Defendants Stand Divided In Tie-In/Laddering Cases

Although co-defendants in a lawsuit usually try to set aside their differences to create a united front against plaintiffs, the recent onslaught of IPO tie-in/laddering cases is leading to finger pointing among defendantseven before the suits go to trial.

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

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 avoid paying claims or ways to get their money back if they have to pay the claims.

IPO laddering or tie-in cases allege some wrongdoing in the process in which lead securities underwriters that handle initial public offerings allocate IPO shares to their customers. The claims allege either that securities underwriters received excessive commissions that werent disclosed in IPO prospectuses or that the underwriters had agreements with investors requiring them to buy more shares at higher prices in the aftermarket in return for generous allocations in the IPOs.

If you read the complaints, “there doesnt seem to be very much in the way of factual allegations relating to active conduct by the issuers or the directors and officers,” said Greg Markel, a partner in the New York office of Brobeck, Phleger & Harrison, at a September conference presented by Minneapolis-based Professional Liability Underwriting Society.

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

Plaintiffs attorneys at the conference alluded to at least one specific type of factual allegation implicating individual directors and officers. They alleged that underwriters made allocations to executives of not-yet-public companies to entice them to bring their companies business back to the underwriters (to work on their IPOs) at a future time, when they decided to go public.

“I would agree that that would create some additional exposure for D&O insurers,” said Joseph Monteleone, a conference moderator and vice president for Hartford Financial Products in New York. “But Im not aware of any case where thats been specifically alleged,” he said in an interview.

“Those allegations are not in the hundreds and hundreds of cookie-cutter complaints,” Mr. Markel said during the meeting. If you listen to the plaintiffs attorneys, “you hear about the conduct of [securities] underwriters, about newspaper articles that refer to the conduct of underwriters, and about a lot of regulation of the conduct of underwriters,” he said. “But you dont hear a word about the issuers or the Ds and Os knowing anything about this alleged conduct.”

Kevin LaCroix, president of Genesis Professional Liability Managers of Beachwood, Ohio, an underwriting management subsidiary of Stamford, Connecticut-based Genesis Insurance Company, told National Underwriter: “My first impression, when the cases started to be filed, was that this was all just a bunch of nonsensethat they were frivolous and would quickly go away.

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

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

“Those comments are made from the perspective of a D&O underwriter,” 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 paid out. “Im enough of a realist to know that I cant predict” the outcome, he said.

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

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

Some of the issues related to “the ultimate whos going to pay question” involve indemnification, he said. He explained that standard securities underwriting agreements (between securities firms and issuers) include cross-indemnification provisions. The underwriters agree to indemnify the issuer and directors and officers for any information they supply with respect to the registration statement, and the Ds and Os or the issuer agrees to indemnify the securities underwriter for essentially anything else, he said.

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 best interests to fight against themselves because they may help the plaintiffs case by throwing darts at each other.”

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

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

Such extensions were added with sublimits, he said. But offering underwriter protection is a coverage trend that came and went quickly, he said. And “if there are going to be any indemnifications here, its going to be the issuing company seeking indemnification from the investment bank and not the other way around.”

Mr. LaCroix and Mr. Perino said the question of whether indemnification provisions are enforceable is destined to come up. While the Securities and Exchange Commission has taken that it is against public policy to indemnify for violations of securities laws, its position hasn't been entirely consistent, Mr. Perino said, noting that there is a regulation that seems to provide a special carve-out for cross-indemnifications in underwriting agreements.

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

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

Tallying up the potential tab for D&O insurers, Mr. Bailey suggests theyll pay out several hundred million dollars absent evidence showing that directors and officers actually knew of the alleged wrongdoing by the securities underwriters. Assuming “modest settlements” of $2-$3 million made on behalf of issuing company defendants for 200 laddering claims, the total loss paid by the D&O insurance market would be $400-$600 million, he wrote in the report he authored for Bermuda-based ACE Limited.

“Its still real early, but based on the allegations, insurers for securities underwriters have greater exposure than those for the issuers and Ds and Os,” Mr. Bailey told National Underwriter. He noted, however, that the insurance implications for professional liability insurers of securities underwriters are even less clear than for D&O insurers. There are typically large retentions on those policies “and there is an issue as to whether these are multiple claims for multiple IPOsor because theyre interrelated, whether those all fall under one retention,” he said.

National Underwriter was unable to reach any domestic professional liability insurers that cover securities underwriters willing to comment for this article. Several experts, however, said that the coverage would fall under a diversified financial services errors and omission policy with deductibles in the $250-$500 million range. One excess and surplus lines broker representative said that the London market might have the biggest share of this professional liability market.

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

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