Monday, August 27, 2007

Special Litigation Committee Terminates Options Backdating Derivative Action

On August 24, 2007, Rambus announced (here) that a Special Litigation Committee (SLC) of its board of directors had completed its review of “claims related to stock options practices that are asserted in derivative actions against a number of present and former directors and officers of the Company.”

Rambus had previously announced (here) on October 19, 2006 that its Audit Committee had completed an independent investigation into stock options grants and had “determined that a significant number of the stock option grants were not correctly dated or accounted for,” and that the company anticipated taking a $200 million charge. The Board also at that time formed the SLC to evaluate potential claims the company may have. The SLC consisted of two members of the company’s board, J. Thomas Bentley, a Managing Director of SVB Alliant (the recently closed investment banking arm of Silicon Valley Bank), and Abraham Sofaer, a former U.S. District Judge who is also a law professor at Stanford.

According to the company’s August 24 press release, the SLC determined, subject to the settlements described in the announcement, that “all claims should be terminated and dismissed against the named defendants in the derivative actions,” with the exception of claims against one individual who served as the Vice President of Human Resources between 1996 and 1999, and Senior Vice President of Administration from 1999 to 2004. The SLC determined that the claims against the individual should proceed and that the SLC itself will “assert control over the litigation.”

The announcement further disclosed that the SLC had “entered into settlement agreements with certain former officers of the Company.” The aggregate value of the settlements, which are “conditioned upon the dismissal of the claims asserted against them in the derivative actions,” exceeds $6.5 million in cash and cash equivalents “as well as additional value to the Company relating to the relinquishment of claims to over 2.7 million stock options." (The Company’s January 4, 2007 press release announcing the company’s former CEO’s relinquishment of the stock options can be found here.)

The company’s August 24 announcement is interesting by way of the contrast it provides to much of the litigation activity that has surrounded the options backdating scandal, where the battle lines typically have been drawn over the “demand futility” issue – that is, whether or not it would be futile to ask a company’s board to investigate and prosecute the alleged wrongdoing. The evidence of the Rambus SLC’s work presents an interesting counterpoint to the arguments that plaintiffs typically raise that it would be futile to demand that a board take responsibility for investigating alleged wrongdoing. There appears to have been nothing futile about the actions of Rambus’s board or its appointed committee.

I have no knowledge of the details of Rambus’s D&O coverage and I have no information beyond what appeared in the company’s news release, but based on the available information and assuming the provisions of the typical policy, the outcome of the SLC’s investigation could raise some potentially interesting coverage issues. To the extent that the amounts the individuals agreed to pay in settlement are in the nature of disgorgement or restitution, a D & O carrier would likely contend that it is not covered “loss.” (Of course, the individuals are likely to contend that the amounts are not restitutionary or otherwise do constitute covered loss.)

In addition, the company may well seek to recover its own investigative costs and costs incurred in connection with the SLC. Indeed, issues surrounding coverage for these kinds of costs have been a great source of tension between D & O carriers and policyholders in connection with the options backdating claims. Attorney and D & O commentator Dan Bailey has a good summary of the coverage issues associated with these kinds of costs in a recent article, here.

The continuing claims against the remaining individual defendant also presents an interesting issue; since the ongoing action would be direct rather than derivative, the carrier may contend that the claim would no longer appear to fall within the derivative claim exception to the insured versus insured exclusion. The availability of insurance (or absence thereof) could have a significant effect on the likely future direction of the claim against the remaining individual defendant.

Bad News and D & O Claims: In prior posts (most recently here), I have commented on the fact that sometimes it is the way a company deals with bad news, rather than the bad news itself, that determines whether or not the company will also have to deal with a securities class action lawsuit. The allegations in the purported securities class action lawsuit that the Lerach Coughlin firm filed on August 24, 2007 against Advanced Medical Optics and several of its directors and officers appears to provide another example of this phenomenon. The press release regarding the new lawsuit can be found here, and the complaint can be found here.

Let me just say at the outset that I have no knowledge of the facts and circumstances other than what is alleged in the complaint, and I do not mean to suggest that the circumstances are as the plaintiffs’ have alleged or that the claims are meritorious. For purposes of discussion, I have simply taken the plaintiffs' allegations as presented.

In the complaint, the plaintiffs allege that in November 2006, the Company announced a voluntary recall of CompleteMoisturePLUS (“Complete”), a bottled soft contact lens solution sold on a worldwide basis, because of bacterial contamination that compromised sterility. (The company’s press release regarding the November recall can be found here) The complaint further alleges that the defendants “moved to assure the market that the problem was isolated to Asia and that the prospects for the Complete product were favorable.”

The complaint cites a number of company statements that supposedly indicate that the Asian facilities had been sanitized, inspected and would be staged back into production, and that the company’s sales for the Complete product were or would be fully restored. The complaint alleges that in April the Company announced favorable results, including rising sales of Complete. The complaint alleges that the defendants made favorable disclosures about Complete though they knew that there were problems and that a recall was “not just a future possibility but a significant likelihood.” The complaint alleges that as a result of the company’s reassurances, the company’s stock performed well and the defendants were able to sell significant amounts of their personal holdings of the company’s stock at a profit.

The complaint goes on to allege that in a May 25, 2007 press release, the company announced that in response to “information received today from the Center for Disease Control regarding eye infections,” the company was immediately and voluntarily recalling its Complete contact lens solution. (A copy of the company's May 25 press release can be found here.) The complaint alleges that the company’s stock price declined 14% on this news.

There are several interesting things about this complaint. The first is that the initial bad news (the November 2006 product recall) is not the basis of the securities lawsuit; indeed, the class period does not even purport to begin until January 2007, well after the initial product recall. It is rather the supposedly reassuring statements that the company allegedly provided between November and May that are the basis of the complaint. The events alleged (again, without taking a position whether or not they are true or that plaintiff’s allegations correspond in any way to what actually happened) seem to illustrate the point, which I have previously observed here, that “partial, incomplete or overly optimistic disclosure can exacerbate damage from bad news disclosure and risk the creation of securities litigation exposure.” As the allegations seek to show, it may be that the “calming” statement itself may be alleged to be misleading – in other words the securities litigation exposure results from the “damage control,” not the underlying event.

The insider trading allegations also illustrate another important point for managing bad news disclosure (which point may or may not have been relevant to AMO's circumstances), which is that companies involved in bad news would be well advised to consider imposing a trading blackout until the problem is entirely contained. My prior essay presenting a more detailed program for managing bad news disclosure can be found here.

Another interesting thing about this lawsuit is the name of the company sued. Long ago, I noted the odd susceptibility to securities class action lawsuits of companies with the word “Advanced” as the first word in their name. The Stanford Law School Securities Class Action Clearinghouse index of securities lawsuits (here) identifies 12 different companies (including Advanced Medical Optics) that have been sued in class action lawsuits. I do not mean to engage in the much-derided confusion of correlation and causation, but I still do think that it is kind of weird that companies with the word “Advanced” in their name seem to get sued all the time.

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