As The D & O Diary has previously noted (most recently here), the attempts by the Paulson Committee to propose ways to improve the competitiveness of the U. S. securities exchanges in the global marketplace may include securities litigation reform. Interest in the Committee’s reform efforts increased substantially as a result of media reports (here) that among other things the Paulson Committee was considering recommending the elimination of a private cause of action under Rule 10b-5. However, in a November 16, 2006 New York Law Journal article entitled "Capital Markets Competitiveness and Securities Litigation" (here, subscription required), Columbia Law School Professor John C. Coffee, Jr. (who supposedly was the source of the recommendation to eliminate private Rule 10b-5 actions) disclaims having made any such recommendation. Instead, Coffee is recommending a "far more modest proposal."

Photobucket - Video and Image Hosting Coffee’s reform proposal begins with his view that the current private securities litigation system is "dysfunctional," but "not because the lawsuits are frivolous or extortionate." Rather, the problem, Coffee believes, is "the circularity of the securities class action." The problem is that

Shareholders are suing shareholders. As a result, diversified shareholders wind up making pocket-shifting wealth transfers to themselves. In the common securities class action dealing with a stock drop in the secondary market, the recovery will go to those shareholders who bought the stock during the "class period"… and the recovery will be bourne by the other shareholders who bought the stock before or after that class period…Inherently, this implies that such an action produces only a shareholder-to-shareholder wealth transfer.

Nevertheless, Coffee thinks that the argument can still be made that securities class action lawsuits may be justified by their deterrence effect. But the problem is that they accomplish deterrence "by punishing the innocent – the shareholders." Coffee proposes a "system of managerial and agent liability that places costs instead on the culpable."

Coffee proposes that the SEC use its regulatory authority under Section 36 of the Securities Exchange Act of 1934 to shield non-trading public corporations from liability under Rule 10b-5. (Section 36 gives the SEC the authority to exempt "any person, security or transaction from any securities laws or regulations, if the exemption is "necessary or appropriate in the public interest, and is consistent with the protection of investors.") According to Coffee, this "would not eliminate a private cause of action under Rule 10b-5, but it would force the plaintiff’s bar to sue and settle with corporate officials and agents – i.e., auditors, underwriters and law firms – instead of treating the corporate entity as the deep pocket."

Coffee anticipates that the targeted directors and officers would seek to rely on indemnification and insurance if they are targeted by the plaintiffs’ lawyers. Coffee recommends that the SEC should act to force corporate boards to take their decision whether or not to indemnify much more seriously, as a result of which, Coffee claims, "in some cases, indemnification might not be paid, and in all cases there would be greater uncertainty." With respect to D & O insurance, Coffee anticipates that active wrongdoers would face substantial coverage barriers (such as the conduct exclusions) as a result of which "the insurer and the corporate insider might well settle such an action on a basis that required some payment out the insider’s own pocket." At that point, Coffee says, "real deterrence begins to be generated."

Coffee’s recommendation to exempt companies from private securities lawsuits to force individuals to bear greater personal exposure as a way to increase deterrence is detailed in Coffee’s October 2006 law review article entitled "Reforming the Securities Class Action: An Essay on Deterrence and Its Implementation" (here). Coffee’s law review article has an extensive review of the fact that although corporate insiders are regularly sued "they rarely appear to contribute to settlement," with specific examples. In the law review article, Coffee also examines at greater length the SEC’s authority under Section 36. Coffee’s article anticipates that his recommendation to exempt companies from Rule 10b-5 liability would "alter the market for D & O insurance" because "executives would demand more insurance;" on the other hand, the recommendation would also "eliminate entity insurance." Coffee’s law review article does not examine whether carriers might alter their basic terms and conditions, as insureds maneuver to assure that coverage for their liability would not be excluded and as carriers jockey to recapture premium revenue lost after entity coverage is eliminated.

The D & O Diary thinks Coffee’s reform proposal is interesting. We do wonder how all of this would actually improve the competitiveness of the U.S. securities markets. Are the managers of foreign companies more likely to list their companies’ shares on U.S. exchanges if the regulatory system is changed to increase their individual liability exposure while at the same time trying to reduce their access to indemnity or insurance? Coffee’s proposal may or may not be a good idea, but it doesn’t seem like it really has anything to do with the reasons for which the Paulson Committee was formed.

Hat tip to the Securities Litigation Watch blog (here) for the links to the New York Law Journal article and Coffee’s law review article.

Photobucket - Video and Image Hosting Thompson Memo Reform?: Reform seems to be today’s theme. According to news reports (here), the U.S. Department of Justice is considering modifying the Thompson Memo to address concerns that prosecutorial pressure is forcing companies to cut off legal support to employees under investigation and to reveal confidential communications with the company’s lawyers. According to the news reports, all prosecutors in each of the 93 U.S. attorneys’ offices would have to get the approval of the attorney general or his top deputy before seeking attorney-client waiver. In addition, companies would not be penalized for refusing to reveal confidential communications with their lawyers – but the could still get credit for cooperation. The Justice Department reportedly is also considering deleting the language in the Thompson Memo referring to legal fees for "culpable employees."

According to the news reports, Deputy Attorney General Paul McNulty has not yet signed off on the proposed changes.

As Professor Ellen Podgor notes on the White Collar Crime Prof blog (here), these proposals represent "baby steps" in the right direction, but they "would not alleviate the problem" that has led to criticisms of the Thompson Memo. For a review of The D & O Diary’s prior posts discussing the Thompson Memo criticisms, refer here and here.

Fortune Smiles on Larry Sonsini: A November 17, 2006 Fortune.com article entitled "Scandals Rock Silicon Valley’s Top Legal Ace" (here) contains a lengthy portrait of Larry Sonsini and discusses his recent involvement in a number of high-profile imbroglios. After reviewing Sonsini’s rise to prominence, the article looks at Sonsini’s involvement, as an NYSE board member, in the dispute over former NYSE CEO Richard Grasso’s compensation; at Sonsini’s connection to the board pretexting scandal at H-P; and Sonsini’s involvement with several companies (including Brocade Communications) implicated in the options backdating scandal. The article essentially exonerates Sonsini on all issues, with the exception of Sonsini’s service on the boards of companies of which he also acted as outside counsel. However, the article reports that Sonsini has resigned or will resign from all of the nine corporate boards on which he previously served.

 

Photobucket - Video and Image Hosting The D & O Diary has previously noted (most recently here) the problems that can arise in connection with “going private” transactions in which management teams up with outside investors to buy out public shareholders’ interests. The latest example may be Clear Channel Communications’ November 16, 2006 announcement (here) that a group led by Thomas H. Lee Partners and Bain Capital Partners will acquire the company for $26.7 billion (including $8 billion of debt assumption).

Early press reports of the proposed transaction were critical of the deal; for example, the Wall Street Journal’s November 14, 2006 article “Clear Channel Buyout Talks Fuel Concern of Management Conflicts” (here, subscription required) commented that the deal was the latest transaction raising concerns that “corporate executives may be pushing transactions that are ideal for themselves but might not be optimum for shareholders.” Among other things, the Journal commented on the “lightning-fast auction” process that produced the two competing bids for the company, and on the close ties between the company’s founders and managers, the Mays family, and the company’s board. The article also raised the question whether the company adequately considered bids from groups less friendly to the Mays family or considered whether a break-up would raise more money than selling the company as one piece. According to other news reports (here), other shareholders have publicly questioned the transaction, including the benefits to the Mays family and the fact that the acquirors plan to sell off assets to finance the transaction.

The Company’s November 16, 2006 8-K (here) describing the transaction reports some details of the deal that may also raise concerns. For example, the company has only until December 7, 2006 to consider any competing bids, and the company would, if it accepting a competing bid, it would have to pay the currently proposed acquirers a break up fee of $500 million. Past going private transactions have been criticized for similarly short “go shop” periods and for break up fees so large that potential competing bidders would be discouraged.

The 8-K also discloses that if following the completion of the transaction, either the company’s CEO, Mark Mays, or its CFO, Randall Mays, have their employment terminated under change of control provisions, they would each receive cash payments equal to the sum of one year’s base salary, bonus and accrued vacation pay, plus 2.99 times the sum of each executive’s annual salary and bonus, as well as three years continued benefits. (The 8-K does note that the executives did at least give up the right to a state and federal tax “gross up” as well as the right to received 1 million options upon termination.) According to news reports (here), these provisions for payment to the Mays family member represent a “significant reduction” from the amounts originally under discussion — but are still substantial, and are still the subject of sharholder objections, according to othere news reports (here). According to a shareholder quoted in these reports, “This is an extremely one sided deal.”

Transactions involving these kinds of potential conflicts of interest create circumstances where accusations of wrongdoing can more easily arise. It is almost to be expected that the Clear Channel transaction is the subject of a purported shareholder class action. On November 16, 2006, the law firm of Wechsler Harwood filed a lawsuit (here) in Texas state court, accusing Clear Channel and its directors of breach of fiduciary duty. The lawsuit alleges that the “going private” transaction is for the benefit of insiders, particularly the Mays family, but to the detriment of the company’s public shareholders. The lawsuit seeks an injunction against the transaction, or, should the transaction be completed, damages on behalf of Clear Channel’s shareholders.

A cynical view of these kinds of lawsuits is that they represent no more than an attempt by plaintiffs’ lawyers to extract a toll from the parties to the transaction. But at least in cases where the allegations of conflicts of interest are substantial, these kinds of claims may present a threat of more than just a cost of doing business.

The Clear Channel transaction is just the latest in a series of huge “going private” transactions. These mega-deals and the accompanying risk of D & O claims are likely to continue into the foreseeable future. As the Wall Street Journal noted in its October 26, 2006 article entitled “Growing Funds Fuel Buyout Boom” (here, registration required), private equity firms have raised buyout funds of as large as $20 billion. According to the article, fifteen of the top 20 buyouts ever have taken place in the last 18 months, and larger buyouts may lie ahead as private equity funds “eye takeover targets with stock market values of $50 billion or more.” (The largest buyout ever is KKR’s $25.1 billion takeover of RJR Nabisco.) The article quotes a leading M & A attorney as saying “We are seeing a significant privatization of corporate America.”

The massive amounts of money involved in these “going private” transactions create enormous opportunities for conflicts of interest to arise, particularly where incumbent management has the potential to benefit if a particular party’s proposed transaction succeeds. These circumstances present a serious potential risk of claims against directors and officers of the target companies.

As The D & O Diary has previously noted, private equity funds themselves are drawing scrutiny; according to media reports (here), the Department of Justice has begun an investigation whether private equity funds’ “club deals” violate antitrust laws by artificially limiting the amount shareholders realize when companies are acquired.

The WSJ.com has an interesting “Who’s Who in Private Equity,” with a listing and description of the leading private equity firms here. Bain Capital, one of the successful bidders for Clear Channel, was founded by the current Republican Governor of Massachusetts, Mitt Romney.

A Rolling Stone magazine profile of Clear Channel and its influence on American radio and popular culture can be found here. Salon.com has an index of its articles about Clear Channel here.

Update: The private equity “buyout boom” continues. On November 20, 2006, the private equity firm the Blackstone Group announced (here) a $19 billion buyout of Equity Office Properties Trust.

Photobucket - Video and Image HostingLucky CEOs: A new study by three leading academics claims to establish a link between governance practices and questionably timed stock options to chief executives. A November 16, 2006 study entitled “Lucky CEOs” (here) by Lucian Bebchuk of Harvard Law School, Yaniv Grinstein of Cornell, and Urs Peyer of INSEAD, examined 19,036 option grants between 1996 and 2005, involving about 6,000 companies and about 8,000 CEOs. The authors looked at the distribution of grant prices within the grant month and found a disproportionately higher numbers of grants on the date during the month with the lowest share price (and a disproportionately lower number of grants on the date with the highest share price). The authors found that these “lucky” grants were likeliest to occur at companies that did not have a majority of independent directors. The authors also found that this luck was persistent; CEOs that had lucky grants tended to have multiple lucky grants.

The authors also found that about 43% of lucky grants were “super lucky,” because they fell on the date with the lowest share price for the quarter.

Among the authors more interesting findings is their conclusion that the lucky grants were not concentrated amongst high tech companies. The authors found that a majority of the lucky grants as well as the super lucky grants were awarded at “old economy” firms.

The authors estimated (using probabilistic techniques) that about half of the lucky grants were due to manipulation rather than chance. They also estimated that about 850 CEOs at about 750 companies received or provided lucky grants produced by opportunistic timing.

The authors also found that lucky grants were likeliest to occur at companies that had CEOs with longer tenure. The authors estimated that the average gain to CEOs from the lucky grants that were backdated exceeded 20% of the reported grants and increased the CEOs total reported compensation for the year by 10%.

News reports describing the study may be found here and here. A brief commentary critical of the study can be found on Professor Larry Ribstein’s Ideoblog, here.

Stock Option Grant Givebacks: On November 15, 2006, EMCORE announced (here) that two top executives will return gains from exercising stock options that a voluntary internal investigation had concluded were the result of improper practices. EMCORE’s CEO voluntarily agreed to return $147,775 and its chief legal officer agreed to repay $97,000. The company said these amounts represented “the entire benefit received from the misdated grants they exercised.” The company’s CFO, who had not exercised any of the misdated stock option grants, voluntarily surrendered his rights to the grants. The company’s internal investigation was “unable to concluded that the company or anyone involved in the stock option granting process engaged in willful misconduct.”

A CFO.com article discussing the EMCORE stock option investigation can be found here.

As The D & O Diary previously noted (here), executives at Molex agreed to repay the company $685,000 to cover gains they realized on misdated options.

These somewhat isolated incidents pale by comparison to the givebacks involving UnitedHealth Group’s options investigation. UnitedHealth Group’s outgoing CEO William McGuire and his successor Stephen Helmsley collectively forfeit $390 million in gains from previously exercised options, and their unexercised stock options were repriced to eliminate paper gains from due to options timing. See the Wall Street Journal’s November 9, 2006 article, here, registration required. UnitedHealth Group’s November 8 press release can be found here.

UPDATE: The November 20, 2006 Wall Street Journal has a front page article entitled “Companies Discover It’s Hard to Reclaim Pay from Executives” (here, subscription required) discussing difficulties companies have had trying to recover past compensation to which executives were not entitled.

Options Backdating Lawsuit Update: With the recent addition of new lawsuits that have been filed against Flowserve, Biomet and Black Box, The D & O Diary’s running tally (here) of companies named as nominal defendants in shareholders derivative lawsuits raising options timing allegations now stands at 113. The number of companies sued in securities fraud lawsuits remains at 21.

On November 8, 2006, a sweeping bill affecting U.K. companies went into affect when the Companies Bill, which at 696 pages is Britain’s longest piece of legislation, received royal approval. (The House of Lords site reflecting all information pertaining to the Bill may be found here.) The Bill contains a statutory statement of directors’ general duties and extended authority for shareholders to sue directors for negligence, default, breach of duty or breach of trust – a broader range of conduct than under prior law.

The Bill’s statutory statement of directors’ general duties sets out seven duties:

  • The duty to act within the company’s powers;
  • The duty to promote the success of the company;
  • The duty to exercise independent judgment;
  • The duty to exercise reasonable care, skill and diligence;
  • The duty to avoid conflicts of interest;
  • The duty not to accept benefits from third parties; and
  • The duty to declare any interest in any proposed transaction or arrangement with the company.

The new general statutory duty to "promote the success of the company" is the most controversial clause in the Bill, and includes many considerations of which directors must now take into account – not only the long term business consequences of any decision, but also "the impact of the company’s operations on the community and the environment." This new statutory duty requires directors to consider wider social responsibility factors when making decisions. The various statutory requirements may create obligations that conflict. But the decision of what constitutes the company’s best interests will not be set aside if made in good faith and the directors have exercised reasonable care, diligence and skill.

The Bill extends existing shareholder rights to bring derivative claims. The new statutory procedure enables a shareholder to bring a claim with respect to any actual or alleged negligence, default, breach of duty (including the new statutorily codified duties) or breach of trust. A shareholder seeking to bring a claim must petition the court for the right to proceed, based upon a showing of good faith and taking into account whether the company decided not to pursue the claim. If leave to continue is granted, the company must reimburse the shareholder for brining the action; if not, the shareholder bears his or her own costs.

According to a detailed review (here) of the Bill by the Norton Rose law firm, the absence of the risk of costs if leave to pursue the derivative claim is granted "may make shareholders more likely to bring an action under the new procedure." The new right to bring an action for breach of any duty, including the new statutory duties, "provides another tool for use by activist shareholders to push for change at underperforming companies." But how useful this tool will be depends on "the court’s willingness to exercise its discretion to intervene in what, in many cases, will be simply commercial decision making by the company, its directors and majority shareholders." In light of these considerations, the Norton Rose firm’s memo suggests that "boards should review the wording of their D & O policies to ensure that defending derivative claims is covered."

A summary of other aspects of the Bill may be found at the CorporateCounsel.net, here.

A Private Conspiracy?: According to a November 15, 2006 Bloomberg.com article entitled "KKR, Carlyle, 11 Other Accused of Rigging Buyouts" (here), the law of Wolf, Haldenstein, Adler, Freeman & Herz has brought a purported class action accusing 13 private equity firms of rigging the market to take companies private. The complaint purportedly alleges that investors did not receive full value for their shares because of a conspiracy that violated antitrust laws. The purported class potentially represents tens of thousands of shareholders in dozens of deals in which public companies were taken private. Among the specific transactions named are deals involving Univision, HCA and Harrah’s Entertainment. The list of defendants reads like a who’s who in the world of private equity, including KKR, Carlyle, Thomas H. Lee Partners, Blackstone Group, Bain Capital, Apollo Management, Texas Pacific Group, and others.

Prior press reports had disclosed that the antitrust division of the U.S. Deparment of Justice in Manhattan is examing potential antitrust violations by private equity firms engaged in "club deals" to acquire public companies. An October 11, 2006 Wall Street Journal article entitled "Probe Brings ‘Club Deals’ to the Fore" can be found here (subscription required.)

Best Commercial Ever?: You decide. Roll the tape, here.

 

One of the most noteworthy corporate phenomena of recent months has been the increasing prevalence of companies buying back their own shares. According to an article in the New York Times (here, subscription required), the S & P 500 companies are on a pace to repurchase more than $435 billion worth of their own shares this year, compared with $349 billion in 2005 and only $131 billion in 2003. The conventional wisdom is that share buybacks help shareholders by reducing the supply of shares, thereby driving up the price. But buybacks only make economic sense of the share purchase is the most advantageous alternative for the cash used – that is, it makes sense if the shares are undervalued compared to other assets. Otherwise, shareholders are better served by a dividend payment. It strains common sense to think that all of the shares of all the companies repurchasing their own shares right now are undervalued relative to other assets, particularly since share prices generally have been rising — which raises the question whether there may be more behind the recent wave of share buybacks than attempted maximization of shareholder interests.

Warren Buffett flagged the issue in his letter to shareholders in the 2005 Berkshire Hathaway Annual Report (here), when he described the share repurchase practices at a fictitious company, Stagnant, Inc. In Buffett’s story, Stagnant’s CEO, Fred Futile, gets rich simply by using buybacks to boost his company’s earnings per share (EPS), despite being unable to grow the company’s net income.

The issue Buffett raise was explored further in a November 12, 2006 New York Times article entitled “Why Buybacks Aren’t Always Good News” (here, subscription required), which examined whether share repurchases are being used to boost executive compensation. The article reports research conducted jointly by the Center for Financial Research & Analysis and the Corporate Library. The researchers looked of companies that engaged in share repurchases while compensating executives based on EPS, while the companies were experiencing negative cash flows for the last two years. The study found 78 companies in the S & P 500 that met these criteria, including three companies the experienced negative cash flow for the last three years. The researchers also found that none of these companies discussed in their proxies the impact of the buyback program on executive compensation.

An additional share repurchase practice that may be even greater concern is the practice of management selling their shares at the same time the company is conducting a share buyback program. An article in the November 2006 issue of CFO Magazine entitled “Can You Have Your Stock and Sell It, Too?” (here) questions whether management sales of company shares at the same time as the companies were conducting share repurchases represent a conflict of interest. The article reports research conducting by Audit Integrity, which looked for companies with market capitalizations over $100 million and that had high levels of both stock buybacks and insider selling. The research identified 16 companies with these characteristics.

None of this has been lost on the plaintiffs’ bar. The CFO Magazine article quotes Bill Lerach of the Lerach, Coughlin firm as saying:

In our view, there is an inherent conflict of interest when insiders are using the stockholders’ money to buy back shares on the theory that they are undervalued, and at the same time are unloading their own shares….We believe it to be an inherently bad practice. Certainly, when we evaluate whether to bring suit against insiders for securities fraud, it’s something we look for, and when we see it we view it to be very incriminatory.

Lerach also is quoted as saying that his is putting the finishing touches on a lawsuit he plans to file against “one of the most high-profile companies in the United States,” along with its CEO, over issues relating to its buyback program.

Because conventional wisdom views share repurchases as benign, or at least as a standard part of the management tool kit, they have at least historically not been questioned. But there really have never been share buybacks anywhere near the current level, and recent media scrutiny may raise concerns with the practice, particularly where executives are being compensated on a EPS basis. Companies whose executives are selling shares while their companies are buying shares back may face particular scrutiny, and indeed if Lerach’s statements are credited, may face a greater possibility of D & O claims. Certainly, a company whose executives are selling shares will be hard pressed to argue that its shares are undervalued relative to other assets, which undermines the theoretical basis for a buyback in the first place.

Given the growing prevalence of share repurchases, this area may represent an area of heightened scrutiny and potentially increased D & O risk in the months ahead.

For an interesting discussion critical of the New York Times referenced above, refer to Professor Larry Ribstein’s Ideoblog, here.

Options Backdating Contagion?: There has been extensive media coverage discussing the potential impact of the options backdating scandals on the insurance industry (for example, see this recent San Francisco Chronicle article here). But there has been relatively little discussion whether the scandal could affect other kinds of companies, other than insurers, as a result of investigations companies under investigation.

At least one bank is at least raising the question whether its customers’ options woes could affect its business. In its 3Q06 10-Q (here), SVB Financial Group, the bank holding company for Silicon Valley Bank, included the following risk factor:

Many technology companies have been subject to scrutiny concerning their historical stock option grant activities which could negatively impact our client borrower market.

In recent periods, there have been several reports in the media questioning public company stock option practices, as well as a number of formal and informal regulatory investigations and other actions in connection with the historical stock option grant activities of certain companies. Many of our client borrowers utilize stock options in their employee compensation programs and, as such, could be adversely affected by these developments. Any increase in litigation, investigations or other regulatory actions which adversely affect companies that grant employee stock options, or that adversely affect the technology sector more generally, could adversely affect our client borrowers and potential client borrowers, and therefore could result in a material adverse impact on our results of operations.

SVB also stated that due to publicity surrounding the options backdating scandal, it had voluntarily launched an internal review of its own options practices. Its review is not yet complete and the company has not released any other details about its review.

A November 13, 2006 CFO.com article discussing SVB Financial Group’s options related disclosures can be found here.

As The D & O Diary has previously noted (here), one of the questions following the Enron and WorldCom civil class actions settlements was whether those settlements’ requirement of individual defendants’ contribution to settlement without recourse to insurance or indemnity represented a trend or an aberration. Several recent high-profile securities lawsuit settlements involving significant individual contributions seem to suggest that individual contributions to securities fraud lawsuit settlements may represent an increasingly important part of case resolution — as well as a disturbing trend, as discussed below.

First, on October 31, 2006, Krispy Kreme Doughnuts announced (here) the settlement of a pending securities class action lawsuit and a pending shareholders’ derivative action. The derivative settlement provided that the Company’s former Chief Operating Officer John Tate and former Chief Financial Officer Randy Casstevens would each contribute $100,000 to the securities fraud case settlement (the settlement of which also included a cash payment of $34.967 million by the Company’s D & O insurers; a $4 million cash payment from the Company’s auditors; and the Company’s contribution of common stock and warrants valued at $35.833 million). Tate also agreed to cancel his interest in 6,000 shares of company stock, and Tate and Casstevens agreed to limit their claims for indemnity from the Company in connection with future proceedings before the SEC and the U.S. Attorney for the S.D.N.Y. to specified amounts. The Stipulation of Settlement expressly preserves claims the company may have against former CEO Scott Livengood to seek reimbursement for any of the settlement amounts, holding out the possibility that Livengood might also have to contribute toward settlement out of his personal assets.

In its third quarter 10-Q dated November 7, 2006, Martha Stewart Living Omnimedia announced (here) the settlement in principle of the securities class action lawsuit that had been filed in connection with Martha Stewart’s December 27, 2001 sale of shares of ImClone Systems. The total value of the class action settlement is $30 million, of which $15 million is to be paid by the Company, $10 million is to be paid by the Company’s D & O insurers, and $5 million is to be paid by Stewart herself. (The Company’s accounting charge for the settlement “does not include that portion of the settlement expected to be paid by Ms. Stweart.”)

These two settlements join the Tenet Healthcare $215 million securities fraud settlement announced earlier this year (here) in which two individuals (the Company’s former CEO and former COO) agreed to contribute an additional $1.5 million toward the settlement without recourse to insurance or indemnity.

These settlements suggest that the requirement for individuals’ contributions may have become an important part of securities fraud lawsuit resolution. While aggrieved shareholders and their counsel may view this development as a just way to compensate for harm done for alleged misrepresentations, it does create a disturbing prospect for potential future individual defendants. A movement toward non-recourse individual recoveries puts individuals in a position where their service as corporate officials requires them to expose their personal assets. Martha Stewart at least has been convicted of a crime (although one having nothing to do with her sales of ImClone shares or any alleged misrepresentations to her company’s shareholders); the Krispy Kreme officials have not yet been convicted of any crimes, yet they are facing what amounts to an asset forfeiture that is from their perspective indistinguishable from a criminal penalty. This alarming trend bears monitoring, and raises troubling questions about the appropriate exposures for individuals in civil lawsuits, particularly in the absence of any trial or definitive judicial finding of misconduct.

New Category of Options Backdating Lawsuits?: Much of the early publicity surrounding the options backdating scandal suggested that options backdating practices disappeared with the new options grant paperwork requirements enacted in the Sarbanes Oxley Act. In a prior post (here), The D & O Diary examined a study by the investor services firm Glass Lewis showing that options backdating practices may not have ended with Sarbanes Oxley, because many companies have not been complying with timing requirements for filing options related paperwork and that the paperwork delay may allow companies to backdate options grants to a time with the stock price was lower. The study poses the question whether there may be a whole new round of options backdating revelations – and related claims – ahead, based on these late filing practices.

A November 9, 2006 Minneapolis Tribune article entitled “Digital River Shareholder Suit Alleges Backdating” (here) reports that shareholders have filed a lawsuit against Digital River and its CEO, based on options backdating allegations. The allegations are based in part on Digital River’s habit of delaying the filing of its options related paperwork with the SEC. Digital River was one of the nine companies identified in the Glass Lewis report.

As noted in the prior D & O Diary post (here), the possibility of these kinds of claims poses a new challenge for D & O underwriters. The arrival of the Digital River lawsuit may establish that this threat is not merely theoretical but real. The underwriters must now consider whether additional claims will arise based on allegations of post-2002 late form filing and stock option increases between the grant date and the filing date.

French Class: Numerous recent media report have focused on various efforts to reduce the regulatory and litigation burden that U.S. companies face, in order to enhance the companies’ ability to compete in the global marketplace. (See my most recent post regarding regulatory reform efforts here.) Ironically, reform efforts in other countries may be moving in the opposite direction, as efforts are made to increase accountability and oversight.

According to news reports (here), the French government this past week approved new legistlation that would introduce a version of the class action lawsuit in France. The bill creates a two-phase process in which judges would hear class-action complaints. Damages are capped at 2,000 euros. If the judge determines “professional fault,” individual plaintiffs would have to individually negotiate with the company for compensation, then personally appear before the judge if the company refuses to settle. The law would not introduce contingency fees, punitive damages or civil trial with juries.

The following is the text of a speech (modified to optimize Internet capabilities) prepared for the Professional Liability Underwriting Society (PLUS) International Conference on November 9, 2006.

Photobucket - Video and Image HostingShortly after former Enron CEO Jeffrey Skilling’s October 23, 2006 sentencing (see prior post here), the Enron Task Force announced that it was closing down, declaring that its mission was mostly complete. The media treated these events as endpoints in the Enron criminal scandal; for example, the Washington Post ran an article entitled “End of Enron’s Saga Brings Era to a Close.” (here, registration required). Whether or not these events really do represent the end of an era, it may now be time to take a look at the Enron scandal and to assess its lasting impact.

This post examines several questions: Have we indeed reached the end of an era of high profile criminal prosecutions? And now that the key figures in the Enron scandal have all had their day in court, what are Enron’s legacies? Finally, what does it all mean for D & O risk?

The End of an Era? While Skilling’s sentencing was highly anticipated and had all the air of a culminating event, a fresh wave of scandals suggests that white collar criminal prosecutions will remain an important part of the legal landscape for the foreseeable future. Indeed, the same week as Skilling’s sentencing, Comverse Technology’s former CFO became the first corporate official to plead guilty to criminal charges in connection with the options backdating scandal (here). In addition, that same week, Refco’s former CFO was indicted for accounting allegations raised following the company’s ill-fated IPO (here). These are just the latest signs that white collar crime prosecutions will remain a high prosecutorial priority for the foreseeable future.

And though Skilling’s sentencing may represent a high water mark of sorts, it is far from the end of the Enron saga itself. There are still a number of Enron-related prosecutions in the pipeline. For example, three British bankers (the “NatWest Three“), extradited to the U.S. earlier this year, will stand trial in early 2007 on allegations that they stole from their former employer in connection with an Enron-related transaction (here). There may be new trials for several former Enron executives whose earlier proceedings ended in mistrials. Several key Enron defendants, including former Enron Chief Accounting Officer Richard Causey, are yet to be sentenced. The civil lawsuit against Enron’s investment banks (at least the ones that have not yet settled) remains pending. For a rundown of the remaining Enron-related events, refer here.

And even when the book is finally closed on Enron, whenever that may be, the assault on corporate fraud seem likely to continue. This forward-looking thought leads to the next question: now that the Enron Task Force has disbanded, what are Enron’s legacies?

Enron’s Legacies: The word “Enron” has moved into the language, both as a reference to the company itself and the scandals that followed its demise, and as a shorthand expression for all of the corporate scandals that were uncovered earlier in this decade. While these two senses of the word are distinct, the two meanings merge when looking at Enron’s legacies, because Enron’s impact has been specific (for example, in connection with the criminal prosecution of former Enron officials), and general (in connection with the larger impact on markets, legislation, and corporate culture). Using “Enron” in both of these senses, here are a few of its legacies:

1. New Corporate Culture of Governance: Without question, the most important of Enron’s legacies is the new culture of corporate governance. In Enron’s wake, no corporation can ignore the implementation of serious internal compliance systems to detect and deter corruption. By the same token, the role and functioning of corporate boards has also been dramatically altered. Boards are now active, independent and involved, and in many important ways providing meaningful oversight of corporate management. Just one aspect of the way boards have changed is the increased emphasis on independent board composition. According to the National Association of Corporate Directors, 83% of boards now say that more than half of their directors are independent, up from only 54% in 2000.

These changes hold out the intriguing possibility that improved corporate governance will result in reduced D & O risk. Indeed, some commentators believe that improved governance explains the reduced number of securities fraud lawsuits that have been filed so far in 2006. For example, Stanford Law Professor Joseph Grundfest has stated (here) that “extensive and expensive corporate efforts to improve governance and accounting have reduced plaintiffs’ ability to allege fraud.” There is no question that the governance reforms have improved corporate officials’ sensitivity to potential wrongdoing. But even allowing for this heightened vigilance, other commentators remain skeptical that governance reforms alone can explain the reduced number of lawsuits. As D & O authority and prominent coverage attorney Dan Bailey has written with respect to the impact of corporate governance reform on the number of securities lawsuits (here), “it appears unlikely that this is a major contributing factor to the reduced filings.”

In fact, increased board independence and oversight has also in some cases led to boardroom turmoil that in turn has resulted in claims against, between and among directors and officers. The unfortunate and highly publicized events involving H-P’s Board are but the most prominent example of this effect. (See my October 2006 InSights article discussing board turmoil and D & O Risk here.)

And so, while improved corporate governance is an unquestionably important part of Enron’s legacy, the positive significance of that legacy in terms of D & O risk still remains uncertain. In addition, as discussed further below, there are movements afoot that could potentially alter this legacy.

2. Whistleblower Protection: The new culture of oversight is not limited just to the boardroom. Serious internal compliance programs, combined with the provisions of the Sarbanes-Oxley Act providing corporate whistleblower protection, encourage employees to speak up and report conduct they believe may have crossed the line. (The Sarbanes-Oxley whistleblower provision, here, is of course a legislative tribute to Enron’s own whistleblower, Sherron Watkins.)

The existence of the whistleblower provisions potentially could translate to increased D & O risk, in light of the possibility of claims based on the whistleblower’s disclosures. It has not turned out that way, at least so far, as the few whistleblower cases to emerge have gotten bogged down in procedural delays of a kind that could well deter future whistleblowers. (See my prior post on Sarbanes Oxley whistleblower procedural delays here.) Certainly there have been no dramatic cases where a whistleblower’s surprising revelations have resulted in significant claims against corporate officials.

The whistleblower provisions may yet have this effect, but so far, the whistleblower provisions have not had a significant impact on D & O claims activity.

3. CEO’s in the Hotseat: With all of the improved corporate governance procedures has also come increased scrutiny of senior corporate management. There is no doubt that following Enron and the other corporate scandals that CEOs’ hold on their jobs is more precarious. Since early 2005, the boards of some of the country’s largest companies have ousted their CEOs – including Bristol-Myers Squibb, Fannie Mae, Pfizer, Merck, and American International Group. In addition, executive compensation has come under intense scrutiny. More active boards and a greater willingness to challenge management, as well as a changed regulatory environment, have all contributed to this effect.

Significant turnover at the most senior levels of management creates a volatile environment in which accusations of wrongdoing may more easily arise. Recurring questions about executive compensation merely add to this atmosphere of increased tension. The recent wave of lawsuits involving options backdating allegations illustrates how quickly questions about compensation and management performance can lead both to executive departures and to D & O claims. (To see my running tally of Options Backdating litigation, refer here.) The increased scrutiny under which top management now operate is an important new source of D & O risk.

4. White Collar Crime Enforcement: One of Enron’s most durable legacies is the creation of a prosecutorial police force to identify and punish corporate crime. Even though the Enron Task Force has disbanded, the Corporate Fraud Task Force remains in existence and continues to find activities to investigate and prosecute. This picture of a permanent white collar fraud police force was vividly illustrated in the recent remarks of Timothy J. Coleman, a former U.S. Justice Department official who was responsible for the Corporate Fraud Task Force and who supervised the Enron Task Force and the Criminal Fraud Section. An October 25, 2006 Washington Post article (here, registration required) attributed to Coleman the statement that:

The legions of investigators hired by securities regulators, federal prosecutors and the FBI will pay lasting dividends because they will become a “standing army” ready to target business wrongdoing. “Whether it’s stock options, mutual funds or something else, corporate America should expect a continuing series of major, nationwide investigations for the foreseeable future,” Coleman said.

A “standing army” to prosecute crime will inevitably find offenses to investigate, prosecute, and punish, and so the likelihood of a series of future major corporate crime investigations is one of the Enron’s most tangible legacies.

With the increased prospect of prosecutorial scrutiny comes the increased possibility of D & O claims. Just as all of the major corporate criminal scandals involved parallel civil claims, and just as the options backdating investigations have also meant a new wave of shareholder lawsuits, so too the criminal investigations yet to come will also lead to civil claims against directors and officers. The threat of future claims arising from corporate criminal investigations is perhaps the most important way that Enron has affected D & O risk.

5. Increased Severity of Civil Securities Fraud Lawsuits: Enron and the other corporate scandals have also changed the environment for civil securities fraud lawsuits. These changes have important implications for D & O carriers and their insureds. Specifically, average settlements in securities fraud lawsuits have escalated enormously due to the civil cases arising out of the corporate scandals. (See my prior post, with links to the leading studies, here.) It may be that the egregiousness of these cases drove an increase in average severity that will diminish once the worst cases have played through the system. But while the average settlements may diminish somewhat after the worst cases are gone, the rough idea of “what cases like this settle for” has been ratcheted upwards in a way that is unlikely to completely go away. This heightened severity standard has important implications for D & O carriers’ average expected severity (particularly for excess carriers) as well as for D & O insurance buyers’ limits selection. Both carriers and policyholders must now be prepared for much more expensive outcomes.

How Permanent Are Enron’s Legacies? Shortly before the Enron Task Force disbanded, another group, the Committee on Capital Markets Regulation, formed to take a look at the effect of regulatory burdens on the competitiveness of the U.S securities markets in the global economy. (The Committee has become known as the Paulson Committee because of the public support that Treasury Secretary Henry Paulson has given the Committee.) The Committee consists of leading figures from academia and business, and includes prominent figures from the current Bush administration. The Committee is taken a look at regulatory reforms that might improve U.S. competitiveness. (See my most recent post regarding the Paulson Committee here).

Among other things, the Paulson Committee is reviewing whether Sarbanes-Oxley represented an overreaction, and whether there are revisions that might swing the regulatory pendulum back to the middle. The Committee’s work has been accompanied by public statements from President Bush and Vice President Cheney that perhaps Sarbanes-Oxley went too far. The Committee’s report is due to be released on November 30, 2006. Of course, merely because the Committee will make proposals does not mean that changes will necessarily follow. But the Paulson Committee clearly has the administration’s support. The extent of its recommendations and the regulatory reforms that could follow potentially could affect the permanency of some of Enron’s most significant legacies.

Conclusion: There may yet be more of the Enron story to be told, and the current scandals (such as the options backdating investigations) undoubtedly will have an impact on corporate culture. The work of the Paulson Committee may also affect the post-Enron regulatory environment. But even though the picture may continue to evolve, that does not diminish the enormous, categorical changes that Enron has wrought. Principles and practices of corporate governance are changed forever. Corporate compliance programs are now an important part of every company’s internal operations. White collar fraud prosecution is empowered and an important component of the contemporary legal landscape. And D & O insurers and their policyholders face a changed claims environment characterized by increased risk and heightened severity expectations. By any measure, Enron’s demise was a milestone event in the history of American corporate culture, and its ramifications will affect companies for years and decades to come.

To see my prior post regarding the significance of Enron, refer here . To see my prior post regarding the sentencing of former Enron CFO Andrew Fastow, refer here.

Stock Option Exercise Backdating: To date, the focus of the options timing scandal has been on the backdating of option grant date. But an October 30, 2006 New York Times article entitled “Dodging Taxes is a New Stock Option Scheme” (here, registration required) reveals that a new area of investigatory focus is the timing of the options exercise date.

Backdating the option exercise date can reduce the options holder’s tax burden. By reporting an exercise date when the share price was lower than it was on the actual exercise date, the option holder can understate his gains and lower his income taxes. It may also cause the company to take a lower tax deduction. The Times article discusses an example involving a former Symbol Technologies executive who, by reporting an exercise date when the share price was lower than the date he actually exercised his options, underreported his gains by nearly $1.5 million and underreported his taxes by nearly $600,000. The article also cites another example involving Mercury Interactive.

According to the Times article, the SEC is now interested in “several cases” where exercise backdating may have occurred. Because exercise backdating raises tax issues as well as disclosure and accounting issues, the SEC has also alerted the IRS. The article does note, however, that some lawyers who have been hired by companies to serve as outside investigators do not currently expect backdated exercises to become a widespread issue.

Options Backdating Litigation Update: The D & O Diary’s running tally of Options Backdating litigation (here) has been updated. With the addition of the recently filed case against Apollo Group (here), the number of companies sued in securities fraud actions stands at 21. The addition of several new options backdating related securities derivative actions brings the total number of derivative action to 99.

Spitzer Bars Employees’ Fees Payment: According to a November 2, 2006 Law.com article entitled “New York AG Presses Companies to Stop Paying Indicted Employees’ Legal Bills” (here), the office of New York Attorney General Eliot Spitzer has joined the practices of the United States Department of Justice in pressing companies that are the target of corporate criminal investigations to cut off the companies’ payment of the attorneys’ fees for the their employees that are also investigative targets. The issue has arisen in connection with Spitzer’s investigation of mutual fund market timing. Nine of the 17 settlements Spitzer has reached so far included “no indemnification” clauses. Under these agreements, the companies are prohibited from paying attorneys’ fees of “current or former directors, officers, employees or agents.” except where required by law or written agreement.

Under an agreement of this type, the Bank of America cut off the attorneys’ fees for an individual who had been indicted in connection with the market timing investigation, even though its by-laws require indemnification. The individual was forced to sue the company to have his fees paid; he was later acquitted of many charges and the prosecutor dropped the remaining charges.

The acquittal of the Bank of America employee is a reminder of the dangers of these heavy-handed prosecutorial tactics. The practice of forcing companies to cut off their employees’ attorneys’ fees have the effect of punishing individuals who have not been convicted of any crime – and who are entitled to a presumption of innocence. The U. S. Constitution is full of so many guarantees for criminal defendants because the founding fathers understood the powerlessness of an individual when targeted by the extensive police power of the state. (Indeed, similar concerns inform the opinion of Judge Kaplan in the KPMG case in which Judge Kaplan found the prosecutors conduct implementing the Thompson Memo to be unconstitutional. My prior post on the topic may be found here.) Prosecutorial efforts to compel companies to cut off payment of their employees’ attorneys’ fees not only threaten to deprive these individuals of their constitutional rights; they arguably are incompatible with the fundamental assumptions about our American system of justice.

An alert D & O Diary reader points out that given Spitzer’s actions and the similar actions of the DoJ, employees could be well advised to look to their indemnification rights, including ascertaining that their companies have the broadest rights available under applicable state law, and whenever possible obtain written indemnification agreements. The possibility of a corporate employer’s withholding of corporate indemnity also argues in favor of Broad Form Side A protection with advancement of defense cost and drop down protections.

Democratic Perspective on Securities Regulation Reform: In my prior posts discussing the Paulson Committee’s review of possible securities regulation reform (most recent post here), I have questioned whether a Democratic party take over of one or both houses of Congress might be a barrier to the Committee’s reform proposals. However, an article in the November 4, 2006 Wall Street Journal entitled “Democrat Nods to Wall Street” (here, subscription required) sheds an interesting light on this question. The Journal article contains an interview with Rep. Barney Frank, the Massachusetts Democrat who would take over the House Financial Services Committee if Democrats gain control of the House in the November 7 election. (The Committee is currently chaired by retiring Ohio Republican Rep. Michael Oxley.) Frank is reported to be opposed to “reopening the landmark Sarbanes-Oxley corporate accountability law, but would be willing to let regulatory agencies adjust their rules in light of business criticism.” This is an interesting comment, because the Paulson Committee has declared its intent to try to seek reform via regulation rather than legislation.

In addition to Frank’s comments, there were similar comments from New York Democratic Senator Charles Schumer in a November 1, 2006 Wall Street Journal op-ed column entitled “To Save New York, Learn From London” (here, subscription required) written Republican New York Mayor Michael Bloomberg. The column suggests that the Sarbanes-Oxley Act needs to be “re-examined” and that “it may be time to revisit the best way to reduce frivolous lawsuits without eliminating meritorious ones.”

These comments may suggest that even thought the Paulson Committee may not itself be bipartisan, there may nevertheless be some bipartisan consensus that some form of regulatory reform is needed to preserve the competitiveness of U. S. securities markets in the global economy.

PLUS International Conference: I will be in Chicago next week for the Professional Liability Underwriting Society (PLUS) International Conference (here). At lunch on Thursday, November 9, 2006, following a presentation by former Enron prosecutor John Heuston, I will be giving a speech on the topic of “Enron’s Legacies and D & O Risk.” I encourage D & O Diary readers to introduce themselves to me during the conference. I would welcome the chance to meet you and to hear your comments about the blog.

One of the standard features of most articles discussing the options backdating scandal has been the obligatory statement that backdating largely disappeared after the 2002 passage of the Sarbanes-Oxley Act, as a result of the Act’s requirement (in Section 403(a)(2)) that all transactions in the company’s shares involving directors or officers must be documented to the SEC “before the end of the second business day following the day” on which the transaction took place. But a new report entitled “The Backdating Scandal’s Second Act?,” shareholder advisory firm Glass Lewis raises doubt about whether Sarbanes-Oxley eliminated the practice after all, and suggests that there may be a whole new round of options timing revelations ahead.

According to news reports (here and here), Glass Lewis found that many companies have not been complying with the timing requirements for filing options related paperwork on SEC Form 4. The report found that the SEC rarely cracks down on companies for filing their paperwork late, which allows the opportunity to change the actual date the stock options were granted to a day when the stock was trading at a lower price. The firm reviewed hundreds of thousands of Form 4 filings from January 2004 to June 2006 and pinpointed some 6,000 questionably timed stock-options grants that were dislosed late to investors. Glass Lewis found that in several instances the price of company shares increased materially between the purported grant date and the date of the filing.

One of the companies Glass Lewis identified in the report is Silicon Image. According to news reports (here), Glass Lewis found that several Silicon Image officers were late filing Form 4s in connection with options grants during 2004, 2005 and 2006. In 11 out of 12 grants during that period, Silicon Image’s stock price increased between the grant date and the (late) filing date. According to an October 31, 2006 San Jose Mercury News article (here), Silicon Image has launched an internal review of its option practices. The Glass Lewis Report cited eight other companies whose Form 4 filings showed a similar jump in share price between the grant date and the filing date.

Based on this analysis, Glass Lewis questioned whether the options timing scandal might be about to enter a “second act,” involving potentially “hundreds” of companies that may have backdated options grants even after the 2002 Sarbanes-Oxley reforms. The report also notes that even where the company’s Form 4 filing were unintentionally or inadvertently filed late, the company’s regulatory filing practices still raise concerns about the company’s internal controls.

It is too early to tell whether or not the Glass Lewis “second act” analysis really does portend a significant new phase in the options timing scandal. It is worth noting that the original trigger for the initial round of options backdating investigations was a similar academic analysis of options practices. And even though there are as yet no claims based on these kind of “second act” allegations, the possibility of these kinds of claims does pose a new challenge for D & O underwriters. The underwriters must now consider whether claims might yet arise based on allegations about post-2002 late Form 4 filings and stock price increases between the grant date and the filing date. Well-advised companies will take steps now to able during their D & O insurance renewal to substantiate the timeliness of their Form 4 filings, or in general to be able to respond to questions about their regulatory filing practices.

Update: A November 9, 2006 article in the Minneapolis Tribune (here) describes a lawsuit that has been filed against Digital River, raising options backdating allegations. The allegations are based in part on Digital River’s habit of being late with its Form 4 filings relating to options grants. Digital River is one of the nine companies named in the Glass Lewis study.

Options Backdating Litigation Update: The D & O Diary’s running tally of litigation arising from options timing allegations (here) was updated today. According to the current tally, 95 companies have been sued as nominal defendants in shareholders derivative lawsuits based on options timing allegations. The number of options timing securities fraud lawsuits stands at 20.

Photobucket - Video and Image HostingInside the Milberg Weiss Indictment: Readers who can’t get enough of the details surrounding the indictment of the Milberg Weiss firm and two of its partners will definitely want to read the October 31, 2006 Fortune article entitled “The Law Firm of Hubris, Hypocrisy & Greed”(here). The article is written by Peter Elkind, co-author of The Smartest Guys in the Room, the standard volume on Enron’s demise. The article contains detailed descriptions of the firm’s interaction with the “paid plaintiffs” identified in the indictment.

The article also has a fascinating account of the reaction of the key players to the criminal investigation, including in particular Mel Weiss. According to the account, as the possibility of indictment moved closer and as the firm’s negotiations with prosecutors to avoid indictment fell apart, Weiss “repeatedly assured the partnership that it faced no danger.” He refused to bring in an outside firm to investigate. He also refused to turn over decisions about the investigation to nontargeted partners. And in the final stages before the indictment, the firm remained controlled by “people in the crosshairs” (including Weiss) and so refused to meet prosecutors’ demands that might have averted the firm’s indictment. In other words, he was conducting himself as he has so often alleged that entrenched public company management behaves when management’s interests conflict with those of shareholders. Pretty ironic.

The Fortune article makes for some pretty interesting reading, and includes a more detailed account of the facts and circumstances surrounding the Cooperman painting insurance fraud scam and its connection to the Milberg indictment, about which I previously wrote here (my prior post includes pictures of the now infamous Cooperman paintings).

And Under No Circumstances Should You Read This Story: Read the story, here.

In an earlier post (here), I commented on the initative of the so-called Committee on Capital Markets Regulation to take a look at the impact of regulation on the competitiveness of the U.S. securities markets in the global marketplace. (The Committee has become known as the Paulson Committee because of the public support that Treasury Secretary Henry M. Paulson, Jr. has shown the Committee.) An October 29, 2006 New York Times article entitled "Businesses Seek Protection on the Legal Front," (here, registration required) takes a comprehensive look at the Committee’s efforts, and also reports some criticism that has already formed in anticipation of the Committee’s recommendations.

Although the Times article is a bit vague on the details, the article reports that the Committee is looking at a number of possible reforms, including proposals to limit the liability of accounting firms; to reduce the burdens of Sarbanes-Oxley; to limit "overzealous state prosecutions"; to curtail the ability of the Justice Department to force companies under investigation to withhold paying executives’ legal fees; and to limits abusive lawsuits by investors. The article reports that "to alleviate concerns that the new Congress may not adopt the proposals… many are tailored so that they could be adopted through rulemaking."

The article quotes one Committee member as saying that "the legal liability issues are the most serious…Companies don’t want to use our markets because of what they see as substantial and in their view excessive liability."

The article reports that among the issues under discussion is the possible revision or elimination of Rule 10b-5. The article says that Columbia Law Professor John Coffee (a member of the Committee) has recommended "that the SEC adopt an exception to Rule 10b-5 so that only the commission could bring such lawsuits against corporations."

In an October 30, 2006 Wall Street Journal op-ed piece entitled "Is the U.S. Losing Ground?" (here, registration required), two Committee members, R. Glenn Hubbard and John L. Thornton lay out their views of the Committee’s work. (Hubbard, who was Chairman of the Council on Economic Advisors under the current President Bush, is now dean of the Columbia Business School; Thornton, now chairman of the Brookings Institution, was President of Goldman Sachs). Among other things, the authors state:

The liability system can also affect the competitiveness of U.S. Markets. Firms are sometimes confronted with circumstances in litigation, including securities class action suits, where even a small probabability of loss, given the size of the claims, could result in bankruptcy. Consequently, companies often must agree to large settlements that result in reduced value for shareholders rather than pursuing a successful outcome on the merits of the case.

Clearly Hubbard and Thornton perceive securities litigation reform as a critical part of the Committee’s mission.

The Committee’s report has not yet been released (according to Hubbard and Thornton, it will be released on November 30), but the Committee’s work is already the target of criticism. The Times article quotes former SEC Commissioner and Columbia Law Professor Harvey J. Goldschmid as saying "It would be a shocking turning back to say that only the commission can bring fraud cases. Private enforcement is a necessary supplement to the work that the S.E.C does. It is also a safety valve against the potential capture of the agency by industry." Professor Peter Henning of the White Collar Crime Prof blog (here) notes that the proposal to have the SEC as the sole agent to enforce against securities fraud "would be truly radical because private actions far outnumber the enforcement cases filed by the SEC and some signicifant recoveries in private securities cases have provided relief to investors." Both Henning and Professor Larry Ribstein on his Ideoblog (here) note that the inherent limitations on the SEC’s resources suggests that the agency alone could not be expected to enforce the securities laws.

Economist and pundit Ben Stein has a much less reserved attack on the Paulson Committee’s anticipated work in his October 29, 2006 New York Times column entitled "Has Corporate America No Shame? Or No Memory?" (here, registration required). Among other things, Stein asks "Is it really right for prominent American executives, amid a host of scandals involving other executives looting their shareholders blind, to have the best and brightest of academe and the Street lobbying for less accountability to shareholders?" (More about Stein below.)

The Paulson Committee has clearly succeeded in attracting attention to its work. As a result, it is fair to describe its planned November 30, 2006 report as "much anticipated."

At one level, it is perfectly understandable that leading academics and business people are focused on the competitiveness of the U.S. securities markets. But there is something more than a little bit "off" with the timing. The unfolding options backdating scandal does not exactly provide the best backdrop against which to contend that what corporate American really needs right now is less regulation. Moreover, the SEC’s hands are already pretty full. I would be surprised if anyone there were really excited about taking over the work of the entire plaintiffs’ securities bar. (I also wonder when we will start to hear from the plaintiffs’ bar on these issues; I can’t imagine they are too thrilled to see the possibility that their livelihood would be entirely eliminated.)

The timing may be "off" in another significant respect. While the Committee plans to propose reform through regulation rather than legislation, the Nov. 7 elections could put a very interesting context around all of these efforts. If one or both houses emerge from the election with a Democrat majority, one or both houses of Congress could well perceive the Committee’s proposals for regulatory rather than legislative change as an effort by a lame duck administration to end run Congress and the democratic process. The Paulson Committee cannot pass itself off as bipartisan, and it would face all the challenges in Congress of identification with the current administration. Perhaps the Committee will anticipate these concerns when it puts its recommendations forward (it will have the advantage of knowing the election’s outcome before it releases its report).

But in any event, the Committee’s report will make interesting reading and could lead to some interesting developments. Stay tuned…

Update: An October 30, 2006 article on Reuters (here) contains the reactions of several promienent plaintiffs’ attorneys to the proposals to reform the securities laws. Bill Lerach is quoted as saying, "Securities lawsuits have fallen off sharply in the last few years and yet they want to further cripple them. Why? Because its the one effective weapon that shareholders have." Sean Coffey of the Bernstein Litowitz firm is quoted as saying, "The body isn’t even cold yet and they are already acting like there were no corporate scandals. It’s mind boggling."

Photobucket - Video and Image Hosting"The Curmudgeon’s Guide to Practicing Law": We here at The D & O Diary were delighted to see the WSJ.com Law Blog post of a very favorable review (here) of The Curmedgeon’s Guide to Practicing Law. The Guide was written by Jones Day partner Mark Herrmann, with whom I attended law school. (Not only that, his wife is my dentist.) The WSJ.com Law Blog describes the book as

a well-written and clear guide on how to be an effective law-firm associate. It’s also funny: Hermann writes as The Curmudgeon, a grizzled law-firm partner who has zero tolerance for such horrors as the passive voice, long string cites and sloppy billing records. Were this material covered in some big-firm internal handbook, it would surely bore us to tears. But Hermann’s cutting wit and lively writing bring to life such painful topics as how to write a brief, how to treat your assistant and how to take a deposition.

The WSJ.com Law Blog has posted a book excerpt here, reviewing the book’ s chapter on how to prepare a witness for a deposition.

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Bueller? Ben Stein actually launched his acting career ad-libbing as a high school economics teacher in the movie Ferris Bueller’s Day Off. A wave file of Stein’s now famous line ("Beuller? Beuller?") can be found here. Stein’s own parody of the Bueller scene can be found here.