First Options Backdating Related Securities Class Action Settlement

Newpark Resources has announced (here) a $9.85 million settlement of a securities class action lawsuit that, as amended, was based in part on allegations of stock options backdating.

The lawsuit against Newpark Resources and several of its directors and officers arose following the company’s April 17, 2006 press release (here) in which it disclosed that the company’s board’s audit committee had "commissioned an internal investigation regarding potential irregularities involving the processing and payment of invoices by Soloco Texas, LP, one of the company’s smaller subsidiaries, and other possible violations." The company also announced that it had placed three officials on administrative leave. The company’s share price declined, and plaintiff shareholders initiated a securities class action lawsuit (here).

On June 29, 2006, Newpark Resources announced (here) that it had completed its initial investigation, and that it would be restating its financial statements for fiscal years 2001 through 2005, and for fiscal quarters in 2004 and 2005. The investigation concluded that certain of the Soloco Texas transactions had not been properly accounted for. The company also announced that during the investigation, "the Audit Committee had also requested a review of the company’s past practices regarding stock options." The "preliminary findings" of the stock options investigation were "that a portion of the stock options granted prior to June 2003 were dated on a date other than the date their issuance was approved and the exercise price of such options were determined in advance of their approval by the appropriate board committee, all in contravention of the company’s stock option plan." Newpark Resources also announced that the Board had terminated its former CEO and current Chairman of one if the company’s subsidiaries, as well as the company’s CFO.

On November 9, 2006, the plaintiffs filed their consolidated amended complaint (here) against Newpark Resources and present and former Newpark directors and officers. The amended complaint contains (at paragraphs 53 through 76) detailed options backdating related allegations. A summary regarding the Newpark Resources securities class action lawsuit can be found here.

On April 13, 2007, Newpark Resources announced (here) that it had settled the securities class action lawsuit as well as a related derivative lawsuit. The company announced that it would pay $1,550,000 toward the settlement, and its directors and officers liability insurer would pay an additional $8,300,000. The company announced that it was settling liabilities related to the Soloco Texas transactions as well as "alleged improper granting, recording, and accounting of backdated grants of stock options to executives." The company also announced that it had also been notified by the SEC that it had opened "a formal investigation into Newpark’s restatement of earnings."

The lead plaintiffs in the case are Plumbers and Pipefitters Local 51 Pension Fund and and co-lead plainiffs law firms in the case are the Lerach Coughlin firm and Glancy Binkow and Goldberg.

The D & O Diary notes that while it had duly recorded, in our running tally of options backdating related lawsuits (here), that Newpark Resources had been named as a nominal defendant in an options backdating related derivative lawsuit, we had not picked up that the Newpark Resources securities class action lawsuit had been amended to add options backdating related allegations. The D & O Diary's options backdating related litigation tally will be amended to add the Newpark Resources lawsuit to the securities class action tally, with a link back to this post.

With respect to a prior partial settlement of a derivative options backdating lawsuit involving SafeNet, refer here.

Special thanks to a loyal reader (who prefers anonymity) for the link to the Newpark Resources settlement.

Another Interesting Class Action Settlement: On April 30, 2007, Doral Financial announced (here) the settlement of a pending securities class action lawsuit, as well as a related derivative lawsuit. The lawsuits related to Doral's April 19, 2005 restatement (here) of its financial statements for the period 2000 to 2004. As part of the settlement, the Company and its insurers will pay an aggregate of $129 million, of which the insurers will pay approximately $34 million. A summary of the class action lawsuit may be found here. The Lerach Coughlin firm acted as lead plaintiff firm, on behalf of the West Virginia Investment Management Board.

There are several interesting things about this settlement, the first of which is the significant amount by which the aggregate settlement amount exceeds the amount of available insurance. The company is responsible for a very significant portion of this settlement (but see below about the company's funding for the settlement). It used to be that the available insurance limits defined the outer limits of the potential settlement. There are more occasions now where the settlements exceed the insurance limits.

Second, in addition to the company's and its insurers joint payment, "one or more individual defendants will pay an aggregate of $1 million (in cash or Doral Financial stock)." This statement is odd for its careful imprecision -- one or more individuals? Cash or stock? Doesn't it seem unlikely at this point that they don't know who is going to pay and what form the payment will take? Or is something else going on? In any event, it seems to be a more common occurence for individuals to be called upon to fund a portion of the settlement. The reference to the possibility of payment in the form of company stock also seems to suggest that the individual (or is it individuals?) will be paying the settlement out of their own assets.

Third, the company also announced that its "payment obligations under the settlement agreement are subject to the closing and funding of one or more transactions through which the Company obtains outside financing during 2007 to meet its liquidity and capital needs, including the repayment of the Company's $625 million senior notes due on July 20, 2007, payment of the amounts due under the settlement agreement and certain other working capital and contractual needs." This sentence is hard to parse, but it apears that the company must borrow or otherwise raise the funds to finance the settlement. The company's press release goes on to say "either side may terminate the settlement agreement if the Company has not raised the necessary funding by September 30, 2007 or if the settlement has not been fully funded within 30 days from the receipt of such funding." Certainly seems like the company has to try to come up with the money somehow. I wonder where that leaves the plaintiffs if the company can't come up with the money?

In any event, Doral's other news today is that it is exploring selling itself to a private equity firm, according to news reports (here).

Hat tip to an alert reader (who prefer anonymity) for the link to the Doral Financial settlement.

Counting the Subprime Lender Lawsuits

Last Updated June 25, 2008 PLEASE NOTE THAT THIS WEBPAGE WILL NO LONGER BE UPDATED!!! Please refer to the corresponding page on my new site, as described in the next paragraph.

To see this page on The D & O Diary's new website, click here. To go to the home page of The D & O Diary's new website, click here.

As shown in the lists below, the lawsuits against subprime lenders are starting to mount up. This is hardly a surprising development; as the WSJ.com Law blog noted (here), law firms are already announcing their formation of subprime lending task forces and teams, just as a year ago law firms were announcing their formation of “options backdating teams.” Along the same lines, on April 25, 2007, Law.com ran an article entitled "Subprime Crash May be a Boon to Attorneys" (here).

The latest subprime lending lawsuit to arrive is a bit unusual. According to news reports (here and here), employees of Fremont General Corp. claim they have lost millions in company stock in their retirement plans when the company was forced out of the subprime lending business in March 2007. The lawsuit, filed this week in federal court in Los Angeles, under the Employee Retirement Income Security Act (ERISA), named nine Fremont General directors as defendants and alleges that executives sold $16.5 million of their own stock shares from January 1, 2003 to April 24, 2007, while causing the company’s retirement plan to buy between $150 million and $210 million of the stock. The lawsuit contends that the defendants knew or should have known that the stock was not a prudent investment for Fremont’s ESOP, which held the stock exclusively, or for a 401(k) retirement plan where employees had invested about two-thirds of their savings in Fremont shares.

The Fremont suit joins a growing list of lawsuits against subprime lenders arising from the deteriorating environment these companies face. The list is now sufficiently long that it seems to be time to create a running tally of the subprime lending lawsuits, as a complement to The D & O Diary’s popular running tally (here) of the options backdating related lawsuits. I have set out below the list of subprime lending lawsuits of which I am aware. This list may be incomplete, and I entreat readers to please let me know of any omission of which they are aware. I will endeavor to keep this list updated and will indicate any additions to the list in red. The legend "2008" indicates that the lawsuit was filed in 2008; items without a legend were filed in 2007.

Securities Class Action Lawsuits (not counting cases against the credit rating agencies and residential home builders, with respect to which refer below):

1. ACA Capital Holdings
2. Accredited Home Lenders
3. Ambac Financial Group [2008]
4. American Home Mortgage Investment Corporation
5. American International Group [2008]
6. BankAtlantic Bancorp.
7. Bank of American (Auction Rate Securities) [2008]
8. Bear Stearns [2008]
9. Calamos Global Dynamic Fund (Auction Rate Preferred Securities) [2008]
10. Care Investment Trust
11. CBRE Realty Finance
12. Centerline Holding Company [2008]
13. Citigroup
14. Citigroup (Auction Rate Securities) [2008]
15. Citigroup/Falcon Strategies Two LLC [2008]
16. Citigroup Mortgage Loan Trust [2008]
17. Coast Financial Holdings
18. Countrywide Financial Corp.
19. Countrywide Home Loans Servicing (refer here about this case)
20. Credit Suisse Group [2008]
21. Deutsche Bank [2008]
22. Downey Financial Corp. [2008]
23. E*Trade Financial Corp.
24. E*Trade Financial Corp. (Auction Rate Securities) [2008]
25. Evergreen Ultra Short Opportunities Fund [2008]
26. Federal Home Loan Mortgage Corporation
27. Fifth Third Bancorp. [2008]
28. Fremont General Corporation
29. Fidelity Ultra Short Bond Fund [2008]
30, First American Corporation [2008]
31. First Home Builders of Florida
32. First Marblehead Corp. [2008]
33. Franklin Bank Corp. [2008]
34. HarborView Mortgage Loan Trust/Royal Bank of Scotland [2008]
35. HomeBanc Corp.
36. Huntington Bancshares Incorporated
37. Huntington/Sky Financial [2008]
38. IMPAC Mortgage Holdings, Inc.
39. IndyMac Financial, Inc.
40. IndyMac Financial/Option ARMs [2008]
41. J.P. Morgan Chase (Auction Rate Securities) [2008]
42. Lehman Brothers [2008]
43. Luminent Mortgage Capital
44. MAT Five LLC/Citigroup Global Markets [2008]
45. MBIA [2008]
46. Merrill Lynch
47. Merrill Lynch/First Republic
48. Merrill Lynch (Auction Rate Securities) [2008]
49. MGIC Investment Corp. [2008]
50. MoneyGram International [2008]
51. Morgan Keegan Funds/Regions Financial Corporation
52. Morgan Stanley [2008]
53. Morgan Stanley (Auction Rate Securities) [2008]
54. Municipal Mortgage & Equity ("Muni Mae") [2008]
55. National City Corporation [2008]
56. National City/Harbor Bank [2008]
57. NetBank, Inc.
58 New Century Financial
59. Nomura Asset Acceptance Corporation [2008] (refer here about this case)
60. Nova Star Financial
61. Oppenheimer Holdings (Auction Rate Securities) [2008]
62. Opteum, Inc.
63. Radian Group, Inc.
64. RAIT Financial Trust
65. Raymond James Financial (Auction Rate Securities) [2008]
66. RBC Dain Rauscher (Auction Rate Securities) [2008]
67. Sallie Mae [2008]
68. Schwab Yield PLUS Funds [2008]
69. Security Capital Assurance, Ltd.
70. Societe Generale [2008]
71. SunTrust Banks (Auction Rate Securities) [2008]
72. Swiss Re [2008]
73. TD Ameritrade [2008]
74. The Blackstone Group, L.P. [2008]
75. The Goldman Sachs Group (Auction Rate Securities) [2008]
76. The PMI Group [2008]
77. Thornburg Mortgage
78. UBS AG
79. UBS (Auction Rate Securities) [2008]
80. Wachovia Corporation [2008]
81. Wachovia (Auction Rate Securities) [2008]
82. Wachovia/Golden West [2008]
83. Washington Mutual
84. Wells Fargo & Co. (Auction Rate Securities) [2008]
85. WSB Financial Group

The Total Securities lawsuit Count including the cases on the preceding list and the cases described below relating to the credit rating agencies and the residential home builders is 93.

In addition to these securities class act7on lawsuits against subprime lenders, on July 19, 2007, a shareholders of Moody's filed a purported securities class action lawsuit (here) against Moody's, alleging that Moody's "misrepresented or failed to disclose that the Company assigned excessively high ratings to bonds backed by risky subrprime mortgages." UPDATE: In addition, on August 28, 2007, shareholders of McGraw-Hill filed a lawsuit (refer here) alleging that the company's Standard & Poor's subsidiary assigned excessively higher ratings to certain mortgage-backed securities.

NOTE ABOUT THE LIST OF CASES: As time has gone by, it has become increasingly difficult to maintain absolute categorical precision regarding what is a subprime related lawsuit. For example, the Care Investment Trust case noted above involved a mortgage trust that holds healthcare related assets. The allegation is that the company's prospectus failed to disclose the impairment of the value of certain of its assets and that the company was having difficulty obtaining warehousing financing for its investment activities. The company's woes are undoubtedly due to contagion in the credit market deriving from the subprime meltdown, but the company itself has no ties to the subprime industry. Owing to the connection of the contagion effect in the credit markets, I have included the case in the list. Reasonable minds might omit the case.

ERISA/401(k) Lawsuits:

1. Fremont General
2. Beazer Homes
3. Citigroup
4. Countrywide Financial Corp.
5. Merrill Lynch
6. UBS AG
7. Morgan Stanley
8. State Street
9. MBIA [2008]
10. Bear Stearns [2008]
11. Regions Financial Corporation [2008]
12. National City Corp. [2008]
13. Huntington Bankshares [2008]
14. Impac Mortgage Corp.
15. Sovereign Bancorp. [2008]
16. Wachovia [2008]
17. First Horizon [2008]

Subprime lenders have also been sued in various lawsuits alleging that they engaged in deceptive or unfair trade practices. Recent examples involve the lawsuit pending against First Franklin Financial Corp. (here) and the lawsuit that Wells Fargo recently settled (here). While I will provide occasional updates on this post of these kinds of deceptive trade practices lawsuit, I do not propose to comprehensively catalog them here.

In at least one instance, an investment bank has been sued in connection with the bond securitization of subprime loans. According to news reports (here), Credit Suisse was sued by Bankers Life Insurance Co. in a lawsuit in which the insurer claims it lost money on the investment grade bonds backed by subprime mortgages the Credit Suisse had sold. The lawsuit generally pertains to the quality (or lack thereof) of the mortgages that backed the bonds.

In addition to these subprime lending companies, home builders have also been suffering from the current deteriorating residential real estate conditions, as well as from the reduction in easier financing for potential buyers. The home construction companies whose woes have led to lawsuits are listed below:

Home Builder Securities Class Action Lawsuits:

1. Beazer Homes USA
2. Hovnanian Enterprises
3. Standard Pacific
4. Tarragon Corporation
5. Toll Brothers
6. Levitt Corp. [2008]


There may well be other companies or kinds of companies adversely affected by the declining residential real estate market who find themselves facing securities class action or other lawsuits, as if so, I will update this post accordingly. UPDATE: I have a separate post here reviewing in greater detail the range of subprime lawsuits and litigants, generally outside the shareholder lawsuit context.

Readers are encouraged to suggest additional listings or references that should be added to this post.

FCPA Developments: The Threat Continues to Grow

As I have previously noted (most recently here), Foreign Corrupt Practices Act (FCPA) investigations and enforcement actions represent an increasing corporate threat, and, in the form of follow-on civil actions, an area of growing D & O risk. Two recent developments underscore the growing magnitude of these concerns.

The first of these two developments is the agreement of Baker Hughes and one of its subsidiaries to settle criminal and civil FCPA charges. News stories about the Baker Hughes agreement can be found here and here. The $44 million in fines and penalties under the agreement represent the largest amounts of combined fines and penalties ever imposed in a FCPA case. Baker Hughes’ subsidiary pled guilty to criminal charges and agreed to pay a $10 million criminal fine in connection with payments of $4.1 million in bribes paid to a consultant in order to secure and oil services contract with Kazakhoil, the state oil company of Kazakhstan, in the Karachaganak oil field. The contract generated more than $219 million in gross revenues from 2001 to 2006. A copy of the April 26, 2007 Department of Justice press release regarding the criminal matter can be found here.

Baker Hughes itself simultaneously agreed to pay $23 million in disgorgement and prejudgment interest and to pay a civil penalty of $11 million for violating a 2001 SEC cease-and-desist order in connection with a prior FCPA matter. The fines and penalties were assessed against the parent company in company in connection with the Kazakhstan bribe, as well as other charges that the company violated the books and records and internal control provisions of the FCPA in Nigeria, Angola, Indonesia, Russia and Uzbekistan. The SEC’s April 26, 2007 press release regarding the Baker Hughes matter may be found here, and the SEC’s complaint is here. An April 27, 2007 CFO.com article describing the Baker Hughes FCPA settlement may be found here.

The second of the two recent developments relates to the proliferation of publicity and action surrounding the burgeoning Siemens corruption investigation. Not only are the company’s top two executives leaving (refer here), but the company has warned that it expects a “significant increase” in the number of possible bribes identified in an internal investigation. This prospective increase is on top of the previously disclosed $544 million in suspected bribes. A prior D & O Diary post about the Siemens bribery investigation can be found here. In its April 26, 2007 filing on SEC Form 6-K (here), Siemens also reported that the SEC had “advised” the company that the SEC had “converted its informal inquiry into these matters into a formal investigation.” The Company previously disclosed that the U.S. Department of Justice is conducting an inquiry of possible criminal violations.

The company also noted in its 6-K filing that it will be obliged to make a number of tax asset and liabilities adjustments in future reporting periods, which could be “material.” The company also said that it “cannot exclude the possibility that criminal or civil sanctions may be brought,” as a result of which its “operating activities may also be negatively affected.” The company said that to date “no charges or provisions for any such penalties have been accrued as management does not yet have enough information to reasonably estimate such amounts.” The company did say that in its most recent fiscal quarter, it had spend 63 million euros (roughly $83 million) in connection with the investigation.

According to news reports (here), Standard and Poor’s has put Siemens on a watch for a possible downgrade.

Several things about these two cases reinforce my view that FCPA investigations will become an even greater concern in the months ahead. First, the sheer scope and magnitude of the concerns, both at Siemens and at Baker Hughes, suggest a larger problem that inevitably will attract increased prosecutorial interest and involve more companies. The enormous unlikelihood that these two companies alone were the only ones involved in this type and scale of activity will encourage investigators and regulators to search for similar activities elsewhere.

Second, a significant factor in the Baker Hughes subsidiary’s plea agreement, which included a deferred prosecution agreement and a three-year probationary period, was the Company’s self-reporting of the violation. The Department of Justice’s press release states that the agreement “reflects, in large part, the actions of Baker Hughes in voluntarily disclosing this matter.” The unmistakable message is that companies have a substantial incentive to self-report FCPA violations, as I have previously noted (here). The increased internal review compelled by the Sarbanes Oxley Act, together with the incentive to self-report, increases the likelihood of further FCPA investigations and enforcement actions. As a recent memo from the Gibson, Dunn & Crutcher law firm notes (here), more than three quarters of the FCPA enforcement actions in the last two years arose as a result of voluntary disclosures.

Third, Siemens’ 6-K discloses that in February 2007 it was sued as a nominal defendant in a New York state court shareholders derivative complaint “seeking various forms of relief relating to the allegations of corruption and related violations.” The complaint also names “certain current and former members of the Company’s Managing and Supervisory Boards.” As I have previously noted (here), the D & O risk arising from FCPA enforcement actions comes from this type of follow-on civil action; the FCPA fines and penalties themselves would not be covered under the typical D & O policy, but the threat of follow-on civil action creates substantial D & O risk. UPDATE: On May 4, 2007, a shareholders derivative suit was filed against Baker Hughes (as nominal defendant) and certain of its present and former directors and officers, alleging breach of fiduciary duties in connection with the FCPA violations described above.

Finally, the unprecedented level of international cooperation involved in the Siemens investigation further increases the likelihood that the various national authorities will provide information across borders that could support antibribery enforcement actions here and overseas.

As the SEC Actions blog noted (here) in its commentary on the Baker Hughes FCPA enforcement case, “it is clear that the number of FCPA cases being brought by the SEC and the DOJ are on the rise. This suggests prudent companies that do business abroad and their directors and officers carefully review their compliance systems in this area to avoid difficulties rather than later at the insistence of the SEC or the DOJ.” In any event, FCPA compliance undoubtedly will become an area of heightened scrutiny for D & O underwriters.

Internal Affairs Doctrine: The shareholders derivative complaint filed against Siemens could face substantial hurdles in the form of the “internal affairs doctrine.” Under New York legal principles that only one state should have the authority to regulate a corporation’s internal affairs, New York courts will refuse to allow actions to proceed against corporations from other jurisdictions if the shareholders have sufficient avenues to address management malfeasance under the laws of the corporation’s domicile.

A March 12, 2007 New York ruling where the court applied these principles to dismiss a shareholders derivative complaint that had been filed against directors and officers of ABN Amro Holdings NV may be found here. An interesting discussion and analysis of the ABN Amro case may be found on the With Vigour and Zeal blog, here.

An interesting article about the possible applicability of the internal affairs doctrine to the BP Alaska shareholders' derivative action, written by Francis Kean of the Barlow Lyde & Gilbert law firm, may be found here. Special thanks to Francis for providing a copy of this article.

Meanwhile, Back in Namibia...

Over the last few days, the papers have brimmed with news about developments in the Apple options backdating investigation (more about which below). But in the meantime, Kobi Alexander, the fugitive former head of Comverse Technology, has been holed up in Namibia. Alexander is free on bail while fighting extradition to the U.S. where he faces a 35-count indictment charging him with conspiracy, securities fraud, lying to the SEC, money laundering and bribery, in connection with the Comverse Technology options backdating investigation. (A good summary and analysis of the charges against Alexander, including a link to Alexander’s September 20, 2006 indictment, can be found on the White Collar Crime Prof blog, here.)

According to a April 24, 2007 Newsday article entitled “Will Comverse Fugitive’s Cash Sway Extradition?” (here), Alexander has promised to spend 100 Million Namibian Dollars ($16 million) on Namibian business projects, through his Kobi Alexander Enterprises vehicle. (Alexander has successfully prevented efforts to freeze bank accounts containing funds he transferred to Namibia from New York and Israel.) He has repeated his commitment to invest in Namibia in full-page newspaper advertisements and on billboards. He has already spent $500,000 building low-income familty housing, and in the days leading up to his scheduled April 25, 2007 extradition hearing, he announced that he would provide $21,000 for scholarships (refer here) and even spend 22,400 Namibian dollars building latrines at schools and kindergartens (refer here). The scholarship fund offer proved short-lived, as Alexander postponed the press conference announcing the fund's launch (refer here).

The April 23, 2007 Namibian, in an article entitled “Wanted in the U.S., Setting Up Scholarship Funds in Namibia” (here), reported that Alexander “has moved swiftly to financially endear himself to Namibians,” and he has “not lacked for takers; neither in the private sector, nor, it appears in political circles.” According to the Namibian, in the press release describing Alexander’s scholarship donations (later postponed), the Namibian Ministry of Education described Alexander as “passionate about Namibia and its people.” The press release apparently identified Alexander as the founder of Comverse but made no mention of the peculiar reason for Alexander’s presence in Namibia.

But while Alexander’s extradition hearing had been scheduled to take place today (April 25), the hearing was postponed until June 8, 2007 (refer here) at prosecutors' request. Prosecutors did not provide a reason for their delay request. One can speculate that prosecutors wanted to avoid the distracting impact of Alexander’s attempts to ingratiate himself financially. On the other hand, government officials may have wanted the delay as the best means to keep Alexander's Namibian gravy train running. Because this is the third postponement, I am going with the latter theory.

The Newsday article quotes Alexander’s attorney in the U.S., Robert Morvillo, as saying “I don’t think he’s trying to buy justice, he’s trying to present another side of himself.” Yes, on one side, he’s a fugitive from justice, on the other side, he’s rich. We’ll compromise and call him a rich fugitive from justice.

Apple Developments: The SEC’s complaint (here) against former Apple CFO Fred Anderson and former Apple General Counsel Nancy Heinen provides a more detailed glimpse of the events surrounding options backdating at Apple. But, as reported in today’s Wall Street Journal (here, subscription required), statements by Anderson’s attorney may present new questions potentially implicating Apple’s CEO, Steve Jobs.

For a good overview of the statements and the potential implications for Jobs, refer to the Ideoblog (here) and the Conglomerate blog (here). As detailed in these blog posts, statements that Anderson claims to have made to Jobs may make it harder for Jobs to continue to contend that he did not “appreciate” the accounting implications of options backdating. However, the White Collar Crime Prof blog (here) is skeptical that these statements will lead to criminal or even civil charges against Jobs. A copy of Fred Anderson’s attorney’s statement can be found here.

Send Lawyers, Guns and Money: According to Wikipedia, Namibia is about half the size of Alaska, but is one of the most sparsely populated countries on earth. Its population of about 2 million is roughly equivalent to the population of the Cleveland metropolitan area. The official language is English. Adjacent to South Africa on Africa’s west coast, Nambia’s climate ranges from desert to subtropical, and is generally hot and dry. Windhoek (pronounced “Vind-hook”), Namibia’s capital, has about 230,000 people, and has a semi-desert climate. Minimum temperatures rarely fall below 40 degrees F. Apparently, you don't have to live like a refugee.

Outside Director Exposure: A Recent Settlement Raises Alarms

Since the well-publicized settlements in the Enron and WorldCom cases, where individual directors were required to contribute toward settlement out of their own assets without recourse to indemnity or insurance, outside director exposure has been a hot topic (refer here for my prior discussion of those settlements). In addition, the SEC’s recent statements about pursuing outside directors as “gatekeepers” with a responsibility to prevent corporate misconduct, reinforced by its recent enforcement action against the outside directors of Spiegel (refer here), have further raised concerns.

The recent scholarly research of Bernard Black of the University of Texas, Brian Cheffens of Cambridge University, and Michael Klausner of Stanford Law School, in an article entitled “Outside Director Liability” (here) provides some reassurance that outside directors’ individual out-of-pocket contributions toward settlements have been, at least historically, an unusual and rare occurrence. The professors found only 13 cases in 25 years in which outside directors had to make out-of-pocket settlement payments. The authors conclude that the risk of outside directors being called upon to contribute has been “very low,” and have largely been a reflection of the insolvency of the corporate entity or the unavailability of D & O insurance. The authors conclude that this remote possibility could be even further reduced “with appropriate [D & O] policy limits and current state of the art protections.”

While the professors’ analysis is comforting, a recent settlement underscores the need for outside directors, as well as their advisors and insurance professionals, to continue to keep a sharp focus on outside director exposure. An April 23, 2007 Wall Street Journal article entitled “Settlement in Just for Feet Case May Fan Board Fears” (here, subscription required) describes a recently completed settlement in which five former outside directors of Just for Feet paid a total of $41.5 million to settle a bankruptcy trustee’s state court breach of fiduciary duty claim against the individual outside directors.

The Journal briefly relates that Just for Feet "collapsed amid an accounting fraud" in 1999. Three former Just for Feet officers pled guilty to crimes, and the company filed for bankruptcy protection in 2000. Just for Feet also settled a securities class action lawsuit, as a result of which, according to the Journal, only $100,000 remained available from the company’s insurance. A brief description of the $24.5 million corporate defendants' class action settlement may be found here. A copy of the consolidated class action complaint can be found here. The Notice of Settlement regarding the Just for Feet class action settlement may be found here. At least one of the individual defendants named in the trustee claim was also named as a defendant in the class action lawsuit.


The Just for Feet bankruptcy trustee filed Alabama state court allegations against the outside directors and the company's outside auditor in 2001. The lawsuit charged the individuals with, among other things, conflicts of interest, misrepresentations, breach of fiduciary duty and bad faith. According to the Journal, in September 2006, four former outside Just for Feet directors agreed to pay $40 million to settle the trustee’s claims against them. Last month, the last remaining outside director paid $1.5 million to settle the trustee’s claims. The former directors neither admitted nor denied liability.

It does not appear that the five individuals were, like the outside directors were in the Enron and WorldCom settlements, prohibited from seeking outside indemnity or insurance. Indeed, the Journal article notes that “[i]t is unclear whether any of the former outside directors’ employers, former employers or any other person on institution helped cover their portion of the settlement.”

The question whether the outside directors’ settlement may have been funded by a third party source, rather than out of the individuals' own assets, is an interesting and important detail (and not just to the individuals themselves). In that regard, it is important to note that one of the individual outside directors is a principal of a venture capital fund; two of the individuals are principals of private equity firms; one is a principal of an investment bank; and one is the president of a commercial bank. (The individuals' names and their respective affiliations are detailed in the Journal article.) These individuals at least potentially could have sought indemnity from the respective firms, particularly if their service on the Just for Feet board was at the direction or request of their firms. In addition, each of these individuals might have had the opportunity to attempt to recover Outside Director Liability (ODL) protection under their respective firms’ D & O insurance. The fact that several of the individuals are principals of venture capital or private equity firms is particularly noteworthy in this regard. The insurance coverage available for individuals’ outside directors service on the boards of venture capital and private equity firms’ portfolio companies’ boards is one of the most important reasons for venture capital and private equity firms to buy insurance providing this protection. Indeed, the Just for Feet settlement provides a powerful example of the reasons why private equity and venture capital firms should acquire this type of insurance.

The fact that the company’s D & O insurance program was virtually exhausted by the class action settlement apparently without obtaining a release of claims against the outside directors presents another question. It is not clear from the sequence of events and the publicly available information whether or not the trustee had initiated the claims against the outside directors at the time the securities class action was settled. But it would typically be a constraint against the exhaustion or near exhaustion of policy limits if the settlement would not secure universal claims releases. The outside Just for Feet directors would obviously have had a strong interest in avoiding exhaustion without their release. That such an outcome occurred in the Just for Feet case suggests that outside directors of other companies would be well served by having more control over the disposition of D & O policy proceeds, so that they are not faced with continuing individual exposure without further insurance protection. One possibility might be to structure the now standard order-of-payments D & O policy provision to that disposition of the policy proceeds is controlled by a vote of the outside directors.

There are now a variety of commercially available insurance structures that might also help in similar situations in the future, although the perverse combination of insolvency and insurance exhaustion is a particularly fraught situation. Certainly, the availability of a Side A Excess layer or stand-alone Side A program designed solely for the protection and benefit of individuals (as opposed to the corporate entity) potentially could have provided protection. For a summary regarding Side A insurance, refer here. Many companies have already taken steps to secure this type of protection; according to the recently recently released 2006 Towers Perrin Survey of Insurance Purchasing and Claims Trends (here), 38% of public companies in the survey reported purchasing a Side A only D & O product. But protecting even these separate limits from depletion by settlement for the benefit of insider individual defendants would seem to require some formal partition of coverage between the individual inside defendants and the outside individuals, especially given the company’s insolvency. The Just for Feet settlement may provide the best example yet of the need for a separate Side A program dedicated solely to the outside directors’ protection -- or better yet, for a separate Individual Director Liability (IDL) policy solely for the benefit of one individual or a group of outside directors. The existence of separate limits that cannot be depleted in resolution of others’ claims is the best protection against the possibility that individuals might be left to face their own liability exposure without insurance protection.

But perhaps the most significant aspect of this individual outside director settlement is its sheer size. As the Journal states, the $41.5 million Just for Feet outside director settlement may represent “the largest out-of-pocket payment by outside directors following corporate fraud allegations.” While many companies now purchase Side A protection or other variants to protect individual officers and directors, the limits available under many of these structures would typically not be sufficient to entirely fund a settlement of the magnitude of the Just for Feet outside director settlement. According to the 2006 Towers Perrin Survey, the average Side A Only limit for survey participants that also have a full A/B/C program is $15 million, and only $8 million for those with only a Side A only limit. According to the data in the survey, only the very largest companies carry Side A only limits that would have been sufficient to fund a settlement of the size of the entire Just for Feet outside director settlement.

This is just one of several recent developments that threaten traditional notions of D & O limits adequacy. The rising size of average and median class action settlements (refer here), the rising level of defense cost expense, and the emerging threat of separate class action opt-opt lawsuits (refer here), have all complicated the usual calculus of D & O limits adequacy. These factors and the continuing threat of outside director liability exposures (and the need for the D & O program to be structured to address this threat) underscore the need for the involvement of a skilled insurance professional in the D & O purchasing process.

Securities Claims Against Pharmaceutical Companies: Frequent but Flawed?

Even as the number of new securities lawsuits in general fell to 10-year lows in 2006 (refer here), the number of lawsuits filed against pharmaceutical companies has remained at elevated levels. As noted in my prior analysis of the 2006 securities lawsuits filings (here), eight of the 110 securities fraud class action lawsuits filed in 2006 were brought against companies within SIC Code 2834 (Pharmaceutical Preparations) and another four were brought against companies within SIC Code 2836 (Biological Products).

These 2006 filings followed elevated levels of securities class action filings against pharmaceutical companies in 2004 and 2005. And the pace of filings has continued in 2007. Already this year, securities fraud lawsuits have been filed against Eli Lilly; Amgen, USANA Health Sciences and OrthoClear Holdings.

Plaintiffs’ claims against pharmaceutical companies proceed on diverse kinds of allegations. The most common securities fraud claims against a pharmaceutical company are based on allegations that the company misrepresented the efficacy of its product. In addition, in recent years, plaintiffs’ lawyers have targeted several drug companies in securities class action lawsuits based on alleged misrepresentations or omissions regarding product safety. Other allegations that have served as the basis of securities fraud allegations relate to clinical trial results; the quality or safety of the company’s manufacturing processes; the commercialization or marketing of the company’s product; the company’s description of its product; or the company’s revenue recognition or financial reporting practices. A good (although now slightly dated) analysis of the securities fraud lawsuits brought against life sciences companies, by Michael Kichline and David Kotler of the Dechert law firm, can be found here.

But while pharmaceutical companies have remained a favored target for plaintiffs’ lawyers , pharmaceutical have not always proven to be easy targets. In the last several weeks, a number of the securities class action lawsuits pending against pharmaceutical companies have been dismissed. For example, on April 13, 2007, Merck announced (here) that a federal judge had dismissed a class action lawsuit that had been filed against the company related to its discontinued arthritis pain reliever Vioxx. The court ruled (refer here) that investor claims should be dismissed because they were time-barred under the statute of limitations. The lawsuit was dismissed with prejudice.

The Merck suit dismissal is only the latest of several dismissals of securities fraud class action cases pending against pharmaceutical companies. On March 28, 2007, a federal judge in Boston dismissed the securities fraud lawsuit pending against Praecis Pharmaceuticals (refer here). The court held that the allegedly misleading statements lacked the requisite allegations of scienter, came within the safe harbor for forward looking statements, or were mere “puffery” that could not serve as the basis for a securities fraud lawsuits. The court held that the pleadings did not present a “strong inference” that the defendants had acted with the requisite mental state.

In addition to the Merck and Praecis cases, the cases pending against Boston Scientific and EPIX Pharmaceuticals were also recently dismissed. The court has not yet released its Memorandum Opinion in the Boston Scientific case. The EPIX Pharmaceuticals case was dismissed (without prejudice) “for failure of Plaintiff to prosecute” the action.

Though the reasons for these various dismissals are varied, collectively the dismissals provide reason to hope that plaintiffs’ firms might yet come to recognize potential disincentives to pursuing securities claims against pharmaceutical companies, and perhaps hesitate before suing them quite so quickly.

Several of the dismissals are described in further detail in an April 20, 2007 National Law Journal article entitled “Defense Wins Key Pharmaceutical Cases” (here).

More About 10b5-1 Plans: In a prior post (here), I examined the increasing regulatory scrutiny regarding 10b5-1 plans. In a recent article (here), Priya Cherian Huskins takes a closer look at this issue, and also provides useful and interesting practical suggestions about how to address the growing concerns regarding these plans. Special thanks to Priya for the link to her article.

Arbitrating Shareholder Claims: Coming Soon?

Two of the recent reports of blue ribbon groups looking at the competitiveness of U.S. capital markets recommended among other things that the SEC should consider permitting public companies to amend their charters to provide for arbitration of securities claims. According to an April 16, 2007 Wall Street Journal article entitled, “SEC Explores Opening Door to Arbitration” (here, subscription required), the SEC, as part of a “broader package” of shareholder rights proposals, is now exploring whether or not to allow corporate charter provisions requiring the arbitration of complaints by aggrieved shareholders.

The Interim Report of the Committee on Capital Markets (here, at pages 109 to 112) recommended “that the SEC should permit public companies to contract with their investors to provide for alternative procedures in securities litigations, including providing for arbitration (with or without class action procedures) or non-jury trials.” The Interim Report went on to state that “the Commission should not force shareholders to accept the costs that go with class action securities litigation, particularly the substantial and unpredictable risk of large jury verdicts that effectively force settlement of what may well be non-meritorious claims.”

The Bloomberg/Schumer Report (here, at pages 100-104) recommended that the SEC reverse “its historical opposition to the arbitration of disputes between investors and publicly traded companies.” The Report asserts that “shareholders should have the opportunity before the fact to determine whether submitting the future securities grievances to arbitration is in their own and the company’s best interest.” The Report also states that arbitration “would benefit all parties involved,” by reducing cost and speeding resolution, while permitting SEC enforcement action in appropriate cases.

While the SEC is exploring the possibility of allowing companies to amend their charters to require arbitration of shareholder claims, the Journal reports that SEC Chairman Christopher Cox does not believe that arbitration is a “panacea.”

There are several obvious shortcomings for the use of arbitration for shareholder fraud claims. First, there is limited opportunity in an arbitration proceeding for discovery, in a type of dispute that increasingly depends on extensive review of electronic communications and other electronic documents and data. Second, there is limited opportunity for appeal, which could substantially affect the rights of plaintiffs and defendants whose legal rights are determined by the arbitration panel. Third, arbitration hearings typically are conducted in private, rather than in a public forum, which would undercut the deterrent effect of private securities claims. Fourth, even if the company were able to require shareholders to pursue claims against the company and company officials through arbitration, shareholders would still be free to pursue related claims against other defendants (underwriters, accountants, lawyers, for example) in court. An overview of arbitration can be found here.

The Journal article anticipates that the arbitration proposal “is likely to spark fierce opposition from both investor-rights groups and trial lawyers.” Another group that might be motivated to object is the states’ attorneys general, who have recently discovered the profit and political appeal of class action opt-out cases (refer here) and who recently filed an amicus brief in the Tellabs case in the U.S. Supreme Court arguing against pleading restrictions that would limit their rights to bring shareholder claims (refer here). The Journal article notes that as a result of likely opposition, there is “a good chance” that the idea of permitting companies to require arbitration of shareholder claims “could fall flat.”

But even if the SEC were to go ahead, the possibility of a charter amendment requiring arbitration would be optional – that is, companies, would have to affirmatively choose to include the arbitration requirement in their charters. For existing public companies, that would presumably require a shareholder vote approving the charter amendment. To consider what shareholders might be asked to approve, it is worth thinking about what a proposed charter amendment might look like.

A prescient April 10, 2007 article entitled “Compelling Arbitration of Stockholder Class Actions Based on Federal Securities Law” (here), by Joseph Bartlett and Cathy Reese of the Fish & Richardson firm, takes a look at what enabling charter language might look like (including a sample charter amendment). The proposed language has some interesting features, including, for example, a requirement that the SEC be notified of the arbitration and have the opportunity to participate. The sample language brings home some of the limitations as well – for example, should a shareholder be compelled to Wilmington, Delaware to arbitrate? Looking at the proposed charter amendment makes me wonder how many companies’ shareholders would approve these kinds of charter amendments?

Interesting blog posts on the arbitration proposal can be found on the FEI Financial Reporting Blog (here), the 10b-5 Daily blog (here), and Ideoblog (here).

D & O Conference: This week, I will be participating in the American Conference Institute event entitled “D & O Liability Insurance” in New York City (refer here). On Wednesday April 18, 2007, I will be speaking on a panel entitled “State of the Market: New Coverages and Developing Exposures,” and on Thursday, April 19, 2007, I will be on a panel entitled “Boards of Directors: What are They Worried About and What are They Looking For?“ If you attend the Conference, I hope you will greet me and introduce yourself.

Opt-Outs: A Worrisome Trend

In the latest issue of InSights, entitled “Opt-Outs: A Worrisome Trend in Securities Class Action Litigation “ (here), I review recent opt-out settlement developments, take a look at whether or not the current trend will continue, and examine what the trend may mean for D&O carriers and policyholders.

Prior D & O Diary posts on class action opt-out can be found here and here.

Options Backdating Lawsuit Dismissed for Insufficient Demand Futility Allegations

On April 11, 2007, Judge William Alsup of the San Francisco federal court granted the defendants’ motion to dismiss the consolidated shareholders’ derivative complaint filed in the connection with alleged options backdating at CNET Networks, based on plaintiffs’ failure “to plead with particularity that demand on the board was excused as futile.”

The plaintiffs’ complaint, as amended, asserted four derivative claims based on federal securities laws, against thirteen individuals and against CNET itself as nominal defendants. Six of the thirteen individuals were board members at the time that the plaintiffs’ filed the initial complaint. In order for plaintiffs to pursue their claim, the plaintiffs are required under Rule 23.1 of the Federal Rules of Civil Procedure to plead the steps they have taken to “obtain the action the plaintiff desires from the directors or comparable authority” or alternatively to show the reasons for not making this effort. The CNET plaintiffs alleged they did not make any demand on CNET’s board because they contend demand would have been futile. In assessing the plaintiffs’ demand futility allegations, Judge Alsop relied on Delaware law because CNET is a Delaware corporation.

In order to support their allegation that demand was futile, the plaintiffs allege that the six individual defendants who were directors when the complaint was filed received backdated options and that they had “ratified” the backdated options grants.

Judge Alsup had “failed to plead with particularity that a majority of the board was not disinterested or independent or did not exercise business judgment in making decisions.” Judge Alsup examined the plaintiffs' options grant allegations, and found with respect to board recipients of the few options grants the plaintiffs successfully allged to have been backdated, only one board member recipient was still on the board when the complaint was initially filed. So the plaintiffs' allegtions that the board members had received the backdated options failed to establish demand futility. Judge Alsup also found that the plaintiffs' allegations that the board members "ratified" the allegedly backdated options grants was conclusory and insufficiently particularized to support demand futility allegations.

In reaching the conclusion that the plaintiffs had not adequately plead demand futility, Judge Alsup expressly distinguished Chancellor Chandler’s recent finding of demand futility in the Maxim Integrated Products case (here), where, Judge Alsop noted, the plaintiffs “had pleaded particularized facts” supporting demand futility, including allegations of knowing approval of backdated option grants, along with alleged intentional failure to disclose the backdated options. (My prior post regarding the Maxim Integrated Products case can be found here.)

The amended complaint on which Judge Alsup granted the dismissal motion was the CNET plaintiffs' fourth iteration, due to which Judge Alsup said that he was “inclined to deny further leave to amend.” However, he withheld his final determination on whether or not to grant leave to amend. He asked the parties to provide additional submissions on the question whether he had authority to allow the plaintiffs limited discovery about the possible “taint” to two of the directors defendants’ service on the CNET board’s compensation committee.

As noted in the April 16, 2007 Law.com article entitled “Federal Judge Axes CNET Stock Option Claims” (here), the CNET decision shows “how difficult it may be for plaintiffs to succeed in numerous similar claims related to stock-options backdating.” It does show that plaintiffs will have to allege more than merely that options grant dates differed from the measurement date, or even that the members of the board received allegedly backdated options.

Judge Alsup’s opinion also show that the Delaware Chancery Court decision in the Maxim Integrated Products case is not necessarily determinative of the demand futility question in other backdating cases, even other cases to which Delaware law applies. Judge Alsup’s particularized inquiry based on the plaintiffs’ specific allegations suggests that these issues will be determined on a case by case basis. Judge Alsup’s insistence on particularized allegations and his unwillingness to accept unsupported inferences as a basis for demand futility suggests that it could prove challenging for demand futility allegations in other options backdating lawsuits to survive dismissal motions.

UPDATE: According to the CorporateCounselNet.com blog (here), Judge Alsup has ruled to allow the plaintiffs to amend, and is considering whether to stay the case while permitting limited discovery.

An interesting and helpful memo on the CNET case by the Fenwick & West law firm can be found here.
Options Backdating Litigation Update: With the addition of the new derivative complaint filed against Lehman Brothers Holdings (here), The D & O Diary’s current tally (here) of the number of companies sued as nominal defendants in shareholders’ derivative complaints based on options backdating allegations stands at 157. The number of securities class action lawsuits stands at 29. In addition, as a result of the ERISA suit filed against KB Homes (here), the number of ERISA or 401(k) options backdating lawsuits now totals 5.

Record European Securities Class Settlement

On April 11, 2007, Royal Dutch Shell announced (here) that it had agreed to pay $352.6 million to non-U.S. investors who bought Shell shares outside the U.S., in connection with the company’s 2004 oil resources accounting scandal. According to the Times (London), here, the agreement is “thought to represent the largest ever class action settlement in Europe.” The agreement is subject to the approval of the Amsterdam Court of Appeals as we as to “agreed opt-out provisions.”

Shell also announced that it will be seeking a proportional settlement in the U.S. class action proceeding. According to Bloomberg (here), the European settlement is “contingent on a U.S. judge’s ruling not to include claims by non-U.S. investors within the existing class action claim.”

Legal counsel for the European shareholder is New York-based Grant & Eisenhofer and the Dutch law firm Pels Rijcken & Drooglever Foruijn .

CFO.com has further information about the settlement, here.

Would-be reformers of U.S. securities regulation, who routinely cite U.S. litigiousness as the justification for proposed reform, should note that this is a European settlement on behalf of European investors (from multiple countries) proceeding in a European court. I have long contended (most recently here) that differences in regulatory and even litigation regimes in advanced economies may well diminish over time, and, in particular, that investors overseas will increasingly seek legal means in local courts to obtain compensation for corporate misconduct. The Shell settlement is the most recent, and perhaps the most vivid, example of these phenomena.

The With Vigour and Zeal blog has interesting and important background on this settlement here as well as links to key resource documents and materials regarding the settlement here. The Best in Class blog also has an interesting post on the settlement here.

A Different Look at Backdating Luck: A central tenet of the backdating scandal has been the supposedly lucky timing of many of the questioned stock option grants (see my earlier post on Lucky Options grants here). A recent paper by NERA Economic Consulting entitled “Options Backdating: The Statistics of Luck” (here) takes a closer look at what role luck or chance might actually have played in many of the questioned option grants, and reaches the somewhat contrarian conclusion that “some of the grant patterns that at first appear extremely unlikely are actually likely and should be expected.”

The study finds that just as there are companies that granted options on very favorable days, there are companies that granted on very unfavorable days. The article specifically states that the calculations presented in the Wall Street Journal articles that launched the backdating scandal “can be misleading,” and in particular “overstate the number of D & O that have been very lucky.”

Hat tip to Kelly Reyher for the link to the NERA article.

Climate Change and D & O Risk

The U.S. Supreme Court’s landmark April 2, 2007 decision in Massachusetts v. EPA (here) may represent a turning point in the evolving governmental response to global warming. As discussed below, the decision itself and the regulatory, legislative and litigation consequences that will likely follow could have important implications for many publicly traded companies and their directors and officers, particularly companies in certain industries. These effects in turn could have important D & O insurance implications as well.

Let me acknowledge at the outset that a short time ago I would probably have had little patience with an article like this one. I cannot abide alarmists who try to turn peripheral concerns into major crises (see, for example, my prior post, here, decrying specious efforts to convert avian flu into a generalized corporate priority). But the Supreme Court’s recent opinion, together with a confluence of other causes and concerns, persuades me that many companies no longer have the luxury of treating global warming as a peripheral concern.

The most important (but by no means the sole) factor in my revised view of this topic is the recent U.S. Supreme Court ruling in Massachusetts v EPA. The Court held that the EPA had violated the Clean Air Act by improperly declining to regulate new-vehicle emissions standards to control carbon dioxide emissions that contribute to global warming. In and of itself, the Court’s ruling is somewhat narrow. Indeed, the Court declined to reach the question whether or not the EPA must reach “an endangerment finding” requiring regulation of carbon dioxide emissions in new vehicles. The Court held only that the EPA had “offered no reasoned explanation for its refusal to decide whether greenhouse gases cause or contribute to climate change.” The court remanded the matter to the lower court (and from there, to the EPA) with the direction that the EPA “must ground its reasons for action or inaction in the statute.”

While the Court's holding is narrow, there are two components of the Supreme Court's decision that are, however, very important. The first is the Court’s holding that the injury of which Massachusetts complained in bringing the suit was sufficiently particularized for Massachusetts to have "standing" to bring its claim. The second is that greenhouse gas emissions are "pollutants" under the Clean Air Act. These elements, taken in the case’s full political, economic and legal context, could mean that the decision will, in the words of the April 3, 2007 Washington Post article discussing the case (here), “serve as a turning point.”

Among the most important reasons the decision may serve as a turning point is the plethora of lower court cases that had been held in abeyance pending the outcome of Massachusetts v. EPA. The most important of these other cases is the Mass v. EPA companion case in the D.C. Circuit, Coke Oven Environmental Task Force v. EPA, No. 06-1322 (D.C. Cir., filed April 27, 2006) (refer here). Just as the Mass v. EPA case challenged the EPA’s inaction on new mobile source (i.e., automobiles) greenhouse gas emissions, the Coke Oven case challenges the EPA’s inaction on new stationary sources (i.e., utilities) greenhouse gas emissions. The Supreme Court’s holding in the Mass v EPA case that greenhouse gases are indeed pollutants under the Clean Air Act is broadly applicable to both mobile and stationary sources. In other words, the EPA’s regulatory response necessarily must carry implications for a broad range of industries. In addition to the Coke Oven case, other lower court cases on these and related issues were also held in abeyance, and will now go forward in light of the Supreme Court’s ruling in Mass v EPA.

In addition, a variety of state and federal cases either filed in the past or now pending have directly attacked the sources of greenhouse gas emissions (particularly automobile manufacturers and electric utilities) in several tort-based lawsuits, usually on public nuisance theories. The courts have largely dodged these cases in the past, invoking the principle that the claimants’ allegations of generalized harm are insufficiently particularized to support a justiciable controversy. The Supreme Court’s holding that Massachusetts had adequate standing to present a justiciable controversy could have a very significant impact on future courts’ rulings on jurisdictional standing and justiciability criteria that must be satisfied for litigants to bring climate change-based cases. (An interesting commentary on the Supreme Court's standing holding can be found here.)

The Supreme Court’s decision is only one of several important recent developments affecting these issues. The November 2006 election also dramatically changed the political landscape, and the Democratic majority in both houses of Congress has brought climate change to the top of the legislative agenda. Bills have already been introduced in both chambers to address climate change directly. While a congressional consensus on these issues may prove elusive, the states are in the meantime moving forward. California’s landmark Global Warming Solutions Act of 2006 is only one of several states' legislative initiatives in this area. A decision by the EPA to decline the Supreme Court's invitation to reconsider its decision not to regulate greenhouse gases could be the worst possible outcome for business, because it will spur Congress to action, and even barring that, invite action from the states, who are racing ahead of Washington on these issues. The Economist magazine has a good summary (here, subscription required) of the confluence of the legistaltive and regulatory forces on the issue of greenhouse gas emissions.

None of this has been lost on the business community. For example, on January 22, 2007, a coalition of ten companies joined several environmental groups to propose (refer here) a cap-and-trade program regarding greenhouse gas emissions.

All of these forces are likely to gain momentum in light of continuing developments, such as the Intergovernmental Panel on Climate Change’s April 6, 2007 release of its latest report (here) on climate change impacts, raising even more alarming concerns regarding global climate change (about which, refer here).

The point here is not merely some generalized concern about the changing cultural, political, regulatory, legislative and litigation context. The point is that all of these changes represent particularized concerns for many public companies, affecting their disclosure obligations under Regulation S-K. Two provisions of Reg. S-K are particularly applicable here, Item 101 and Item 303.

Item 101(c)(1)(xii) requires companies to disclose current and anticipated “material effects” of compliance with environmental regulations:

Appropriate disclosure also shall be made as to the material effects that compliance with Federal, State and local provisions which have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, may have upon the capital expenditures, earnings and competitive position of the registrant and its subsidiaries. The registrant shall disclose any material estimated capital expenditures for environmental control facilities for the remainder of its current fiscal year and its succeeding fiscal year and for such further periods as the registrant may deem material.

As new EPA regulations and state mandates regarding greenhouse gas emissions accumulate, many companies may find themselves for the first time obliged to provide Item 101 environmental regulation impact disclosure, and other companies will be compelled to provide more extensive Item 101 disclosure than may have been the case in the past.

Item 303 requires companies to “describe any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenue or income from continuing operations.” There are an increasingly large number of increasingly important trends and uncertainties surrounding global climate change that will affect an increasingly greater number of companies, requiring these companies to adapt their Item 303 disclosure accordingly.

The type and range of financial consequences that might arise from global warming is a topic far beyond the scope of the blog format. A good summary of these topics can be found in the Association of British Insurers June 2005 report entitled "Financial Risks of Climate Change" (here). There is, in brief, no limit to the number of potential "risks, trends and uncertainties."

Because of these disclosure obligations, many public companies will face the increasing challenge of articulating the impact of global climate change regulation, legislation and litigation on their business and operations. Because of the extent of the impact (both probable and possible) and the prospect for developments that could have dramatically negative consequences for at least some companies, future shareholder litigation surrounding these disclosures necessarily must be anticipated. The various political, regulatory and litigation trends identified above will obviously affect companies in the automotive and energy generation businesses (and supporting industries), but emphatically not these companies alone. Other industries that seem likely to be affected include insurance, transportation, manufacturing, shipping, and other businesses whose operations have (or which could sustain) a substantial environmental impact, even if it is entirely localized. There are certainly other industries that are beyond my imaginative capacity to anticipate here.

In short, the public company disclosure obligations create a context within which it is prudent to assume that D & O claims may arise. To the extent claims do arise, the wording of applicable D & O policies could have an enormous impact on the availability of D & O insurance to defend and indemnify companies and their directors and officers.

D & O policies typically contain a pollution exclusion. I was surprised to observe, upon careful reading of several typical pollution exclusions for purposes of writing this post, that it is not obvious that the standard pollution exclusions were intended to pertain to greenhouse gas emissions or consequences arising therefrom. The term “pollutant” as used in many policies’ exclusions simply may not encompass greenhouse gas emissions. Indeed, there may be several arguments on which to contend that the standard pollution exclusion wording has no relation to greenhouse gas emissions or their environmental consequences. (Of course, whether or not such contentions would be persuasive to a court is a matter of pure conjecture, on which I do not opine.)

Nevertheless, assuming the exclusion would otherwise preclude coverage for claims pertaining to greenhouse gas emissions, the pollution exclusion in most D & O policies these days carves back coverage for derivative suits and shareholder claims. In light of the possible course of future litigation in this area, the wording of the pollution exclusion, and in particular the wording of the carve back for shareholder claims and derivative lawsuits, will be absolutely critical. The fact that this policy language must anticipate cases and claims of kind that may not have previously arisen underscores the importance of enlisting the assistance of skilled D & O insurance professionals in the D & O insurance transaction.

A good resource in this area is the article by J. Wylie Donald and Loly Garcia Tor of the McCarter & English law firm entitled “Climate Change and The D & O Pollution Exclusion” (here).

A good round up of blog commentary on the Massachusetts v. EPA case can be found here. A round up of press coverage about the case can be found here.

Connecticut Law School Conference: On Thursday April 12, 2007, I will be participating on a panel at a conference at the University of Connecticut Law School. The conference is entitled “D & O Insurance: Shareholder’s Friend or Foe?” and the panel on which I am participating is entitled “Can Insurers Reduce Securities Litigation Risk?” Further information about the conference can be found here. Prior D & O Diary posts on the topic of D & O insurance and corporate governance can be found here and here.

Weather Central: If the rest of the world must learn to adapt to extreme weather as a result of climate change, they may want to spend a little time here in Cleveland. For the first time in recent memory we missed a White Christmas last year, but by God we are going to "enjoy" a White Easter this April. The rest of the country has no absolutely no idea how chilling is the phrase "The lake effect snow machine is engaged and stalled over the lakeshore." The old story about the Eskimos having dozens of words for "snow" undoubtedly is true, but kindred spirits here understand that almost all of the "snow words" would be unsuitable for a family-oriented blog.