What to Watch Now in the World of D & O
Will Securities Class Action Filings Return to Historical Levels?: As has been noted in several recent statistical studies (for example, refer here), the level of securities class action lawsuit filings has been well below historical averages since mid-2005. This phenomenon has begun to seem so well-established that Stanford Law Professor Joseph Grundfest speculated (here) in July that that there may have been a "permanent shift" to a lower level of class action filings.
But in its recently released study of class action lawsuit filings through the first half of 2007, NERA Economic Consultants noted that while class action filings in the first of 2007 were well below historical norms, the level of filings in the first half of the year was well above the filing level in the second half of 2006. Moreover, the NERA study looked only at filings through June 30, 2007. If anything, the filing trend since that time has accelerated, and (as noted here) the number of securities lawsuit filings during August and September 2007, when extrapolated to an annualized filing rate, was well above historical averages.
By my count, during the two-month period between August 1 and September 30, 2007, 37 publicly traded companies were sued for the first time in securities class action lawsuits. If this filing rate were extrapolated over a 12-month period, the resulting annualized filing rate would be 222 lawsuits. By way of comparison, according to Cornerstone, the average number of securities class action filings during the nine-year period between 1996 and 2004 was 202, compared with 116 filings for the full year 2006.
The accelerated securities class action lawsuit filing level so far in the second half of 2007 is being driven in part by the wave of lawsuits growing out of the subprime lending mess (about which, see more below). But the subprime lending-related litigation wave, while substantial, is only a part of the story. The lawsuits filed so far in the second half of 2007 have swept across many industries and arisen from a variety of circumstances. While a couple of months may be too short of a period from which to generalize, it is certainly true that it has been several years since the securities lawsuit filing level has been as high as it has been so far in the second half of 2007. It may be too early to call the change, but it certainly appears possible that filing levels may be reverting back to historical levels.
How Big Will the Subprime Lending-Related Litigation Wave Become?: The subprime lending meltdown has dominated the headlines, riled the credit marketplace, and disrupted the financial markets. It has also generated a wave of litigation, much of it directed against directors and officers of publicly traded companies. As of October 4, 2007, according to the running tally of subprime lending-related lawsuits I am maintaining here, there have been 17 companies sued in subprime lending-related securities class action lawsuits, in addition to four home construction companies that have been sued in securities lawsuits arising from subprime related issues. There have also been two shareholder lawsuits filed alleging that credit rating agencies failed to disclose that they were providing inflated ratings to subprime mortgage-backed securities (about which refer here), and two lawsuits filed on behalf of employees against their subprime-related employers alleging violations of ERISA in connection with the companies’ 401(k) plans.
The subprime lending-related litigation filed so far already represents a substantial development for D & O insurers. The larger concern for insurers at this point is how much worse the problem will become. As I have noted previously (most recently here), D & O insurers have stepped up their underwriting related to subprime issues, not only to identify companies that were directly involved in subprime lending but also to identify companies that may be carrying troubled mortgage-backed securities on their balance sheets. These assets are only as valuable as the performance of the underlying mortgages. Because so many mortgages are adjustable rate mortgages that will reset to higher interest rates in the months ahead, there would appear to be reason to concerned about the possibility of further deterioration in the value of subprime mortgage-backed assets. (For a more detailed discussion of this later point, refer here.)
Unfortunately, under there circumstances, it appears likely that the subprime mortgage-related litigation wave will continue to grow, at least in the near term. My detailed overview of "The Subprime Lending Mess and the D & O Marketplace" can be found here.
How Will the Securities Plaintiffs’ Bar Respond to Changes at the Industry-Leading Firms?: Bill Lerach has agreed to plead guilty to a criminal charge (about which refer here), and Mel Weiss has taken a leave from his firm to contest the criminal indictment that has been returned against him (about which refer here). These two lawyers unquestionably were the most prominent figures in the plaintiffs’ securities class action bar, and their respective law firms unquestionably were the most active plaintiffs’ securities class action firms. The firms already have shown the effects of their leaders’ legal woes; the Milberg Weiss firm essentially has filed no new lawsuits since mid-2005 (not coincidentally, the same time period during which there had been a general lull in class action filings, as noted above) and the former Lerach Coughlin firm was recently reconstituted as Coughlin Stoia Geller Rudman and Robbins.
There certainly is no shortage of firms already jockeying to position themselves to take advantage of the changes at the industry leading firms. For that matter, a number of plaintiffs’ firms more commonly associated with asbestos and tobacco litigation, such as the Motley Rice firm and the Kahn Gauthier Swick firm, have recently entered the securities class action space, and new plaintiffs firms, such as Saxena White, have formed from former Milberg Weiss partners.
But while there are many opportunistic plaintiffs’ lawyers hoping to capitalize on the misfortune of the industry leaders, it is not yet clear whether any of these players can play the role that Lerach and Weiss previously played. As the September 21, 2007 Wall Street Journal noted in reporting (here) on Weiss’s indictment, the Milberg Weiss firm was willing to make big investments to support cases and "fronted costs that could be recouped only if it achieved a result that forced opponents to pay damages." It remains to be seen whether the would-be successors to Weiss and Lerach will be willing to make this kind of investment or otherwise play the role they played in the past.
Will Securities Class Action Settlement Opt-Outs Be a Significant Part of Future Claims Resolution?: There have always been class action settlement opt-outs – that is, shareholders who chose not to participate in the settlement of a securities class action lawsuit. What has changed is that more investors, representing significant investment interests, are concluding that it is in their financial interest to opt-out. As noted in greater detail here, over the last several months, public pension funds have announced their settlement of individual opt-out claims, often claiming that their opt-out recoveries exceeded what they would have recovered in the class settlement.
The sheer scale of these opt-out settlements is enormous. In the Time Warner securities lawsuit alone, the aggregate $795 million that the nine publicly announced opt-out claimants have garnered represents a significant portion of the $2.65 million class settlement. And there are many more opt-out claims in that case yet to be resolved.
If investors believe they can substantially improve their recoveries by proceeding individually rather than as part of a class, the utility of class action lawsuits will be undermined. At some point, if enough investors opt out, the defendants may invoke the "blow" provisions to have the class settlement set aside. A more universal trend toward opting out as a routine part of the class action settlement process could also increase the total litigation cost. If a defendant must defend itself against both a class action settlement and multiple opt-out lawsuits, the costs of defense and of ultimate claims resolution could escalate enormously.
These developments could pose a significant problem for D & O insurers and policyholders. Insurers base their pricing and claims reserves on data derived from past settlements. But with the emergence of significant opt out claims, past claims data may not longer be indicative of future claims severity. And for policyholders, the emergence of opt out claims significantly complicates the question of limits adequacy.
It is unclear whether the recent wave of opt-outs will become a permanent part of the class action settlement process. All of the recent opt-outs have come in "mega-cases" associated with the corporate scandals from earlier in the decade. But while it remains to be seen whether opt out settlements will or will not be a significant part of class action settlements going forward, it is hard to disagree with Columbia Law School’s John Coffee, who called the emergence of class action opt-outs "possibly the most significant new trend in class action litigation."
My prior detailed analysis of the opt out issue can be found here.
Will Claims Disputes With Excess Carriers Become a Standard Part of the D & O Claims Process?: Many of the same studies noted above detailing the recent reduction in securities class action filings have also noted a rise in both the average and median securities class action settlements (refer, for example, here). As settlement amounts have escalated, and as defense expense also has continued to increase, excess D & O carriers, and in particular, upper level excess D & O carriers, have become an increasingly important part of D & O claims resolution.
Perhaps because of their increasing involvement in D & O claims, excess carriers also have been increasingly involved in disputed D & O claims and claims litigation. Indeed, a very significant number of the recent significant D & O claims litigation developments have involved litigated claims disputes between policyholders and their excess D & O carriers. (For example, the recent high-profile CNL Resorts case, refer here, involved coverage litigation with two excess insurers.) Strikingly, many of the disputes with excess carriers have arisen after the primary carrier and even the lower level excess carriers have paid all or substantially all of their policy limits.
As discussed at length in a prior post (here), some of these disputes involved follow form excess insurers who take the position that they are not bound by the primary carrier’s actual or implied coverage decisions. Other disputes with excess D & O carriers have arisen when the excess carrier has taken the position that an underlying carrier’s payment of less than its full policy limit relieves the excess carrier of its payment obligation, even if the policyholder funds the "gap" resulting from the underlying carrier’s partial payment.
One particularly important area of concern is the excess policy’s exhaustion language. Policyholders’ interests are best served by flexible language that reduces restrictions around the kinds of payments of loss that could trigger the excess carrier’s payment obligations. And as for the problem of follow form excess carriers that take different coverage positions than the underlying carriers, the industry ought to be doing a better job keeping track. When it threatens to become routine for follow form excess D & O carriers to take positions that the underlying carriers are not, the industry has a problem that it needs to address, whether through modification of the policy language or through the development of serial denier league tables. Given the increasing importance of excess insurance in D & O claims resolution, these issues will remain critical in the months ahead.
The issues cited above are all likely to develop and evolve. So many dynamics affect directors and officers liability exposure, but it is that very dynamic that makes the world of D & O so interesting.
One Final Note: Last year's big story arguably was the whole option backdating scandal, and while the options backdating cases will be working their way through the system for quite a while, the story does seem like old news. Yet, the options backdating cases are still coming in. Just today, the Coughlin Stoia Geller Rudman Robbins firm filed a new options backdating related securities class action lawsuit against Sonic Solutions. The firm's October 4 press release can be found here, and the complaint can be found here. (An options backdating related shareholders derivative complaint had previously been filed against the company.)
With the filing of the lawsuit against Sonic Solutions, the total number of options backdating related securities class action lawsuits now stands at 34, according to the running tally I have been maintaining here.