Photo Sharing and Video Hosting at Photobucket In a partial but significant victory in the New York Supreme Court Appellate Division, former NYSE Chairman Richard Grasso may have accomplished just enough to be able to keep his infamous NYSE pay package. In April 2004, Eliot Spitzer, then New York’s Attorney General, sued Grasso to compel him to return the bulk of his nearly $190 million deferred compensation and pension package. Spitzer alleged in the Complaint (here) that the pay package was “objectively unreasonable” under New York law governing nonprofit institutions – the NYSE was a nonprofit institution while Grasso was its Chair – and that Grasso had improperly influenced or misled the NYSE’s board of directors to obtain their approval.

In an October 2006 ruling, New York Supreme Court Judge Charles Ramos entered partial summary judgment against Grasso, holding that Grasso had breached his fiduciary duty and that Grasso must return almost $100 million. A copy of Judge Ramos’s opinion can be found here. Grasso appealed from this ruling as well as prior rulings in which Judge Ramos had permitted the claims to proceed.

A May 8, 2007 opinion of the New York Supreme Court Appellate Division (here) reversed an earlier ruling of Judge Ramos (here), and granted Grasso’s motion to dismiss the first, fourth, fifth and sixth causes of action against him. Each of the dismissed counts were ones that Spitzer had alleged that New York’s Attorney General had an implied right of action to pursue under the states Not-for Profit Corporation law. The appellate court held, however, that “these four causes of action are not within the scope of the Attorney General’s authority.” The appellate court contrasted these four claims with the two claims against Grasso that were not dismissed; the other two claims were based upon specific statutory provisions granting the Attorney General the right to pursue a cause of action. In essence, the appellate court held that the Attorney General is not “authorized to bring causes of action against directors and officers of not-for-profit corporations other than the causes of action the Legislature expressly authorized the Attorney General to bring.”

Even though two of the Attorney General’s six causes of action against Grasso remain pending, this appellate decision represents a significant victory for Grasso and may ultimately allow him to prevail. Under the two remaining causes of action, unlike the four that were dismissed, the Attorney General must prove both that the payments were “unlawful” and that Grasso knew of the “unlawfulness.” Whether or not the Attorney General can prove the unlawfulness of Grasso’s pay package, proving that Grasso knew of the “unlawfulness” will be a difficult and perhaps impossible task.

With Eliot Spitzer now occupying the New York Governor’s Mansion, the decision whether or not to proceed will now fall to New York’s new Attorney General, Andrew Cuomo. Cuomo of course has nothing vested in the case, and he must now decide whether it is in New York’s interest to try to overcome the obstacles and to try to compel Grasso to repay his compensation. According to AP (here), a spokeperson for Spitzer said the “state was expected to appeal.” The same article quotes Spitzer as saying “This was just a technical issue related to some of the counts and was not the subject of the summary judgment we won.” Well, maybe…

Grasso has made it clear that he intends to fight, and he has already expended a significant amount of his fortune fighting the case, as noted in a prior D & O Diary post (here, replete with quotations from Bleak House).

Because the appellate decision deals only with the Attorney General’s authority to pursue supposedly implied causes of action under New York’s Not-for-Profit Corporation law, it is unlikely to have any significant impact on other efforts to recoup allegedly excessive executive compensation.

Hat tip to the WSJ.com Law Blog (here) for the link the the appellate decision. A May 9, 2007 Wall Street Journal article discussing the decision can be found here (subscription required). A very detailed May 9, 2007 New York Law Journal article discussing the decision can be found here.

ISS Webcast: Adam Savett of ISS (and of the Securities Litigation Watch blog) will be hosting a webcast at 9:30 am on Wednesday May 9, 2007 on the topic Accountability Goes Global: International Investors and U.S. Securities Class Actions. Details about the webcast can be found here. Some of the preliminary findings to be discused are reviewed here.

Photo Sharing and Video Hosting at Photobucket In their perceptive and thought-provoking article, “The Missing Monitor in Corporate Governance: The Directors’ & Officers’ Liability Insurer” (here), Professors Tom Baker of Connecticut Law School and Sean Griffith of Fordham Law School, among other things, examine the consequences of the standard D & O policy feature whereby D & O insurers (by contrast to other liability insurers) do not control the claim defense. Under this D & O policy provision, the insured chooses its own counsel, the costs for which are reimbursed by the D & O carrier, subject only to the policy’s limits and the requirement that defense costs be reasonable and necessary. The authors found that the “predictable effects” of this arrangement are that “D & O insurers are unable to control the costs of defending the claim,” and that D & O insurers are “pressured” to settle claims “at greater expense than an insurer in full control of defense and settlement would allow.” (A prior post where I discuss the professors’ article at much greater length can be found here.)

The D & O insurers’ general inability to control the defense can present a significant issue, because the costs of defending D & O claims are substantial. According to the 2006 Towers Perrin Survey of Insurance Purchasing and Claims Trends (here), the survey respondents’ average cost of defending a shareholder claim in 2006 was $2,798,404, up from $2,140,343 in 2005. (If anything, these numbers are understated since the 2006 survey response incorporated an increased number of smaller and private company respondents.) The increasing magnitude of defense expense is one of several factors escalating general perceptions of D & O limits adequacy, a development that ultimately drives up the aggregate cost of D & O insurance transaction as buyers feel compelled to acquire higher limits. Because defense expense erodes the limits that would otherwise be available to settle claims, escalating defense expense is contrary to the interests of both carriers and policyholders.

Carriers often try to manage defense expense through counsel guidelines and similar means, but all too often these efforts add friction to the claims process. In the end, carriers and the policyholders are still left to argue over whether a disputed expense was or was not reasonable.

An April 30, 2007 opinion from the Southern District of New York sheds some interesting light on the issue. In a coverage dispute arising from two claims filed in connection with bankruptcy proceeding relating to entities associated with Indotronix International Corp., Judge Charles Brieant held (here) that the carrier did not have to pay certain defense fees incurred that were “facially excessive.” The Court had previously held that the plaintiff insured was entitled to recover its reasonable and actual fees incurred in defending the two claims. Both of the claims had been dismissed due to the claimants’ lack of standing. (The procedural history surrounding the underlying claims is somewhat complex; for simplicity’s sake, I have not attempted to reproduce it here.)

The plaintiff insured sought to recover from its insurer $443,496 in fees and $75,772 in disbursement amounts, amounts which the Court found that the plaintiff insured, “a sophisticated business organization with a competent in-house lawyer,” had “willingly paid…without any assurance of disbursement.” The Court looked at the work the attorneys had done while the various motions to dismiss were pending; the Court found numerous occasions “when nothing was happening and all papers due had been filed,” and found that the defense lawyers were “spending an awful lot of time looking at documents” and “days on end sitting at Indotronix.”

Based on this review, the Court found that the amount of fees was “facially excessive,” and that “far too much work was done at too great a cost to be visited on the insurer.” The Court found that defense counsel had continued to work (and to bill) during a lull in litigation when no action was required; that the legal research “should not have required a great investment of time”; and that the “number of hours spent looking at documents appears to be highly excessive.”

In addition, the Court also looked at the hourly rates charged by the defense firm, a Manhattan law firm, for work done in Westchester County. The Court observed that the firm’s blended rate of $357.69 an hour “while perhaps reasonable in Manhattan is in excess of rates reasonably charged for similar work” in Westchester County. The Court took judicial notice that $300 an hour was a reasonable rate in the relevant judicial district.

Based on its review and applying the $300 per hour rate, the Court reduced the requested fees from the requested $443,496, to “a reasonable award of $141,153,” leaving the plaintiffs with an unreimbursed fee expense of $302,343.

Whether or not this case represents a significant development in the ability of D & O insurers to control D & O claims expense of course remains to be seen, as it will be relatively rare that courts will be willing to undertake any kind of review of defense expense, much less the kind of detailed review that Judge Brieant undertook in this case. Nevertheless, the case does at least establish that because defense fees must be reasonable in order to reimbursed, defense fees that are not reasonable are not reimbursable, and that the defense efforts must be proportionate and relevant to the defense issues in the case.

While the Court’s holding undoubtedly will provide some comfort to D & O insurers, it does not assure that disputes over fees will be any less prevalent or intense, and indeed there is some risk that carriers emboldened by this decision will agitate even more vigorously to contest fee reimbursement requests. But in addition to any comfort it may give the D & O carriers, Judge Brieant’s opinion also provides some clues about the steps that policyholders can take to try to avoid or reduce disputes.

First, Judge Briant not only examined the defense firm’s activities, he also reviewed the firm’s billing practices. It clearly did not help the insured plaintiff’s reimbursement request that “some hourly records are missing from the record and some services involved attending at proceedings [that were] not directly related to the Adversary Proceeding.” Policyholders’ will greatly improve the prospects for success of their reimbursement request by assuring that the substantiating documentation is complete, accurate and reflects only relevant charges.

Second, while the plaintiff insured had in fact paid the fees for which it sought reimbursement, it does not seem to have subjected the fees or the attorneys’ work to review or oversight. The Court’s finding that the fees were “facially excessive” and reflected “far too much work” implicitly suggests that the insured itself could have done more to monitor and control the attorneys’ work. The first step toward convincing a carrier that requested fees are reasonable and necessary is for the policyholder to first subject the fees to its own review, before even seeking reimbursement. All parties in the claims process (except perhaps defense counsel) have a stake in ensuring that defense fees incurred are reasonable and necessary, and the policyholder does have an important role to play in the process. Indeed, because defense expense depletes the policy limits, the policyholder has every incentive to ensure that the defense goes forward efficiently.

Finally, the key ingredient to avoid fee disputes is communication. The hourly rate charged, the amount of work done, and even the completeness of the bills are all issues that should have been sorted out during the unfolding of the claim, not afterwards, when it was too late to alter the circumstances. In this case, the existence of potential coverage dispute with the carrier clearly did not help communications; coverage uncertainty can often prove an insurmountable barrier to effective communication between the policyholder and the carrier. But timely and accurate communication between the policyholder and the carrier, when possible, can frequently avert or minimize issues that can lead to significant defense expense disputes. The involvement of a skilled claims advocate can help facilitate these communications, even where coverage remains uncertain.

Special thanks to a loyal reader for a copy of the opinion.

Photo Sharing and Video Hosting at Photobucket It is nothing new for corporate America to have to contend with activist investors. But an activist international institutional investor, backed by a sovereign nation and burgeoning oil wealth and committed to a broadly-based social and environmental agenda, represents a different level of activist pressure. The prototype for this international institutional investor is the Norwegian Government Pension Fund, which collects and invests surplus revenue from the country’s petroleum production, and which at $300 billion in asset value represents the largest public pension fund in Europe. The Fund is prohibited from investing in Norway, so instead it owns what amounts to a considerable slice of the world.

The Norwegian Fund’s impact is not merely financial. The Fund operates according to "ethical" investment principles, pursuant to which the Fund has divested ownership in companies that the Fund’s Advisory Council on Ethics believes are involved in certain kinds of weapons production, environmental damage and human rights violations. The most prominent example of its divestitures for ethical reasons was its high profile divestiture of its $400 million investment in Wal-Mart because of alleged child labor law violations by WalMart suppliers (refer here).

A May 4, 2007 New York Times article entitled in the print edition "Norway Backs Its Ethics With Its Cash" (here) discusses the Fund’s ethical investing practices and their impact. The article quotes the Norwegian Finance Minister, Kristin Halvorsen, as saying "In a global economy, ownership of companies is the most important way to have influence." As many as 21 companies (so far) have felt this Norwegian "influence," twelve of them American.

Nor is the Fund’s activist impact restricted to its investment activities. Norges Bank, the division of the Norwegian Central Bank responsible for managing the Fund’s investments, has made its presence felt as a securities fraud lawsuit litigant. For example, Norges Bank was one of the prominent litigants that chose to opt-out of the Time Warner class action settlement (here). Norges Bank was also a major participant in the recent historic Royal Dutch Shell investor settlement (here).

The most prominent institutional investor activist in the U.S. has arguably been the California Public Employee Retirement System (Calpers), which with current investement assets of about $244 billion is actually smaller than the Norwegian Fund. Moreover, because Norway is the world’s No. 3 oil exporter (behind Saudi Arabia and Russia), Norway’s Fund will grow substantially in the years ahead. The Times article estimates that at the rate at which it is growing, the Fund could be worth $800 billion to $900 billion in a decade. With the Fund’s growing size and activist agenda, its impact could be enormous, particularly given the Fund’s apparent willingness to resort to litigation.

The Fund’s growth will provide it with the powerful tools to drive its agenda. As a result, companies could face growing pressure to provide compliance and disclosure on a broad range of social and environmental issues. Readers of The D & O Diary will recall my recent post (here) on the growing importance of climate change disclosure; the Times article reports that the Norwegian Fund’s next area of scrutiny will be companies that contribute to global warming. (There is of course some irony in a country which has grown wealthy from oil production presuming to lecture the rest of the world about global warming.)

The upshot is that public companies could face growing pressure on environmental and social issues, from the Norwegian Fund as well as other investors that follow their lead. Traditional notions of "good corporate governance" will necessarily evolve to adapt to these circumstances. These evolving issues represent risks that may not be apparent on companies’ financial statements. Companies will face changing levels of reputational risk and even political risk as part of this evolving global investment dynamic. It will be increasingly important for companies to have tools to measure and control their exposure to these developing concerns, as well as to provide adequate disclosure of these issues to their shareholders.

Cross-Border Prosecutorial Collaboration: Along with the globalization of political and social issues, the increasing global collaboration of national regulatory and investigative personnel also represents a new and growing risk to companies in the global economy. The high-profile collaboration of a multinational investigative force in the Siemens bribery investigation (here) is a recent prominent example. Another example is illustrated in a May 4, 2007 Wall Street Journal article entitled "Cartel Arrests in U.S. Bolster Europe Probe" (here, subscription required).

According to the Journal, executives from companies in Italy, France, the United Kingdom and Japan were arrested in the U.S. this past week for their role in an alleged international cartel to fix prices for industrial hoses used in oil transportation. The arrests reportedly were "the result of a joint U.S. investigation with the European Union and U.K. agencies under a program of trans-Atlantic cooperation against bid rigging." The stumbling block for EU enforcement of its anti-cartel laws has been the lack of any personal liability for cartel participants under EU law. These limitations have restricted EU authorities’ ability to pursue cartel activities. The enlistment of American authorities in the anti-cartel efforts circumvents these EU limitations by exposing individuals to personal liability under tougher American anti-cartel laws.

While these developments are perhaps socially desirable for their ability to punish and deter anticompetitive activity, the developments also carry some disturbing implications for officials at companies engaged in the global economy. Executives could face the threat of prosecution not only under the laws of their own country but under the laws of many other countries. The willingness of the U.S. to enforce its antibribery laws against foreign companies whose shares or ADRs trade on U.S. exchanges is another example of this extraterritorial impact of domestic laws. The result of this globalization of criminal enforcement could be a dramatic expansion of corporate executives’ risk exposure.

Not only does this evolving globalization of criminal enforcement create a new category of risk management challenges, but it could create new challenges for the structure of the companies’ D & O insurance program. Certainly, companies engaged in the global economy will want to understand their policy’s potential protection for foreign investigations and proceedings, as well as the policy’s protection for criminal processes such as extradition.

Be Here Now: As scientists and commentators have struggled to prefigure a future world beset with the consequences of global climate change, they have projected a litany of grave impacts: coastal erosion and subsidence from rising sea levels; extreme weather events; unprecedented economic impacts; and a deteriorating health environment.

Readers skeptical of these scenarios will want to consider these stories appearing in newspapers just this week alone: the seacoast of East Anglia in the U.K. is sliding into the sea because of rising sea levels (here); Australia’s six year drought is now so serious that the country must restrict crop irrigation, while politicians struggle to respond (here); Germany will no longer apply seasonal adjustment to its unemployment statistics because the increasingly mild winters have a diminished employment impact (here); and the global incidence of asthma and hay fever has escalated as a result of the proliferation of allergens due to warming conditions (here).

After I wrote my post a few weeks ago about global climate change and D & O risk (here), I received some very skeptical and even derisive reactions. But the reality is that global climate change is not some distant theoretical construct. Its impacts are already being felt throughout the world. The answer to the question whether or not this will affect the risk profile of publicly traded companies is simply a reflection of the way you frame the issue. You can, as I think is the proper approach, regard global climate change as a separate category of risk to be analyzed as such. Or you can simply look at it as imbedded within numerous other risk categories, such as commodities pricing risk, political risk, and currency risk, as well as what insurers call parameter risk (the risk of events different than those that have occured in the past). Whether viewed separately or as a part of the overall panoply of corporate risk, global climate change will be an increasingly important part of the risk landscape that companies face. The influence of activist investors like the Norwegian Fund suggests that companies disregard these risks at their peril.

 

Adding its contribution to the previously released studies of NERA (here) and Cornerstone (here), PricewaterhouseCoopers recently released its annual report (here) regarding 2006 securities class action litigation. The PwC report is generally consistent with the other studies, but it does add a few interesting additional insights.

Perhaps most interesting observation in the PwC study relates to its comments about the overall level of shareholder litigation activity. The PwC study notes that while the number of securities class action lawsuit filings declined in 2006, the total number of shareholder lawsuits did not decline, when shareholder derivative lawsuits are taken into account. Accounting for the derivative suits, “a more stable level of shareholder activity begins to emerge in comparison to prior years.”

The PwC study reports that the total of 214 class actions and derivative claims in 2006 was “higher than the 172 cases analyzed in 2005 and not so different from the average of 218 total cases filed since 2002.” So rather than facing a decline, “the more relevant observation is the shift in venue and the type of action employed to address shareholders’ protestations.”

Other noteworthy observations:

Audit Committees: “A more startling statistic for 2006 is that audit committee members were named in 8 percent of federal cases filed, compared to 2 percent in 2005 and an average of 4 percent since 2002.”

Settlement Amounts: By contrast to the NERA and Cornerstone studies which reported a higher average class action settlement in 2006, the PwC study found that in 2006 “average settlements dropped from $62.3 million from $69.8 million, down by 11 percent.” This numerical divergence between the studies is most likely explained by the footnote on page 37 of the PwC study, where the report states that “settlement year is determined by the year the settlement is disclosed.” This approach contrasts to the other studies, which use the year that the settlement is approved (refer here). The PwC study also notes that the most frequent settlement amount fell between $2 million and $4.99 million.

Foreign Issuers: The PwC study notes that the number of securities class action lawsuits filed against foreign issuers fell from 19 in 2005 to 13 in 2006, which represents the lowest number filed against foreign issuers in the last seven years. The 13 foreign companies sued in 2006 represent only 1 percent of the total of 1,200 foreign issuers whose shares trade on U.S exchanges.

The study also contains a number of interesting essays and commentaries on a variety of subjects, including SEC enforcement trends, regulation of foreign issuers and of hedge funds, and evolving international extradition standards.

As the number of securities fraud lawsuits has declined (refer here), an alternative means that plaintiffs lawyers are finding to amuse and enrich themselves are lawsuits filed in connection with “going private” transactions. An April 24, 2007 National Law Journal article entitled “New Legal Battles Over Going Private” (here) takes a look at the court fights that “challenge the terms of a merger that would transform a public company into a private one.”

On the one hand, there is nothing new about litigation arising from M & A activity. There is a well-established tradition of plaintiffs’ lawyers using the courts to force companies that are being acquired to re-open the bidding process or bump up the proposed acquisition price – and also to earn themselves some fees. But as The D & O Diary has previously noted (here), these lawsuits in the “going private” context sometimes have additional elements that represent a variation on the established M & A litigation theme.

As the National Law Journal article discusses, plaintiffs’ lawyers frequently target certain aspects of going private transactions, including “deal sweeteners that enhance executives’ compensation.” Lawsuits also challenge deals because they “unfairly benefit specific corporate directors and executives” at shareholders’ expense. The lawsuits can lead to a reopened bidding process, a higher acquisition price, and even in some circumstances “damages to shareholders after the deal closes.”

The massive amounts of money involved in going private transactions create enormous opportunities for conflicts of interest to arise, particularly where incumbent management stands to benefit if a specific buyout group succeeds. These circumstances present a serious risk for claims against the directors and officers of the target companies. To see these factors at work within the context of a specific going private transaction, refer here to see my prior post regarding the Clear Channel Communications deal and lawsuit.

These kinds of lawsuits are expensive to defend because of the high stakes and time frames involved. The defense fees will usually be covered under the typical D & O policy, but in some instances settlements may not, in whole or in part. Some settlements or awards represent amounts (for example, for return of improper compensation) would be excluded under the typical amounts. Remedial steps, such as a reopened bidding process or a bumped up acquisition cost, would not in most instances represent covered loss. But to the extent awards or settlements are based on misrepresentations or other alleged malfeasance, the D & O policy could provide an important funding source for settlements and awards. Because of the complicated way that these kinds of claims intersect with the D & O policy, it could be particularly important for companies to enlist the assistance of a skilled D & O claims advocate in representing their interests in connection with the claim.

Another Subprime Lawsuit: One of the reasons I recently added a post (here) where I will maintain a running tally of subprime lending lawsuits is an intuition that as the consequences from deteriorating subprime mortgages ripple outwards, there will be more lawsuits against a broadening array of companies.

Along those lines, I updated the subprime lending lawsuit tally today to add a lawsuit that represents a new variant in the mix. According to news reports (here), Credit Suisse has been sued in connection with its bond securitization of subprime loans. Bankers Life Insurance Co. claims that it lost money on the investment grade bonds that Credit Suisse sold and that were backed by subprime mortgages. The lawsuit alleges, among other things, that the bank misled bond investors about how much protection they had against accelerated defaults. The lawsuit also accuses the bank of covering up delinquencies and attempting to maintain the illusion that the level of defaults were not serious.

We will undoubtedly be seeing more claims against a broader range of companies as the ripples from the subprime meltdown expand.

ABA Panel: On Friday May 4, 2007, I will be participating in an American Bar Association Tort Trial & Insurance Practice Section conference entitled “Beyond Legal: A Business Approach to Corporate Governance.” A copy of the conference brochure can be found here. I will be appearing on a panel entitled “D & O Insurance: Placing a Premium on Good Corporate Governance.” The panel will be moderated by my good friend Sean Fitzpatrick, and will include a number of distinguished speakers, including Professors Tom Baker of Connecticut Law School and Sean Griffith of Fordham Law School. If you will be attending the conference, I hope you will greet me and introduce yourself.

Photo Sharing and Video Hosting at Photobucket Newpark Resources has announced (here) a $9.85 million settlement of a securities class action lawsuit that, as amended, was based in part on allegations of stock options backdating.

The lawsuit against Newpark Resources and several of its directors and officers arose following the company’s April 17, 2006 press release (here) in which it disclosed that the company’s board’s audit committee had “commissioned an internal investigation regarding potential irregularities involving the processing and payment of invoices by Soloco Texas, LP, one of the company’s smaller subsidiaries, and other possible violations.” The company also announced that it had placed three officials on administrative leave. The company’s share price declined, and plaintiff shareholders initiated a securities class action lawsuit (here).

On June 29, 2006, Newpark Resources announced (here) that it had completed its initial investigation, and that it would be restating its financial statements for fiscal years 2001 through 2005, and for fiscal quarters in 2004 and 2005. The investigation concluded that certain of the Soloco Texas transactions had not been properly accounted for. The company also announced that during the investigation, “the Audit Committee had also requested a review of the company’s past practices regarding stock options.” The “preliminary findings” of the stock options investigation were “that a portion of the stock options granted prior to June 2003 were dated on a date other than the date their issuance was approved and the exercise price of such options were determined in advance of their approval by the appropriate board committee, all in contravention of the company’s stock option plan.” Newpark Resources also announced that the Board had terminated its former CEO and current Chairman of one if the company’s subsidiaries, as well as the company’s CFO.

On November 9, 2006, the plaintiffs filed their consolidated amended complaint (here) against Newpark Resources and present and former Newpark directors and officers. The amended complaint contains (at paragraphs 53 through 76) detailed options backdating related allegations. A summary regarding the Newpark Resources securities class action lawsuit can be found here.

On April 13, 2007, Newpark Resources announced (here) that it had settled the securities class action lawsuit as well as a related derivative lawsuit. The company announced that it would pay $1,550,000 toward the settlement, and its directors and officers liability insurer would pay an additional $8,300,000. The company announced that it was settling liabilities related to the Soloco Texas transactions as well as “alleged improper granting, recording, and accounting of backdated grants of stock options to executives.” The company also announced that it had also been notified by the SEC that it had opened “a formal investigation into Newpark’s restatement of earnings.”

The lead plaintiffs in the case are Plumbers and Pipefitters Local 51 Pension Fund and and co-lead plainiffs law firms in the case are the Lerach Coughlin firm and Glancy Binkow and Goldberg.

The D & O Diary notes that while it had duly recorded, in our running tally of options backdating related lawsuits (here), that Newpark Resources had been named as a nominal defendant in an options backdating related derivative lawsuit, we had not picked up that the Newpark Resources securities class action lawsuit had been amended to add options backdating related allegations. The D & O Diary’s options backdating related litigation tally will be amended to add the Newpark Resources lawsuit to the securities class action tally, with a link back to this post.

With respect to a prior partial settlement of a derivative options backdating lawsuit involving SafeNet, refer here.

Special thanks to a loyal reader (who prefers anonymity) for the link to the Newpark Resources settlement.

Another Interesting Class Action Settlement: On April 30, 2007, Doral Financial announced (here) the settlement of a pending securities class action lawsuit, as well as a related derivative lawsuit. The lawsuits related to Doral’s April 19, 2005 restatement (here) of its financial statements for the period 2000 to 2004. As part of the settlement, the Company and its insurers will pay an aggregate of $129 million, of which the insurers will pay approximately $34 million. A summary of the class action lawsuit may be found here. The Lerach Coughlin firm acted as lead plaintiff firm, on behalf of the West Virginia Investment Management Board.

There are several interesting things about this settlement, the first of which is the significant amount by which the aggregate settlement amount exceeds the amount of available insurance. The company is responsible for a very significant portion of this settlement (but see below about the company’s funding for the settlement). It used to be that the available insurance limits defined the outer limits of the potential settlement. There are more occasions now where the settlements exceed the insurance limits.

Second, in addition to the company’s and its insurers joint payment, “one or more individual defendants will pay an aggregate of $1 million (in cash or Doral Financial stock).” This statement is odd for its careful imprecision — one or more individuals? Cash or stock? Doesn’t it seem unlikely at this point that they don’t know who is going to pay and what form the payment will take? Or is something else going on? In any event, it seems to be a more common occurence for individuals to be called upon to fund a portion of the settlement. The reference to the possibility of payment in the form of company stock also seems to suggest that the individual (or is it individuals?) will be paying the settlement out of their own assets.

Third, the company also announced that its “payment obligations under the settlement agreement are subject to the closing and funding of one or more transactions through which the Company obtains outside financing during 2007 to meet its liquidity and capital needs, including the repayment of the Company’s $625 million senior notes due on July 20, 2007, payment of the amounts due under the settlement agreement and certain other working capital and contractual needs.” This sentence is hard to parse, but it apears that the company must borrow or otherwise raise the funds to finance the settlement. The company’s press release goes on to say “either side may terminate the settlement agreement if the Company has not raised the necessary funding by September 30, 2007 or if the settlement has not been fully funded within 30 days from the receipt of such funding.” Certainly seems like the company has to try to come up with the money somehow. I wonder where that leaves the plaintiffs if the company can’t come up with the money?

In any event, Doral’s other news today is that it is exploring selling itself to a private equity firm, according to news reports (here).

Hat tip to an alert reader (who prefer anonymity) for the link to the Doral Financial settlement.

 Updated November 12, 2011: As shown in the lists below, the lawsuits against subprime lenders are starting to mount up. This is hardly a surprising development; as the WSJ.com Law blog noted (here), law firms are already announcing their formation of subprime lending task forces and teams, just as a year ago law firms were announcing their formation of "options backdating teams." Along the same lines, on April 25, 2007, Law.com ran an article entitled "Subprime Crash May be a Boon to Attorneys" (here).

There is a growing list of lawsuits against subprime lenders arising from the deteriorating environment these companies face. The list is now sufficiently long that it seems to be time to create a running tally of the subprime lending lawsuits, as a complement to The D & O Diary’s popular running tally (here) of the options backdating related lawsuits. I have linked below to the list of subprime lending lawsuits of which I am aware. This list may be incomplete, and I entreat readers to please let me know of any omission of which they are aware. I will endeavor to keep this list updated and will indicate any additions to the list in red. The legend "2008" indicates that the lawsuit was filed in 2008; items without a legend were filed in 2007.

Securities Class Action Lawsuits: To see the list of the 229 subprime related securities lawsuits, refer here. (Word Document)

NOTE ABOUT THE LIST OF CASES: As time has gone by, it has become increasingly difficult to maintain absolute categorical precision regarding what is a subprime related lawsuit. For example, the Care Investment Trust case noted above involved a mortgage trust that holds healthcare related assets. The allegation is that the company’s prospectus failed to disclose the impairment of the value of certain of its assets and that the company was having difficulty obtaining warehousing financing for its investment activities. The company’s woes are undoubtedly due to contagion in the credit market deriving from the subprime meltdown, but the company itself has no ties to the subprime industry. Owing to the connection of the contagion effect in the credit markets, I have included the case in the list. Reasonable minds might omit the case.

ERISA/401(k) Lawsuits:

1. Fremont General
2. Beazer Homes
3. Citigroup
4. Countrywide Financial Corp.
5. Merrill Lynch
6. UBS AG
7. Morgan Stanley
8. State Street
9. MBIA [2008]

10. Bear Stearns [2008]

11. Regions Financial Corporation [2008]

12. Huntington Bankshares [2008]

13. National City Corp. [2008]

14. Impac Mortgage Corp. [2008]

15. Sovereign Bancorp [2008]

16. Wachovia [2008]

17. First Horizon [2008]

18. PFF Bancorp. [2008]

19. Fannie Mae (2008)

20. Hartford Financial Services Group (2008)

21 Bank of America (2009)

22. IndyMac (2008)

23. American Express (2009)

24. Northern Trust Investments (2009)

25. Sterling Financial (2010)

Subprime lenders have also been sued in various lawsuits alleging that they engaged in deceptive or unfair trade practices. Recent examples involve the lawsuit pending against First Franklin Financial Corp. (here) and the lawsuit that Wells Fargo recently settled (here). While I will provide occasional updates on this post of these kinds of deceptive trade practices lawsuit, I do not propose to comprehensively catalog them here.

In at least one instance, an investment bank has been sued in connection with the bond securitization of subprime loans. According to news reports (here), Credit Suisse was sued by Bankers Life Insurance Co. in a lawsuit in which the insurer claims it lost money on the investment grade bonds backed by subprime mortgages the Credit Suisse had sold. The lawsuit generally pertains to the quality (or lack thereof) of the mortgages that backed the bonds.

There may well be other companies or kinds of companies adversely affected by the declining residential real estate market who find themselves facing securities class action or other lawsuits, as if so, I will update this post accordingly.

 

Readers are encouraged to suggest additional listings or references that should be added to this post.

 

Photo Sharing and Video Hosting at Photobucket As I have previously noted (most recently here), Foreign Corrupt Practices Act (FCPA) investigations and enforcement actions represent an increasing corporate threat, and, in the form of follow-on civil actions, an area of growing D & O risk. Two recent developments underscore the growing magnitude of these concerns.

The first of these two developments is the agreement of Baker Hughes and one of its subsidiaries to settle criminal and civil FCPA charges. News stories about the Baker Hughes agreement can be found here and here. The $44 million in fines and penalties under the agreement represent the largest amounts of combined fines and penalties ever imposed in a FCPA case. Baker Hughes’ subsidiary pled guilty to criminal charges and agreed to pay a $10 million criminal fine in connection with payments of $4.1 million in bribes paid to a consultant in order to secure and oil services contract with Kazakhoil, the state oil company of Kazakhstan, in the Karachaganak oil field. The contract generated more than $219 million in gross revenues from 2001 to 2006. A copy of the April 26, 2007 Department of Justice press release regarding the criminal matter can be found here.

Baker Hughes itself simultaneously agreed to pay $23 million in disgorgement and prejudgment interest and to pay a civil penalty of $11 million for violating a 2001 SEC cease-and-desist order in connection with a prior FCPA matter. The fines and penalties were assessed against the parent company in company in connection with the Kazakhstan bribe, as well as other charges that the company violated the books and records and internal control provisions of the FCPA in Nigeria, Angola, Indonesia, Russia and Uzbekistan. The SEC’s April 26, 2007 press release regarding the Baker Hughes matter may be found here, and the SEC’s complaint is here. An April 27, 2007 CFO.com article describing the Baker Hughes FCPA settlement may be found here.

The second of the two recent developments relates to the proliferation of publicity and action surrounding the burgeoning Siemens corruption investigation. Not only are the company’s top two executives leaving (refer here), but the company has warned that it expects a “significant increase” in the number of possible bribes identified in an internal investigation. This prospective increase is on top of the previously disclosed $544 million in suspected bribes. A prior D & O Diary post about the Siemens bribery investigation can be found here. In its April 26, 2007 filing on SEC Form 6-K (here), Siemens also reported that the SEC had “advised” the company that the SEC had “converted its informal inquiry into these matters into a formal investigation.” The Company previously disclosed that the U.S. Department of Justice is conducting an inquiry of possible criminal violations.

The company also noted in its 6-K filing that it will be obliged to make a number of tax asset and liabilities adjustments in future reporting periods, which could be “material.” The company also said that it “cannot exclude the possibility that criminal or civil sanctions may be brought,” as a result of which its “operating activities may also be negatively affected.” The company said that to date “no charges or provisions for any such penalties have been accrued as management does not yet have enough information to reasonably estimate such amounts.” The company did say that in its most recent fiscal quarter, it had spend 63 million euros (roughly $83 million) in connection with the investigation.

According to news reports (here), Standard and Poor’s has put Siemens on a watch for a possible downgrade.

Several things about these two cases reinforce my view that FCPA investigations will become an even greater concern in the months ahead. First, the sheer scope and magnitude of the concerns, both at Siemens and at Baker Hughes, suggest a larger problem that inevitably will attract increased prosecutorial interest and involve more companies. The enormous unlikelihood that these two companies alone were the only ones involved in this type and scale of activity will encourage investigators and regulators to search for similar activities elsewhere.

Second, a significant factor in the Baker Hughes subsidiary’s plea agreement, which included a deferred prosecution agreement and a three-year probationary period, was the Company’s self-reporting of the violation. The Department of Justice’s press release states that the agreement “reflects, in large part, the actions of Baker Hughes in voluntarily disclosing this matter.” The unmistakable message is that companies have a substantial incentive to self-report FCPA violations, as I have previously noted (here). The increased internal review compelled by the Sarbanes Oxley Act, together with the incentive to self-report, increases the likelihood of further FCPA investigations and enforcement actions. As a recent memo from the Gibson, Dunn & Crutcher law firm notes (here), more than three quarters of the FCPA enforcement actions in the last two years arose as a result of voluntary disclosures.

Third, Siemens’ 6-K discloses that in February 2007 it was sued as a nominal defendant in a New York state court shareholders derivative complaint “seeking various forms of relief relating to the allegations of corruption and related violations.” The complaint also names “certain current and former members of the Company’s Managing and Supervisory Boards.” As I have previously noted (here), the D & O risk arising from FCPA enforcement actions comes from this type of follow-on civil action; the FCPA fines and penalties themselves would not be covered under the typical D & O policy, but the threat of follow-on civil action creates substantial D & O risk. UPDATE: On May 4, 2007, a shareholders derivative suit was filed against Baker Hughes (as nominal defendant) and certain of its present and former directors and officers, alleging breach of fiduciary duties in connection with the FCPA violations described above.

Finally, the unprecedented level of international cooperation involved in the Siemens investigation further increases the likelihood that the various national authorities will provide information across borders that could support antibribery enforcement actions here and overseas.

As the SEC Actions blog noted (here) in its commentary on the Baker Hughes FCPA enforcement case, “it is clear that the number of FCPA cases being brought by the SEC and the DOJ are on the rise. This suggests prudent companies that do business abroad and their directors and officers carefully review their compliance systems in this area to avoid difficulties rather than later at the insistence of the SEC or the DOJ.” In any event, FCPA compliance undoubtedly will become an area of heightened scrutiny for D & O underwriters.

Internal Affairs Doctrine: The shareholders derivative complaint filed against Siemens could face substantial hurdles in the form of the “internal affairs doctrine.” Under New York legal principles that only one state should have the authority to regulate a corporation’s internal affairs, New York courts will refuse to allow actions to proceed against corporations from other jurisdictions if the shareholders have sufficient avenues to address management malfeasance under the laws of the corporation’s domicile.

A March 12, 2007 New York ruling where the court applied these principles to dismiss a shareholders derivative complaint that had been filed against directors and officers of ABN Amro Holdings NV may be found here. An interesting discussion and analysis of the ABN Amro case may be found on the With Vigour and Zeal blog, here.

An interesting article about the possible applicability of the internal affairs doctrine to the BP Alaska shareholders’ derivative action, written by Francis Kean of the Barlow Lyde & Gilbert law firm, may be found here. Special thanks to Francis for providing a copy of this article.

Photo Sharing and Video Hosting at Photobucket Over the last few days, the papers have brimmed with news about developments in the Apple options backdating investigation (more about which below). But in the meantime, Kobi Alexander, the fugitive former head of Comverse Technology, has been holed up in Namibia. Alexander is free on bail while fighting extradition to the U.S. where he faces a 35-count indictment charging him with conspiracy, securities fraud, lying to the SEC, money laundering and bribery, in connection with the Comverse Technology options backdating investigation. (A good summary and analysis of the charges against Alexander, including a link to Alexander’s September 20, 2006 indictment, can be found on the White Collar Crime Prof blog, here.)

According to a April 24, 2007 Newsday article entitled “Will Comverse Fugitive’s Cash Sway Extradition?” (here), Alexander has promised to spend 100 Million Namibian Dollars ($16 million) on Namibian business projects, through his Kobi Alexander Enterprises vehicle. (Alexander has successfully prevented efforts to freeze bank accounts containing funds he transferred to Namibia from New York and Israel.) He has repeated his commitment to invest in Namibia in full-page newspaper advertisements and on billboards. He has already spent $500,000 building low-income familty housing, and in the days leading up to his scheduled April 25, 2007 extradition hearing, he announced that he would provide $21,000 for scholarships (refer here) and even spend 22,400 Namibian dollars building latrines at schools and kindergartens (refer here). The scholarship fund offer proved short-lived, as Alexander postponed the press conference announcing the fund’s launch (refer here).

The April 23, 2007 Namibian, in an article entitled “Wanted in the U.S., Setting Up Scholarship Funds in Namibia” (here), reported that Alexander “has moved swiftly to financially endear himself to Namibians,” and he has “not lacked for takers; neither in the private sector, nor, it appears in political circles.” According to the Namibian, in the press release describing Alexander’s scholarship donations (later postponed), the Namibian Ministry of Education described Alexander as “passionate about Namibia and its people.” The press release apparently identified Alexander as the founder of Comverse but made no mention of the peculiar reason for Alexander’s presence in Namibia.

But while Alexander’s extradition hearing had been scheduled to take place today (April 25), the hearing was postponed until June 8, 2007 (refer here) at prosecutors’ request. Prosecutors did not provide a reason for their delay request. One can speculate that prosecutors wanted to avoid the distracting impact of Alexander’s attempts to ingratiate himself financially. On the other hand, government officials may have wanted the delay as the best means to keep Alexander’s Namibian gravy train running. Because this is the third postponement, I am going with the latter theory.

The Newsday article quotes Alexander’s attorney in the U.S., Robert Morvillo, as saying “I don’t think he’s trying to buy justice, he’s trying to present another side of himself.” Yes, on one side, he’s a fugitive from justice, on the other side, he’s rich. We’ll compromise and call him a rich fugitive from justice.

Apple Developments: The SEC’s complaint (here) against former Apple CFO Fred Anderson and former Apple General Counsel Nancy Heinen provides a more detailed glimpse of the events surrounding options backdating at Apple. But, as reported in today’s Wall Street Journal (here, subscription required), statements by Anderson’s attorney may present new questions potentially implicating Apple’s CEO, Steve Jobs.

For a good overview of the statements and the potential implications for Jobs, refer to the Ideoblog (here) and the Conglomerate blog (here). As detailed in these blog posts, statements that Anderson claims to have made to Jobs may make it harder for Jobs to continue to contend that he did not “appreciate” the accounting implications of options backdating. However, the White Collar Crime Prof blog (here) is skeptical that these statements will lead to criminal or even civil charges against Jobs. A copy of Fred Anderson’s attorney’s statement can be found here.

Send Lawyers, Guns and Money: According to Wikipedia, Namibia is about half the size of Alaska, but is one of the most sparsely populated countries on earth. Its population of about 2 million is roughly equivalent to the population of the Cleveland metropolitan area. The official language is English. Adjacent to South Africa on Africa’s west coast, Nambia’s climate ranges from desert to subtropical, and is generally hot and dry. Windhoek (pronounced “Vind-hook”), Namibia’s capital, has about 230,000 people, and has a semi-desert climate. Minimum temperatures rarely fall below 40 degrees F. Apparently, you don’t have to live like a refugee.

Photo Sharing and Video Hosting at Photobucket Since the well-publicized settlements in the Enron and WorldCom cases, where individual directors were required to contribute toward settlement out of their own assets without recourse to indemnity or insurance, outside director exposure has been a hot topic (refer here for my prior discussion of those settlements). In addition, the SEC’s recent statements about pursuing outside directors as “gatekeepers” with a responsibility to prevent corporate misconduct, reinforced by its recent enforcement action against the outside directors of Spiegel (refer here), have further raised concerns.

The recent scholarly research of Bernard Black of the University of Texas, Brian Cheffens of Cambridge University, and Michael Klausner of Stanford Law School, in an article entitled “Outside Director Liability” (here) provides some reassurance that outside directors’ individual out-of-pocket contributions toward settlements have been, at least historically, an unusual and rare occurrence. The professors found only 13 cases in 25 years in which outside directors had to make out-of-pocket settlement payments. The authors conclude that the risk of outside directors being called upon to contribute has been “very low,” and have largely been a reflection of the insolvency of the corporate entity or the unavailability of D & O insurance. The authors conclude that this remote possibility could be even further reduced “with appropriate [D & O] policy limits and current state of the art protections.”

While the professors’ analysis is comforting, a recent settlement underscores the need for outside directors, as well as their advisors and insurance professionals, to continue to keep a sharp focus on outside director exposure. An April 23, 2007 Wall Street Journal article entitled “Settlement in Just for Feet Case May Fan Board Fears” (here, subscription required) describes a recently completed settlement in which five former outside directors of Just for Feet paid a total of $41.5 million to settle a bankruptcy trustee’s state court breach of fiduciary duty claim against the individual outside directors.

The Journal briefly relates that Just for Feet “collapsed amid an accounting fraud” in 1999. Three former Just for Feet officers pled guilty to crimes, and the company filed for bankruptcy protection in 2000. Just for Feet also settled a securities class action lawsuit, as a result of which, according to the Journal, only $100,000 remained available from the company’s insurance. A brief description of the $24.5 million corporate defendants’ class action settlement may be found here. A copy of the consolidated class action complaint can be found here. The Notice of Settlement regarding the Just for Feet class action settlement may be found here. At least one of the individual defendants named in the trustee claim was also named as a defendant in the class action lawsuit.

The Just for Feet bankruptcy trustee filed Alabama state court allegations against the outside directors and the company’s outside auditor in 2001. The lawsuit charged the individuals with, among other things, conflicts of interest, misrepresentations, breach of fiduciary duty and bad faith. According to the Journal, in September 2006, four former outside Just for Feet directors agreed to pay $40 million to settle the trustee’s claims against them. Last month, the last remaining outside director paid $1.5 million to settle the trustee’s claims. The former directors neither admitted nor denied liability.

It does not appear that the five individuals were, like the outside directors were in the Enron and WorldCom settlements, prohibited from seeking outside indemnity or insurance. Indeed, the Journal article notes that “[i]t is unclear whether any of the former outside directors’ employers, former employers or any other person on institution helped cover their portion of the settlement.”

The question whether the outside directors’ settlement may have been funded by a third party source, rather than out of the individuals’ own assets, is an interesting and important detail (and not just to the individuals themselves). In that regard, it is important to note that one of the individual outside directors is a principal of a venture capital fund; two of the individuals are principals of private equity firms; one is a principal of an investment bank; and one is the president of a commercial bank. (The individuals’ names and their respective affiliations are detailed in the Journal article.) These individuals at least potentially could have sought indemnity from the respective firms, particularly if their service on the Just for Feet board was at the direction or request of their firms. In addition, each of these individuals might have had the opportunity to attempt to recover Outside Director Liability (ODL) protection under their respective firms’ D & O insurance. The fact that several of the individuals are principals of venture capital or private equity firms is particularly noteworthy in this regard. The insurance coverage available for individuals’ outside directors service on the boards of venture capital and private equity firms’ portfolio companies’ boards is one of the most important reasons for venture capital and private equity firms to buy insurance providing this protection. Indeed, the Just for Feet settlement provides a powerful example of the reasons why private equity and venture capital firms should acquire this type of insurance.

The fact that the company’s D & O insurance program was virtually exhausted by the class action settlement apparently without obtaining a release of claims against the outside directors presents another question. It is not clear from the sequence of events and the publicly available information whether or not the trustee had initiated the claims against the outside directors at the time the securities class action was settled. But it would typically be a constraint against the exhaustion or near exhaustion of policy limits if the settlement would not secure universal claims releases. The outside Just for Feet directors would obviously have had a strong interest in avoiding exhaustion without their release. That such an outcome occurred in the Just for Feet case suggests that outside directors of other companies would be well served by having more control over the disposition of D & O policy proceeds, so that they are not faced with continuing individual exposure without further insurance protection. One possibility might be to structure the now standard order-of-payments D & O policy provision to that disposition of the policy proceeds is controlled by a vote of the outside directors.

There are now a variety of commercially available insurance structures that might also help in similar situations in the future, although the perverse combination of insolvency and insurance exhaustion is a particularly fraught situation. Certainly, the availability of a Side A Excess layer or stand-alone Side A program designed solely for the protection and benefit of individuals (as opposed to the corporate entity) potentially could have provided protection. For a summary regarding Side A insurance, refer here. Many companies have already taken steps to secure this type of protection; according to the recently recently released 2006 Towers Perrin Survey of Insurance Purchasing and Claims Trends (here), 38% of public companies in the survey reported purchasing a Side A only D & O product. But protecting even these separate limits from depletion by settlement for the benefit of insider individual defendants would seem to require some formal partition of coverage between the individual inside defendants and the outside individuals, especially given the company’s insolvency. The Just for Feet settlement may provide the best example yet of the need for a separate Side A program dedicated solely to the outside directors’ protection — or better yet, for a separate Individual Director Liability (IDL) policy solely for the benefit of one individual or a group of outside directors. The existence of separate limits that cannot be depleted in resolution of others’ claims is the best protection against the possibility that individuals might be left to face their own liability exposure without insurance protection.

But perhaps the most significant aspect of this individual outside director settlement is its sheer size. As the Journal states, the $41.5 million Just for Feet outside director settlement may represent “the largest out-of-pocket payment by outside directors following corporate fraud allegations.” While many companies now purchase Side A protection or other variants to protect individual officers and directors, the limits available under many of these structures would typically not be sufficient to entirely fund a settlement of the magnitude of the Just for Feet outside director settlement. According to the 2006 Towers Perrin Survey, the average Side A Only limit for survey participants that also have a full A/B/C program is $15 million, and only $8 million for those with only a Side A only limit. According to the data in the survey, only the very largest companies carry Side A only limits that would have been sufficient to fund a settlement of the size of the entire Just for Feet outside director settlement.

This is just one of several recent developments that threaten traditional notions of D & O limits adequacy. The rising size of average and median class action settlements (refer here), the rising level of defense cost expense, and the emerging threat of separate class action opt-opt lawsuits (refer here), have all complicated the usual calculus of D & O limits adequacy. These factors and the continuing threat of outside director liability exposures (and the need for the D & O program to be structured to address this threat) underscore the need for the involvement of a skilled insurance professional in the D & O purchasing process.