Saturday, November 11, 2006

Individuals’ Contributions to Securities Lawsuit Settlements

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.

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