The year just ended was eventful in many ways.
Earthquakes, hurricanes, tornadoes, floods, blizzards and droughts were
scattered across the globe, and political unrest shook many countries. In a
year filled with such significant developments, events in the world of D&O
liability pale by comparison. But even if there were no earth-shaking events,
2011 was nevertheless an eventful year in the directors and officers' liability
arena. Here is my selection of the top ten stories from the world of D&O
1. M&A Litigation Becomes the Lawsuit of
Choice for Plaintiffs' Securities Attorneys: The traditional focus
for any discussion of D&O litigation exposure has been federal securities
class action litigation. But in recent years, there has been a shift in the mix
of corporate and securities litigation filings. Taking into account both federal
and state lawsuit filings, M&A-related lawsuits now
outnumber federal securities lawsuit filings and M&A-related litigation
is now the lawsuit of choice for many plaintiffs' securities attorneys.
As a result of legislative changes and U.S. Supreme Court
case law developments, "dispossessed plaintiffs' lawyers" (as one academic recently
put it) have been forced to seek an alterative business model. And M&A
litigation appears to be an attractive business model for many plaintiffs'
lawyers. Corporate defendants, eager to complete the underlying business
transaction, often are keen to settle these cases quickly. Settlements often
include a not insignificant provision for plaintiffs' fees.
The attractions of this business model is drawing
competition, as increasingly each merger transaction is attracting
multiple separate lawsuits, often filed in differing jurisdictions. The
jockeying between the plaintiffs' lawyers in the competing cases in multiple
jurisdictions has led to procedural complications and rapidly increasing costs
of defense. Delaware, the traditional forum for this type of litigation,
arguably now faced
with "market share" competition, is according to some under
pressure to show that it is not inhospitable to these kinds of lawsuits,
and even to support plaintiffs' fee awards (about which see more below).
Not only are both defense expenses and plaintiffs' fee
awards in merger objection suits mounting, but it is increasingly common for
M&A-related cases to result in cash settlements on an order of magnitude
often seen only in traditional securities class action lawsuits. Thus, the
Kinder Morgan case, settled in August 2010 for $200 million (refer here); the
Del Monte case settled in September 2011 for $89 million (refer here); the May
2010 ACS settlement was $69 million (refer here); and the
2011 Intermix Media settlement was $45 million (refer here).
The new M&A litigation model represents both a high
frequency and a high severity risk. The severity risk is particularly
acute given the exacerbating effects of escalating defense expenses and
rising plaintiffs' attorneys' fees. The bottom line is that it is no longer
sufficient to focus just on federal securities class action litigation. M&A
related litigation is an increasingly important part of the overall mix of
corporate and securities litigation. For anyone whose tasks include
understanding the risks and exposures associated with corporate and securities
litigation, this is an important development with significant
2. Chinese Take-Out: U.S.-Listed Chinese
Companies Hit With Class Action Securities Litigation: Every
year there seems to be one group or sector of companies that draws the unwanted
attention of plaintiffs' securities attorneys. During 2011, the hot sector was
U.S.-listed Chinese companies. There were 39 different U.S.-listed Chinese
companies hit with securities class action lawsuits during 2011, representing
nearly one-fifth of all securities class action lawsuit filings during the
year. Since January 1, 2010, there have been securities class action lawsuits
filed against 49 different Chinese companies.
This surge of litigation involving Chinese companies has
arisen out of accounting scandals, many of which were first revealed by online
of whom have short positions in the companies they are attacking. The Chinese
companies have attempted to deflect the assertions by charging that the attacks
are merely rumors started by interested parties with a financial incentive to
drive down the companies' shares prices. Fair or not, the online reports seem
to be leading directly to shareholder litigation, as in many cases the
shareholder plaintiffs' are simply quoting the online analysts' reports in
Obviously not all of these cases are meritorious and
indeed some of them have been dismissed (refer for example here).
On the other hand, other cases have survived the initial dismissal motions
(refer for example here).
Even in those cases in which the plaintiffs' claims survive the initial
pleading threshold, their claims stiff face substantial challenges, not the
least of which are problems involved with effecting service of process and in
conducting discovery in China, as well as deriving from the geographic
distances and language issues involved. (Refer here).
Eventually the plaintiffs' lawyers will simply run out of
Chinese companies to sue, but for now the phenomenon shows no sign of letting
up. During the second half of 2011, there were a total of 13 Chinese companies
sued in securities class action lawsuits in the U.S., including two in December
The recent litigation against the U.S.-listed Chinese
companies is a reminder of circumstance-specific events that can drive
securities class action lawsuit filings. Countless things determine litigation
activity levels, many of which cannot be captured or predicted in historical
filing data. Simply put, the numbers vary over time, because, for example,
contagion events and industry epidemics happen.
3. Massive Settlements Emerge as the Subprime
and Credit-Crisis Litigation Wave Slowly Plays Out: The
subprime and credit crisis-related litigation wave is about to enter its sixth
year. Though there were additional credit crisis-related lawsuit filings during
2011, the arrival of new cases seems to have largely come to an end. However,
there is still a massive backlog of cases filed over the last five years that
is yet to be resolved. During 2011, a number of these cases were settled, and
in some cases the settlements were massive.
The 2011 settlements include the largest so far in
subprime and credit crisis-related cases, the $627 million Wachovia bondholders
settlement, about which refer here.
Other settlements include the following: Merrill Lynch Mortgage Backed
Securities, $315 million (refer here);
Lehman Brothers offering underwriters settlement, $417 million (refer here);
Washington Mutual, $208.5 million (refer here);
Wells Fargo Mortgage Backed Securities, $125 million (refer here);
National City, $168 Million (refer here);
Colonial Bank, $10.5 million (refer here);
and Lehman Brothers executives, $90 million (refer here)
and E*Trade, $79 million (refer here).
If you include the Lehman Brothers' offering
underwriters' settlement, the various subprime and credit crisis lawsuit
settlements total about $4.432 billion. The average settlement so far is about
$110 million, although that figure is clearly driven upward by the largest
settlements. If the Countrywide, Wachovia bondholders and Lehman offering
underwriters' settlements are removed from the equation, the average settlement
drops to about $74.7 million.
As impressive as these settlement numbers are, there are
still many more cases pending. Of course, a certain number of the pending cases
will ultimately be dismissed. But many will not, and eventually those remaining
cases will be settled. Although it is impossible to conjecture how large the
total tab for all these cases ultimately will be, the implication from the
cases that have settled is that the total amount will be massive.
The possibilities here may have significant implications
for D&O insurers. Of course, not all of these amounts will be covered by
D&O insurance. But a significant chunk will be. Indeed, a number of the
recent settlements will be funded entirely or almost entirely by D&O
insurance, including the D&O portion of the WaMu settlement, the Colonial
Bank settlement, the E*Trade settlement and the Lehman Brothers executives'
settlement. Interestingly, the Lehman executives' settlement will come close to
exhausting what is left of Lehman's $250 million insurance tower.
In other words, the D&O insurers have had some very
large bills to pay. Signs are that there will be further amounts due in the
4. Costs Incurred in Connection with Informal
SEC Investigation Held Not Covered: One of the perennial
D&O insurance coverage questions is whether or not a D&O insurance
policy provide coverage for defense expenses and other costs incurred in
connection with an informal SEC investigation. In October 2011, in a case that
was closely watched in the D&O insurance industry, the Eleventh Circuit
a per curiam opinion affirming a lower court holding that costs Office
Depot had incurred in connection with an informal SEC investigation and
investigating an internal whistleblower complaint were not covered under its
D&O insurance policies.
The sheer dollar value of the costs for which Office
Depot had sought coverage underscores the extent of the problems involved.
Office Depot had incurred tens of millions of dollars in expense before the SEC
investigation became formal. Under the circumstances presented and based on the
policy language at issue, the district court held and the Eleventh Circuit
affirmed that Office Depot did not have insurance coverage for these costs. The
holding was a reflection of the specific policy language at issue, but D&O
insurers undoubtedly will try to rely on the holding in other circumstances in
which coverage is sought for costs incurred in connection with informal SEC
Meanwhile, the insurance marketplace has evolved in
recognition of policyholders' interest in having insurance coverage for the
costs of informal SEC investigations. Recently, some carriers have been willing
to provide coverage for costs individuals incur in connection with informal SEC
investigations. In addition, at least one carrier now offers a
separate insurance product that provides coverage for costs that the entity
itself incurs in connection with an informal SEC investigation. Although this
entity protection for informal SEC investigative costs is subject to a large
self-insured retention and to coinsurance, the fact remains that if such a
policy had been available to Office Depot and if Office Depot had had such a
policy in place, at least a significant part of Office Depot's costs of
responding to the informal SEC investigation might have been covered.
Policyholder advocates undoubtedly will take the position
that the Eleventh Circuit's opinion in the Office Depot case does not represent
the final word on the question of D&O insurance coverage for costs incurred
in connection with informal SEC investigation. In making these arguments, the
policyholder advocates undoubtedly will seek to rely on the Second
Circuit's July 2011 opinion in the MBIA case, in which the court held that
costs incurred in voluntarily responding to a governmental investigation are
covered. (The MBIA case is itself also a reflection of the policy language
involved and circumstances presented, including in particular the fact that
most of the costs at issue were incurred after the SEC had issued a formal
investigative order, by contrast to the Office Depot case, where most of the
costs were incurred before the investigation was formalized.)
These questions undoubtedly will continue to be disputed
and even litigated. But it will be interesting to see how the marketplace
continues to evolve as the industry continues to try to craft solutions to this
5. FDIC Litigation Against Failed Bank
Directors and Officers Slowly Emerges: Since January 1, 2008, there
have been 414
bank failures, including 92 in 2011 alone. Though the number of bank
closures this past year represents a decline from the prior year's total of
157, the likelihood is that there are further bank failures ahead in 2012,
albeit at a reduced pace from recent years. (The January 3, 2012 Wall Street
that "failures will be a part of the landscape for many months, maybe years, as
weak banks take a long time to recover or fail.") But even if the number of new
bank failures may finally be starting to decline, the FDIC's pursuit of
litigation against the directors and officers of failed banks may just be
During 2011, the FDIC stepped up its failed bank
litigation activity. The FDIC filed 15 lawsuits against directors and officers
of failed banks in 2011, bringing the total number of FDIC failed bank lawsuits
to 17. Signs are that the number of FDIC lawsuits will continue to grow in the
months ahead. According to the FDIC's website,
as of December 8, 2011, the FDIC has authorized suits in connection with 41
failed institutions against 373 individuals for D&O liability for damage
claims of at least $7.6 billion. These figures representing the authorized
lawsuits contrast starkly with number of lawsuits that the agency has actually
filed: So far, the agency has filed only 17 lawsuits against 135 former
directors and officers of 16 failed financial institutions. Given the
discrepancy between the number of suits authorized and the number of suits
filed, there clearly are many more suits in the pipeline, with even more
lawsuits likely to be authorized in the months ahead.
As the FDIC's failed bank lawsuits have begun to emerge,
settlements of these cases are also slowly developing. The most noteworthy of
the settlements so far is the well-publicized resolution of the FDIC's lawsuit
against three former WaMu officers. Although widely
reported as having a value of $64.7 million, the cash value of the
settlement was actually about $40 million, as discussed here.
All but a very small portion of the cash component was paid for out of WaMu's
directors and officers' insurance coverage. Although it is interesting
that the individual defendants were called upon to contribute out of their own
assets toward the settlement, the fact is that D&O insurance represented
almost all of the cash component of the settlement.
The point here is that as the FDIC failed bank lawsuits
accumulate in the coming months and as the filed cases move toward resolution,
D&O insurers could be called upon to contribute amounts toward defense and
resolution of these cases that in the aggregate could be massive.
6. Eurozone Crisis Includes Corporate Liability
Exposures: The financial crisis gripping the European economic community has
many dimensions. As governments wrestle with concerns about sovereign debt of
Eurozone countries, as well as unemployment and unrest, companies exposed to
European sovereign debt face perils of their own. As the
fallout from the collapse of MF Global demonstrates, the hazards these
companies face include, among many other concerns, liability exposures stemming
from the companies' investments in European sovereign debt.
Among the many disturbing features of MF Global's demise
is the speed of its collapse. And inevitably its collapse was immediately
followed by an onslaught
of securities class action lawsuit filings against the firm's directors and
officers. MF Global collapsed because of its exposure to European sovereign
debt. The company is of course far from the only enterprise exposed to European
debt. A host of other financial institutions and banks are also exposed and
many more enterprises are exposed to the companies with European debt exposure.
The possibility of sovereign debt rating downgrades or even debt write-offs
looms over the firms carrying these assets on their balance sheets.
Though the larger problems for the global financial
marketplace clearly are of a much higher order, these issues also pose a
challenge for D&O insurance underwriters. As noted above, there is not just
the question of whether or not a company is exposed to European sovereign debt.
There is also the far more difficult to discern question of whether or not a
company is exposed to a company that is exposed to European sovereign
debt. If the European difficulties were to evolve from a crisis to a disaster
- for example, though the withdrawal of one or more countries from the
Euro - the aftereffects could be even more widespread. As MF Global's rapid
demise illustrates, these kinds of concerns are sufficient to quickly send a
company into bankruptcy.
There is no way to know for sure, but I suspect strongly
that as the New Year progresses, there will be a lot more to be said about
European sovereign debt risk, at both the global and individual company levels.
7. Whistleblower Rules Go Into Effect,
Whistleblower Lawsuits Emerge: The SEC
issued its implementing regulations with respect to the Dodd-Frank
whistleblower provisions in August 2011. In November 2011, the agency released
report to Congress, as required by the Dodd-Frank Act, on whistleblower
activities, as of the end of the 2011 fiscal year end on September 30, 2011.
Though the SEC's report reflected only a seven week time
period, it revealed a heightened level of whistleblower reporting. In just the
first seven weeks, the program recorded 334 whistleblower reports, which
implies an annualized level of nearly 2,500 reports. Interestingly, about 10
percent of all whistleblower reports during the period reflected in the study
originated outside the United States. The SEC made no whistleblower bounty
payments during the period reflected in the study, as permitted under the
Dodd-Frank Act. It seems likely that as the agency makes bounty payments
additional whistleblowers will be motivated to come forward.
With the implementation of provisions for potentially
rich whistleblower bounties under the Dodd-Frank Act, there have been concerns
that the incentives will not only lead to increased numbers of reports and
increased enforcement activity, but that the regulatory action will in turn
generate follow-on civil litigation. As discussed here,
a December 2011 securities class action lawsuit filed against Bank of New York
Mellon give a glimpse of how heightened whistleblower activity could lead to
increased follow-on civil litigation.
The lawsuit followed whistleblower reports that the
company engaged in a scheme to fraudulently overcharge its customers for
foreign currency exchange transactions. Although the whistleblower allegations
first emerged in separate whistleblower lawsuits, the foreign currency exchange
allegations are also the subject of whistleblower
reports to the SEC. In addition to the securities class action lawsuit, the
whistleblower allegations have also triggered multiple regulatory actions. The
train of events that the BNY Mellon whistleblower allegations set in motion
shows how the revelation of whistleblower allegations can lead not only to
significant regulatory action but also to significant follow on civil
Given the substantial bounties for which the Dodd-Frank
Act provides, it seems likely there will be increased numbers of reports to the
SEC, which in turn could mean increased levels of enforcement activity. Along
with all other concerns these possibilities present, there is also the concern
that the increased number of reports and increased enforcement activity could,
following the same sequence illustrated in connection with the BNY Mellon
whistleblowers, lead to a surge in follow-on civil litigation. As we head into
2012, we will have to watch whether increased whistleblowing will lead to
increased follow-on civil litigation, similar to the suit against BNY Mellon.
8. Aggrieved Overseas Investors Seek
Litigation Alternatives Outside the United States: For
many years, the United States was the forum of choice for aggrieved investors
to seek redress, regardless of whether or not the investors purchased their
shares in the United States. However, the U.S. Supreme Court's June 2010
decision in Morrison v. National Australia Bank abruptly and
unexpectedly eliminated access to U.S. courts for investors who purchased their
shares outside the U.S. As a result, these investors increasingly are seeking
alternative means to pursue their claims. Though we are still in the earliest
days following the Morrison decision, there seem to be significant indications
that aggrieved investors are developing a
new playbook that includes resort to non-U.S. courts.
Investors' pursuit of claims outside the United States
was not long in coming after the Morrison decision and as its
implications began to emerge in the lower U.S. courts. For example, in January
2011, after investors' claims in U.S. court against Fortis were
dismissed based on the Morrison decision, investors filed
an action in Dutch court seeking remedies under Dutch law, but raising the
same allegations that previously had been asserted in U.S. courts. Similarly,
in December 2011, hedge funds and other investors whose action against Porsche had
been dismissed from U.S. courts based on Morrison filed
an action raising the same allegations against the company and its
management in a German court.
Developments in other jurisdictions also reflect
investors' efforts to develop alternative remedies in the absence of access to
U.S. courts. Among other things, at
least two class actions pending in Canadian courts have not only survived
dismissal motions but have had global classes certified. As discussed here,
investors have also shown a willingness to pursue claims in a variety of other
countries, including, for example, Germany and Australia. Recent statutory
amendments in other countries (including, in particular, Mexico) may lead to
investors in those countries to seek to pursue claims there.
Increased litigation and regulatory exposure outside the
United States has a variety of implications, not the least of which concerns
D&O insurance. As companies and their directors and officers face increased
exposures on a global basis, D&O insurance policies will be called upon to
respond in new and unusual situations. These developments in turn will require
policies that are well adapted to the changing circumstances.
9. Judge Rakoff Rejects Settlement of SEC
Enforcement Action Against Citigroup: Southern District of New
York Judge Jed Rakoff's November
2011 rejection of the $285 million settlement of the SEC's enforcement
action against Citigroup was not the first occasion on which Rakoff rejected a
proposed SEC settlement. But this latest rejection has caused
quite a stir, and not only because of the sharp rhetoric he used in
rejecting the settlement (among other things, he derided the settlement because
it "shortchanged" investors.) The most significant aspect of Rakoff's rebuff is
his refusal to accept a settlement in which Citigroup neither admitted nor denied
the SEC's allegations.
The SEC, perhaps stung by the Rakoff's sharp words, and
even more concerned about the possibility that it might be constrained from the
entry into future no admit/no deny settlements, has appealed
Rakoff's ruling to the Second Circuit. The SEC is right to be
concerned about the implications of Judge Rakoff's ruling. Following Judge
Rakoff's ruling, at least one other
court has questioned a proposed SEC settlement that contained the "neither
admit nor deny formulation."
The problem for the SEC is that if proposed settlements
cannot be approved unless the target defendants admit to wrongdoing, it may
become significantly more difficult to settle cases and the SEC will be forced
to take more enforcement actions to trial. This would not only put an enormous
strain on the agency's resources, but it could result in an overall reduction
in the agency's enforcement reach as it is forced to concentrate both more time
and means on fewer enforcement actions.
The inability to enter into a no admit/no deny settlement
presents a highly unattractive picture for target defendants as well. If fewer
enforcement actions settle and more enforcement actions are forced to trial,
the costs of defending an SEC enforcement action could escalate substantially.
Target defendants unable to avoid the risks and uncertainty of trial without
admitting wrongdoing will have to consider the possible effects of any
admission on separate private civil actions. Any admissions in the enforcement
actions could undermine their defenses in the separate civil actions. Moreover,
depending on what is admitted, the admissions could have the further also
undermine the target defendant's insurance coverage by triggering a conduct
exclusion on the defendant's insurance policy.
For these and a host of other reasons, the SEC's appeal
of Judge Rakoff's ruling to the Second Circuit will be very closely watched.
Crucially, however, the
Second Circuit has not yet agreed whether or not it will actually hear the
appeal of Judge Rakoff's ruling. In additiona, there is always the possibility
that Citigroup and the SEC will reach an agreement that Judge Rakoff finds
acceptable (a footnote in his opinion rejecting the initial settlement does lay
out a schematic for a settlement that would be acceptable to him, as I discuss here).
Depending on how it all finally goes down, this case has the potential to be
one of the top stories of 2012, as well.
10. A Big Fee Award in Delaware Gets
Everybody's Attention: Sometimes in litigation, a case that
results in a big number is interesting in and of itself. And on that score,
Delaware Chancellor Leo Strine's October
2011 post-trial damages award of $1.263 billion in a lawsuit arising out of
Grupo Mexico's 2005 sale of Minerva Mexico to Southern Peru Copper Corporation
certainly qualifies as interesting. (The later addition of pre-judgment and
post-judgment interest increased the amount of the award to $2 billion). But
what really has drawn attention to the case is Strine's award to the
plaintiffs' of fees amounting to 15% of the damages and interest - that is,
$300 million. A December 28, 2011 Wall Street Journal article entitled
"Christmas Comes Early for These Lawyers" (here)
describes the award.
As noted in a December 28, 2011 WSJ.com Law Blog
the $300 million fee award may be the largest fee award ever in a shareholders'
derivative suit. Indeed it appears to be one of the largest fee awards in any
corporate or securities case, approaching in order of magnitude the awards in
the massive Enron and World Com cases (where the fees awarded were $688 million
and $336 million, respectively).
Grupo Mexico undoubtedly will appeal both the damages
award and the fee award. Whether or not the $300 million award ultimately
withstands scrutiny, there are reasons to be concerned about the award. As
noted above with respect to M&A litigation, Delaware's courts are facing
competition and appear to have been losing "market share" for corporate
litigation. At least some interpreters have concluded, as reported in the Journal
article linked above, that the plaintiffs' fee award is a not-so-subtle signal
to plaintiffs' lawyers that Delaware's courts are "open for business." Other
interpreters suggested that the fee award represents a "message to the
It is an obvious concern if Delaware's judges feel
obliged -- in order remain competitive in the jurisdictional competition and to
try to preserve declining corporate litigation market share -- to prove that
plaintiffs' lawyers will be rewarded for resorting to the state's courts.
Bloggers of the World, Unite!:
Everyone here is pretty much reconciled to the fact that writing a blog is not
exactly accorded equal dignity with, say, writing for The New Yorker.
So we were all very gratified by the article in December 31, 2011 issue of The
Economist entitled "Marginal Revolutionaries" (here), in whch the magazine
reports that "the financial crisis and the blogosphere have opened up mainstream
economics to new attack." Among other things, the article cites "the
power of blogging as a way of getting fringe ideas noticed." The
article recounts the experiences of the "invisible college of
bloggers" whose revolutionary economic analyses have moved from the
fringe to become part of the central economic dialog of our times.
In the immortal words of the theme song of
revolutionaries everywhere , "Allons enfants de la patrie, Le Jour de
gloire est arrivé!"
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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