Cornerstone Releases Study of 2006 Securities Class Action Settlements
On March 21, 2007, Cornerstone Research released its analysis of 2006 securities class action settlements (here). Cornerstone had previously released its study of 2006 securities class action filings (here). NERA Economic Consulting also previously released its analysis of 2006 securities class action filings and settlements (here). Cornerstone’s study differs in some details from the NERA report but the two studies are directionally consistent. The Cornerstone study also includes some interesting additional observations and conclusions.
The most significant conclusion of the Cornerstone study is its observation that the aggregate value of all 2006 settlements was $17.1 billion, an all-time high, and that even excluding the massive Enron settlement, the remaining $10.6 billion was still an all-time high, exceeding 2005’s previous high of $9.4 billion. The 2006 record high was primarily driven by an increase in average settlements, which in turn was driven by the presence of multiple settlements in excess of $1 billion. These mega settlements are part of a group of 14 cases that settled for $100 million or more.
These large settlements led to a 2006 average settlement of $100.6 million (excluding the Enron settlement), compared with a 1996-2005 average of $22.6 million (adjusted for inflation and excluding the WorldCom and Cendant settlements). If the excluded cases are included, the 2006 average is $180.6 and the 1996-2005 average (adjusted for inflation) is $36.2 million. If the five 2006 settlements over a billion are excluded, the 2006 average settlement is $45 million.
But while the mega cases were driving up the average settlement, settlements in smaller cases did not change that much from prior years. 60% of all 2006 settlements were below $10 million, and the 2006 median settlement of $7.0 million is close to the $6.7 million median during the period 1996-2005.
The 2006 settlement data may reflect a peak of sorts. According to Stanford Law Professor Joseph Grundfest's comments in Cornerstone's press release about the study, (here), “2007 is virtually certain to generate a far smaller aggregate settlement amount.” This is largely because the bulk of the mega cases have worked their way through the system, as a result of which, according to Grundfest, “aggregate settlement amounts have only one way to move, and that’s down.” Grundfest noted that “because a smaller number of cases are now being filed and because these cases involve smaller market losses, I wouldn’t be surprised if the aggregate annual settlement statistics fall dramatically over a period of several years.”
The Cornerstone study also notes a number of specific factors that appear to affect settlement amounts:
Section 11/Section 12(a)(2) Claims: These allegations appear in about 20% of lawsuits, and appear to result in increased settlements. During the period 1996 to 2006, lawsuits with Section 11/Section 12 (a)(2) claims settled for 4.2% of estimated damages, compared to 3.3% for lawsuits with no Section 11/Section 12 (a)(2) claims.
Institutional Investors: Institutional investors are serving as lead plaintiffs in an increasing number of class actions, and served as lead plaintiffs in 50% of all cases settled in 2006. Cases with institutional investors have significantly higher settlement amounts, but that raises a question whether institutions choose to participate in cases with stronger merits or higher potential damages. But even when the data is controlled for these factors, “the presence of an institutional investor results in a statistically significant increase in settlement size.” For example, the median settlement for a case with an institutional investor lead plaintiff in 2006 was $9.0 million, compared with $4.3 million in cases without an institutional investor lead plaintiff. (For a more extensive discussion of the impact of institutional investors as lead plaintiffs, see my prior post, here.)
Derivative Actions: The number of cases with companion derivative actions is increasing, and an accompanying derivative action appears to correlate with a higher class action settlement (perhaps because accompanying derivative actions are most likely when investor loss is greater or the allegations are most serious). During the period 1996 to 2006, the median class action settlement in class actions with accompanying derivative cases was $13.8 million, compared to $5.1 million for cases without accompanying derivative settlements.
SEC Actions: Over 20% of post-Reform Act securities class actions are accompanied by SEC enforcement actions. Class actions with accompanying SEC enforcement actions tend to result in larger settlements (again, perhaps because the SEC Actions are most likely to arise in cases with the most egregious facts). During the period 1996 to 2006, the median settlement in class actions with accompanying SEC actions was $11.0 million, compared to $6.5 million for cases without SEC actions.
Bankruptcy: Over 35% of settlements involved companies that had filed for bankruptcy or had their stock delisted. But settlements of cases involving distressed companies resulted in smaller settlement. The median settlement during the period 1996 to 2006 for a distressed company was $5.3 million, compare to a median settlement for non-distressed companies of $6.8 million.
Opt-Outs: The Cornerstone study notes what “might be the beginning of the trend of an increase in ‘opt-out’ plaintiffs.” But other than noting the (potential) trend, the study does not report or comment on the opt-out cases, undoubtedly because the momentum in opt-out settlements didn’t really get going until 2007.
For whatever it may be worth, I note that the prevalence of opt-out settlements may prove to be a factor that cuts against a decline in securities fraud lawsuit severity, notwithstanding Professor Grundfest’s comments about the probably decline in the size of class action settlements. The D & O Diary’s prior comments about the effect of opt-out settlements in severity can be found here and here.
One final interesting detail: according to the Cornerstone study, the aggregate amount paid in securities class action settlements between 1996 and 2006 is $43.69 billion. That of course does not include defense expense and amounts paid in settlement of SEC actions, or fines or penalties.
My prior analysis of the 2006 securities class action filings and settlements can be found here.
My prior post about Cornerstone’s study of 2006 securities class action filings can be found here. My prior post about the 2006 NERA study can be found here.
Options Backdating Litigation Update: With the addition of the Wireless Facilities securities fraud lawsuit (here), the count of companies that have been sued in securities class action lawsuits based on options backdating allegations now stands at 29. The number of companies named as nominal defendants in shareholders derivative suits stands at 154. The D & O Diary’s running tally of the options backdating lawsuits can be found here.
The Securities Litigation Watch is also maintaining a count of the options backdating related securities lawsuits, which can be found here.
A Break in the Action: There will be a break in The D & O Diary’s publication schedule over the next few days. Normal publication will resume after April 1.
Another Call to Eliminate Private Securities Lawsuits
Amidst the current clamor over the competitiveness of the U.S. financial markets, a recurring theme has been the burden on the financial markets of U.S. litigiousness. One variant of this theme that has gotten air time is the idea that private securities lawsuits should be eliminated. The most prominent proponent of this idea is Stanford Law School professor Joseph Grundfest, whose Wall Street Journal op-ed piece on this topic (here, subscription required) was the subject of a prior D & O Diary post (here).
The editorial page editors at the Journal clearly like this particular idea, because on March 20, 2007, they ran a second op-ed piece on this same topic, this one (here, subscription required) entitled "Capital Complaints," by Peter Wallison of the American Enterprise Institute. (Wallison served as White House counsel during the Reagan administration.)
Wallison’s article starts with the notion that the "financial pre-eminence of the U.S. is eroding," and if "you listen closely to what foreign and U.S. business and financial people are saying, there’s one central cause – private class action enforcement of the SEC’s Rule 10b-5." Wallison invokes a parade of horribles weighing on U.S. competitiveness, each component of which "is exacerbated by class action risk." The solution, according to Wallison, "is restoring what Congress originally intended – enforcement of Rule 10b-5 only by the SEC."
I have previously reviewed elsewhere (here) the reasons why an SEC monopoly on enforcement of the securities laws is not necessarily in investors’ best interests. Essentially, I believe that private investors ought to have the ability to seek redress of their grievances without having to depend on an over-burdened SEC to enforce their rights. And while Congress may not have originally put an explicit private right of action in the securities laws, during the decades since the courts first implied a private right of action, Congress has revised the securities laws multiple times but has never gone back to legislatively prohibit private lawsuits.
The most significant problem I have with Wallison’s article is its very premise, that the most significant cause in the erosion of U.S. financial markets is the existence in the U.S of private securities class action lawsuits. Would foreign companies view the U.S more favorably if they "only" had to worry about the SEC? And as I have discussed at length previously (most recently, here and here), the causes of the increased competitiveness in the global financial marketplace are myriad, diverse, and subtle, and have more to do with the growth overseas capital and the increased sophistication of overseas markets.
The only evidence that Wallison cites for his premise that the existence of private securities lawsuits is undermining U.S. competitiveness is his assertion that the cause is apparent if "you listen closely to what foreign and U.S. finance people are saying." I don’t doubt that this particular notion may have a certain currency in certain circles, and that people who talk to each other all the time have persuaded themselves, but that does not make it true. If you look at what companies are doing rather than what "finance people" are saying, the picture looks quite a bit different.
For example, if Wallison’s premise were true, you would think there would be evidence that foreign companies were fleeing the U.S. because of the threat of litigation. While the evidence shows that some companies are, indeed, leaving the U.S. securities markets, it is not for the reasons Wallison cites.
A March 19, 2007 CFO.com article entitled "Bluff or Bluster?" (here) takes a look at delistings from U.S. exchanges, and concludes that "predictions of mass delistings have failed to materialize" and the companies "that have delisted rarely cite onerous regulation." Of the 12 European companies that delisted from the NYSE in 2006, "nine were because the company was taken over." Of the remaining three, one (Vivendi) delisted to save costs because its trading volume was virtually nonexistent; one, Tatneft, and energy company controlled by the Russian state of Tatarstan, delisted after failing to submit audited financials; and one, Espirito Santo Financial, a Luxembourg-based company that delisted because its trading volume on Euronext was six times greater than on NYSE.
The CFO.com article also notes another important point that often gets overlooked amidst the hubbub about U.S. competitiveness; that is, while its global equity market share may be declining, its participation in the debt marketplace is booming. According to the article, the number of European companies going to the U.S. to raise debt capital increased by 77 percent between 2000 and 2006, and the annual volume of debt raised during that period grew from $174 billion to $396 billion.
In other words, the global marketplace is dynamic and is changing in many ways, with a variety of effects and from a diversity of causes. To seize a single aspect as the sole or even the most important cause, and to use that as the pretext for radical changes to the enforcement of our securities laws, simply ignores the complexity of the global marketplace. Given the diversity of causes and effects, the elimination of private lawsuits would have only an uncertain impact on U.S. competitiveness, but it would eliminate the means by which private investors can seek redress without depending on the government to take up the cause on their behalf.
None of this should be interpreted to suggest that I think our system of private securities litigation could not be improved. Anyone who watches these cases up close knows that that system can be wasteful and excessive. But while it undoubtedly can (and should) be improved, I do not think it is in the best interests of investors or the markets for private securities lawsuits to be eliminated.
Professor Larry Ribstein has some interesting comments on his Ideoblog (here) about Wallison’s column.
One final observation: as I have previously noted (here), differences between the litigation systems in the U.S. and elsewhere may be diminishing over time. A recent interesting post along those lines can be found on the Drug and Device Law blog (here).
Those who remember that the options backdating scandal first got started with an academic study may want to take a close look at a recent research paper examining Rule 10b5-1 plan trading. The paper, and subsequent press coverage and comments, suggest that questionable trading in Rule 10b5-1 plans could become the focus of the next big investigative event.
The SEC promulgated Rule 10b5-1 in 2000 to provide company insiders with a "safe harbor" within which to trade their shares in company stock without incurring litigation exposure. The Rule creates an affirmative defense against an accusation of improper insider trading if the insider has established a predetermined trading plan. The written plan should not permit the insider to "exercise subsequent influence over how, whem and whether to effect purchases or sales." A good summary of the purpose and structure of 10b5-1 plans can be found here.
A recent study by an assistant accounting professor at Stanford’s Graduate School of Business takes a hard look at actual trading inside 10b5-1 plans. The December 2006 paper by Alan Jagolinzer, entitled "Do Insiders Trade Strategically Within the SEC Rule 10b5-1 Safe Harbor?" (here), studied roughly 117,000 trades in 10b5-1 plans by 3,246 executives at 1,241 companies. He found that trades inside the plans beat the market by 6% over six months, by contrast to executives at the same companies who traded without plans and who beat the market by only 1.9%.
Specifically, Jagolinzer found that "a substantial portion of randomly selected 10b5-1 plan initiations are associated with pending adverse news disclosure" and "early sales plan termination is, on average, associated with pending positive firm performance." In other words, the study shows that insiders initiated plans to sell shares– and sold their shares – ahead of stock price declines, locking in sales at higher prices, and that insiders terminated plans – and refrained from selling shares—before the company’s release of positive news that drove the share price higher. Since most of the trading related to stock sales (as opposed to purchases), Jagolinzer’s findings regarding share sales are particularly significant. He found that "participants’ sales…tend to follow price increase and precede price declines, generating statistically significant forward-looking abnormal returns."
A December 16, 2006 BusinessWeek.com article reporting on Jagolinzer’s study, entitled "Insiders With a Curious Edge" (here), takes a closer look at trading in 10b5-1 plans at several specific companies, finding several instances of "impeccable" timing and "curious patterns." For example, the article found several instances of massive sales at stock price peaks, followed by plan terminations. The article notes that "despite the 'prearranged' nature of the trading plans, executives have enormous flexibility to start, stop, restart and amend them at will." As one analyst quoted in the article observes, if executives are "ending plans and starting new ones with each trade, how does that differ from simply trading outside a plan?"
None of this has been lost on the SEC. In a March 8, 2007 speech (here) at the Corporate Counsel Institute, SEC Enforcement Division Director Linda Chatman Thomsen specifically noted Jagolinzer’s study, and commented that his analysis
raises the possibility that plans are being abused in various ways to facilitate trading based on insider information. We’re looking at this – hard. We want to make sure that people are not doing here what they were doing with stock options. If executives are in fact trading on inside information and using a plan for cover, they should expect the "safe harbor" to provide no defense.
A March 19, 2006 BusinessWeek.com article entitled "The SEC Is Eyeing Insider Stock Sales" (here) amplifies the theme that the SEC will be cracking down on improper trading in 10b5-1 plans and suggests that the SEC may be scrutinizing insider trading inside 10b5-1 plans at New Century Financial Corporation prior to its recent spate of bad news.
The SEC Actions Blog (here) also suggests that 10b5-1 plans are "a new enforcement target" and that the SEC may have already started to crack down on insider trading in connection with the New Century Finance Corporation investigation.
It is far too early to predict a trend, much less the arrival of the next scandal. Nevertheless, the combination of academic research, press attention, and most significantly, regulatory scrutiny, suggests that 10b5-1 plans will be an area of increasing attention in coming months.
All of this may be slightly disorienting for D & O insurance professionals, who are accustomed to thinking of 10b5-1 plans as the essence of good corporate practice. Indeed, trading plans structured and implemented according to the original intent of the Rule should still afford the protection for which the Rule was designed. However, insiders who are stopping or starting plans, or running multiple plans, for "strategic purposes," may find themselves unable to rely on the Rule’s safe harbor, or potentially even the focus of unwanted regulatory scrutiny.
This clearly is an area of emerging D & O risk, and while it is developing, it will also be the focus of increased scrutiny from D & O underwriters. Underwriters will want to know not only that a trade was pursuant to a plan, but also when the plan was started and whether the insider has multiple plans, or has had prior plans that started and stopped.
UPDATE: The April 4, 2007 Wall Street Journal has an article (here, subscription required) on the SEC's heightened scrutiny of Rule 10b5-1 plans. The article also discusses that the possible abuse of a 10b5-1 is at issue in the insider trading trial of Joseph Naccio.
On March 14, 2007, in a decision that has important implications for D & O insurers and their policyholders, Judge Gregory Presnell of the federal court in Orlando granted partial summary judgment on behalf of two excess D & O insurers, holding that the $35 million settlement to which CNL Hotels & Resorts agreed to resolve Section 11 claims does not constitute “loss” and is therefore not insurable as a matter of law. The opinion can be found here.
In 2004, CNL was sued in a securities class action lawsuit (refer here) alleging violations of Section 11 of the Securities Act of 1933. The plaintiffs alleged that they had purchased their stock from CNL at an artificially inflated price of $20/share, based upon materially misleading statements in the offering documents. CNL settled the underlying action for $35 million.
CNL filed a declaratory judgment action against its D & O insurers seeking a determination of coverage for the settlement. CNL’s primary D & O carrier settled with the company. In his grant of partial summary judgment in the favor of CNL’s two excess insurers, Judge Presnell held that the underlying settlement represented a disgorgement of CNL’s ill-gotten gain, which he held did not constitute “loss” under the relevant policy language, and is therefore not insurable under applicable law.
The key to the court’s decision is his conclusion that the amount CNL agreed to pay by settling the Section 11 claim represented profits that CNL had wrongfully obtained. The insurers based their argument to that effect on evidence that:
shareholders in the underlying suit purchased their stock in secondary markets at a (split-adjusted) price of $20 per share, and that a planned public offering collapsed when an industry expert opined that the shares were only worth approximately $12 per share. The plaintiffs in the underlying suits sought to recover the $8 per share difference, attributing the inflated price to the use of “materially false and misleading” offering documents in violation of Section 11. CNL admitted to Landmark that the overwhelming majority of the shares had not been redeemed, traded, or sold in the market– in other words, that if the share price was inflated, CNL reaped the benefit…the Court concludes that the Settlement Amount represents CNL being compelled to return money that it wrongfully appropriated.
The Court’s ruling in this case is at one level not a surprise, as it arguably is just an extension of a case law trend recognizing that some types of settlements or payments do not constitute insurable loss. It is perhaps noteworthy that Judge Preswell’s opinion represents the first recognition by a federal court of the 2002 Indiana intermediate appellate court decision in the Conseco case that a Section 11 settlement was uninsurable.
From the judge’s perspective, based on his review of the case law, “if an insured is simply being forced to return money to which it was not entitled, the event is not a loss. It is simply not reasonable for an insured to assume otherwise.” With all due respect to Judge Presnell, his view about what an insured reasonably may assume to be insured may be unrelated to what a company in fact expects to be insured when the company buys a D & O policy. Therefore, even if the court’s ruling does arguably represent only an extension of an already developing case law trend, it also poses a challenge for the D & O insurance industry to address these issues in the policy itself.
In light of the developing case law trend, and now a federal court’s affirmation of the trend, it is going to be indispensable for D & O insurers to clarify within the language of their policy the coverage that policyholders can expect for amounts paid in resolution of Section 11 claims. In that regard, it is critical to note that Judge Presnell specifically stated that “Section 11 claims are not per se uninsurable.”
A good brief discussion of these issues written by the Edwards, Angell, Palmer & Dodge law firm can be found here. Special thanks to John McCarrick of that firm for the link.
Many thanks to the numerous alert readers who sent me copies of the CNL opinion and related materials.
A Big Bill: As the criminal trial of former Qwest Communications CEO Joseph Nacchio gets ready to start on Monday, March 19, 2007, the Rocky Mountain News took a look (here) at how much Qwest has spent defending itself and its directors and officers from civil and criminal allegations. The newspaper estimate that the company has spent over $1 billion in class action settlements, opt-out settlements, attorneys’ fees, and other related costs and expenses. Interesting, the newspaper also reports that “in a mediated settlement, Qwest agreed to pay $157.5 million to salvage $350 million worth of liability coverage for directors, officers, and [its] employee benefit plans.”
Way back in 2003, long before any of the rest of us had ever heard of options backdating, Micrel sued its former auditor, Deloitte and Touche, alleging that the accounting firm had given the company faulty advice regarding its options grant practices. In its recently filed 2006 10-K (here), Micrel dislosed that on February 23, 2007, it settled the lawsuit, the first of its kind against an outside professional of which The D & O Diary is aware.
Micrel first disclosed its lawsuit against Deloitte in an April 23, 2003 8-K filing (here). The lawsuit didn’t attract much attention at the time, but it gained notoriety after the options backdating scandal broke almost exactly a year ago. On June 19, 2006, the New York Times ran an article about the case entitled “Inquiry Into Stock Options Pricing Casts a Wide Net” (here). The article can also be found on the International Herald Tribune’s website (here).
According to the Times article, Micrel was having a problem in the mid-90’s due to the volatility of its share price. It was providing new hires with stock option grants, with the exercise price set at the closing price on the new employee’s first day. Because the exercise price was so variable, a “fairness problem” emerged. Micrel wanted to make its option grants “a little more equitable.”
According to the allegations in the subsequent lawsuit, Deloitte proposed that Micrel set the exercise price at the lowest point in the 30-day period from when the grant was approved. The lawsuit also alleged that Deloitte advised Micrel that this 30-day pricing method followed the rules and would not have adverse accounting consequences. The 30-day pricing method was originally used for just new employees, but was subsequently extended across the company. According to the Times article, “Morrison and Foerster, the San Francisco law firm hired as Micrel’s outside counsel, affirmed the terms of the plan in an opinion letter.” Senior management also signed off on the plan, as did three members of the board.
In December 2001, Deloitte decided to reverse its view regarding the 30-day pricing method. (According to the Legal Pad blog, here, Deloitte’s reversal came when a new audit partner replaced the audit partner who approved the plan.) According to the Times, Deloitte urged Micrel to restate its prior financial reports. Micrel subsequently restated its financial statements for 1998, 1999, 2000 and the first three quarters of 2001 (refer here). Micrel claimed that the total cost to the company of the flawed options plan was $58.6 million. In its 2003 lawsuit, Micrel sought to recover, among other things, the additional professional fees incurred to “address the impact on Micrel’s financial statements and other effects”; changes to earnings that would not have occurred but for the advice; and liability and potential liability for taxes that would not have been due but for the advice.
According to Micrel’s 2006 10-K (here, refer to footnote 15 of the financial statements), “Deloitte agreed to pay Micrel a settlement amount of $15.5 million.” The Company expects to record the settlement as other income during the first quarter of 2007.
Micrel was not the only company with which Deloitte was entangled over the 30-day pricing method. According to a June 16, 2006 Wall Street Journal article entitled “During 1990’s, Microsoft Practiced a Variation of Options Backdating” (here, subscription required), Microsoft also awarded options at monthly lows, each July, from 1992 to 1999. During that period, Microsoft issued options “covering what would now amount to about three billion shares, adjusting for stock splits,” according to the Journal. The article also states that the July-low practice was “approved by Microsoft’s longtime auditor – Deloitte and Touche.”
Microsoft voluntarily stopped the practice, and on July 19, 1999, announced that it was ending the practice and took a $217 million charge. According to the Journal article, “Microsoft and Deloitte consulted about the practice before making the 1999 change.”
All of this makes me wonder a couple of things: why did it take Deloitte more than two years after Microsoft had taken a $217 million charge to earnings to discontinue the practice at Micrel? And were Micrel and Microsoft the only two companies who received Deloitte’s counsel regarding this specific options grant practice?
More generally, the sequence of events involving these two companies make me wonder whether outside gatekeepers may have spread these and other kinds of options grant practices among companies?
And finally, I wonder whether we will be seeing more lawsuits against outside professionals for their options grant related advice, or for negligent oversight regarding options backdating?
The Legal Pad blog discusses these issues further, here. Special thanks to a loyal reader (who prefers anonymity) for the link regarding this settlement.
The D & O Diary’s prior post about the Micrel case can be found here.
Now This: Before you fly, read these important messages (here).
Led by Marc Dann, the recently elected Democratic Attorney General of Ohio, the attorneys general for 22 states, plus the attorneys general for Puerto Rico and American Samoa, have filed an amicus brief (here) in the Tellabs case pending before the U.S. Supreme Court. The states’ brief strongly disagrees with the SEC’s recently filed amicus brief (here). The D & O Diary’s prior discussion of the SEC’s Tellabs brief can be found here.
The AGs urge the Supreme Court to reject the pleading standard advocated by the SEC and to affirm the pleading standard adopted by the Seventh Circuit in the Tellabs case. The state’s brief says:
The States are alarmed by this case because Tellabs and the SEC are advocating a pleading standard so high that investors will be prevented from bringing most fraud suits. If that happens, the investor rights so carefully protected by the States for so many decades are in grave danger. And if investors are not protected from fraud, the market could return to the days when fraudulent promoters were the norm and not the exception.
Among the arguments that the attorneys general raise is that, as representatives of public pension funds on whose behalf the AGs initiate securities fraud lawsuits in order to protect the interests of fund participants, the AGs are interested in the availability of effective legal means to pursue securities fraud. In making these arguments, the AGs make an oft-repeated mistake; they argue that “these state funds willingly litigate to protect their members retirements, whereas the private funds do not.” The states further argue that private funds “are discouraged from filing because it takes time and resources away from income-producing activities.”
As Adam Savett at the Securities Litigation Watch blog (here) has demonstrated, it simply is not true that private funds (such as mutual funds, banks and insurance companies) do not act as lead plaintiffs in securities class action lawsuits. (The D & O Diary’s prior post on this topic can be found here.) While it does not diminish the states’ arguments that they have a legitimate interest in the maintenance of vigorous mechanisms to address securities fraud, it is not true that there are no private investor funds willing to act on behalf of injured investors.
Readers will recall that Ohio AG Dann took the lead in Ohio’s recent opt-out settlement in the Time Warner securities litigation (refer here). In his March 9, 2007 press release announcing the Tellabs amicus brief’s filing (here), Dann said that his decision to become involved in the case was “a response to the brief filing in the case by the [SEC] in which the Commission took a position that would make it more difficult for public and private institutional investors and other shareholders to recover losses in securities class action.” Dann states in the press release that the position advocated by Tellabs and the SEC “would severely damage one of the most powerful mechanisms for controlling fraud in the marketplace: legitimate securities lawsuits by large institutional investors such as the States’ pension funds.”
I had supposed that the other attorneys’ general who signed onto the brief would all turn out to be Democrats, like Ohio’s Dann. To my surprise, according to party-affiliation information posted on the National Association of Attorneys General website (here), seven of the 22 state AGs who signed the brief are Republicans. (I am not sure of the political affiliation of the Attorney General of Puerto Rico and the acting Attorney General of the Territory of American Samoa, both of whom were appointed to their positions.)
It was actually pretty interesting going through the list of attorneys general who signed onto the brief. For example, from the great state of California, there's old Governor Moonbeam himself, Edmund G. "Jerry" Brown, Jr. There are also some famous sons amongst some states' native sons who signed onto the brief, like New York's Andrew Cuomo and Delaware's Joseph R. "Beau" Biden III. (Jerry Brown is also of course a famous son himself.) There are also a number of women, including Minnesota's recently elected Democratic AG Lori Swanson; Illinois's second-term Democratic AG Lisa Madigan; Kelly Ayotte, New Hampshire's first woman AG (and a Republican), who has served since 2004; and Nevada's Democratic AG Catherine Cortez Masto (whose official online biography is borderline incomprehensible and does not divulge when she was elected). (If it seems like I have a thing about state AGs, it is because early in my career, I worked for Mary Sue Terry, who later went on to become Virginia's first woman attorney general.)
I do wonder why some AGs signed onto the brief, but not others. For example, why would the Puerto Rico AG and the AG for American Samoa sign on, but not the AG for Guam or AG for the Northern Mariana Islands? Or, why the AGs for New York and Connecticut, but not the Democratic AG for New Jersey, Stuart Rabner?
One final note of blog envy; the AGs’ brief quotes the WSJ.com Law Blogin support of their brief. Another blow for the legitimacy of the blogosphere.
Hat tip to Bruce Carton at the Best in Class Blog (here) for his prior post on the state AGs’ amicus brief.
The D & O Diary's prior post on why the Tellabs case matters can be found here.
U.S. Chamber Commission Reports on Capital Markets Competitiveness, Recommends Securities Reform
On March 12, 2007, in the latest in the apparently never-ending series of big thick reports on the competitiveness of U.S capital markets, the U.S. Chamber of Commerce released the Report and Recommendations of its Commission on the Regulation of the U.S. Capital Markets in the 21st Century (here). An Executive Summary of the Report can be found here.
The Chamber Commission advertises itself as “an independent bipartisan Commission established by the U.S Chamber of Commerce.’ The Commission is co-Chaired by Arthur Culvahouse, who is Chairman of the O’Melveny & Myers law firm and former White House counsel in the Reagan administration, and William Daley, Vice Chairman of JPMorgan Chase and Commerce Secretary in the Clinton administration. The Chamber Commission report will be formally released on March 14, 2007, as part of the Chamber’s “First Annual Capital Markets Summit: Securing America’s Competitiveness” (here)
Including appendices, the Chamber Commission’s Report weighs in at 179 pages, putting it in a competitive position, girth-wise, with the Interim Report of the Committee on Capital Markets Regulation and the Bloomberg/Schumer Report. (The Chamber Commission's Executive Summary even weighs in at 20 pages.) The Chamber Commission did reduce its recommendations to six bulleted points:
• Reform and modernize the federal government’s regulatory approach to financial markets and market participants.
• Give the Securities and Exchange Commission (SEC) the flexibility to address issues relating to the implementation of the Sarbanes-Oxley Act of 2002 (SOX) by making it part of the Securities Exchange Act of 1934.
• Convince public companies to stop issuing earnings guidance or, alternatively, move away from quarterly earnings guidance with one earnings per share (EPS) number to annual guidance with a range of EPS numbers.
• Call on domestic and international policy-makers to seriously consider proposals by others to address the significant risks faced by the public audit profession from catastrophic litigation, as well as the Commission’s suggestion that national audit firms be allowed to raise capital from private shareholders other than audit partners.
• Increase retirement savings plans by connecting all employers of 21 or more employees without any retirement plan to a financial institution that will offer a retirement arrangement to those employees.
• Encourage employers to sponsor retirement plans and enhance the portability of retirement accounts through the introduction of a simpler, consolidated 401(k)-type program.
The six principal recommendations are discussed further in the March 12, 2007 Wall Street Journal article (here, subscription required). The recommendation regarding the incorporation of SOX into the ’34 Act is discussed further on the FEI Financial Reporting Blog (here). The CorporateCounsel.net Blog also has a post on the Report, here.
While not included in the six principal recommendations, the Chamber Commission does also make “a number of specific recommendations designed to enhance the effectiveness of the U.S. legal system.” The most significant of these recommendations is based on the Commission’s view that there is a “strong need to investigate the accuracy of the widely held global perception that the U.S. securities litigation and regulatory environment makes it dangerous to participate in our capital markets.”
But rather than make any specific reform recommendations in that regard, the Commission “recommends that Congress call upon the SEC to undertake a comprehensive study of state and federal securities enforcement mechanisms to assess whether they are enhancing the goal of investor protection and capital formation and whether the PSLRA is achieving the objective set forth by Congress.” The Commission specifically recommends that the study analyze:
• civil and criminal cases brought by governmental agencies and regulatory actions brought by [self-regulatory organizations];
• PSLRA’s impact on the effectiveness of the federal securities laws; and
• impact of post-PSLRA litigation on the dual objectives of protecting investors and promoting capital formation.
The Chamber Commission notes that “time is of the essence” in the study’s completion. (These issues are discussed at pages 28 to 31 of the full Report.)
The Chamber Commission Report also identifies three other “problem areas” in private securities litigation and makes recommendations that “should reduce costs while preserving investor protections”:
Fair Funds: The Chamber Commission recommends that “the SEC adopt a forma policy that prohibits duplicative payments from Fair Funds and private litigation on the same claim.” (Discussed at page 88-89 of the full Report)
Scope of Professional Liability: The Commission recommends the adoption by the other federal judicial circuits of the Second Circuit’s bright-line test for primary liability of secondary actors in securities fraud cases; and the Commission advocates that other circuits follow the Eighth Circuit in rejecting “scheme liability” as “incompatible with the Supreme Court’s rejection of aiding and abetting theories under Section 10b and Rule 10b-5.” (Discussed at pages 90-92 of the full Report).
Selective Waiver: The Commission recommends that Congress adopt legislation “establishing a selective waiver that would permit corporations to share privileged information with the SEC and continue to assert the privilege against other parties.” The Commission also recommends that Congress establish a selective waiver that would “permit a private party to share privileged information or documents with external audit firms or government appointed corporate compliance monitors…without waiving the attorney-client privilege to other third parties.” (Discussed at pages 92-95 of the full Report)
The Chamber Commission’s Report also has extended discussion (at pages 80-87 of the full Report) of the controversies surrounding the federal prosecution of business organizations. The bulk of this discussion related to concerns regarding prosecutorial ability to seek or require production of attorney-client privileged materials or work-product materials. The Commission expresses its concern that the Department of Justice’s (DoJ) McNulty Memorandum “does not adequately address the concern that companies feel pressured to waive attorney-client privilege and work product protection under threat of indictment or other enforcement actions.” The Chamber Commission endorses the “ongoing efforts to have the DoJ eliminate as a cooperation credit factor a company’s decision to waive the attorney-client privilege or attorney work product protection.”
The Chamber Commission also recommends that Congress and the DoJ “reevaluate the standards of corporate criminality” to “place more weight on the proactive efforts of corporations to prevent criminal conduct.” The Commission recommends that “corporate criminal conduct should be largely reserved to instances where the corporate form is a mere shell or in which criminal conduct is pervasive within the company’s senior executive ranks.”
The SEC Actions Blog has a thoughtful discussion (here) of the Chamber Commission's recommendations regarding the McNulty Memo, the attorney client privlege and federal corporate criminal prosecutions.
The Report contains quite of number of other interesting suggestions, as a result of which the Report merits a full review, notwithstanding its daunting length. The sheer number of reform recommendations defies quick summary, but there are several that are particularly worth closer review, including the Report’s suggestion (at pages 71-77) that all public companies “eliminate the practice of providing quarterly guidance” because “reducing the pressures to meet precise quarterly earnings targets…is an important first step toward shifting the focus away from quarterly results and toward the long-term performance of U.S. companies.” The elimination of qurterly earnings guidance was previously recommended by the Business Roundtable Institute for Corporate Ethics in is July 2006 Report (here). The D & O Diary’s prior views regarding the pitfalls of earnings guidance can be found here and here.
The Report also recommends the creation of two federal chartering mechanisms, one for accounting firms and one for insurance companies. In both cases, the objective is to reduce regulatory burdens that add friction costs and impeded competitiveness. The D & O Diary believes the recommendation for an option federal level insurance chartering system is particularly noteworthy and is a concrete suggestion that could in fact actually help U.S. based insurance companies (which are very important participants in the U.S. financial markets) to operate more efficiently and compete more effectively.
The Chamber Commission’s Report is merely the latest in a series, and we will be hearing more of the same tomorrow (March 13) when the Treasury Department holds its conference on U.S. Capital Markets (here). But the Chamber Commission deserves credit for not replowing the same ground as the prior reports, and for avoiding the shortcoming of the prior reports of confusing the interests of Wall Street with the interests of the overall economy. The Chamber Commission’s Report seems much less concerned than prior reports with simply removing things that Wall Street finds annoying, and more focused on ideas that will aid capital formation and competitiveness of U.S.-based financial enterprises.
As the regulatory reform dialog continues, the process seems to be becoming additive and cumulative. There have unquestionably been a number of interesting and promising ideas that have emerged, and the more the continuing dialog focuses on improving U.S economic prospects and the less it focuses on weakening the integrity of the U.S. regulatory system, the more promising will be the outcome.
The D & O Diary’s prior discussion of the Interim Report of the Committee on Capital Markets Regulation can be found here and here. The D & O Diary’s prior discussion of the Bloomberg/Schumer Report can be found here. My prior commentary on the weak case for regulatory reform can be found here and here.
Welcome to the Litigation Consulting Blog:The D & O Diary would like to welcome the Litigation Consulting Blog (here), which appears to be a worthy addition to the blogsphere. The blog is relatively new but has already had a number of interesting posts, including today's post (here) about activist investing. D & O Diary readers will undoubtedly find this new blog interesting. Hat tip to Werner Kranenberg of the With Vigour and Zeal blogfor the link.
A shareholder of SafeNet has filed a shareholders derivative lawsuit in Delaware Chancery Court, claiming that the SafeNet directors agreed to sell the company to a private equity firm to avoid potential options backdating related liabilities. On March 5, 2007, SafeNet announced (here) that it had agreed to be acquired by Vector Capital for $634 million, which represented a 1.6% premium over the prior trading day's closing price. According to a March 9, 2007 Baltimore Sun article entitled "Suit Claims SafeNet Being Sold to Shield Directors," (here), the lawsuit seeks to stop the sale to Vector, order directors to account for "special benefits" tied to the deal, and award unspecified damages. The news article quotes a spokesperson for the plaintiff as asserting that the buyout is designed to protect the directors from their liability for wrongdoing associated with options backdating; "Why else would the director-defendants cause the company to agree to a low-ball offer with virtually no premium?"
SafeNet announced in July 2006 (here) that it would be revising several years' financial statements. In addition, as a result of the Company's review of its options grant practices, the company's Chairman and CEO and its President and Chief Operating officers resigned (here) It has delayed filing its periodic reports with the SEC (here), struggled to maintain its NASDAQ listing (here), and also had its creditors claim that its delayed SEC filing violated debt covenants (here). Current and former directors and offercers have also been sued (refer here) along with the company as a nominal defendant in a separate shareholders derivative lawsuit alleging breaches of fiduciary duty and unjust enrichment in connection with options grant manipulations.
The D & O Diary has no basis on which to judge the merits of the new lawsuit's claim that the directors are selling the company to avoid liability or as an alternative to trying to tidy up the various problems arising from options backdating issues. The WSJ Deal Journal blog (here) notes that companies that have announced options backdating woes do have a way of getting acquired; the Deal Journal notes that the SafeNet acquisition "swells the ranks of those that have disclosed backdating issues and later gone on to find suitors to at least 10." The Deal Journal also identifies five other companies that are mired in the backdating scandal that it speculates might also be takeover targets. Whether or not that is a coincidence, it it true that, for example, Mercury Interactive, as well as other companies, have successfully had previously filed derivative lawsuits dismissed after the company was acquired (regarding the Mercury Interactive dismissal, refer here).
However, The D & O Diary also notes that in addition to the shareholders derivative lawsuit, SafeNet and its directors and officers have also been sued in a securities class action lawsuit (here). The sale of the company would have no effect on this pending securities fraud lawsuit, which will go forward without respect to the pending acquisition.
Options Backdating Litigation Tally: The filing of a new securities fraud lawsuit against HCC Insurance Holdings and certain of its directors and officers (here) brings the number of options backdating related securities lawsuits to 27, as reflected on The D & O Diary's running tally of options backdating related lawsuits (here). The number of companies named as nominal defendants in options backdating related shareholders derivative lawsuits stands at 152. Readers may also be interested to know that the Securities Litigation Watch is also maintaining a list of options backdating related securities fraud lawsuits, here. Fortunately, the two tallies agree.
Competitiveness of U.S. Capital Markets: According a March 10, 2007 Wall Street Journal article entitled "Business Leaders, Washington Aim to Fix Wall Street's Ailment" (here, subscription required), the U.S. Chamber of Commerce and the U.S. Treasury Department will both be hosting daylong conference this upcoming week to discuss the competitiveness of the U.S. financial markets in the global economy. The Treasury Department will go first on Tuesday March 13, with a meeting that is expected to include Alan Greenspan and Warren Buffett in addition to Treasury Secretary Henry Paulson. (The full list of speakers and schedule can be found here.) The U.S. Chamber of Commerce will follow on Wednesday March 14 with the "First Annual Capital Markets Summit" and will be heavy on politicians, including Senator Chris Dodd and Representative Barney Frank. The agenda for the Chamber's conference can be found here. The Chamber is also releasing a report on Monday. The early signals are that the report will emphasize the things that businesses themselves can do, for example, by eliminating quarterly guidance as a way to reduce the focus on short term results. (The D & O Diary has previously commented on the virtues of eliminating quarterly earning guidance, here.)
Campos on Capital Markets Competition: While the upcoming conferences and reports undoubtedly will repeat the conventional wisdom the culprit for the decline in U.S. competitiveness is regulation and litigation, a March 8, 2007 speech (here) by SEC Commissioner Roel C. Campos (pictured above) had a different perspective. Campos commented on the various calls that have arise to adjust the U.S regulatory approach to enable it financial markets to be more competitive. He started by disagreeing that the U.S markets are in fact in decline, citing the recent Thompson Financial study (about which The D & O Diary recently commented, here). He added that, even were it true that U.S markets were declining, "the evidence does not support the claim that regulation is to blame." He cited a recent Goldman Sachs study, which states that "growth of the capital markets outside the U.S. is a natural consequence of economic growth and market maturation elsewhere," and that "regulation is not the problem." (For a more detailed discussion of the Goldman Sachs study, refer to the With Vigor and Zeal blog, here).
Campos went on to note that many of the would-be reformers and their supporters "have a broad ideological agenda," but the bottom line is that "most capital and investment will go to jurisdictions that have a high level of protection" and "if a jurisdiction promotes itself as having lower standards, it risks driving capital away to other markets where capital is perceived to be better protected."
Campos apparently also caused a flap by making a comment comparing the London Stock Exchange's Alternative Investment Market to a "casino" because, he claimed, 30 percent of new listing are "gone within a year." Campos apparently later retracted that statement. (The With Vigor and Zeal blog has a detailed discussion of the Campos casino comment flap, here.)
It may have been impolitic (not to mention bad manners) for Campos to refer to the AIM as a casino. But as The D & O Diary previously noted (here), a recent study did show that 52 percent of the companies that listed on the AIM during the three year period ending December 31, 2006 are "either trading at or below their issue price or have had their shares suspended."
Ohio Joins the Time Warner Opt-Out Settlement Parade
The Ohio Attorney General, Marc Dann, issued a March 7, 2007 press release (here) announcing a $144 million net settlement in the opt-out action filed against the Time Warner defendants on behalf of the Ohio Bureau of Workers’ Compensation and five state pension funds. As explained further below, the gross amount of the settlement is $175 million.
Dann stated in the press release that the settlement "will yield $135 million more than the pension funds would have received had we remained a party to the class action suit." In other words, Ohio's net recovery in the opt-out settlement represents 16 times more than the $9 million Ohio believes it would have recovered from the class settlement. Ohio's net recovery of $144 million represents 36% of its estimated $400 million investment loss.
The decision to opt-out from the Time Warner class action settlement had actually been made by Dann’s predecessor, Republican Jim Petro. (Dann, a Democrat, was sworn in as AG on January 7, 2007.) At the time of the opt-out decision, Petro said (here) explaining his decision to opt-out, "the class action suit, you get peanuts at the end of it." In an unusual gesture, Dann went out of his way in the press release to praise his Republican predecessor: "Jim Petro did the right thing by opting out of the class action. His decision put me in a very strong negotiating position."
Ohio was represented in its opt-out action by the Lerach Coughlin firm and the Cleveland law firm of Benesch, Friedlander, Coplan & Aronoff. According to news reports (here), the $144 million is Ohio's net recovery from a gross settlement of $175 million. The remaining $31 million will pay expenses and attorneys. Petro had agreed to a 17.5% contingency fee to Lerach Coughlin and hourly compensation to Benesch. Dann said he negotiated the Lerach Coughlin fee down by $3 million and that firm agreed to pay Benesch from its contingency fee. Dann said this was a signal to other future outside counsel that he "will drive a harder bargain in the future." (I guess the plaintiffs' bar has been warned; let that $31 million be a lesson.)
A couple of things about Dann’s press release strike me as particularly troublesome. The first is the grandstanding tone. For example, Dann is quoted as saying "Today, we are sending a loud and clear message to corporate American and to Wall Street: we will not tolerate fraud, stock manipulation, or deceit in this state." There is much more in a similar vein that I cannot bring myself to quote here. Dann clearly felt comfortable mining this settlement for political capital. If other state or local politicians perceive that they might be able to use opt-out settlements to buff up their images as protectors of the little guy and scourges of corporate fat cats, watch out. Given Dann’s comments about attorneys’ fees and sending messages for future cases, he anticipates that there will be a next time.
The other troublesome note is the care Dann's press release takes to validate the Ohio settlement among the other recently announced opt-out settlements: "Mr. Dann said the amount of the settlement is proportionate to or greater than those reached by plaintiffs who have filed and settled similar cases against AOL/Time Warner." A March 8, 2007 issue of the Cleveland Plain Dealer quotes Bill Lerach (here) as saying that Dann would not settle for anything less than the 36 percent of investment loss that the University of California (also represented by Lerach) recovered in its separate opt-out action. Clearly, there is some benchmarking going on in the Time Warner opt out cases, which undoubtedly will weigh on remaining settlement negotiations in other Time Warner opt out cases. The greater concern is that some kind of universal standards are being set that could affect negotiations in other cases, or future cases.
In any event, the $175 million Ohio gross settlement, taken together with the gross amounts of the other previously announced Time Warner opt-out settlements (refer here), brings the total value of the publicly announced Time Warner opt-out settlements to $730 million. Based on the information on the Stanford Law School Class Action Clearinghouse website (here), a class action settlement of $730 million would rank as the ninth larges class action settlement ever. The aggregate attorneys’ fees (which by the way do not have to approved by a court) undoubtedly are similarly staggering. Settlements (and attorneys' fees) of this magnitude obviously will attract keen interest in opting-out as a securities lawsuit strategy, particularly if others share the view of Ohio’s former Attorney General that a class action settlement only gets you "peanuts."
The Cleveland Plain Dealer (here) reports that negotiations on the Ohio settlement began on February 27, with Time Warner's attorneys offering $30 million, and by the following afternoon the parties had reached the $175 million deal. Time Warner was represented by Cravath Swaine & Moore (which Dann called "a fancy New York law firm) and Jones Day. The settlement does not resolve the state's case against Ernst & Young, AOL's accountant.
Oxley Surveys His Work: Speaking of retired Ohio Republicans, Michael Oxley , as reported in the March 2, 2007 International Herald Tribune interview (here), while addressing at a conference of 200 accountants in Paris, had some choice words to say about his best known legislative legacy, the eponymous Sarbanes Oxley Act. Among other things, Oxley, in repsonse to questions about the statute's impact, acknowledged that if he knew then what he knows now, "I would have written it differently and [Sarbanes] would have written it differently."
Oxley went on to explain that the statute was not the product of "normal times." He says that "Everybody felt like Rome was burning. People felt like they were getting cheated. It was unlike anything I had ever seen in Congress in 25 years in terms of the heat from the body politic. And all the members were facing it." Oxley now says that he felt at the time that Section 404 could spell trouble, but said that with the pressure on the Bush administration, there was no question that a bill needed to be passed, however imperfect.
Oxley also said that the decision to prosecute Arthur Andserson was a "White House decision." The Bush administration made the decision to "give the death penalty to Arthur Anderson" because "they had to look really tough." Oxley says now that "virtually anyone would agree it was a terrible decision" because it "eliminated a major accounting firm" and sent a chill through the accounting industry, causing accountants to revert to "extremely conservative practice."
Hat tip to Houston’s Clear Thinkers blog (here) for the link to the Oxley article.
Mow Down The Laws Just to Get the Devil?: Oxley’s frank acknowledgement that Arthur Anderson was sacrificed for mere political effect has made me reflective. The politicians feel they must protect us from the fraudsters, or, rather, that they must be seen as protecting us from the fraudsters, but who protects us from the politicians? This all reminds me of one of the scenes in A Man for All Seasons , the play based on the life of Thomas More, the 16th Century English chancellor and author. In the scene, More’s wife Alice, and his son-in-law William Roper, urge More to arrest an informer who had sought to curry favor with More by providing information (this excerpt taken from the complete text of the play, which may be found here ) :
ALICE: While you talk, he's gone!
MORE: And go he should, if he was the Devil himself, until he broke the law!
ROPER: So now you'd give the Devil benefit of law!
MORE: Yes. What would you do? Cut a great road through the law to get after the Devil?
ROPER: I'd cut down every law in England to do that!
MORE: Oh? And when the last law was down, and the Devil turned round on you --where would you hide, Roper, the laws all being flat? This country's planted thick with laws from coast to coast -- man's laws, not God's -- and if you cut them down --and you're just the man to do it -- d'you really think you could stand upright in the winds that would blow then? Yes, I'd give the Devil benefit of law, for my own safety's sake.
In the latest issue of InSights (here), I take a look at the Tellabs case now pending before the U.S. Supreme Court and discuss why the outcome of the case will matter. As noted at greater length in the article, the case "has the potential to significantly alter the securities litigation landscape for public companies and their directors and officers."
With a conscious nod to London’s Alternative Investment Market (AIM), Pink Sheets LLC has launched a new designation called OTCQX for domestic and international companies that meet certain criteria. In a March 5, 2007 press release (here), Pink Sheets announced that it had launched the designation for “reputable operating companies that wish to create enhanced visibility and respectability with investors.”
Pink Sheets is an electronic quotation system and not a stock exchange. It has no listing standards, nor do its companies have to register with the SEC. According to a March 6, 2007 Wall Street Journal article entitled “Pink Sheets Tries to Spiff Up Its Image” (here, subscription required) there are about 8,200 stocks quoted on the Pink Sheets and the OTC markets combined. Of these, 600 are foreign shares. Many of the companies “are speculative” and “some are distressed.” Some of the shares can go weeks or months without any trading, creating liquidity concerns. A Wikipedia article providing background on Pink Sheets can be found here.
The new Pink Sheets designation is intended as a “simple listing process that allows trusted companies to efficiently distinguish themselves.” So far 3 U.S. companies and 3 non-U.S. companies have qualified, and Pink Sheets says that it is “processing applications from 20 additional companies.”
The new designation is available for U.S. companies “with ongoing business operations that have professional advisors and provide credible disclosure,” including annual GAAP audited financial statements. The International designation is available for non-U.S. based companies “listed on a qualified international stock exchange that makes their home country disclosures available in English to U.S. investors.”
All companies seeking the new designation must have professional advisors. U.S. based companies must nominate a “Designated Advisor for Disclosure” (DAD) and each non-U.S. based company must nominate a “Principal American Liaison.” (PAL) prior to being accepted for the designation. According to Pink Sheets’ press release, the DAD and PAL designations are modeled on AIM’s Nominated Advisors (NOMAD). These advisors role is designed to “bolster investor confidence in the quality and availability of issuer disclosure.”
The new Pink Sheets designation, with its DAD and PAL advisors, is a clear effort to emulate the AIM and perhaps to replicate some of its success. However, Pink Sheets labors under a couple of handicaps that will challenge its efforts to compete with AIM. First, unlike AIM, which is affiliated with and supported by the London Stock Exchange, Pink Sheets is not affiliated with any exchange. AIM enjoys reflected prestige of its well-respected parent. Pink Sheets has only its own reputation, such as it is.
Even though AIM itself has had a rash of recent investigations (refer here), its reputation remains more or less solid. Pink Sheets, by contrast has a legacy that has caused the SEC to post on its website (here) strong warnings about the listing service, stating, among other things, “companies quoted on the Pink Sheets can be among the most risky investments” and “you should take extra care to thoroughly research any company quoted exclusively on the Pink Sheets (emphasis in original).”
But these concerns notwithstanding, Pink Sheets’ attempt to copy the successful elements of the AIM is one of the more economically rational responses to the competitive challenge that the AIM poses for U.S. financial markets. Pink Sheets may have a very long way to go before it presents serious competition to the AIM, but it has made a start, and its attempt to renovate itself to offer an alternative to AIM is preferable to the would-be reformers efforts to reduce the mainstream exchanges’ regulatory standards as a response to AIM’s competition.
All of that said, the regrettable DAD and PAL advisor designations are too cute to take seriously. Those features were better left on the cutting room floor.
Now This: According to The Economist magazine (here, subscription required) the new generation of container ships are being built to enormous proportions. The Emma Maersk, which is the largest container ship ever built, can carry 11,000 20-foot containers (1,400 more than any other ship can carry). A train carrying that load would be 44 miles long! Its engine has as much power as 1,200 automobiles and its anchor "weighs as much as five african elephants." Yet, according to Wikipedia (here), its normal crew is only 13 people. That's a little scary now, isn't it?
These mega-ships are too large for the Panama canal. Ships that fit the dimensions of the Panama canal are known as Panamax. (The new mega vessals are known as "Post-Panamax,"and the canal will soon be modified to accomodate them.) To picture what it means for the Panama canal to have vessels designed to maximize its capacity, view this timelapse video of the canal in operation. This is solid visual evidence of what global oceanborne trade really means. (You think your job is complicated...)
In the securities fraud lawsuit arising out of the Comverse Technology options backdating scandal, a federal district judge, applying principles derived from the Supreme Court’s 2005 decision in the Dura case, has overturned a magistrate judge’s lead plaintiff ruling, resulting in the Lerach Coughlin firm's removal lead counsel in the case. (The background on the case can be found here.) The district judge’s ruling is interesting and potentially significant because of its implications about the factual determinations a district court must make under the Private Securities Litigation Reform Act (PSLRA) at the earliest stages of the case.
Reyes had found that P & P had purchased 534,471 shares that resulted in losses of approximately $2.9 million, exceeding the Menorah Group’s claimed loss of $343,242 on its 172,000 shares. Because Reyes determined that P & P had the greatest financial interest in the outcome of the case, he selected P & P as lead plaintiff.
The Menorah Group based its objection on the fact that most of P & P’s losses resulted from "in and out transactions," in that both the purchase and the sale of the shares took place before the alleged misrepresentations were disclosed. The Menorah Group argued that if the "in and out" shares were excluded, P & P did not suffer a $2.9 million loss, but instead actually realized a $132,722 gain. Judge Garaufis agreed, vacated the Magistrate Judge’s ruling, and appointed the Menorah Group as lead plaintiff.
Judge Garaufis based his ruling on the Supreme Court’s holding in Dura. He reasoned that because Dura provided that plaintiffs in a fraud-on-the-market securities case can recover only if a specific loss was proximately caused by a defendant’s misrepresentations, the plaintiffs in the Comverse case could not recover any losses they had incurred before Comverse’s conduct was disclosed. Specifically, losses incurred prior to the curative disclosure cannot be considered in the recoverable losses calculation that courts engage in when selecting a lead plaintiff.
In making this determination, Judge Garaufis rejected the argument that loss causation was a factual issue that should not be considered at the pre-discovery stage. Judge Garaufis reasoned that "where (as here) it is clear from the face of the pleading that most of P & P’s losses were suffered before any alleged corrective disclosure, the Court would be abdicating its responsibility under the PSLRA if it were to ignore that issue."
It may be true, as Judge Garaufis states, that his ruling is a logical extension of Dura’s requirements, but this consequence of the Dura decision was not immediately apparent when the Dura case first came down. After all, Dura involved a motion to dismiss; it did not involve a lead plaintiff motion.
Judge Garaufis’s ruling is also somewhat unexpected for its conclusion that courts must in effect reach some factual conclusions about a prospective lead plaintiff’s recoverable losses, and exclude losses that are not recoverable in calculating the plaintiff’s financial interest. In the Pomerantz Hudek law firm’s press release announcing its selection as lead counsel (here), Patrick Dahlstrom, one of the lawyers for the Menorah Group, is quoted as saying that the decision "reinforces the growing recognition that Courts must conduct such analysis of the facts…and eliminate those losses that are clearly not recoverable, in determining which movant has the largest financial interest."
The determination of allowable losses is not the only pre-discovery factual determination that courts have decided they are required to make under the PSLRA. As The D & O Diary noted (here) in its discussion of the Tellabs case now pending before the U. S. Supreme Court, many courts have also decided they must weigh alternative inferences, in order to determine whether a plaintiff’s complaint meets the PSLRA’s heightened pleading standard. The evolving case law under the PSLRA seems to be moving toward a series of successive early stage factual determinations, all pre-discovery and based on the pleadings alone. Whether or not these determinations are required under the PSLRA, there is a certain cart-before-the-horse feel to these procedures. There is something uncomfortable (for me at least) about a court determining at the earliest stages of a case and without evidence that a plaintiff’s losses are not recoverable and must be excluded. (On the other hand, it is pretty hard for P & P to argue that they have the most significant financial interest in the outcome if on a net basis they didn't even lose any money on their investment. )
A March 6, 2007 Law.com article entitled discussing the lead counsel decision in the Comverse Technology case can be found here.
More Bad News for the Lerach Coughlin Firm: The Lerach Coughlin firm’s removal from as lead counsel in the Comverse case is the firm’s second high profile removal as lead counsel in a matter of days. On February 27, 2007, Judge Barbara Lynn of Dallas granted the request of the lead plaintiff in the Halliburton securities lawsuit to replace the Lerach Coughlin firm with the Boies, Schiller firm. (The D & O Diary’s earlier post on the Halliburton lead plaintiff’s motion can be found here.) Judge Lynn also removed that Scott & Scott firm as co-lead counsel. The lead plaintiff had sought to remove the Lerach Coughlin firm because its relationship with the firm "deteriorated" after the criminal indictment of the Milberg Weiss law firm. (The Lerach Coughlin firm split off from the Milberg Weiss firm in 2004.) The Lerach Couglin law firm’s removal as lead counsel in the Halliburton case is discussed in greater detail on the Legal Pad blog, here.
But Not All the New is Bad: On the other hand, not all the news for the Lerach Coughlin firm these days is bad. For example, the firm is lead counsel in the securities lawsuit pending against First BanCorp and several of its directors and officers. On March 5, 2007, First BanCorp. announced (here) that it had settled the case for $74,250,000. The lead plaintiff in the case is the Plumbers & Pipefitters Local 51 Pension Fund (the Lerach Coughlin firm seems to be on good relationships with the organizations for plumbers and pipefitters). The Securities Litigation Watch blog has a detailed post about the First BanCorp. settlement here.
And the Lerach Coughlin firm also represented the University of California in its opt-out action against the Time Warner defendants. As The D & O Diary previously noted (here), on February 28, 2007, the University of California announced (here) that it had settled the opt-out action for $246 million. The University also announced that Lerach Coughlin firm’s fee was approximately $37 million.
As the WSJ.com Law Blog noted (here) about these developments, for the Lerach Coughlin firm, it has been "the best of times, the worst of times."
One Final Note: As described above, the Menorah Group, selected to serve as lead counsel in the Comverse Technology case, includes the Menorah Insurance Company, Ltd. This may be one more example that Adam Savett of the Securities Litigation Watch blog can add to his list (here) of cases where private institutional investors (like, for example, insurance companies) have served as lead plaintiff in a securities class action lawsuit under the PSLRA.
Institutional Investors, Lead Plaintiffs, and Opt-Outs
A frequently repeated – but demonstrably false – statement about securities class action lawsuits is that, while public pension funds have served as lead plaintiffs in securities fraud lawsuits, private institutional investors, such as banks, mutual funds, and insurance companies, have not. However, as Adam Savett points out (here) on the Securities Litigation Watch blog, private institutional investors do indeed seek to serve as lead plaintiffs, and his blog post cites several specific instances where mutual funds, insurance companies and banks have done just that.
Savett’s observations are relevant to the discussions I have been having in response to the recent wave of institutional investor opt-out settlements. (See my most recent post on opt-out settlements here.) The usual line of analysis goes that because the recent opt-out settlements have involved public pension fund opt-outs, the threat of future opt-out exposure is limited to companies that have significant public pension fund investor ownership. But this assumption could prove to be very misleading.
As Savett’s blog post substantiates, private institutional investors will choose to take an active litigation role when they see it in their interests to do so, and there is no reason why they might not elect to opt-out of a class settlement, just as they might elect to see to serve as a lead plaintiff. However, unlike Savett, I am unable to support my assertion with concrete examples. Watch this space – if I learn of an example of a private institutional investor entering into a significant securities opt-out settlement, I will post it to this blog.
Readers who might think that the Amalgamated Bank’s recent opt-out settlement with Time Warner (refer here) is an example of a private institutional investor opt-out settlement may want to take a closer look at Amalgamated. According to its website (here), Amalgamated Bank was founded in 1923 by the Amalgamated Clothing Workers of America and serves working class consumers and trade unions. In addition to normal banking functions, the bank also administers union-related trust funds and multi-employee benefit plans. The bank is owned by UNITE HERE, a trade union of textile and hospitality trade workers. Readers can reach their own conclusions, but I am not prepared to describe Amalgamated Bank as a private institutional investor.
Readers who are aware of any private institutional investor opt-out securities settlements are encouraged to let me know.
UPDATE: Adam Savett points out that the Lerach Coughlin law firm's web site's list of the opt out plaintiffs the firm represents in the AOL Time Warner lawsuit (here) include a number of private institutional investors, including mutual funds and insurance companies. To my knowledge, none of these plaintiffs have yet settled with the defendants, but their involvement suggests it is only a matter of time before we start seeing private institutional investor opt out settlements.
SUPPLEMENTAL UPDATE: At least one of the institutional investors that has settled with Time Warner appears to be a private institutional investor. According to Time Warner's 2006 10-K (here, refer to page 53), Time Warner has reached a settlement of the opt out action filed by DEKA Investment GmbH, which from its website (here) appears to be an investment fund company for institutional investors. The amount of DEKA's settlement is not disclosed. Hat tip to Adam Savett for the link.
A Fraudster’s Take on Fraud: Readers who may have missed it over the weekend will definitely want to go back and read Herb Greenberg’s March 3, 2007 column in the Wall Street Journal entitled “My Lunch With 2 Fraudsters” (here, subscription required). The column reports on Greenberg’s lunch interview with Sam E. Antar of Crazy Eddie’s infamy and Barry Minkow of ZZZZ Best infamy. It comes as no surprise to me that Sam did most of the talking. Readers may recall my prior post (here) about Sam’s views on preventing fraud. Sam also maintains the White Collar Fraud blog (here). Sam has quite a lot to say, a small portion of which comes through in Greenberg’s column. Sam makes no bones about the fact that as the architect of the Crazy Eddie’s securities fraud, he is a criminal. Among other interesting observations, Sam told Greenberg:
As criminals, we built false walls of integrity around us. We walked old ladies across the street. We built wings to hospitals…We wanted you to trust us. Simply said …if you want to be an investor, you cannot accept information at face value. "Unexamined acceptance” is the greatest cause of investor losses.
Professor Larry Ribstein has an interesting commentary (here) on his Ideoblog about Sam’s remarks.
Welcome to the Drug and Device Law Blog: The D & O Diary would like to welcome, and to encourage readers to read, the Drug and Device Law Blog, which may be found here. This new blog is written by Jim Beck of the Dechert law firm and Mark Herrmann of the Jones Day law firm. (Full disclosure: Mark and I were at Michigan Law School together, and Mark’s wife is my dentist. Small world.) The blog take a very lawyerly approach to legal issues affecting the drug and medical devices industries, although it should be noted that many of the blog’s posts are of more general interest. A particularly noteworthy recent post (here) discussed the recent Supreme Court punitive damages case and explored its implications for punitive damages awards in future class action cases.
Mark is also the author of the Curmudgeon's Guide to Practicing Law, a humorous and irreverant guide to surviving the practice of law (big firm style). According to the WSJ.com Law Blog (here), the Guide is "a well-written and clear guide on how to be an effective law-firm associate. It’s also funny."
This site was created and is written by Kevin M. LaCroix. I am an attorney and a director of OakBridge Insurance Services, a specialized insurance intermediary focused exclusively on Executive Liability coverages.
