Securities-Related D&O Litigation More Focused & More Intense, But is it “Effective”?

By Tom Hagy featuring: Priya Cherian Huskins, Woodruff Sawyer & Company

While there may be some good news in the shrinking number of Directors & Officers (D&O) actions (at least those that would trigger D&O insurance coverage) and derivative actions, there has been an uptick in securities class actions and the ultimate cost of resolving derivatives litigation. Those are some of the conclusions drawn in Advisen’s Quarterly D&O Claims Trends: 2014 End of Year Wrap-Up.

But at least two commentators recently addressed the larger question: has all this litigation done anything to stem the tide of financial scandals in the corporate world?  “Probably not,” seems to be the conclusion, given the focus on directors and not on corporate officers.

Advisen reported a 10 percent decrease in lawsuits that would trigger D&O coverage, dropping from 1,492 to 1,342, but the increase in securities class actions has been steady. Derivative suits are down, but those that are filed are more intense, with a number of nine-figure settlements in the last few years. Notable settlements were the $275 million Activision agreement and the $137.5 million Freeport McMoRan settlement, representing the largest and third largest in history, respectively.

On the enforcement front, there are no signs that the SEC is taking its foot off the pedal when it comes to hunting down and prosecuting bad actors at public companies, the report says. Watch for more of this in 2015, Advisen predicts—meaning more insider-trading actions and more actions against individuals who violate securities laws.

Foreign Corrupt Practices Claims a Growth Area

Priya Cherian Huskins, one of the report’s contributing commentators, said to expect more FCPA claims in 2015. While some types of D&O claims declined in 2014, settlements paid under the FCPA “skyrocketed,” with one case settling for $772 million, Huskins pointed out.

Huskins, a senior vice president and partner with Woodruff Sawyer & Company, wrote in her “almost weekly” D&O Notebook, that two Supreme Court decisions will fuel more of these claims. In Lawson v. FMR LLC, Huskins said the Supreme Court expanded whistleblower protections. Plus, she said actions will be further encouraged by the Office of the Whistleblower’s Dodd-Frank whistleblower incentive program. In U.S. v. Esquenazi and Rodriguez 2014, 2014 U.S. LEXIS 1783 (2014) and U.S. App. LEXIS 9096, No. 11-15331 (11th Cir. May 16, 2014), the court further defined “instrumentality”; that is, who is a “public official” and how that factors into bribery—lending support to the DOJ’s broad view of the term, Huskins wrote. The Supreme Court denied a petition for certiorari on Oct. 6, 2014.  

[Editor’s Note: You can read more about Lawson v. FMR here  and and U.S. v. Esquenazi at the LexisNexis® Legal Newsroom here

Financial Sector Still Hot, But Cooling

Kevin M. LaCroix with RT ProExec observed that the financial sector continues to see the most corporate and securities litigation activity, but “the spike in actions against corporations in this sector during the period 2008 through 2011 has subsided.”

LaCroix wrote in his popular D&O Diary that while the number of securities cases has remained steady, the number filed in 2014 stayed below the 10-year average of 199. He agreed with the conclusion of the Advisen report that the number of securities class actions as a percentage of all corporate and securities litigation has been declining as other types of litigation and enforcement activity have increased. “However,” he wrote, “in the past three years, the securities class action lawsuit filings as a percentage of all corporate and securities filings has been increasing. The 183 securities class actions lawsuit filings that Advisen tallied in 2014 represented 13.6 percent of all corporate and securities lawsuit filings during the year.”

Cyber Liability a Board Responsibility

An increasing risk for D&Os is coming from cyber security breaches, and SEC Commissioner Luis A. Aguilar has said that a company’s security measures must be “a critical part of a board of director’s oversight.” The Advisen report says data breaches are often being followed by lawsuits questioning board oversight.

Richard J. Bortnick of Traub Lieberman Straus & Shrewsberry, echoing Aguilar’s comments, was quoted in the Advisen report that cyber security should be a top priority for corporate boards, predicting that it will be routine for breaches to trigger D&O claims. Bortnick said the National Institute of Standards and Technology (NIST) Framework, while it provides only minimum standards, can serve as a “best practices playbook” for corporate responsibility. 

Bortnick, a frequent writer and commentator on cyber risks and D&O liability, was also quoted in theFinancier Worldwide January 2014 report on the subject, saying that entrepreneurial securities lawyers are always on the hunt for the next big thing, and cyber risks and exposures are in their crosshairs. “Best practices filter throughout an organization from the top down. If D&Os ignore or even fail to account for the gravity of cyber, technology, and privacy risks and exposures, they are setting themselves up to be sued,” Bortnick says.

“The costs of a proactive cost avoidance and remediation strategy can be dwarfed by the response costs for those companies that haven’t created, implemented and properly tested such an approach. It should be a no-brainer. Sadly, it’s not. Which, of course,” Bortnick says, “is music to the ears of lawyers, both plaintiff and defense.”

IPO Claims

Advisen says to watch failure-to-disclose critical information claims arising from initial public offerings, or IPOs. “The increase in the number of IPO-related suits is directly correlated with an increase in IPO activity, and in the U.S. 2014 saw the most IPOs since 2000,” the report says.

Joseph Monteleone of Rivkin Radler LLP says in the report that plaintiff attorneys tend to clear motion-to-dismiss hurdles in these cases. He added that with regard to D&O insurance, there has been more focus on "the real value of these cases and less pressure on the entire tower of insurance." A case where there has been a market cap loss of $100 million may settle for $5 million—a number that won't typically impact the entire tower of insurance. “It’s been refreshing,” Monteleone said, particularly where there’s a well-qualified mediator.”

Litigation: What’s the Efficacy, Kenneth?

Has D&O litigation had an impact on corporate scandals? LaCroix takes that question on in his D&O Diary blog. He responded to a post in the CLS Blue Sky Blog by Oklahoma Law School Professor Megan W. Shaner, who wrote that plaintiff attorneys tend to target the conduct of corporate directors, not that of officers, so an adequate disincentive isn’t there.

“Despite officers’ key roles in modern corporate governance,” Shaner writes, “there has been surprisingly limited specific attention given to the officer as an individual corporate actor. Officer fiduciary duties, in particular, are underdeveloped and relatively unenforced, yet officer misconduct has been inextricably linked to most corporate scandals. [T]he lack of focus on officers is attributable in part to, and is further exacerbated by, the current enforcement scheme for officer fiduciary duties. In fact, many of the enforcement mechanisms available actually discourage those who should be able to hold officers accountable for their actions from doing so.”

Professor Shaner proposes that the solution is to correct the current fiduciary enforcement scheme—the focus should be on “the role of the board of directors and stockholders in enforcing officer fiduciary obligations.” They are in the best position to monitor and enforce the officers’ duties, she says. With regard to the relationship between officers and shareholders, she advocates “strengthening the role of stockholders as an enforcer of officer fiduciary duties” by “reevaluating and relaxing derivative lawsuit requirements for stockholders.” This, Professor Shaner says, “will improve enforcement incentives and aid in ensuring that officers are being held accountable for their fiduciary obligations.”

What? Me Worry?

LaCroix, however, questions the efficacy of litigation. “Most directors and officers believe they will never get sued in a shareholder lawsuit,” he writes. “They look at the conduct that led to the scandals and to the lawsuits, and they say, ‘I would never do anything like that, so I will never get sued.’”

He agreed with Shaner, though, that more needs to be done to prevent corporate officer misconduct. “Where she and I diverge is that I am against any proposed solution that will lead to more rather than less shareholder litigation. Litigation will not suddenly become a more effective deterrent mechanism if there is more of it or if corporate officers are named as defendants more frequently. Improved monitoring through increased shareholder involvement is a more promising method of trying to prevent corporate officer misconduct than is increased or expanded shareholder litigation, and it is less likely to lead to the inefficiencies and excess to which shareholder litigation is prone.”

Whatever the answer is, 2015 D&O actions should prove interesting, especially with the specter of high-cost settlements, new cyber-related risks, more attention to FCPA violations, and the continuing pace of IPOs.