Securities Suits Tied To Mortgage Crisis Not Over, Plaintiffs’ Lawyer Says

"I think you're going to see more RMBS litigation now as we're coming up on statutes of limitations, depending on the claims and the state, Mr. Silk predicted. "Allstate is a good example of that," he said, referring to a late December 2010 suit filed by the Northbrook, Ill.-based insurer against Countrywide Financial Corp., seeking damages related to its purchases of more than $700 million in mortgage-backed securities from the company, now owned by Bank of America.

After "a bit of a lull" created, in part, by a spate of court rulings on securities class actions that were "not particularly investor friendly," Mr. Silk said he believed sophisticated investors would soon "start bringing their own direct non-class RMBS cases."

"There will be others" besides Allstate. "I can assure you of that," Mr. Silk said.

Four days after making the observation, several wire services reported that Mr. Silk's firm, representing a group of institutional investors that includes TIAA-CREF, New York Life Insurance Co. and Dexia Holdings, filed a separate case against Countrywide and Bank of America. A day later, three more suits with similar allegations were filed by the states of Michigan, Oregon and Fresno County in California.

WHAT THE NUMBERS SAY

Two analytical reports—one by Advisen and a separate one published by Stanford Law School and Cornerstone Research—recently revealed that securities class action filings were stuck at low levels last year, with both sets of researchers highlighting the precipitous declines in class filings tied to the subprime mortgage and credit crisis to explain the figures.

The Stanford/Cornerstone report, which reported a 4.8 percent jump in federal securities class actions overall—to 176 filings for 2010 from 168 in 2009—noted that the 2010 level was still 9.7 percent below the annual average of 105 filings between 1997 and 2009. Beneath the aggregate figures, the report said that class filings related to the credit crisis plummeted 76.4 percent to only 13 in 2010, compared to 55 filings in 2009.

The Advisen analysis, unlike Stanford/Cornerstone and other researchers, includes counts of securities lawsuits beyond class actions brought in federal court. Two of the additional case types—regulatory actions and securities cases alleging breaches of fiduciary duty brought in state courts—are now more prevalent than class action securities suits, Advisen said.

"As new filings of credit crisis suits… wound down, securities class actions slid to 16 percent of all suits filed in 2010," Advisen said in its report, noting that just five years ago, class actions represented one-third of all types securities suits included in its analysis.

Advisen reported a 17 percent drop in securities class actions in 2010, counting 193 filings for all of last year compared to 233 in 2009.

M&A DRIVES SECOND-HALF JUMP

Although Advisen's class action count differs from Stanford/Cornerstone and other researchers (see related textbox "A Record Year"), all the analysts reported a surge in their respective tallies of securities lawsuit filings during the second half of 2010.

Stanford/Cornerstone, for example, said that securities class actions filings totaled 104 in the second half of the year, compared to 72 during the first six months.

The counters all identified three subsets of cases that fueled the second-half surge:

• An uptick in lawsuits filed on the heels of M&A deals, first reported by NU P&C late last year. (See related Nov. 9, 2010 article, "M&A-Related Securities Suits Soaring," posted on NU's website www.propertycasualty360.com.)

• A spike in filings against companies from China brought in U.S. courts, including a dozen class actions according to Stanford/Cornerstone.

• A spate of suits naming for-profit educational institutions as defendants (10 class actions by Stanford/Cornerstone's count).

The for-profit education suits were filed after an August 2010 Government Accountability Office report detailing deceptive recruiting practices and a Congressional hearing delving into fraudulent practices, such as encouraging falsified applications for federal tuition assistance.

Among the three categories, it was the M&A suits that captured the attention of researchers and audience members tuning into Advisen's webinar, while lawyers like Mr. Silk downplayed their significance.

Prompted by Mr. Blinn to select the biggest story impacting the D&O insurance market in 2010 in a snap poll, one-third of webinar listeners selected "growth in merger objection litigation" as the top story. Only 19 percent of the webinar audience, which included D&O underwriters, selected "the decline in securities class actions" over the M&A surge among five topic choices, and only 15 percent said the story most impacting their business in 2010 was "the disappearance of subprime litigation."

John Molka III, the author of Advisen's statistical report, said merger-objection litigation was the area most responsible for the filing of a record number of breach of fiduciary suits—398 filings—in 2010. Although he did not give a specific count of the M&A-related suits included in the fiduciary-breach suit total, he observed that merger-related suits "increased faster than the level of M&A" transactions.

"Perhaps attorneys are looking for new revenue streams as securities class action suits are in decline, or perhaps shareholders are disgruntled because they feel cheated with low valuations of company stock," Mr. Molka speculated.

The Stanford/Cornerstone report noted that there were 40 federal securities class action filings alleging disclosure violations in M&A deals in 2010, compared to just seven such suits recorded in 2009. "The 20 percent increase in underlying M&A activity seems insufficient to explain fully the almost sixfold increase in M&A [suit] filings, an increase that may largely be a result of changes in plaintiff law firm behavior rather than underlying market factors.

EXPERTS VS. NUMBERS: GLOBAL ISSUES DOMINATE

The explosion of M&A litigation has "to be looked at for what it is," said Mr. Silk. "I would characterize it as not significant to the [D&O] carriers…because it tends to be driven by law firms that have less resources," he said, going on to distinguish firms like Bernstein Litowitz that have continued to bring "high-impact cases in Delaware courts" for years from a collection of newbies that have "different standards and different types of clients."

The breach of fiduciary duty cases brought by less-experienced plaintiffs' firms tend to resolve with less monetary impact on defendants than those in the securities class action arena, he said.

He observed that for many of the recent merger cases, there is no regime like the Private Securities Litigation Reform Act, which guides the procedure of federal cases. "You could have multiple jurisdictions on the same deal," he said, noting that some M&A cases are filed in federal courts and others in state courts. "There's really no way to organize those cases, no way for the court to empower an investor that has the largest holdings in a company or to empower the [law] firm that will do the best job"—all of which drives "non-significant types of resolutions," he said.

Mr. Silk agreed with two other webinar participants that litigation involving non-U.S. firms and the dealings of U.S. firms abroad were bigger stories impacting D&O insurers in 2010 and looking ahead to 2011.

For example, Panelist Kevin LaCroix, a broker with OakBridge Insurance Services in Beachwood, Ohio, said he believed the most interesting 2010 development for D&O insurers was a U.S. Supreme Court ruling in a case known as Morrison v. National Australia Bank—dealing with foreign plaintiffs suing foreign defendants for wrongdoing that relates to securities traded on foreign exchanges.

In its June decision, the court ruled that the antifraud provisions of U.S. securities laws do not apply to these so-called "F-cubed" situations. Although plaintiffs in Morrison had argued that executives engaged in deceptive conduct and made misleading statements in the United States, the court held that U.S. securities laws' antifraud provisions only apply to purchases or sales of securities listed on U.S. exchanges or purchases or sales of some other security within the United States.

"In the global economy, the authority of courts and laws to reach companies in other countries is an important question," said Mr. LaCroix, who is also the author of the D&O Diary blog. "The ramifications of Morrison are going to continue to unfold," he predicted, noting that district courts have already started interpreting the Supreme Court ruling in ways that further limit cases involving foreign company exposures.

Not precluded by Morrison or the district court rulings was the wave of cases against defendants from China. Advisen, which counted 21 such suits last year—with 19 of them coming post-Morrison—noted that these cases were filed against companies from China that choose to list on U.S. exchanges.

Mr. Silk said that many large securities cases are getting impacted by limitations prescribed by the Supreme Court in Morrison, including suits against Toyota filed in the wake of vehicle recalls, but he also said that plaintiffs and their lawyers remain undeterred.

Investors who don't have federal claims because of Morrison "are going to bring state law claims. They might bring foreign law claims," he said. "In Toyota, for example, investors have asserted Japanese law claims," he reported.

Kevin Mattessich, managing partner in the New York office of Kaufman Dolowich Voluck & Gonzo, the sponsor of the Advisen webinar, highlighted another securities suit development arising from a global economy—increasing scrutiny of possible violations of the U.S. Foreign Corrupt Practices Act from the Securities and Exchange Commission and the U.S Department of Justice.

The FCPA is a federal law containing anti-bribery and accounting requirements. The anti-bribery provisions make it unlawful to pay foreign officials for the purpose of obtaining or retaining business. U.S. firms are subject to criminal and civil penalties for actual or promised payments to foreign officials that could be considered bribes.

Mr. Mattessich said that while FCPA has been a DOJ priority for many years, he foresees an expansion of the focus of regulators—beyond "big mega-corps," such as electric companies and manufacturing firms, to smaller organizations and even hedge funds that invest overseas. These firms, he reasoned, "do not have the compliance and regulatory experience that bigger companies have."

Beyond foreign exposures, both Mr. Mattessich and Mr. LaCroix expect Federal Deposit Insurance Corporation lawsuits against directors and officers of failed banks to explode over the next few years. (See related article, "D&O Insurers Getting Notice On FDIC Claims," posted on NU's website last week.)

Offering another potentially worrisome trend for D&O insurers, Mr. Silk hinted that his firm is poised to file more derivative litigation—suits filed by shareholders on behalf of the corporation rather than as individuals. He noted a recent victory for his firm in a case against New York-based Pfizer, a large pharmaceutical company. (For background, see related article, "Plaintiffs Choosy About Derivative Suit Filings, Lawyer Tells D&O Underwriters,' in NU's Feb. 3, 2010 edition.)

The firm filed the derivative suit in the wake of a $2.3 billion settlement with the government arising from what the DOJ found to be fraudulent and criminal promotional activities used to sell 13 of Pfizer's most important drugs. The derivative suit was settled for $75 million in December.

"At the end of the day, we were able to get a real independent committee formed at the company with the authority to prevent that sort of conflict going forward, and it's being funding with some portion of the $75 million," Mr. Silk said.

"We've seen more opportunities and we have been recommending more cases to our clients in the derivative arena where they could get a seat at the table and try and implement corporate governance changes," he said, citing cases his firm has filed against the boards of Johnson & Johnson and Massey Energy.

These cases all "stem from really what we believe to be egregious lack of controls and lack of involvement by directors," he said, characterizing the Pfizer case as "a real foundation for trying to do similar types of things" in the other cases.

In 2010, Advisen reported that derivative actions jumped 39 percent to 129 from a prior level of 93 such actions in 2009.