guidance Note” from Australia’s Takeovers Panel, entitled “Insider Participation in Control Transaction” (here). (According to its website, the Takeovers Panel is “the primary forum for resolving disputes about a takeover bid until the bid period has ended. The Panel is a peer review body, with part time members appointed from the active members of Australia’s takeovers and business communities.”).

The Note provides that when a board or company becomes aware of a takeover bid that is likely to involve the participation of insiders, the board should appoint an “independent board committee” and “establish protocols” regarding who should communicate on the target company’s behalf and what limitations should restrict the participating insider. Essentially the Note recommends that the participating insider be quarantined from the transaction. Significantly, the guidelines are not meant to be exhaustive, nor even meant to encompass all the legal duties any particular situation may require.

Hat tip to the SOX First blog (here) for the link to the Guidance Note.

Global Warming and D & O Coverage: In prior posts (most recently here), I have commented on the D & O insurance exposure arising from global climate change. A recent paper by Joe Monteleone of the Tressler, Soderstrom, Maloney & Priess law firm entitled “Global Warming – Will There Be Exposures for Directors and Officers and Will It Be Covered?” (here) takes a deeper look at these issues, with particular emphasis on the relevant D & O policy provisions. Special thanks to Joe for allowing me to link to this timely and well-written article.

Photo Sharing and Video Hosting at Photobucket In an earlier post (here), I wrote about global climate change and D & O risk. The potential challenge to D & O insurers from the risks and potential liabilities of global climate change is only a part of the full range of liability exposures the insurance industry potentially faces as a result of climate change. A May 2007 article by Christine Ross, Evan Mills and Sean Hecht entitled “Limiting Liability in the Greenhouse: Insurance Risk-Management Strategies in the Context of Global Climate Change” (here) take a comprehensive look at the insurance industry’s liability exposures arising from the causes and consequences of climate change.

The authors’ premise is that the discussion of potential insurance consequences from climate change tends to focus on the property damage concerns of extreme weather events. Their article, by contrast, focuses on the “relatively subtle but equally important dimension of liability.” The authors examine a broad range of potential liabilities and insurance coverages that could be implicated, including commercial general liability claims; product liability claims; environmental liability claims, professional liability claims; political liability claims; and others.

The authors’ starting point is that “parties that disproportionately contribute to the impacts of climate change are not required through any statutory or regulatory scheme to internalize costs of these impacts.” The externalized costs “are left of the victims to bear,” based upon which, the authors observe, “applying tort law to climate change harm could be consistent with tort law’s basic goals of reducing the societal costs of human activities, compensating those who are harmed unduly by these activites, and providing corrective justice.” While substantial barriers could impede efforts to impose tort liability, the costs of defense alone will be burdensome on companies and their insurers.

In addition to attempts to redress climate change through litigation, other climate change initiatives are or will impact many companies. For example, investors have evinced an increasing desire to compel full disclosure of environmental liability risks. The article notes that “over the last seven proxy seasons, climate change resolutions filed by shareholders have increased from six in 2001 to a record forty-two filed in the first two months of 2007.” The authors also specifically note that “shareholder resolutions were filed with four insurance companies during the 2007 proxy season … requesting those companies to disclose strategy and actions on climate change.” While in the past these kinds of resolutions would have arisen from special interest investor groups, now “some of America’s most powerful institutional investors …are becoming increasingly active in environmental and social issues.”

The authors also note that several SEC regulations deal directly or indirectly with environmental risk disclosure, including Items 101 and 303 of Reg. S-K. The article does note that, at least in the past, there has been “lax enforcement” of these disclosure requirements, and that only five times in the last thirty years has the SEC taken action to enforce environmental liability disclosure. Moreover, the SEC “does not specifically require reporting on greenhouse gas emissions and climate change.”

The authors assert that the growing awareness of the potential impact of climate change on companies’ circumstances is increasing pressure on the companies to address these disclosure issues. The authors cite the 2006 SEC enforcement action (here) against Ashland Inc., where the SEC found that the company understated its environmental reserves by improperly reducing its remediation estimates. The authors state that this enforcement action may “be a signal of the SEC’s increasing willingness to hold companies accountable for failure to adequately disclose material environmental risks.” (Refer here for my prior post about the Ashland enforcement action.)

In addition, the authors further note that “failing to establish standards or to take proactive measures to reduce greenhouse gas emissions could expose companies to reputation and brand damage, as well as regulatory and litigation risk.” Among the specific litigation risks, the authors note that “shareholder lawsuits could be focused on a company’s performance suffering due to negligent planning by corporate directors for climate change risk.” The authors also note that “ignoring climate change, or even worse, misrepresenting its risks can result in exposure to litigation risk.”

The authors cite a study finding that 53% of the largest 500 publicly traded companies are doing “a poor job” describing climate change risks to investors, and “are thus at risk of shareholder lawsuits.” The authors further note that insurers may be particularly vulnerable, since insurers in particular “have been reluctant to disclose their climate-related risks.”

After comprehensively reviewing a wide variety of potential liability exposures, the authors move on to suggest a variety of risk management and mitigation strategies. The authors also call on financial services companies in general to incorporate environmental awareness into their portfolio strategies. The authors call on insurers in particular to “offer innovative products and services that maximize incentives for energy efficiency while minimizing risk.” The authors cite, among other things, insurer initiated property loss mitigation efforts and pay-as-you-drive automobile insurance as examples of innovative insurance efforts “to take concrete actions that generate profits while maintaining insurability and protecting customers from extreme weather-related losses, as well as reducing greenhouse gas emissions.”

The authors conclude by noting that:

The insurance industry, perhaps more than any other institution, has the power to set the stage for enduring and significant contributions to solving the problem of global climate change. In doing so, liability insurance considerations could prove to be as important as the more widely studied property insurance consequences of climate change.

As I discussed in my earlier post, global climate change is going to loom increasingly large, not least as a growing source of potential liability risk for companies and their directors and officers. Readers who are interesting in these topics will want to know about the free June 12, 2007 webinar entitled “Tackling Global Warming: Challenge for Boards and Their Advisors,” co-sponsored by The CorporateCounsel.net and the National Council for Science and the Environment. Information about the webinar can be found here.

Readers interested in global climate change as an environmental phenomenon will be interested to read the June 7, 2007 Washington Post article entitled “Icy Island Warms to Climate Change” (here) discussing the wide-ranging impacts of climate change that Greenland and its inhabitants are already experiencing.

Hat tip to the Sox First blog (here) for the link to the climate change article.

Photo Sharing and Video Hosting at Photobucket In prior posts (here and here) I have questioned whether SOX whistleblower protection is "more theoretical than real." A forthcoming study by Richard Moberly of University of Nebraska Law School entitled "Unfulfilled Expectations: An Empirical Analysis of Why Sarbanes-Oxley Whistleblowers Rarely Win" (here) takes a look at just how poorly employee whistleblowers have fared under the Sarbanes-Oxley whistleblower protections and why.

The study looked at the 470 SOX Whistleblower cases filed at the initial regulatory level between August 19, 2002 (when the first case was filed) and July 13, 2005, as well as all 236 administrative appeals filed through June 1, 2006. Of the 361 cases that actually reached decision at the initial regulatory level, employees won only 13 times, or a rate of 3.6%, and of the 93 decisions at the administrative appeal level, employees won only 6 times or 6.5%.
Based on these statistics, the authors observes that

Despite Sarbanes-Oxley’s pro-whistleblower provisions and a few early employee victories…administrative decisions over the first three years of the Act’s life failed to fulfill Congress’ expectation that a strong anti-retalitatory provision would both encourage and protect whistleblowers.

Based on his study of the whistleblower cases, the author suggests several statutory revisions that "would better reflect Congress’ goal of protecting whistleblowers and remedying retaliation."

First, the author found that many claimants ran afout of the short 90-day statute of limitations, which he recommends extending at least to 180 days.

Second, he found that there is uncertainty surrounding "boundary issues" such as whether the company was a "covered employer" or the employee engaged in "protected activity." He calls for Congressional clarification of these issues, and clarification that "employees of privately-held companies are protected when they report fraud at publicly-traded corporations." He also recommends that the Act be modified to requires whistleblower exposure on general fraud only, without the added requirement that the disclosure pertain to securities fraud.

The author concludes by observing that:

Ultimately, Sarbanes-Oxley failed to fulfill the great expectations generated by the Act’s purportedly-strong anti-retaliation provisions…The under enforcement of [the whistleblower provisions] undermines Congress’ policy goal of deterring corporate fraud and leaves literally millions of private-sector employees vulnerable to retaliation.

It may be important to note that in the author’s statistical analysis, he does not include as within his tally of employee "wins" the whistleblower cases that were settled. A significant percentage of cases (11.6%) have settled at the initial regulatory stage and a larger percentage (18.3%) have settled at the regulatory stage. While settlement suggests compromise, the fact that the affected employee was willing to compromise further suggests that the employee found the settlement acceptable under the circumstances. Employers for their part felt compelled to compromise, whether or not they agreed the case had merit, and so at least incurred the cost of settlement. So the "win" rate as expressed by the author’s analysis may not be a sufficient statement of employers’ exposure to SOX whistleblower claims. The risk to the employer extends beyond the concern that employees might prevail outright.

But in any event, it is hard to contradict the author’s conclusion that the SOX whistleblower provision apparently has failed to encourage fraud detection and disclosure or to provide employees from fear of retaliation for blowing the whistle.

Hat tip to the SOX First blog (here) for the link to the article.

Original Whistleblower Loses Case: As if to prove the point, a June 5, 2007 article on CFO.com reports (here) that David Welch, the first person to win a case under the Sarbanes Oxley Whistleblower provisions, has had the lower-level ruling in his favor overturned by the Department of Labor’s Administrative Review Board. In part the Board overturned the decision because the Welch’s complaints were not "protected activtity" (because they were not with SOX itself and because they did not relate to the federal securities laws). The Board also found that Welch could not have reasonably believed that the alleged fraud would have presented investors with a misleading picture of the company’s financial picture.

The Administrative Review Board’s May 31, 2007 opinion can be found here.

Photo Sharing and Video Hosting at Photobucket Let Them Eat Self-Reliance: In his readable one-volume biography of Gandhi, Yogesh Chadha reports following incident that occured while Gandhi was still a young lawyer with a growing family:

Shortly after Gandhi took up chambers in Bombay, an American insurance agent visited him in his office. The smooth-talking agent discussed Gandhi’s future "as though we were old friends." He stressed the need for insurance coverage for the family. Gandhi was impressed and took out an insurance policy for ten thousand rupees. Later, however, he became annoyed with himself for having fallen into the agent’s trap, for he had earlier maintained that "life insurance implied fear and want of faith in God." He let the policy lapse. "In getting my life insured I had robbed my wife and children of their self-reliance," he reasoned. "Why should they not be expected to take care of themselves? What happened to the families of numberless poor in the world? Why should I not count myself as one of them?"

I don’t think I have ever heard anyone contend that life insurance is a moral hazard for the beneficiaries. How many among us would consciously allow a life policy to lapse to avoid "robbing" the putative widow and orphans– by providing for their future? I guess only a truly moral person could see that an uneducated widow with life-long, chronic health problems and a squadron of children who were prevented by their father from receiving formal schooling would be much better off without the moral burden of financial protection.

Even though the life insurance agent is twice-disparaged (not only smooth-talking but American) in my mind the unnamed agent has to be the all-time, indoor-outdoor, world champion closer – to seal the deal, he managed to overcome Gandhi’s moral qualms, for crying out loud. Otherwise, how could Gandhi possibly have fallen into such a "trap" as providing for his dependants?

All in all, yet another example proving that a working professional’s continuing education necessarily requires a broad curriculum.

If it has been a while since you have seen Ben Kingsley’s amazing portrayal of Gandhi in Richard Attenborough’s 1983 academy award winning film biography of Gandhi, you may want to view this brief excerpt from the movie; the first scene shows how Gandhi’s moral rigor complicated his relations with everyone, even his wife, and in the the second scene, he articulates his philosophy of nonviolence:

https://youtube.com/watch?v=yGllzwttUPc

 

Photo Sharing and Video Hosting at Photobucket The SEC’s settlements of options backdating civil enforcement actions against Brocade Communications and Mercury Interactive received extensive coverage in the financial press last week (refer here and here). But there are several features of these settlements and the underlying civil actions that merit closer attention, particularly with respect to the Mercury Interactive action and settlement. The SEC’s Mercury Interactive litigation release and complaint can be found here and here The SEC’s Brocade Communications litigation release can be found here.

One aspect of the Mercury Interactive civil enforcement action that is particularly noteworthy is the sheer accumulation of numeric detail. The complaint alleges that all 45 of the company’s stock option grants made to executives and employees during the period 1997 to April 2002 were backdated, some by as much as four months, causing “Mercury to fail to record over $258 million in compensation.”

This apparently comprehensive program of options backdating stands in odd contrast to the option plan arrangement that Mercury’s shareholders approved. According to the complaint, not only did the shareholder approved plan specifically require all options grants to be priced at 100% of fair market value at the date of the grant, but the shareholders had earlier rejected an option grant plan that would have permitted the stock options to be granted at less than fair market value. In order to create the appearance that the backdated grants (which were in the money when they were actually awarded) were priced at 100% of the fair market value, the Company’s former general counsel allegedly created falsified written consents and meeting minutes, and other false reports to create the appearance that the approvals had taken place at the earlier date. (Law.com has a June 1, 2007 article entitled “SEC Says Former Mercury GC Falsified Records” (here) that examines in greater detail the SEC’s specific allegations against the Mercury’s former general counsel.)

But perhaps even more interesting that the options grant backdating allegations are the allegations in the complaint relating to options exercise backdating. Through this process, several corporate officials were able to report that they had exercised their options earlier than the actual exercise date. The company’s stock was trading lower at the selected earlier date, which reduced the apparent spread between the strike price and the market value on the reported exercise date. Because the amount of this spread is taxed as ordinary income, the use of the earlier date with the lower market price permitted the officials to minimize the gain that would have to be reported as ordinary income. The underreporting reduced the tax deduction benefit to the company as well. The backdated exercise date also shortened the period the officials had to hold the stock in order for gain on any stock sales to be taxed at the lower capital gains rate.

One official’s tax benefit from the exercise backdating was as much as $17.7 million, and another official’s benefit was as much as $2.2 million. In some instances, these officials allegedly were backdating their exercise on backdated options. (Refer here for my prior post on exercise backdating.)

The complaint also contains other allegations not directly related to backdating. For example, the complaint also alleges that the defendants manipulated its revenue recognition in order to manage the company’s reported earnings per share. The complaints also alleges that the defendants fraudulently structured loans for overseas employees’ options exercises to conceal the loans’ accounting consequences, causing the company to fail to report $24 million in related compensation expense.

All in all, it is difficult to disagree with the assessment of Peter Henning, the Wayne State law professor who maintains the White Collar Crime Prof blog, in the Law.com article (here), that the company had a “widespread culture of fraud.”

Yet there are nevertheless a couple of things that trouble me. It had been discussed in the press for some time that the SEC Commissioners were struggling with the question whether or not to impose civil fines directly on the companies involved in the backdating scandal. (Refer here for a Bloomberg.com article discussing the Commission’s debate about whether or not to approve the $7 million Brocade settlement). There is an awkward question about the imposition of civil penalties on corporations for past violations, since the financial burden falls on current shareholders.

The Mercury civil penalty put this question in sharp focus since Hewlett Packard acquired Mercury on November 8, 2006, and Mercury is now a non-trading subsidiary of HP. The burden of Mercury’s civil penalty falls on HP’s shareholders, who of course have nothing to do with what happened at Mercury. And while it may be surmised that the acquisition price that HP paid for Mercury was discounted due to the uncertainty surrounding the SEC’s investigation, that does not eliminate the question surrounding the purpose of the corporate civil penalty.

With the Brocade and Mercury Interactive settlements, it is clear that the SEC has resolved its internal debate and is now committed to pursuing civil penalties against at least some of the companies involved in the options backdating scandal. The imposition of corporate civil penalties to be borne by current shareholders for past misconduct does raise questions about the punitive or deterrent value of the penalties; it is hard not to wonder whether the penalties are misplaced. And why was Mercury Interactive’s settlement $28 million and Brocade’s $7 million?

To be sure, the SEC’s civil enforcement actions against the individual officials at Brocade and Mercury Interactive are continuing. It remains to be seen what penalties (if any) these individuals will face. Along those lines, however, one very interesting omission from the Mercury Interactive civil enforcement complaint is the absence of any reference in the civil complaint to Mercury’s former outside directors. As Mercury disclosed prior to the HP merger (here), three individual Mercury Interactive outside directors had been served with Wells Notices in connection with the SEC’s investigation. However, the only individuals named in the SEC’s civil enforcement complaint were former Mercury officers; no former outside directors were named. UPDATE: Alert reader Uri Ronen points out that the SEC’s press release (here)announcing the Mercury Interactive enforcement action specifically states that “The Commission’s investigation is continuing.” As the SEC Actions blog notes (here), the Brocade Communications release does not mention that the investigation is continuing. The statement in the Mercury Release about the continuing investigation suggests at least the possibility that there could be further actions brought in the future.

One final note– the SEC, in its civil complaint, could not resist adding the following detail when describing Mercury’s software business: “One of the product solutions [Mercury] sold was marketed as a means to implement best practices frameworks for Sarbanes-Oxley compliance.”

Special thanks to alert reader Lauren Murphy Pringle for providing several links relating to the Mercury Interactive settlement.

Lerach Status: As I noted in a prior post (here), rumors continue to circulate about Bill Lerach’s possible retirement from the Lerach Coughlin law firm and a possible link between his supposed impending retirement and developments in the Milberg Weiss criminal investigation. Perhaps the most provocative article the rumor mill has produced it the Los Angeles Times’ June 1, 2007 article (here), relating to Lerach’s possible retirement, entitled “Class-Action Lawyer Could Face Charges.” The WSJ.com Law Blog has a good summary (here) of the various stories currently in circulation.

According to a separate WSJ.com Law Blog post (here), the Lerach Coughlin firm has issued a press release acknowledging that Lerach is “considering retirement.” The release notes that the firm itself has never been the subject of the investigation – which by negative inference certainly suggests that developments in the investigation have something to do with Lerach’s retirement considerations. (The complete text of the press release can be found on the Legal Pad blog, here.) The WSJ.com Law Blog post also notes that the prosecutors and criminal defendants filed a sealed agreement last week postponing all motions in the criminal case for two weeks, which is consistent with the notion that there are active plea negotiations underway.

There will clearly be some interesting developments in the story in the next few days.

401(k) Fee Suits: A May 31, 2007 Law.Com article entitled “401(k) Suits Over High Costs to Employees on the Rise” (here) takes a look at the growing number of lawsuits against companies, and in some cases their directors or 401(k) plan trustees, alleging that the defendants breached their fiduciary duties by allowing third parties to charge undisclosed or excessive fees to employees who participate in the plan. One law firm, St. Louis-based Schlichter, Bogard and Denton, has filed 13 of these cases, some of which have already survived preliminary motions to dismiss. However, other cases have been dismissed, including one case against Grumman that had named the Grumman board of directors as defendants.

The several plaintiffs’ lawyers quoted in the article all indicate that they expect to be filing more of these excessive fees suits in the future. As one defense lawyer quoted in the article put it, the claims for excessive 401(k) fees are like the “new toy in the toy box” for plaintiffs’ lawyers.

In an earlier post (here) entitled “Options Backdating: Sue the Gatekeeper,” I discussed a recent case where a company had sued its former accountant for the accountant’s options timing advice. It now appears, in addition to “sue the gatekeeper,” that “blame the gatekeeper” has emerged as a part of options backdating litigation. A May 30, 2007 Law.com article entitled “On Judge’s Advice, Brocade Drops Wilson Sonsini” (here) discusses a number of cases in which companies and individuals who are defending themselves against allegations of options-related misconduct have attempted to blame alleged improprieties on outside lawyers and accountants.

The case discussed most prominently is the article involves Brocade Communications, whose ex-CEO George Reyes is facing criminal charges related to backdating at the company. According to the article, Reyes blames Wilson Sonsini partner (and former Brocade director) Larry Sonsini “for recommending that Reyes be allowed to aware options with little oversight.” In light of Reyes’s defense, and apparently at the suggestion of the trial judge, Brocade has dropped Wilson Sonsini as its counsel on its own options-related lawsuit. According to a prior San Jose Business Journal article (here) discussing the hearing at which the judge questioned Wilson Sonsini’s involvment in connection with the proposed settlement of the Brocade derivative case; the Business Journal article reports that the judge asked the Wilson Sonsini attorney at the hearing: “There is evidence out there that Mr. Sonsini was involved in the mechanism … which officers utilized in granting backdated options. Is it appropriate for you as the law firm to negotiate the settlement?”

Another company mentioned in the Law.com article is KLA Tencor, for whom Sonsini also apparently acted as outside counsel. The article quotes a November 1998 email from KLA Tencor’s general counsel to Sonsini, in which the general counsel tells Sonsini that PricewaterhouseCoopers accountants had approved a process by which the company’s stock options committee could meet “during the 30 days following August 31 and set the price for repricing at that time in order to maximize the value for employees.” KLA Tencor apparently has acknowledged that the August grant was backdated and has repriced those options.

The article suggests that the difficulty and complexity of relevant options accounting rules put management in a position where they had to rely on outside lawyers and accountants for guidance. The defendants will argue that that their interactions with lawyer and accountants show that they did not intend to commit a crime. The difficulty for defendants trying to use this as a defense is that they will have to show that the attorneys or accountants were explicitly informed of the defendants’ behavior. Moreover, as Mark Fagel, the head of enforcement in the SEC’s San Francisco office, puts it in the article, “I’m skeptical of the claim that someone didn’t understand that there was an accounting issue when they created a false document.”

In an earlier post (here) entitled “Is Backdating Criminal?” I discuss an op-ed piece written by Reyes’s criminal defense lawyers in which they contend that “most backdating cases” are “not fraud, but books and records errors.” In the post, I contend that the “authors’ theme that backdating is essentially innocent gets weaker the more a particular set of circumstances involves personal benefit, document falsification, and the greater the impact the activity had on the company’s reported financial condition.”

To Woo Rather Than Scourge: When he was New York’s Attorney General, Eliot Spitzer made his name, and paved his way to the New York governor’s mansion, by taking on Wall Street and major insurance companies. Now that he is governor, he has decided to try New York financial services companies now need his help in order to remain competitive in the global market place.

In a May 29, 2007 Executive Order (here), Spitzer formed the New York Commission to Modernize the Regulation of Financial Services. A press release accompanying the order (here) states that the purpose of the Commission will be to “identify ways in which regulatory powers could be integrated, rationalize and changed in order to promote economic innovation and protect the consumer.”

Spitzer’s Executive Order follows the recent tradition established by other leading New York politicians in their release of the Bloomberg-Schumer report (here), also designed to suggest ways to address the competitiveness of the New York financial markets. According to a May 30, 2007 New York Times article entitiled “Now, Spitzer Is Warming to Wall St.” (here), the Bloomberg/Schumer report “focused on the patchwork of federal and state regulation,” whereas Spitzer’s Commission will be “focused, at least initially, on trying to rationalize outdated state regulations.”

New York currently has four departments responsible for regulating financial service in New York. The Commission will seek to rationalize the structure. The Commission will produce a report by the end of June 2008, but will try to put changes into place before then, including in particular a new principles-based system of insurance regulation.

The Commission will be chaired by Eric Dinallo, the New York State Insurance Commissioner, and will include leaders from Insurance, Securities, Banking, Business, Law and Government. The full list of Commission members can be found here.

This story brims with irony, particularly in the fact that among the insurance leaders that Spitzer has appointed to the Commission is AIG CEO Martin Sullivan. I am sure that most readers will recall that on March 15, 2005 (refer here), Sullivan’s predecessor, Maurice “Hank” Greenberg, resigned under pressure from Spitzer while Spitzer was New York Attorney General. As summarized in Wikipedia (here), Spitzer later filed a complaint against Greenberg and others alleging fraudulent business practices, securities fraud, common law fraud, and other violations. All criminal charges were later dropped and Greenberg was not held responsible for any crimes. Some civil charges remain (refer here). An interesting commentary on Spitzer’s criminal nonprosecution of Greenberg can be found here.

Spitzer appears to have decided that his current political interests are better served by ingratiating himself with business leaders, rather than suing them (which served him so well in the past). I think most of us would understand if it took Sullivan a while to get comfortable in his new Commission seat.

I wonder, is it an inate human instinct to suspect zealous converts, particularly where the conversion is still recent and has an unmistakable air of calculation about it?

Hat tip to the FEI Financial Reporting Blog (here) for the link to the Executive Order and the Press Release.

Is Lerach Going to Retire?: According to a post yesterday on the Legal Pad blog (here), Bill Lerach of the Lerach Couglin law firm may be getting ready to retire:

The nation’s preeminent class action lawyer, Bill Lerach, 61, informed at least one major client this week that he would be retiring imminently from his firm, Fortune has learned.

There have been multiple hearsay accounts all day to the effect that Lerach also informed his partners at San Diego-based Lerach Coughlin Stoia Geller Rudman & Robbins at a meeting last night, but Fortune has been unable to confirm those accounts with any one actually present.

Special thanks to a loyal reader for the link to the Legal Pad blog.

At the same time, there are also rumors circulating (refer here) that former Milberg Weiss partner David Bershad is in plea talks in connection with the ongoing Milberg Weiss criminal investigation and prosecution.

Photo Sharing and Video Hosting at Photobucket In a recent post on his SEC Actions blog entitled “Trends in Securities Class and Derivative Actions Suggest Proactive Steps for Directors and Officers” (here), Thomas Gorman of the Porter Wright law firm reviews a number of trends that potentially could threaten the interests of directors and officers. Gorman’s blog post references the rising level of average class action securities settlements. He also reviews in interesting detail the increasing level of recent derivative settlements. The post also discusses the recent Just for Feet settlement (about which see my prior detailed commentary here). The SEC Actions blog post concludes with the comment that “all of this suggests that directors and officers would do well to take proactive steps to protect themselves.” Among other steps, “D & O policies should be reviewed” focusing on “the amount and scope of coverage.”

Consistent with this recommendation to consider the scope of D & O coverage as part of an overall effort to protect corporate officials in the current changing exposure environment, in the latest issue of InSights (here), I take a closer look at the changing exposures of outside directors in particular, and I also review the critical insurance options available to provide outside directors with optimal insurance protection.

Photo Sharing and Video Hosting at Photobucket Effective Governance: Sixteen Men on a Dead Man’s Chest?: I suspect that many D & O Diary readers will be interested to know about the May 2, 2007 article by Peter Leeson of the West Virginia University Department of Economics, entitled “An-arrgh-chy: The Law and Economics of Pirate Organization” (here). The author’s abstract describes the paper as follows:

This paper investigates the internal governance institutions of violent criminal enterprise by examining the law, economics, and organization of pirates. To effectively organize their banditry, pirates required mechanisms to prevent internal predation, minimize crew conflict, and maximize piratical profit. I argue that pirates devised two institutions for this purpose. First, I analyze the system of piratical checks and balances that crews used to constrain captain predation. Second, I examine how pirates used democratic constitutions to minimize conflict and create piratical law and order. Remarkably, pirates adopted both of these institutions before the United States or England. Pirate governance created sufficient order and cooperation to make pirates one of the most sophisticated and successful criminal organizations in history.

Hat tip to the Ideoblog (here) for the link to the article.