The International Law Firm of Fulbright & Jaworski - Corporate Governance
Barbara Jean D'Aquila, Tarifa B. Laddon and John Tishbi
September 23, 2009
- Towers Perrin Releases 2008 Directors and Officers Liability Survey
- Judge Scheindlin Rejects Rating Agencies’ First Amendment Motion to Dismiss in Subprime Suit
- Eighth Circuit Affirms Dismissal in Subprime Related Securities Class Action
- Court Denies Proposed Consent Judgment Between SEC and Bank of America
Towers Perrin Releases 2008 Directors and Officers Liability Survey
On September 9, 2009, Towers Perrin released its survey results for its 2008 Survey of Directors and Officers Liability Insurance Purchasing Trends. Towers Perrin’s most recent survey is its 31st study of D&O liability insurance purchasing trends. Over 2,500 participants responded to the 2008 survey, representing an 11% decline from the prior year’s survey. Three business classes represented 60% of the respondents, specifically: Technology (29%), Biotechnology & Pharmaceuticals (16%), and Government and Other Nonprofit (15%). Ownership profiles revealed that 60% of the respondents were privately owned companies, with public companies representing 25% of the respondents, and nonprofits accounting for the remaining 15%. As for company size, the majority of the responding companies employed less than 100 people, and only 1% employed more than 25,000.
According to Towers Perrin, “the 2008 results continue to show a soft market for D&O liability insurance” and the ongoing mortgage and credit crisis does not seem to have materially impacted the D&O market.
Towers Perrin’s survey provides some interesting statistics, information, and trends regarding a variety of topics, including D&O policy limits, types of policies (e.g., Side A only D&O policies), independent director liability (IDL) coverage, international D&O coverage, and coverage enhancements. The entire survey is available here. Although not all inclusive, some of the interesting trends and information reported by Towers Perrin include the following:
- “Survey participant policy limits ranged from $500,000 to $300 million.” Although a number of participants reported decreasing their policy limits in 2007, the new survey results revealed this was not the practice in 2008, as “only 3% of participants reported decreasing their D&O limits”.
- The average policy limit for all survey participants increased from the previous year. But organizations with assets exceeding $10 billion “reported decreased policy limits’” according to Towers Perrin.
- Repeat survey participants also reported that their D&O policy limits had increased, with the average increase being 6%. Only the banking business class and the petroleum, mining and agriculture business class reported decreasing policy limits. Having experienced a 46% increase in 2007, in the 2008 survey, “[t]he banking business class reported a 10% decline.”
- The 2008 survey also found growth of Side A only D&O policies, which “cover individual directors and officers when not indemnified by their organization.” Repeat public company participants reported “a 33% increase in purchases of Side A only coverage”. Seventy-three percent of the organizations with assets exceeding $10 billion “purchased Side A only coverage.”
- Less than 1% of public companies reported buying IDL coverage, coverage that protects “only the outside independent directors” and not internal officers and directors. Indeed, only 3.2% of all survey respondents indicated they were even considering purchasing IDL coverage. As a result, Towers Perrin has concluded that “[o]rganizations are not purchasing IDL policies.”
- Regarding employment practices liability (EPL) coverage, most of the survey participants purchased this coverage, with 57% purchasing it “with their D&O insurance policy” and 33% buying a “stand-alone EPL policy.”
- Survey participants reported increased purchasing of fiduciary coverage. Whereas 37% of the 2007 survey participants reported buying such coverage, 45% reported purchasing fiduciary coverage in 2008. Some companies purchased “shared limits with their D&O policy,” while others “bought a stand-alone policy.”
- According to Towers Perrin, “[p]remiums continued to slide during 2008.” Indeed, “[r]epeat participants reported their average premium decreased by 5%, from $148,672 in 2007 to $141,029 in 2008.”
Towers Perrin describes its survey process in its report and notes that “survey biases must be considered when interpreting the results” because the survey is not a random survey, but rather it involves a “non-probability sample” where “respondents choose—or are selected—to participate.” Nevertheless, the survey provides interesting information on an important subject that may assist officers and directors to keep current on D&O liability trends. top
Judge Scheindlin Rejects Rating Agencies’ First Amendment Motion to Dismiss in Subprime Suit
On September 2, 2009, in Abu Dhabi Commercial Bank v. Morgan Stanley & Co. Incorporated, a class-action lawsuit initiated by two institutional investors against eight corporate defendants for alleged note losses, Southern District of New York Judge Shira Scheindlin rejected the rating agencies’ arguments that they should be dismissed on First Amendment immunity grounds and because their ratings were nonactionable opinions.
The suit involved the institutional investors’ claims that the defendants’ conduct, including that of the rating agencies having rated the notes, caused them to suffer losses when notes issued by a structured investment vehicle (SIV) were liquidated. The investor-plaintiffs asserted 32 claims that included common law fraud, negligent misrepresentation, negligence, breach of contract and breach of fiduciary duty, According to the Court, the plaintiffs had purchased notes rated by rating agencies, and the notes were issued by several entities that were not parties to the suit. When the SIV collapsed during the credit crisis, it could not repay certain debt as it became due. After the SIV declared bankruptcy, the rated notes were ultimately liquidated at severe discounts. Certain note holders purportedly received “only a ‘fraction of their investment’”, while other note holders’ investments were allegedly “worthless.” Plaintiffs’ suit sought to recover their alleged losses as note holders.
In response to the suit, defendants filed various Rule 12 (early-stage) motions to dismiss. Among those motions were the rating agencies’ contentions that they should be dismissed because the First Amendment entitles them to immunity and that their ratings were opinions and not actionable misrepresentations.
In deciding not to dismiss the rating agencies’ at a Rule 12 stage on First Amendment grounds, the Court noted that, indeed, absent “actual malice”, the First Amendment typically “protects rating agencies . . . from liability arising out of their issuance of ratings and reports because their ratings are considered matters of public concern.” The Court, however, indicated that when rating agencies have “disseminated their ratings to a select group of investors rather than to the public at large,” they are “not afforded the same [First Amendment] protection.” In light of the plaintiffs’ assertion in their complaint that the ratings were not “widely disseminated” but rather were only distributed “in connection with a private placement to a select group of investors”, the Court declined to dismiss the rating agencies on First Amendment immunity grounds.
The Court also rejected the rating agencies’ opinion argument, noting that “opinion may still be actionable if the speaker does not genuinely and reasonably believe it or if it is without basis in fact.” The Court concluded that the plaintiffs’ complaint had sufficiently asserted an actionable claim for misrepresentation, as it alleged the absence of a genuine or reasonable belief, or basis in fact, that the ratings were accurate.
The Court’s discussion of the rating agencies’ alleged conduct included assertions that the rating agencies did more than assign ratings to the notes. The decision notes that “[a]lthough a rating agency’s roles as an unbiased reporter of information typically requires the rating agency to remain independent of the issuer for which it rates notes,” the defendant rating agencies’ had “played a more integral role in the structuring and issuing” of the SIV’s notes.
Eighth Circuit Affirms Dismissal in Subprime Related Securities Class Action
A federal appellate court recently issued a noteworthy decision related to subprime and credit crisis litigation, On September 1, 2009, in its In re: 2007 Novastar Financial Inc., Securities Litigation decision, the United States Court of Appeals for the Eighth Circuit affirmed the dismissal of a subprime-related securities class action lawsuit.
In the case, the district court had consolidated various class-action securities fraud lawsuits into one single class action lawsuit. The combined class-action suit involved two counts alleging violations of the securities laws. As the Court’s decision noted, the plaintiffs were investors who asserted that the defendants had violated the securities laws, “by making false and misleading statements about Novastar’s operations and financial health”. According to the Court, the class complaint described “the alleged deterioration of Novastar’s underwriting standards and auditing process and the alleged increasing number of loan defaults”. It also included 19 communications from Novastar (“including press releases, SEC filings, and conference call transcripts”) that the plaintiffs claimed were false or misleading.
In response to the class complaint, the defendants filed a Rule 12 motion to dismiss, asserting that the plaintiffs had failed to comply the heightened pleading requirements established by the Private Securities Litigation Reformation Act of 1995 (“PSLRA”). Among other things, as the Court noted, the PSLRA requires the plaintiffs’ complaint to “specify each statement alleged to have been misleading [and] the reason or reasons why the statement is misleading” and to “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind”. The district court granted defendants’ motion on several grounds.
On appeal, the Eighth Circuit conducted its own independent (de novo) review and affirmed the dismissal. Citing another of its decisions, the Eighth Circuit noted that, under the heightened pleading requirements of the PSLRA, the plaintiffs had to “plead the ‘who, what when, where and how” in connection with the allegedly misleading statements or omissions. Although the plaintiffs’ complaint had a 36-page section that included excerpts of or entire communications from Novastar, the Court found that the complaint failed to provide “any indication as to what specific statements within these communications are alleged to be false or misleading.” The Eighth Circuit also found that the complaint failed, as the PSLRA requires, to “provide any link between an alleged misleading statement and specific factual allegations demonstrating the reasons why the statement was misleading or false.” In light of these pleading deficiencies, the Eighth Circuit held that the district court did not err in dismissing the complaint. The Eighth Circuit declined to address the pleading requirements concerning scienter.
Court Denies Proposed Consent Judgment Between SEC and Bank of America
In a well-publicized turn of events in the case of SEC v. Bank of America Corporation, on September 14, 2009, Judge Jed S. Rakoff of the United States District Court for the Southern District of New York refused to approve a proposed consent judgment presented by the Securities and Exchange Commission (“SEC”) and Bank of America (“BofA”). The SEC brought suit, asserting that BofA had allegedly “materially lied to its shareholders” in its November 3, 2008 proxy statement soliciting approval of BofA’s $50 billion acquisition of Merrill Lynch & Co. (“Merrill”). According to the Court, the proposed consent judgment, which it declined to approve, would have enjoined BofA “from making future false statements in proxy solicitations” and would have required BofA to pay a $33 million fine in order to settle the SEC’s lawsuit.
In the complaint originally filed by the SEC, the SEC specifically claimed the material lie was the proxy statement’s representation “that Merrill had agreed not to pay year-end performance bonuses or other discretionary incentive compensation to its executives prior to the closing of the merger” without BofA’s consent. The SEC further asserted that, to the contrary, as part of the merger deal, BofA “had agreed that Merrill could pay up to $5.8 billion” in such compensation to its executives for 2008.
The Court discussed the benefits of settlement and noted the “considerable deference” that it must typically give to the parties’ proposed resolution. However, the Court concluded that because the SEC was essentially seeking to invoke the Court’s “contempt power by having the Court impose injunctive prohibitions” against BofA, the proposed judgment warranted closer scrutiny to ensure that it was “within the bounds of fairness, reasonableness, and adequacy.”
Examining the complaint’s allegations and finding that the parties’ proposed consensual resolution of the matter failed to satisfy the fairness, reasonableness, and adequacy requisites, Judge Rakoff denied the proposed consent judgment and ordered that the case proceed to trial.
Concerning the fairness requisite, Judge Rakoff found the proposed consent judgment is not fair because it requires BofA’s shareholders, who were allegedly victims of BofA’s purported misconduct, to pay the $33 million proposed penalty. In commenting that the SEC did not follow its normal policy to pursue the corporate executives allegedly responsible for the purported lie, the Court pondered why the SEC did not seek the penalties from the lawyers who “drafted the documents at issue and made the relevant decisions concerning disclosure of the bonuses.” The Court also indicated that, despite the Court’s request for the underlying facts concerning the proxy statement and BofA’s “voluminous papers protesting its innocence,” BofA never told the Court the particular facts, including “how the proxy statement came to be prepared” and “who made the relevant decisions” on what to include and exclude regarding the Merrill bonuses. According to the Court, “[i]t is one thing for management to exercise its business judgment to determine how much of its shareholders’ money should be used to settle” former shareholders’ disputes and “quite something else for the very management accused of having lied to its shareholders to determine how much of those victims’ money should be used to make that case against the management go away.”
The Court ruled that the proposed consent judgment is not reasonable. In addition to finding it unreasonable to have the alleged “victims pay a fine for having been victimized, ” the Court also noted that the proposed resolution is not reasonable for other reasons including that it “violates” SEC policy. The proposed consent judgment contemplated closing the case against BofA without the SEC complying with its own policy of pursuing charges against either BofA management or its attorneys, whichever group was allegedly responsible for the purported false and misleading statements in the proxy statement. The Court questioned the SEC’s contentions that insufficient proof of the knowledge and intent requirements exists against the management or attorneys and questioned how that could be when the complaint essentially alleges that BofA management approved Merrill’s ability to pay the bonuses prior to the issuance of the proxy statement and the lawyers supposedly “made all the relevant decisions.”
Concerning the adequacy requisite, the Court concluded that the proposed consent judgment is inadequate, stating that “$33 million is a trivial penalty for a false statement that materially infected a multi-billion-dollar merger. But since the fine is imposed, not on the individuals putatively responsible, but on the shareholders, it is worse than pointless: it further victimizes the victims.”
Barbara Jean D'Aquila
Tarifa B. Laddon