Defendants Stand Divided In Tie-In/Laddering Cases

Although co-defendants in a lawsuit usuallytry to set aside their differences to create a united front againstplaintiffs, the recent onslaught of IPO tie-in/laddering cases isleading to finger pointing among defendantseven before the suits goto trial.

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Attorneys representing issuers of initial public offerings andtheir directors and officers believe the tie-in/laddering casesshould not be directed at their clients, but rather should focus onthe allegedly more culpable securities underwriters.

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Also, D&O insurers, who may be called upon to pay at least a$400-$600 million settlement bill are trying to find ways to avoidpaying claims or ways to get their money back if they have to paythe claims.

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IPO laddering or tie-in cases allege some wrongdoing in theprocess in which lead securities underwriters that handle initialpublic offerings allocate IPO shares to their customers. The claimsallege either that securities underwriters received excessivecommissions that werent disclosed in IPO prospectuses or that theunderwriters had agreements with investors requiring them to buymore shares at higher prices in the aftermarket in return forgenerous allocations in the IPOs.

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If you read the complaints, “there doesnt seem to be very muchin the way of factual allegations relating to active conduct by theissuers or the directors and officers,” said Greg Markel, a partnerin the New York office of Brobeck, Phleger & Harrison, at aSeptember conference presented by Minneapolis-based ProfessionalLiability Underwriting Society.

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As a result, during the “IPO Tie-In/ Laddering Claims”conference in New York, Mr. Markel questioned why these two groupsare two of the three defending groups in the cases.

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Plaintiffs attorneys at the conference alluded to at least onespecific type of factual allegation implicating individualdirectors and officers. They alleged that underwriters madeallocations to executives of not-yet-public companies to enticethem to bring their companies business back to the underwriters (towork on their IPOs) at a future time, when they decided to gopublic.

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“I would agree that that would create some additional exposurefor D&O insurers,” said Joseph Monteleone, a conferencemoderator and vice president for Hartford Financial Products in NewYork. “But Im not aware of any case where thats been specificallyalleged,” he said in an interview.

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“Those allegations are not in the hundreds and hundreds ofcookie-cutter complaints,” Mr. Markel said during the meeting. Ifyou listen to the plaintiffs attorneys, “you hear about the conductof [securities] underwriters, about newspaper articles that referto the conduct of underwriters, and about a lot of regulation ofthe conduct of underwriters,” he said. “But you dont hear a wordabout the issuers or the Ds and Os knowing anything about thisalleged conduct.”

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Kevin LaCroix, president of Genesis Professional LiabilityManagers of Beachwood, Ohio, an underwriting management subsidiaryof Stamford, Connecticut-based Genesis Insurance Company, toldNational Underwriter: “My first impression, when the casesstarted to be filed, was that this was all just a bunch ofnonsensethat they were frivolous and would quickly go away.

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“I only became concerned because of the volume of cases. Theconcept of nuisance value goes out the window, when itsnuisance-cost times 150,” he said.

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“D&O insurers are going to have to take a strong positionthat they did not undertake to insure” these risks, he said. “Wewill resist any efforts to get us to provide recompense. We intendto do everything possible to seek indemnification or subrogation,”Mr. LaCroix said.

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“Those comments are made from the perspective of a D&Ounderwriter,” he said. “As a lawyer, I believe that the allegations[against issuers] dont have legs,” he added, explaining, however,that he didnt want to imply that settlement money wouldnt be paidout. “Im enough of a realist to know that I cant predict” theoutcome, he said.

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“What I can say, as a D&O underwriter, is that we dontintend to get left holding the bag,” if investment banks ultimatelyare found to have engaged in the practices alleged, he said.

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“Theres a huge tension” in these cases, said Michael Perino,assistant professor from St. Johns University Law School inJamaica, N.Y., at the tie-in/laddering conference in September.“The issuers and the Ds and Os obviously have a huge incentive tosay its the underwriters problem, not ours. On the other hand, theymay want to go back to the capital markets one day in the future.That may create some issues for them.”

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Some of the issues related to “the ultimate whos going to payquestion” involve indemnification, he said. He explained thatstandard securities underwriting agreements (between securitiesfirms and issuers) include cross-indemnification provisions. Theunderwriters agree to indemnify the issuer and directors andofficers for any information they supply with respect to theregistration statement, and the Ds and Os or the issuer agrees toindemnify the securities underwriter for essentially anything else,he said.

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D&O coverage expert Dan Bailey, a partner in the Columbus,Ohio, office of the law firm Arter & Hadden, said that“co-defendants traditionally believe it is not in their bestinterests to fight against themselves because they may help theplaintiffs case by throwing darts at each other.”

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But “in this instance, one could argue that issuers should workto separate themselves as much as possible [from the underwriters]by asserting cross claims for indemnification,” he said. By doingso, the issuer defendants would be emphasizing the fact that anywrongdoing was committed solely by the securities underwriters, hesaid.

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Mr. LaCroix noted that there were some D&O policies writtenfor IPOs in 1997-1999 with coverage extensions for underwriterindemnification. In other words, the policies would pay if theissuing companies had to indemnify their investment banks for somereason.

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Such extensions were added with sublimits, he said. But offeringunderwriter protection is a coverage trend that came and wentquickly, he said. And “if there are going to be anyindemnifications here, its going to be the issuing company seekingindemnification from the investment bank and not the other wayaround.”

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Mr. LaCroix and Mr. Perino said the question of whetherindemnification provisions are enforceable is destined to come up.While the Securities and Exchange Commission has taken that it isagainst public policy to indemnify for violations of securitieslaws, its position hasn't been entirely consistent, Mr. Perinosaid, noting that there is a regulation that seems to provide aspecial carve-out for cross-indemnifications in underwritingagreements.

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“You can't just look at the SEC,” he added. “You've got to lookat case law and there seems to be a much broaderanti-indemnification policy that the courts articulate with respectto federal securities laws,” he said.

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“But the courts have never tested questions like those that theladdering cases present,” Mr. LaCroix said. “Information that wassupposedly omitted” from prospectuses “was uniquely in control ofthe investment banks. Not only was there no way the issuers couldhave known” about the laddering agreement between underwriters andinvestors, “but laddering couldnt work if they did.” The wholepoint was the secretive nature of these agreements, he said.

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Tallying up the potential tab for D&O insurers, Mr. Baileysuggests theyll pay out several hundred million dollars absentevidence showing that directors and officers actually knew of thealleged wrongdoing by the securities underwriters. Assuming “modestsettlements” of $2-$3 million made on behalf of issuing companydefendants for 200 laddering claims, the total loss paid by theD&O insurance market would be $400-$600 million, he wrote inthe report he authored for Bermuda-based ACE Limited.

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“Its still real early, but based on the allegations, insurersfor securities underwriters have greater exposure than those forthe issuers and Ds and Os,” Mr. Bailey told NationalUnderwriter. He noted, however, that the insuranceimplications for professional liability insurers of securitiesunderwriters are even less clear than for D&O insurers. Thereare typically large retentions on those policies “and there is anissue as to whether these are multiple claims for multiple IPOsorbecause theyre interrelated, whether those all fall under oneretention,” he said.

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National Underwriter was unable to reach any domesticprofessional liability insurers that cover securities underwriterswilling to comment for this article. Several experts, however, saidthat the coverage would fall under a diversified financial serviceserrors and omission policy with deductibles in the $250-$500million range. One excess and surplus lines broker representativesaid that the London market might have the biggest share of thisprofessional liability market.


Reproduced from National Underwriter Property &Casualty/Risk & Benefits Management Edition, November 12, 2001.Copyright 2001 by The National Underwriter Company in the serialpublication. All rights reserved.Copyright in this article as anindependent work may be held by the author.


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