Monday, August 06, 2007

A Week’s Worth of D & O News

I was only away one week, but even in that short time there were many interesting developments in stories I have been following on this blog. Here is a news round-up, in no particular order:

NASDAQ’s Private Portal Approved: In an earlier post (here), I discussed the arrival of private securities markets, where accredited investors can exchange Rule 144A shares without the issuing companies becoming subject to reporting company burdens and responsibilities. On August 1, 2007, Nasdaq announced (here) that the SEC had approved its Portal system for centralized trading of Rule 144A securities. The new Portal system, which will be available to qualified users on August 15, is “intended to improve the efficiency and transparency of the private placement market – thereby encouraging capital formation.”

Interestingly, in its press release, one of the advantages Nasdaq cited for the market is not (as I had supposed) that it provides an alternative means to raise capital without the burdens and delay of an IPO; rather the press release suggests that the existence of an efficient trading market for private placements will smooth the companies’ path to going public by providing, among other things, more accurate pricing. The Nasdaq press release does say (as I would have expected) that as a result of the Portal market’s availability, “companies considering a traditional IPO should have an attractive new option to gain faster, simpler, less expensive access to the capital they require.”

The press release also explains that, to aid companies avoid the 500 shareholder threshold that would trigger reporting responsibilities, NASDAQ will collaborate with third-party providers to incorporate industry-wide shareholder tracking.

Because the Nasdaq Portal system will not be limited to customers of any one investment firm, it will be interesting to see what effect its availability will have on the proprietary trading markets, such as the Goldman Sachs GSTrUE system (about which see my prior post, here).

Tellabs in the Courts (Already!): So soon after the recent Tellabs decision in the Supreme Court (about which refer here), we are already getting some feedback about how the lower courts will apply the decision. In a July 27, 2007 opinion, the Seventh Circuit held in the Baxter International case (here) that a securities class action plaintiff’s allegations attributed to confidential witnesses must be “discounted” because it cannot be weighed in competing inferences, and thus are not sufficiently “compelling” to support a “strong inference” of scienter. The Seventh Circuit affirmed the lower court’s dismissal of the case. Hat tip to the 10b5-Daily (here) for the link to the Seventh Circuit decision.

The Seventh Circuit is of course the circuit whose ruling was reversed in the Tellabs case, and so it might have been predicted that the court might be likelier to dismiss a case (or affirm a dismissal) after Tellabs. (In fact, I predicted that very thing, here.) The decision may nevertheless have a larger significance, in that many securities class action plaintiffs rely on allegations based on information from confidential witnesses. If confidential information generally is held to be insufficiently compelling to support a strong inference of scienter, the Baxter International holding could have a significant impact.

More Milberg Woes: Regular readers know that I have been following (most recently here) the developments surrounding the criminal indictment of the Milberg Weiss firm and two of its former partners (refer here for the indictment). In what can only be called “turnabout,” the Milberg firm, three of its present or former partners, and the Lerach Coughlin firm have been sued in Manhattan federal court. The Complaint can be found here, and news coverage discussing the Complaint can be found here. Hat tip to the Law Blog (here) for the link to the Complaint.

The six individual plaintiffs previously were class members in two securities class action lawsuits (the Safeskin and the Schein Pharmaceuticals cases). They purport to represent a class of “all persons or entities who were members of the certified plaintiffs classes in the lawsuits in which Defendants and/or [the Milberg firm] made illegal payments to their clients to appear as plaintiffs, Lead Plaintiffs, and Class Representatives.”

The plaintiffs allege that the defendants breached their fiduciary duties to members of the various classes; engaged in a pattern of “racketeering activities,” including “commercial bribery”, in violation of RICO; and violated the statutes governing selection of lead counsel. The plaintiffs seek compensatory damages as well as treble damages under RICO.

The Complaint does not explain or even really suggest why the Lerach Coughlin firm was named as a defendant. The Lerach Coughlin firm's inclusion is odd, since at this point neither the firm nor any of its attorneys has been indicted. The civil complaint is replete with references to actions by or on behalf of the Milberg firm, but contains no allegations specifically addressed to the Lerach Coughlin firm. Indeed, the complaint does not mention the Lerach Coughlin firm by name after the firm’s identification as a defendant.

It seems probable that the plaintiffs will face challenges trying to establish sufficient commonality to support the certification of a class, but even if a class is established, the plaintiffs will face a monumental challenge in attempting to identify all of the members of the purported class.

But even as the proceedings continue in the criminal case and as the lawyers gear up to do battle in the civil case, a parallel discussion is emerging over whether the Milberg firm’s alleged misconduct, even if it took place, is legally objectionable. The Wall Street Journal ran a column on August 4, 2007 (here, subscription required) referring to an unpublished article (here) by Ideoblog author Larry Ribstein and Bruce Kobyashi. In the article, the two academics argue that fee sharing (“kickbacks,” in the pejorative terms used in the indictment) provides an incentive for a plaintiff to file a case and to take the role of lead plaintiff. They further argue that no one is harmed, since the persons sharing in the fee are motivated to maximize the class recovery to improve the returns on the fee sharing agreement.

This argument is interesting, but whatever its theoretical merits, I don’t think it helps the Milberg defendants defend themselves against allegations that they supported, encouraged or suborned false swearing, misrepresented fees and arrangements to courts and to class members, and so on. In other words, the theory may or may not be debatable, but the actual practices at issue may be less arguably blameless. According to August 7 news reports (here), the court presiding over the criminal case rejected the remaining Milberg defendants' motion to dismiss built around similar arguments as those raised in the academics article.

The Legal Pad blog has an interesting post on the civil RICO suit, here.

This Year’s Pink: Jolly Roger?: In an earlier post (here), I noted the new OTCQX system that Pink Sheets LLC has adopted in order that qualifying companies trading on the Pink Sheets would be able to (positively) distinguish themselves from other, less savory companies trading on the system. (A list of the 15 companies that have qualified for the OTCQX system can be found here.)

A July 28, 2007 Washington Post article entitled “Watch Out for the Skull and Crossbones” (here) discusses some additional markers that Pink Sheets has adopted to help investors assess companies that trade on the system. For example, a black skull and crossbones icon will identify securities promoted by “spam” or “other questionable action.” A pink check mark will indicate a company “whose issuers currently and fully disclose their financial results.” A triangular “yield” sign will indicate issuers that have disclosed limited financial information, and a stop sign will mean the issuer has provided no information for six months.

According to the Post article, these new labels are part of the efforts of the current owners of Pink Sheets to clean up the joint. But there is no reason why this rating system (or something similar) should not be adopted by the various exchanges. Certainly, all retail investors would benefit from a system that separates companies by quality. For that matter, D & O underwriters could use some objective guidance too; for example, it certainly would be useful for underwriters to know which publicly traded companies are going to be sued in securities class action lawsuits in the next, say, twelve months. Perhaps a skunk icon next to the ticker symbol, or maybe a ticking time bomb...

Sun Times Media Group Settles: In a recent post (here), I discussed coverage litigation that had arisen between the Sun Times Media Group (formerly known, and referred to here, as Hollinger International) and several of its former officers and directors, on the one hand, and the company’s excess D & O carriers on the other hand. In a July 31, 2007 press release (here), the company announced that it had settled the underlying securities lawsuits, and that it had also “reached an agreement to settle litigation over its directors and officers insurance coverage.”

The securities class action settlement will resolve the consolidated U.S securities litigation, as well as related Canadian litigation. The Company’s settlement of the lawsuits “will be funded entirely by $30 million in proceeds from the Company’s insurance policies.”

The press release further states that the insurers will deposit $24.5 million in escrow to fund payment of defense fees, with the allocation of the escrow funds to be judicially determined. Upon the funding of the escrow and the settlement, the D & O carriers “will be released from any other claims for the July 1, 2002 to July 1, 2003 policy period.”

The defense fee arrangement appears to resolve the coverage litigation that was the subject of my earlier post. It is unclear whether the insurance settlement described in the press release entirely resolves all related insurance issues. For example, the reference in the press release to a specific policy period certainly suggest the possibility that issues relating to policies applicable to other periods may be unresolved. There may also be issues remaining with the respect to the former Hollinger officers and directors who have pled guilty to or been found guilty of criminal misconduct. But even taking the statement about the resolution of insurance claims on its face, I still am curious about where these arrangements leave the various D & O carriers that were in the Hollinger insurance program.

As discussed in my prior post (here), Hollinger carried $130 million in limits arranged in four basic layers. The first two layers, totaling $50 million, were apparently exhausted in a shareholders’ derivative settlement (refer here). The third layer consisted of $40 million excess of the $50 million, and the fourth layer consisted of $40 million excess of $90 million. The recent class action settlement and related defense fee escrow fund together will require a total of $54.5 million, which would appear to exhaust the third layer as well as a portion of the fourth layer, all other things being equal.

A lifetime of D & O claims involvement makes me curious about exactly how the class action settlement and escrow obligations are to be allocated amongst the third and fourth layer excess insurers. It seems unlikely to me (although it is of course possible) that only the fourth layer insurers would benefit; without any direct knowledge of what the actual arrangements were (and feeling unrestrained from speculating), I suspect that the “savings” were distributed in some fashion among all of the excess carriers in the third and fourth layers – although I obviously could be completely mistaken in that speculation, too. Any readers who care to disabuse me of my illusions are encouraged to let me know what the actual circumstances may be.

Options Backdating Litigation: With all of the current focus on the growing wave of subprime mortgage lending lawsuits (refer here), it is very hard not to treat the options backdating mess as old news. But the shareholders’ derivative suit filed against past and current officers and directors of Eclipsys shows that while this story may well be aging, it still has legs. (An August 1, 2007 article describing the Eclipsys lawsuit can be found here.) With the filing of the Eclipsys lawsuit, the number of options backdating-related derivative lawsuits now stands at 161, according to the running tally that I have been maintaining here.

And in an interesting development in one of the longer-standing options backdating related securities class action lawsuits, on July 30 , 2007, Judge Jeremy Fogel, in the Mercury Interactive securities class action lawsuit, granted the defendants’ motion to dismiss, with leave to amend. (A copy of the opinion can be found here.) The judge found that the plaintiffs had inadequately argued that the plaintiffs had defendants had acted (as required under the Ninth Circuits’ idiosyncratic definition of scienter) with “deliberate recklessness.” Judge Fogel also found that the plaintiffs did not state a specific enough amount of loss that shareholders supposedly had suffered as a result of share-price drop. Judge Fogel also found that the Complaint should have omitted shareholders who held Mercury Interactive stock before September 2001, because the statute of limitations for those allegations had passed.

Even though Judge Fogel allowed the plaintiffs 30 days to amend their complaint, the ruling is potentially significant, particularly with respect to the statute of limitations issues. Many of the pending options backdating related securities lawsuits reach far back in time. Were other courts similarly to refuse to allow allegations to relate back to earlier periods, the scope of potential damages in these cases could be significantly reduced, since many of the options backdating securities cases involve technology companies whose shares were flying high in the late 90s. However, it should be noted that Judge Fogel's opinion is designated as "not for citation." Judge Fogel is a great judge and a fine American, but designating an opinion as "not for citation" runs counter to the system of precedent embodied in Anglo American jurisprudence. Previously decided cases should inform and help decide future cases, not merely resolve the immediate dispute before the court. If cases cannot be treated as providing precedential authority, judges are reduced to little more than referees, deciding whether the runner is safe or out. If I were king of the world, judges would never be allowed to publish a decision "not for citation."

An August 2, 2007 article further describing the Mercury Interactive decision can be found here.


As Walter Cronkite would say, that's the way it is -- even after a week away. This news round up proves that we here at The D & O Diary are deeply committed to upholding the principles embodied in our motto: all the news we are interested in, we print.


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