ACC Boston: notes on some of the substantive presentations (Part 1)

As we have said in several of our posts about last week’s ACC meeting, there was a lot to cover.  There was a cornucopia of information:  excellent panels on intellectual property, doing business in China, handling bankruptcy litigation, real estate practices, creating an in-house law department, pro bono opportunities for in-house counsel, HR and employment law issues, primers on trade laws, etc. 

And there was a lot of discussion about how corporations continue their trend to by-pass law firms and go directly to data management and e-discovery vendors to manage their compliance, ESI needs, etc. as they seek to “save a buck” and secure more ownership over the costs – especially the e-discovery process.  As Ari Kaplan pointed out yesterday in his column “In a market where in-house legal teams must control cost, many are seeking to eliminate it completely, at least with respect to their technology budgets” (click here).

We are going to post a series of interviews on the complex enterprise-wide technology systems available and discussed at ACC, the technology available and best practices.  We also interviewed several GCs, several vendors, a number of legal staffing agencies, etc. and we’ll share all that. 

But first a recap of the seven formal presentations we covered which we thought would be beneficial to our membership.  We provide these to Posse List members who are involved in these legal areas, as well as to to Posse members who might be interested in some “primers” and want to learn more.

In this Part 1 we cover:  (1) crossborder e-discovery, (2) basic bankruptcy law, (3) the FCPA and (4) board of director liability and the financial industry/subprime litigation. 

 

▪  CrossBorder Discovery

The panel was composed of Michael Butler (attorney for UPS), Mary Mack (Corporate Technology Counsel for Fios, Inc.) and Kenneth Rashbaum (consultant to Fios, Inc. and Principal of Rushbaum Associates)

With the increase of corporate globalization, potentially relevant evidence can reside in many countries. From foreign language and computer language barriers, to privacy laws and safe harbor issues, counsel encounter numerous challenges when litigation is anticipated. It’s critical to understand the rules and regulations that govern the access to and the use of foreign data. This session will examine ethical issues and practical solutions for cross-border e-discovery, including e-discovery vs. e-disclosure — managing conflicts between US and foreign laws and procedures, cross-border, multi-language e-discovery requirements — managing data from collection and translation through review and production, and cost containment — managing the costs of e-discovery while data volumes and legal complexities explode.

The panel focused on issues involving the production of electronically stored information (ESI) pursuant to civil discovery.   The practitioner in U.S. civil litigation may expect to confront three facets of discovery of ESI either physically stored outside of United States jurisdiction or otherwise subject to concurrent jurisdiction and, thereby, foreign legal impediments to disclosure. These concern:

1.  court control of discovery practice

2.  extraterritoriality of U.S. procedural law, and

3.  foreign compulsion

However, the legal principle of reasonableness requires U.S. courts to remain cognizant of the potential foreign aspects of U.S. discovery when exercising this manner of jurisdiction.  Decisions have established conditions under which foreign law or foreign governmental interests can have legal aspects on discovery pursuant to U.S. proceedings.  However, even in cases with the strongest foreign aspects, a U.S. court with jurisdiction to adjudicate will not be deprived of its jurisdiction related to discovery; rather, the foreign elements will merely factor into the U.S. court’s exercise of its power to compel discovery or to sanction for noncompliance with its discovery orders.

It should also be noted that the use of discovery in establishing personal jurisdiction over a nonconsenting foreign defendant further distinguishes the reach of United States judicial rules.

The Federal Rules of Civil Rules leave federal courts to factor, on one side, their very “robust” power to compel production of discovery maintained abroad or otherwise subject to foreign law and, on the other side, their duty to duly regard conflicts with foreign laws precluding or limiting such disclosure. In recent years, the explosive growth in the reliance on electronic data integrated in webs of geographically dispersed communication networks has increased the volume and variation of material beyond U.S. borders yet susceptible to the scope of discovery in U.S. litigation. At the same time, the amount and nature of information stored on U.S. territory yet subject to concurrent jurisdiction of another state is similarly increasing. Foreign compulsion may apply not only to ESI abroad but to U.S. situated information with a foreign origin or a connection to a foreign legal relationship (e.g., banker-client confidentiality), making illegal or otherwise limiting under the foreign jurisdiction any production or disclosure of the information in discovery conducted in the U.S. court. The exponential proliferation of electronic mail is a very obvious source of the sort of growth and geographic dispersal precipitating these issues of concurrent jurisdiction, as is the ascent of Web.  Trading platforms of integrated capital and financial markets located in traditional centers such as New York, London, Shanghai, and Tokyo and emerging loci like Singapore, Shenzhen, and Dubai are other manifestations of such vast streams of data generation and cross-border exchanges capable of posing jurisdictional conflicts in civil litigation.

Discovery controversies in U.S. courts due to the laws of a concurrent, foreign jurisdiction long predate the ascent of ESI as the main material of discovery. In the former era, the general crux of the disputes about extraterritorial discovery concerned a) whether a U.S. court would compel a party to produce certain information the disclosure of which, it would be argued, was prohibited by foreign law, or b) in the event such production had been compelled and was then not produced, how—if at all— foreign compulsion in the given case informed the court’s determination regarding sanctions for such noncompliance.

The current era presents recurrences or variations on those previously manifested questions. For instance, many trial and appellate courts have addressed the extent to which Civil Rule 34(a) notions of “possession, custody, or control” extend abroad.

However, the extent to which “control” should be made to apply to various types of ESI maintained abroad by a nonlitigant affiliated with the party subject to the given discovery obligation may be seen to generate distinct considerations. As another example, many courts have had to address foreign laws prohibiting the production of information due to confidentiality and/or privacy.

But the panel zeroed in on how foreign laws specifially relating to data privacy and/or confidentiality introduce novel questions.

A series of short definition set the tone.  “Privacy Law” in US  = “Data Protection” in EU.  “Data Subject” is usually an individual, but can also be a legal entity (Italy).  “Data Processing” can be storage, or mere accessing of data. Preservation (Litigation Hold) may be considered processing if it involves manipulation of data, such as moving data to a secure server or even preserving in place.  “Discovery” in U.S. = “Disclosure” in Civil Law jurisdictions.  And e-mail in U.S. is “Personal Data” in EU and elsewhere.

There are also differing notions of privacy.  Privacy is a fundamental right in much of the world.  Definitions of personal data subject to privacy protection outside the U.S. are extremely broad.  Privacy protections in the U.S. are industry specific.  Personal data subject to protection is limited to specific categories (e.g., social security numbers, medical information, banking data).

And we must deal with common law vs. civil law.  Common law: expansive pre-trial discovery conducted by the parties with judicial supervision as needed to resolve disputes or manage court calendar.  The U.S. has the most expansive: discovery is permitted of documents which may lead to admissible evidence.  Canadian “semblance of relevance” test seems almost as expansive.  In the U.K.: parties must produce “documents relied upon and documents that adversely affect or support litigant’s position” but document request must seek specific documents, not broad categories.

The panelists provided the following as excellent sources for more information:

The Sedona Conference® Framework for Analysis of Cross-Border Discovery Conflicts: A Practical Guide to Navigating the Competing Currents of International Data Privacy & e-Discovery (click here)

The Model Rules (click here)

Case cites  (click here)

Industry websites:

Fiosinc.com (click here)

discoveryresources.org  (click here)

The Posse List  (click here)  (yes, we were cited)

For an excellent article that touches on all of these issues see Scaling the Virtual Tower of Babel by Ken Rashbaum (click here).

               Note: later this week we will be posting an extensive interview we conducted at ACC Boston with Mary Mack and Ken Rashbaum that details many of these crossborder discovery issues.

 

▪  Basic Issues in Bankruptcy

This presentation was led by Ronda Bayer (associate general counsel for the The Valspar Corporation), David Garfield (Deputy General Counsel of Wells Fargo & Company) and Timothy Howe (Senior Lawyer for  Cargill, Incorporated).

The more you know about bankruptcy, the less overwhelming it is.  This program introduced in-house counsel with minimal knowledge of bankruptcy to the basics of the process.  Topics addressed were various creditor remedies, proofs of claim, impact on intellectual property, licensing agreements and leases, responding to preference demands and the purchase of assets from a company in bankruptcy.  The purposes:  to gain a broad-based understanding of bankruptcy that will help you navigate the process.

Much of bankruptcy terminology is unique to the bankruptcy process and unfamiliar to those who do not regularly practice bankruptcy law.  The panel recommended a glossary of bankruptcy terms on the U.S. Courts’ web site (click here). 

The two principal forms of business bankruptcy:  Chapter 7 liquidation, which is the selling off of assets, and Chapter 11, which can be a reorganization or a liquidation. 

Basically, you’re stripping off “stuff” to keep the enterprise going, or selling off pieces of everything that you have of value, until there’s nothing left.  You can start either as a 7 or 11, and then convert from one to the other. 

The panel ran through the principal Chapters (chapter refering to the chapter number of the Bankruptcy Code):

Chapter 7: Individual or Corporate Liquidation.  Chapter 7 provides a structure for: liquidating non-exempt assets; pursuing claims to recover assets; determining allowance of claims of creditors against the bankruptcy estate; and ultimately distributing assets to the creditors.  The U.S. Trustee appoints a Chapter 7 trustee, who locates and sells assets, distributing the proceeds to creditors.

Chapter 9: Municipalities.  It is designed for municipalities and is seldom used.

Chapter 11: Individual or Corporate Reorganization.  Chapter 11 is “Reorganization.”  While a Chapter 11 reorganization will not magically cure financial problems, Chapter 11 provides a formal procedure for operating and possibly reorganizing a company, partnership or individual, and for dealing with its creditors in an organized fashion. Once a Chapter 11 petition is filed, most creditors are held at bay for a period of time to give the debtor, operating as a debtor-in-possession, “breathing room” to attempt to formulate a reorganization plan. While breathing room is the theoretical goal, in reality, the debtor is generally required to breathe twice as fast just to keep up.  For the uninitiated, the one-year to 18-month or longer period that companies are generally in a contested reorganization is like an Antarctic Expedition: unfamiliar territory; difficult and strenuous conditions; and what appears to be the whole world against you. Chapter 11 has, however, provided many debtors with a final opportunity to reorganize and has produced many success stories. Many debtors use Chapter 11 as the avenue to sell their assets and then either convert to Chapter 7 or seek confirmation of a liquidating plan. A debtor-in-possession in Chapter 11 generally has the rights of a trustee.  Confused by the terms?  See glossary cited above.

Chapter 12: Family Farmer or Family Fisherman Reorganization.  Chapter 12 provides an abbreviated reorganization alternative for those who qualify as family farmers or fishermen and, if successful, results in a confirmed plan of reorganization.

Chapter 13: Individual Reorganization.  Chapter 13 provides an abbreviated reorganization alternative for individuals who: do not qualify for Chapter 7 because they have the ability to repay creditors in part; have certain non-dischargeable debts they hope to satisfy; or need payment terms with respect to taxes or certain secured debts.

Chapter 15: Cross Border Cases.  Chapter 15 is a new section of the Bankruptcy Code which applies to crossborder bankruptcy cases.

Chapters 1, 3 and 5:  These apply to all.  These Chapters of the Bankruptcy Code (and sections contained therein) include sections on general bankruptcy issues, case administration, creditors, debtors and the estate, and are generally applicable to each of the other Chapters. For example, a Chapter 11 case will be governed by these three Chapters along with Chapter 11.

The bankruptcy laws provide a scheme defining the various claims a creditor can file to protect his interest, and a priority scheme that governs distributions to creditors.  All very detailed stuff and a bit much to go into here (but see references at end of this piece).  

Other issues they covered:

With respect to litigation, you can get an automatic stay, but you need to file a suggestion of bankruptcy with each court where you have a matter pending.  Pending litigation does not equal a claim of bankruptcy, therefore you will need to perfect your claim.  This applies to your legal fees for those claims.

So, legal fees are considered unsecured claims.  They’re capped at $25,000 a month for an ordinary business.  If the amount is more than $25,000 for litigation, or other matter, then you have to have to file a claim with the bankruptcy trustee, and it has to be approved by the other creditors.  If you have claims against executives, directors, etc. which are not stayed by bankruptcy, you will need to request a stay. 

Note:  government investigations are not stayed by bankruptcy, director and officer legal fees and employment agreements are not stayed, either. 

This brings an interesting question of whether the company will be obliged to pay the legal fees, or if they have to try and get the insurance company to pay the legal fees.

If the insurance is something in the “ordinary course”, or you get it in your articles or your by-laws that you’re required to pay legal fees for representation for officers and directors, you may be able to have the company’s D&O insurance cover the legal fees if they’re less than $25,000 a month.

You need to have good records.  And records management becomes a critical thing throughout the bankruptcy period.  So, with records management, a lot of it comes down to spending the money to have your records brought in order by a certain deadline.  If you haven’t done that, it’s going to cost you considerably more money, just because you’re going to need to do so much more work in a short amount of time.

For insurance, your D&O policy is very important if litigation continues against a director and officer.  For example, if you have $500 million in D&O insurance, you have to look at whether this is a corporate asset or not.  If litigation is ongoing, and there’s no formal discovery request, and then the litigation is stayed, then there’s no obligation to disclose the amount of the insurance coverage.

For example, you have an ongoing securities fraud litigation, and you’ve just filed for bankruptcy.  If the insurance company revokes the policy, it has to refund the premium.  But if it doesn’t reach the limit of the policy, or the policy is not rescinded, that $500,000 is gone.

So, one of the things you may look at is whether you need to go along with a revocation of the policy.  Because the company is your client, not the directors and officers.  Or if it’s in the interest of the company to fight to keep the policy from being rescinded, and grab the cash value of that policy.

Another interest that comes up with bankruptcy considerations is that the attorney-client privilege.  The trustee in the bankruptcy becomes your client.  The trustee becomes the company and has the absolute unilateral right to waive attorney-client privilege, and all files — including legal files — become company files and trustee files.  The CEO of the company can’t waive the privilege, it has to be the bankruptcy trustee, and that trustee can waive attorney-client privilege retroactively.

Another issue that comes up is affiliate and subsidiary companies.  As an in-house counsel, you may have multiple roles.  With respect to the subsidiary companies, you may be General Counsel for those, or you may also be the Secretary for those.  In the bankruptcy, you may have to resign from the boards of the subsidiary, and file notice of your resignation from those boards.

With a foreign subsidiary, and an insolvent parent company, the parent is the whole owner of the stock in that company, all of your assets may be coming in from the foreign, solvent subsidiary.  So, you may look at selling off the subsidiaries in order to pay off your domestic creditors. 

These are just some of the considerations that come into play with bankruptcy.

For several bankruptcy reference material/resources sites, the panel suggested:

1.  The American Bankruptcy Institute  especially their bookshop.  

2. Bankruptcy petitions, schedules and all pleadings are readily available electronically at http://pacer.psc.uscourts.gov.  This site can also be searched to confirm or dispel a rumor that a bankruptcy filing has occurred.

 

▪ The globalization of U.S. business – the FCPA

This session was led by Jeffrey Harwin (First VP, Anti-Corruption & Code Ethics Executive at Bank of America), Howard Sklar, Global Trade and Anti-Corruption Strategist at Hewlett Packard) and Alexandra Wrage (Chief Legal Officer at Trace International).

The Foreign Corrupt Practices Act (FCPA) criminalizes an offer, promise of a payment, or anything of value to a government official, including government employees of state-owned enterprises.   You are (generally) not going to violate the Act through bad recordkeeping, but bad recordkeeping can result in FCPA violations particularly if you don’t correctly account for what it is that you’re giving as a gift or a hospitality to a government employee or official.  We have covered the FCPA in numerous posts (click here).

The grey areas are gifts and hospitality.  Everybody does it.  It’s a “cultural” thing.  But globally there are different standards, and things that may be customary — whether it’s a wedding in India, where everybody gives the gift of $200 or you offer moon cakes in China during the New Year’s festival.  So these things aren’t really addressed under the FCPA. 

And there are great reasons for transparency.  Bribery:

– increases the cost of doing business;

– induces officials to contrive new rules and delays because of the availability of bribes;

– distorts the playing field by shielding firms with connections from competition and leads to inefficient distribution of resources;

– negatively impacts business growth;

– discourages foreign direct investment and can amount to as much as a 20% tax on such investment;

– undermines the rule of law and provides fertile ground for organized crime; and

– leads to a general loss of confidence in public institutions.

But all of this hits a certain “common sense” level:  what would be customary vis-à-vis directly related to the execution or performance of a contract with a government agency.  That’s really what you’re looking at here.

The Act doesn’t put a limit or a dollar amount on materiality.  So what you need to do is look at the country and the country policies, in addition to the FCPA.  It is all very much a look at what the appearances are.

If you have centralized control over what your people are doing globally, this can be very helpful because you’re giving guidance to the man in the field, and that’s what the government wants.  If you’re looking at gifts for an official, what you’re really looking at is what’s reasonable and customary, complying with your own business policies and the laws of the other country, and no cash gifts (ever) are allowable.

The other thing that you’re looking at is the pattern of gifts.  If you have an employee in another country making routine gifts or presents to government personnel you need to know further who those people are, what they’re doing, and why they’re doing it, and how much it involves.

The other thing is how they’re being presented.  If these are small things that are presented at a press release, like a plaque or a certificate, that may be more appropriate.  What you’re trying to do is to avoid doing anything improper or illegal, or that would have the appearance of impropriety or illegality.

So part of this is contextual, and a lot of it is really complying with your internal control policies, as well as the laws of those countries.  One of the things that you never want to do if you have a government official traveling to a company site for business or for an event is have their spouse or children along on side trips.  That’s strictly forbidden, it looks bad, and it gives the appearance of a gift to the foreign official.

You never do political contributions, because those can be seen as payments.  One of the solutions is to work with your business people, and explain to them in business terms — versus legal terms — why payments such as cash are not acceptable.  It’s not just a matter of law or company policy, it’s bad business.

For example, if you’re in India and somebody brings in a bunch of protesters outside of your plant, and then you pay  to make them go away, all that does is encourage other people to come and do the same thing.  So it’s a form of extortion.  Once you do this, you’re opening the floodgates. 

And ask them what their operating expenses are, and if they increase month over month, because this is where the money would be coming from to pay this.  They need to account for those under operating expenses, and chances your business people will realize very quickly that making this “facilitation payment” is not the best thing to do, and they’ll come up with alternate strategies in order to adhere to company policy and local law.

Facilitating payments are essentially small bribes and are inherently illegal

and therefore should be avoided. Every bribe of a government official, regardless of size, breaks the law of at least one country. No country permits the bribery of its officials.  Paying facilitating payments is poor legal practice and it is bad business practice. Widespread payment of small bribes sets a permissive tone, which invites more and greater demands. These types of payments amount to a hidden tax on business, tend to proliferate, and buy an uncertain, unenforceable advantage. Well-run businesses seek clear, dependable terms and enforceable contracts. Small bribes introduce uncertainty, risk and delay. Permitting facilitating payments engenders cynicism and disregard for foreign laws and the cultures in which a company operates.

One of the best ways to rollout FCPA compliance issues globally is to start with the U.S.  Tell them it’s simple:  conviction for corruption can be jail for a U.S. person.  Then look at the local scene for examples of real-world treatment.

And talk to your locals about the U.N. Convention and take this outside of the FCPA and cast it in the language of local anti-corruption laws and the U.N. Convention.  It makes it much more palatable for your overseas affiliates, subsidiaries and business partners then tying in FCPA as just an extension of U.S. law.

If you’re doing an internal investigation, the cost of your investigation and litigation can be huge (attendees quoted $300,000 to investigate an ordinary allegation of corruption) and often you find out nothing happened, that there was no actual corruption.  It can be an expensive undertaking. 

But … the flip side is if you don’t do it and there is something that you’ve missed your costs can be well into the millions.  So, the $300,000 — while not cheap — is money well-spent to make sure that your own internal compliance policies are in place to conduct an in-person interview, to do the digging globally and to really tighten up your ship.

You need to be sure you have good internal controls and that you are monitoring the systems, and that it’s enforced.  And be sure you look at the local laws in the countries in which you’re operating, to make sure that those controls comply with the laws of this country and are enforceable.

Another thing that you need to look at are your audit provisions.  If you have it in your bylaws or your articles or your company policies that you’re going to do audit and then you don’t do the audit .. there is a failure and you have a corruption allegation or an investigation … the DOJ can use that against you and attribute knowledge to the company or to the officials that are involved.

So you either need to either make sure that you’re doing your audits regularly and that you can police yourself internally and have strong indemnity provisions.

Another issue is jurisdiction.  You won’t win any arguments with DOJ over whether or not they have jurisdiction — they’re going to have jurisdiction, regardless.  So, once you make a disclosure to DOJ — whether it’s unofficially, or not — they’re going to push you to waive your attorney-client privilege, and have you cooperate with them in order to get a private settlement agreement out of them. 

Even though it’s not being “required”  now and again, there is “unofficial” pressure to disclose and cooperate.  You can’t stop cooperating once you start, and you can’t pull back a disclosure once you make one.  So, again, part of this is having all of your ducks in a row before you go to DOJ.  You don’t want them coming to you, you want to go to them, but you need to do it smartly, and make sure that you’ve taken appropriate measures with your own internal investigation.

Another thing is third-party due diligence, particularly for mergers and acquisitions.  There are the equivalent of SEC no-action letters.  An opinion released by DOJ on the FCPA has the equivalent effect of an SEC no-action letter.  You’re going to get this before you act, and you’re not going to take any action until you get the no-action letter, or opinion from DOJ.   To elicit the opinion release form, you can go to usdoj.gov for the FCPA and see what they’re doing now on those.  They don’t have precedential value, but they are very instructive.

So, what’s happening now?  Some bullet points at the end of the session:

1.   There are going to be heightened FCPA enforcement.

2.  There will be a closer look at individuals versus firms.

3.  Multi-jurisdiction prosecution has escalated.

4.   There is (has been) increased industry and sector-wide investigation and not just “by company” investigation.

5.  There is an increased focus on transactional and M&A activity, and also other non-FCPA crime such as obstruction, false claims, and export control and asset trust — are all things that you need to look at on a globalization basis.

TRACE has published a guidebook on facilitating payments titled “The High Cost of Small Bribes,” which can be found on the TRACE Resource Center (click here).   For an excellent primer on the FCPA click here.

 

▪  Board of Director Liability and the Subprime Mess

The panel consisted of Charles Blixt (Director, Krispy Kreme Doughnut Corporation), Jennifer O’Neill (In-house Counsel and Vice President Zurich – Management Solutions Group) and Thomas Schroeder (Senior Attorney Georgia Lottery Corporation)

This session focused on recent developments and emerging trends in D&O liability, indemnity and D&O insurance coverage issues.  Shaken by seismic waves generated by the sub-prime mortgage debacle, the credit crisis, and billion-dollar Ponzi schemes, among others, financial institutions and their directors must now suffer the aftershocks of securities lawsuits seeking damages in the billions.   No director likes to be reminded of the possibility, no matter how remote, of being sued and held personally liable for service on a board.  

Boards like to hear:  “we have the broadest indemnification permissible under the law and the D&O insurance program we have constructed is world-class and will you safely through even the worst-case scenario”.

When public companies get into trouble, very frequently it is for a violation of the securities laws. Its not a topic to be messed with. The liability is significant. The issues are complicated. The impact can be mind boggling. Don’t be uninformed.

In the last year, what we’ve seen is $7 trillion mortgage credit crisis, versus $68 trillion credit default crisis.  Over the last three years, there’s been a spike of class actions.  Part of this is because of huge losses in the financial sector, which is where the bulk of these suits have been.

From the materials provided at the presentation, the litigation tsunami in a nutshell (and the tsunami in document reviews):

Lawyers filed individual suits and class actions in 2006 and 2007 on behalf of shareholders, securities investors, plan participants, and a wide variety of other claimants.  First to be sued in 2006 and 2007 were the players most irectly involved in subprime lending, such as lenders, originators, and home builders.   Next in line for 2008 were companies involved in the securitization process, including banks, insurance companies, rating agencies, bond insurers, and pension funds,7 as well as entities that directed or advised investments in those securities. Investment banks have been hammered by lawsuits in both waves because they are involved in virtually every stage of the origination and securitization process.  Auction rate securities have also been a litigation lightning rod in this latest round, with firms that structured or sold them being involved in 20 securities class action suits and 10 securities fraud suits through October 2008.   During 2007 and 2008, the subprime and credit crisis spawned more than 650 major federal and state lawsuits.  Fully one-half of the 210 federal securities class actions filed in 2008 are related to the subprime and credit crisis, and the estimated maximum dollar loss attributable to these 2008 filings is a staggering $856 billion, a 27% increase over 2007.  Although the number of shareholder derivative suits decreased from 2007 to 2008 by an estimated 22%, derivative plaintiffs now typically seek substantial monetary damages.  Monetary settlements are now becoming both more frequent and larger as exemplified by a September, 2008 derivative suit that AIG executives agreed to settle for $115 million.

Financial firms bore the brunt of the 2008 filings, having been named as defendants in half of the securities class actions and half of all securities lawsuits.   To put this into perspective, nearly one-third of all large financial firms in the U.S., representing two-thirds of the industry by market capitalization, were sued in a securities class action in 2008.  In addition, financial firms hold 46% of the estimated $856 billion maximum loss for 2008 class action filings.  Plaintiffs’ lawyers pulled directors and officers into the fray in 62% of “credit crisis” complaints filed in 2008.

The subprime and credit crisis has also generated an impressive number of investigations by regulatory and law enforcement agencies around the world, including 48 investigations by the SEC, 21 investigations by the FBI’s Subprime Mortgage Industry Fraud Initiative, and 40 investigations by the Financial Industry Regulatory Authority. Because the subprime and credit crisis had caused such a spike in securities lawsuits, it may be surprising to hear that the October, 2008 plunge in global stock markets did not trigger an avalanche of filings. Some believe this is because the downturn was so widespread that few companies escaped its impact.   As one commentator explained, “the market volatility has been so large that plaintiffs found it difficult to isolate companyspecific stock movements that could be alleged to be the result of fraudulent activity from the noise generated by a market that could swing 5 percent in a single day.”  Another theory is that the major financial players had already been sued during the 2007-2008 flurry of class action filings arising out of the sub prime and credit crisis.  

However, having begun as a lion, the year 2008 did not go out like a lamb. Bernie Madoff was arrested on December 11, 2008, and lawyers managed to file 37 Madoff-related lawsuits before the end of the year, 29 of which are securities suits.   Through the second quarter of 2009, the total number has increased to 189.

Outside of the financial sector, the year 2008 was largely uneventful with average filings against the usual defendants. IT companies were sued in approximately 12% of 2008 securities cases, and life sciences companies (including pharmaceutical and biotechnology companies) accounted for 5% of total filings.  The healthcare industry came in at 4%. 

Litigation in 2009:  the first half of 2009 saw 87 total securities class action filings in federal court, of which only 35 were filed in the second quarter. On an annualized basis, this is a 22% decrease from 2008.  Financial firms continued to shoulder the heaviest burden as defendants in more than 60% of 2009 federal securities class actions.   More than 40% of 2009 federal securities class actions relate to the subprime and credit crisis. 

During the second quarter of 2009 is the precipitous increase in the estimated maximum dollar loss.  The estimated dollar loss for securities class actions filed in the first half of 2009 is $429 billion, 22.2% higher than the second half of 2008.   Seven “mega-filings” accounted for a whopping $367 billion, with five exceeding $25 billion each.  Three of the seven mega-filings are related to the credit crisis.   Including all state and federal securities-related lawsuits, rather than just federal securities class actions,  we saw 361 filings through the second quarter of 2009, which on an annualized basis marks a 28% increase from 2008.

Coming soon to a law firm near you:  businesses outside of the financial services sector will be impacted in the next wave of securities litigation that will surely flow from the increasing number of bankruptcies.  Federal class action filings against companies outside the financial sector have continued to be essentially flat through the first half of 2009.

The evolution of securities litigation:  another interesting development in 2008 and 2009 is the metamorphosis of securities class action complaints into pleadings exceeding 100 pages and asserting, in addition to traditional theories, novel, often common-law theories sounding in tort, contract and breach of fiduciary duty.  Defense lawyers theorize that the complaints are longer and more complex because the facts are more complicated; class action attorneys are attempting to distinguish their suits to avoid consolidation with similar suits; and detailed complaints maybe more likely to survive a motion to dismiss, especially post-Twombly and Iqbal.  A significant increase in defense costs is an inevitable result of lengthier pleadings and novel, complex liability theories. 

Only time will tell whether the new liability theories will pass judicial muster under the heightened judicial scrutiny of pleadings.  However, the statistics from the first batch of 48 subprime and credit crisis cases resolved through March, 2009:  courts granted complete dismissals of 48% and partial dismissals of 4%, while plaintiffs voluntarily dismissed 13%, and parties settled 15%.

Now, D&O insurance, explained very well for the unschooled (read: us).  Companies are still still clamoring for company business and are more than willing to underwrite business risks in the toughest environment that the insurance industry has experienced in decades.

How it all works (ok, in a nutshell):  standard D&O insurance policies typically provide three forms of claims-made coverage often referred to as Sides A, B, and C. Side A protects directors and officers for loss resulting from “claims” alleging “wrongful acts,” but only if the insured entity cannot provide indemnification. Side B covers losses incurred by the insured company when it indemnifies directors and officers for “claims” alleging “wrongful acts.” Side C indemnifies the company for claims made directly against it. The scope of Side C coverage, otherwise known as “entity coverage,” varies significantly from policies that restrict coverage to securities-related claims to others that broadly cover claims alleging “wrongful acts” by the company. Some policies provide only Sides A and B coverage. More recently, excess Side A/DIC [Difference in Conditions] policies have also garnered a significant percentage of the marketplace.  Finally, D&O coverage is sometimes bundled with fiduciary liability [ERISA], commercial crime, or EPLI [Employment Practice Liability] coverages.  The scope of “wrongful acts” coverage provided by these insuring clauses, when viewed separately from the exclusions, is seemingly all-encompassing. Indeed, the term “wrongful act” is typically defined broadly to include, for example, “any actual or alleged breach of duty, neglect, error, misstatement, misleading statement, omission or act.”  The categories of claims that may trigger coverage include securities lawsuits, derivative actions, antitrust or environmental lawsuits naming individuals,129 as well as simple business torts such as false advertising, commercial fraud and negligence, and intentional interference with prospective business advantage. Because of the broad scope of coverage available under

Side C in some policies, all business tort complaints, whether or not naming individuals, should be analyzed for coverage under a D&O policy.

Oft-repeated is the unfortunate remark that private companies do not need D&O insurance. This is not true. Directors and officers of private companies owe similar duties to their shareholders as their counterparts in publicly-held corporations. While the risk of being sued may be smaller in a private company, the risk is still not worth taking when the personal assets of the directors and officers are the potential sacrifice. Consider also that D&O policies cover claims asserted by a host of claimants other than shareholders, such as employees, competitors, regulators, creditors, suppliers, and customers. Chubb conducted a random survey of 451 privately-held companies in 2005 and determined that 26% of the companies or their directors or officers had been sued in the past few years by a customer, government agency, vendor, or partner/shareholder.

What do you do on all these liability issues?  One of the key things the panelists said they are at the securities litigation reform, and how it will affect liability and litigation.   The case to look at is Twombly and you also need to look at the impact of the Tellabs and the Dura Pharmaceuticals cases if you’re trying to get dismissal of securities fraud at the pleadings stage.

Hubbard is another case, and that focused on scienter, and dismissal for lack of specific facts showing individual directors had knowledge of allegations that were made by the SEC.

You need to look at the potential causes of a stock disclosure, which must be considered in the general market decline, industry complaints, etc. in order to show proximate cause.  So if you fail to also list, not just your specific facts, but also the overall industry facts, like the overall market decline, the overall industry decline, et cetera, in your pleading, you can be dismissed, because you’re not taking into all of the other factors that may have caused your stock to dip.

There have been a number of recent cases in multiple jurisdictions that touch on derivative actions and liability of directors and officers, as well as indemnification.   

With respect to D&O insurance, if there’s a material misstatement that was made at the time that the policy was written, most states allow the insurance company to deny coverage of payment, and rescind the policy if the policy was issued at a price for a type of coverage based on an incorrect assumption or a false disclosure by the applicant. 

This can result in a huge hit to your bottom line because the company may not be able to have the insurance company pay that indemnity, and pay those legal fees which could be in the millions.  And they may yet be on the hook to indemnify that employee or officer, and have that money come out of their hide, instead of from the insurance policy, because it was revoked for failure to properly inform them of the correct status of the company at the time the policy was written.

Another issue is change of control.  If you’re trying to cut off wrongful acts, which are covered up to a certain time prior to a merger or acquisition, you can have limited coverage, or a gap in coverage.  For example, the merger occurs at 2:00 in the afternoon, but your new insurance policy doesn’t kick in until 12:01 a.m. the following day.  So, you’ve got 8 hours of gap, where if something happened in that gap, it’s unclear who picks up the tab, or who’s liable, or if there’s no insurance coverage.  So, you may want gap coverage, or try and have your policies back up to each other so that there is no gap coverage — no gap period.

Another thing is post-claim dialogue.  You’ve got to give prompt notice of a claim, which is broadly written, for all other applicable policies.  So, if you have a new claim or an amended complaint or an indictment, you need to make sure that those are covered.

If you’re relying on the broker to send notices of amendments or changes, you need to follow-up with the broker to make sure those notices went out and where they went.  Don’t roll along “fat, dumb and happy” in hopes that everything was sent properly into where it’s supposed to go because brokers can make mistakes. 

There are also some international risks that you need to look at.  All policies pay or provide worldwide coverage, where legally permitted.  In some countries, they do not allow for D&O coverage (Brazil being one of them).  So, if you have an international policy with coverage, you want to also look at country by country, where you may need to get in-country insurance coverage, supplemental to your U.S.-based policy, because your U.S.-based policy won’t be honored.  

And be aware that certain countries also have Sarbanes-Oxley-type laws — Japan and Germany being the primary ones — and those countries have enhanced shareholder rights.  This is something that you will also need to consider when you’re looking at international risks and coverages.

For the BEST site to follow all the “what’s what”:  Kevin LaCroix’s D&O Diary (click here). 

Coming up in Part 2:  the personal liability of a general counsel, and DOJ/SEC enforcement efforts in 2009

And then … tech, tech and more tech as we chat with ACC Alliance members about all the enterprise-wide technology systems available (complex and otherwise) for in-house legal departments.