The short week after the July 4th holiday is
usually quiet. There certainly did seem to be less traffic on the roads. But
nevertheless, there was news of note this past week on several stories we have
been following, as discussed below. The traffic on the roads may have slowed
but the circulation on the information superhighway continued unabated.
Pace of Bank Failures Slows - But More
Closures Loom: Earlier this year (refer here),
I had noted that it seemed as if the pace of bank failures had finally started
to decline. As discussed in a July 9, 2011 Wall Street Journal article (here),
the pace of bank failures did indeed slow in the first half of 2011,
compared both to the equivalent period a year ago as well as to the second half
of last year. There were 48 bank failures in the first half of 2011, compared
to 74 in the second half of 2010 and 86 in the first half of 2010.
This slowdown is consistent with the FDIC's projections.
The agency had previously
indicated that it believed 2010 would represent a high water mark for bank
failures. But while the pace of bank closures has finally started to slow, the
wave of bank failures is far from finished. As I noted here,
the FDIC's most recent Quarterly Banking Profile, released in May, showed that
the number of "problem institutions" was a record levels, a situation that the
Journal article characterized as representing a "backlog" of troubled banks.
The FDIC reported that as of the end of March 31, 2011 there were 888 "problem
And while the 48 bank failures in the year's first half
represents a decrease compared to recent periods, that figure still represents
a sizeable number. By way of comparison, in 2008, when the financial crisis
reached its crescendo, there were only 25 bank failures. Moreover, it is clear
that bank failures will continue for the foreseeable future, even if at reduced
levels from a year ago. Indeed, on Friday evening - the first Friday of the
year's second half - the FDIC took control of
three more institutions.
The Journal article quotes one commentator as
saying that historically about 19% of the banks on the FDIC's problem list wind
up failing, which implies about 169 bank failures after March 31, 2011. Since
22 banks failed in the second quarter of 2011, that would suggest that there
may be about 147 bank failures yet to go. The completion of the current
bank closure process could, according to a source cited in the Journal
article, take about two more years. As another commentator quoted in the
article put it, the process is about in "the seventh inning" of the cycle of
Though the bank closure process may now be slowing and
will run its course in time, the mopping up process may only have just begun.
Allowing for the extensive post-mortem that follows each failure, and the
attendant lag time before the FDIC initiates litigation against the directors
and officers of failed banks, the era of failed bank litigation may just be
getting started. If the wave of bank failures is in the seventh inning, we are
much earlier in the bank litigation wave ball game. Refer here
for my recent review of the details surrounding the failed bank litigation.
U.S. Investors Are Not the Only Ones
Concerned About Chinese Company Accounting Scandals: As
various accounting scandals involving U.S.-listed Chinese companies have
emerged, shareholders have launched a series of lawsuits in the U.S. against
the companies and their senior officials, as I have previously
noted on this blog. It turns out that U.S. investors are not the only ones
upset about the problem involving Chinese companies.
A July 8, 2011 Bloomberg article (here)
examines the concern that investors in Singapore have about Chinese companies,
based on the various accounting issues that have come to light. Among other
things, the article states that since 2008, more than ten percent of the
Chinese companies listed on the Singapore stock exchange have been delisted or
had trading in their shares suspended. The article also reviews investor
concerns that executives of Chinese companies are outside the reach of
Singapore enforcement authorities.
The crescendo of voices raising concerns about the
Chinese companies may be being heard in China itself. News reports this past
week (refer here)
suggest that officials from the SEC and the PCAOB will be meeting with their
Chinese counterparts this upcoming week to discuss the possibility of allowing
the U.S. regulators to investigate Chinese companies and Chinese audit firms
for the first time.
In the meantime, however, the wave of lawsuits in the
U.S. involving U.S.-listed Chinese companies continues to mount. The latest
lawsuit involves A-Power Energy Generation Company, which obtained its
U.S. listing by way of a reverse merger with a U.S. listed publicly traded
shell company. According to their July 5, 2011 press release (here),
plaintiffs' counsel have filed a securities class action lawsuit in the
District of Nevada against the company and certain of its officers. The
complaint (which can be found here), refers to
reports describing the company's auditors concerns about weaknesses in the
company's internal controls and differences between financial figures the
company reported to Chinese regulatory source compared to those reported in the
company's SEC filings. On June 28, 2011, the company announced (here)
that its auditor had resigned because of the company's failure to hire an
independent forensic accountant to investigate certain business transactions.
With the arrival of this latest lawsuit, there have now
been a total of 27 securities class action lawsuits filed against U.S. listed
Chinese companies so far in 2011, representing about one-quarter of all 2011
securities lawsuit filings in the U.S.
One variation on this litigation theme has arisen in a
separately filed securities suit that has been brought as an individual action
rather than as a class action. As discussed in Jan Wolfe's July 5, 2011 Am
Law Litigation Daily article (here).
Starr International has amended its
securities suit against China MediaExpress Holdings and certain of its
directors and officers to include as defendants three American businessmen who
helped the company obtain its U.S. listing by way of reverse merger.
While there have been calls
to reform the reverse merger process, particularly for foreign companies,
if the functionaries that make the process possible are going to find
themselves hauled into litigation involving the companies they help to go
public, the reverse merger process may cease to exist as a means for non-U.S.
companies to use in order to process the more conventional method of going
public. In any event, in the current climate, it seems likely that there would
be much investor interest in shares of foreign domiciled companies that
obtained their U.S. listings by way of a reverse merger.
Variation on the Auction Rate Securities
Concerns: There have been extensive developments recently
involving financial companies involved with marketing or selling auction rate
securities, as Tom Gorman summarized in a July 5, 2011 post on his SEC
Actions blog. But a new adversary action filed in the Land American
Financial Group bankruptcy proceeding shows an interesting variation on the usual
auction rate securities litigation theme.
As discussed at length in the bankruptcy trustee's June
24, 2011 complaint (here), Land
America had a division ("LES") whose purpose was to facilitate tax-advantaged
land swaps. In essence, a property seller could "park" the proceeds of a land
sale with LES until an appropriate land swap counterparty emerged, allowing the
"exchange" to take place. The property sales proceeds were invested during the
holding period. According to the complaint, beginning in about 2003, LES
invested a substantial portion of the proceeds in auction rate securities. When
the auction rate securities market froze up in 2008, 41% of LES's assets were
tied up in auction rate securities. The failure of the auction rate securities
market eventually created a liquidity crisis for LES and for its parent
company. The liquidity crisis, according to the complaint, was a substantial
cause in the demise of the parent company.
According to the complaint, the parent company (LFG) "met
its demise because the LFG and LES directors and officers failed to properly
inform themselves and failed to consider and implement any timely action to
mitigate the effects of the LES liquidity crisis. These failures caused LFG and
its stakeholders to incur hundreds of millions of dollars in damages."
As discussed in this July 8, 2011 Richmond Biz Sense
the bankruptcy trustee is seeking damages of $365 million in the action , which
names 21 former Land America directors and officers as defendants. The article
quotes sources as saying that "the purpose of the suit is to trigger insurance
policies that protect executives and directors in such instances."
Though the lawsuit itself may be an unremarkable
bankruptcy-related effort to snare D&O insurance proceeds for the benefit
of the bankruptcy estate, the allegations themselves represent an interesting
variation from the usual action rate securities allegations. The typical
auction rate securities lawsuit involves allegations by the securities buyer
against the firm that sold the securities. Here the allegations are brought
against the buyer's own company officials in connection with the purchases.
These kinds of auction rate securities allegations are
not unprecedented - as I have previously noted (for example, here),
there have been prior lawsuits brought against the auction rate securities buyers
rather than the sellers. The fact that these kinds of complaints are
continuing to arise even critical events of the financial crisis continue to
recede into the past suggests that while time may have passed, the critical
effects of the crisis remain. And the lawsuits continue to mount.
Special thanks to a loyal reader for forwarding the news
article about the Land America case.
Second Circuit Rules out RICO Claims Against
Securities Fraud Aiders and Abettors: One of the interesting
questions is whether private claimants, foreclosed from pursuing claims against
third parties for aiding and abetting securities law violation, could pursue
their aiding and abetting claims against the third parties under RICO. In a
July 7 decision (here),
in a case captioned MLSMK Investment Company v. J.P. Morgan, the Second
Circuit held that the aggrieved investors cannot pursue the aiding and abetting
claims under RICO.
Alison Frankel has an excellent summary of the legal
issues and of the holding in her July 8, 2011 article on Thompson Reuters
News & Insight (here).
As Frankel's article discusses, the case has mostly drawn attention for its
connection to the Madoff scandal and for its implications for the Madoff
trustee's pending claims against certain litigation targets. However, as she notes,
the case does "far more" - it "forecloses the only possible route to recovery
through federal court for securities investors suing defendants who help a
company engage in securities fraud." Frankel's interesting article details the
larger significance of the decision.
Special thanks to the several loyal readers who called
this decision to my attention and for sending me a link to Frankel's article.
other items of interest from the world of directors & officers liability,
with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.
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