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D&O Discourse

D&O Discourse Authors Davis and Greene to File Amicus Brief in Omnicare Case

Posted in Falsity Analysis, Securities Class Action, Statements of Opinion, Supreme Court

My partner Claire Loebs Davis and I are honored to be working with Washington Legal Foundation on a U.S. Supreme Court amicus brief in the Omnicare securities class action.  Omnicare concerns what makes a statement of opinion false.

As many of our readers know, Claire and I feel that improvement in the law on statements of opinion is of great importance for companies, their directors and officers, and their D&O insurers.  Although Omnicare arises in the context of Section 11, the issues raised are fundamental to the question of what makes a statement of opinion false, and it thus is important for Section 10(b) cases as well.  We are thrilled to have a chance to influence how this area of law develops.

You can find the docket and briefing on the SCOTUSblog page for Omnicare.

Here is a link to Claire’s D&O Discourse blog post on the Sixth Circuit’s (incorrect) decision in Omnicare.  Here is a link to the Law360 version of Claire’s post, which Omnicare cited in its cert petition.

Here are links to other helpful articles about the Omnicare case:

Securities Defense Bar Has High Hopes Riding On Omnicare

Important Conflict Being Overlooked In Omnicare Case

We will update this post with further links as the matter progresses.

 

Ineffective Motions to Dismiss Erode the Power of the Reform Act

Posted in Defense Counsel, Falsity Analysis, Litigation Strategy, Motions to Dismiss, Safe Harbor, Scienter Analysis, Securities Class Action, Statements of Opinion, Supreme Court

In 1995, public companies and their directors and officers received one of the greatest statutory gifts in the history of American corporate law:  the Private Securities Litigation Reform Act.  The Reform Act established heightened standards for pleading falsity and scienter, among other protections, to allow for dismissal before discovery in a fair percentage of cases.  That was a tremendous change from the pre-Reform Act world, in which dismissals were infrequent and expensive discovery was the norm.

The provisions of the Reform Act make motions to dismiss in securities cases different from those in any other area of law, and guide our strategy in every case that we litigate.  As a full-time securities litigation defense lawyer, I feel a responsibility to understand the Reform Act and the cases applying it with as much sophistication as possible.  I have a sense of pride in my Reform Act analysis.  It may sound hokey, but I consider myself a craftsman, and I know that some of the most effective full-time securities litigators tend to feel the same.

I was recently asked about the biggest threats to the Reform Act’s protections, and have since been giving that question a lot of thought.  To be blunt, the biggest threat is the failure by many defense firms to make rigorous arguments on motions to dismiss that hold plaintiffs to the strict pleading standards of the Reform Act, allowing for court decisions that likewise lack rigor and fail to enforce the Act’s high pleading burdens.

This lack of technical rigor has many causes.  One factor is the dwindling number of securities litigation defense specialists, caused by the downturn in classic securities litigation cases calling for straightforward Reform Act motions to dismiss.  Beginning in 2006, securities litigation defense has mostly consisted of stock-option backdating derivative cases, large credit-crisis cases, and merger objection cases.  Through these waves, very few securities litigators remained dedicated to studying Reform Act developments and devising better arguments that take advantage of its provisions.  As a result, today there are relatively few practitioners whose practices are devoted to securities litigation defense – defense lawyers who sweat over subtleties in the law that in isolation may seem trivial, but which collectively make a big difference in the development of the law.

Another factor is the biglaw approach to writing motions to dismiss “by committee.”  Biglaw firms tend to write motions with large teams composed of new associates, mid-level associates, senior associates, and partners.  Writing by committee doesn’t work.  It is not only expensive, it is ultimately far less effective.  If the first draft of a motion is written without sufficient intellectual rigor and sophisticated understanding of the law and practice of securities litigation, it is difficult to reach an end result that will compensate for these deficiencies.  To draft the best motion to dismiss possible, Reform Act “craftsmen” should be involved in the process from the beginning, the entire drafting team needs to coordinate closely on the strategic objectives of the motion, and all the attorneys need to be well trained to appreciate the subtleties of the law.

Whatever the cause, the declining quality of many motions to dismiss is leading to a deterioration of the law that is eroding the Reform Act’s protections.  The rate of dismissals remains relatively high, but I predict that the dismissal rate will decrease, perhaps dramatically, over time as the law becomes more lax.

Below, I discuss the building blocks of a strong motion to dismiss and then address flaws found in many that I have seen filed lately – both by practitioners who do not specialize in the field, and by some “go to” biglaw firms with departments that specialize in securities litigation.

Constructing a Strong Motion to Dismiss

The Reform Act erected high hurdles for plaintiffs to clear before requiring a company to be put through the burdens of discovery:

  • To plead the falsity of a challenged statement of fact, plaintiffs must plead inconsistent contemporaneous facts.
  • To plead a false statement of opinion, in most circuits plaintiffs must plead that the statement was both objectively false and subjectively false, meaning they must show the speaker did not genuinely believe the opinion expressed.
  • To plead that the defendant made a false statement with intent to defraud, plaintiffs must plead facts demonstrating a strong inference that the defendant either knew the statement was false or was extremely and deliberately reckless in choosing not to find out whether it was true or false.
  • Even if plaintiffs plead facts demonstrating it was false, a forward-looking statement is not actionable under the Safe Harbor provisions of the Reform Act if either: (1) the statement was accompanied by meaningful cautionary statements, or (2) plaintiffs fail to plead that the speaker had actual knowledge of the statement’s falsity.

A rigorous motion to dismiss uses the Reform Act’s pleading tools in the most advantageous way possible, by really understanding them and maximizing their usefulness.  These tools give defense lawyers the opportunity to delve into factual issues in a manner that is unusual in motion -to-dismiss practice, and which may feel unnatural to attorneys who are not securities litigation specialists or who didn’t become securities litigation specialists during the Reform Act era.  An effective motion to dismiss not only dismantles the complaint with these tools, but capitalizes upon them to tell the judge a compelling story of an honest company that did its best to make straightforward disclosures to the market.

The Reform Act’s standards give judges enormous discretion; they can dismiss most complaints, or not, with very little room to challenge their decisions upon appeal.  Winning motions recognize the human element to  this discretion.  Even if a complaint is technically deficient, judges are less likely to dismiss it (certainly less likely to dismiss it with prejudice) if they nevertheless get the feeling that the defendants committed fraud.  Effective motions use the leeway given to defendants by the Reform Act to give judges a sense of comfort that they are not only following the law, but that by strictly applying the Reform Act’s protections, they are also serving justice.  On the other hand, one of the most common flaws in ineffective motions to dismiss is the use of formulaic and hyper-technical arguments, which fail to take advantage of the Reform Act to dig into the facts of the individual case, expose the flaws of each complaint in detail, and tell the judge a compelling story of the case that negates the inference of scienter.

Flaws Found in Many Motions to Dismiss

Flaws in Arguments against Falsity

The first element of a claim under Rule 10b-5(b) – the classic securities claim – is a false or misleading statement.  As we recently wrote, it is an incorrect statement of law to characterize this element as requiring a “materially false statement or omission.”  An omission is only actionable if it made what the defendant said materially misleading (or he or she otherwise had a duty to disclose it, which is a rare assertion as the main claim in a securities class action).

Yet if I had a dollar for every motion to dismiss that contained this misstatement of law, I would be writing this blog from a vacation home in Hawaii.  This is not a semantic issue; the difference between an “omission” and a “misleading statement” is enormous.  Every disclosure problem involves dozens or even hundreds of omitted facts that seem “material” in the sense that an investor would want to know them, but far fewer involve statements that were materially misleading (it is the statement that must be material, not the omitted fact) as a result of the omission.  I realize that many courts, including the U.S. Supreme Court, use this incorrect terminology.  But that doesn’t mean we need to parrot it – and every time that we do, we weaken the standard that is an explicit part of the Reform Act statute.

Defense lawyers’ loose language is a symptom of a bigger problem:  a lack of focus on falsity.  The allegedly false statements frame the entire case; other defense arguments are derived from the attack on plaintiffs’ falsity claims.  Foremost among the arguments derived from a strong falsity argument is the argument against scienter.  Scienter requires plaintiffs to show that a speaker knew what he or she said was false.  Falsity thus sets the stage for the scienter analysis – if there was no false statement to begin with, there can be no knowledge of that falsity.  On the other hand, the more egregiously false plaintiffs can make a statement appear, the easier it will be for them to show knowledge of falsity.  A strong scienter argument has as its North Star, “scienter as to what?”  That “what” must be a false statement, and a good motion to dismiss will enforce that structure from the beginning.  I cringe when I read a motion to dismiss that addresses scienter before falsity.  That is simply backwards.

The lack of focus on falsity infects the way defense firms tend to argue against falsity.  The Reform Act falsity standard generally requires the plaintiffs to allege contemporaneous facts that are inconsistent with each challenged statement.  That is a high hurdle.

To be sure, it isn’t easy to make a fact-specific argument against falsity; it requires a great command of the complaint and judicially noticeable documents, which isn’t the forte of most litigators.  And it can seem “too factual” to general litigators, or to many senior securities litigators who became securities litigation specialists under the pre-Reform Act regime, where motions to dismiss had to be simple and safe to have any chance of success under lenient pleading standards.  Perhaps for these reasons, in addition to those discussed above, a large number of motions to dismiss bypass this advantageous and fundamental argument, or fail to emphasize it, and instead opt for arguments that lump statements together by type and argue against them as a group in a boilerplate fashion.  In my view, one of the worst arguments of this type is the “puffery” defense – which basically concedes that a statement was false, but contends it was too immaterial to be actionable.  The subtext is cavalier, and unlikely to reassure a dubious judge: “sure the defendant lied, but it doesn’t matter because no one cared.”  Although courts do sometimes accept this argument, whether to do so or not amounts to an unprincipled coin-flip, and it is often made at the expense of better and more definite arguments.  For example, statements constituting “puffery” also generally qualify as statements of opinion, which have a standard for falsity that is protective and can be analyzed specifically.

The Reform Act called out forward-looking statements for special analysis and protection.  As we have previously written, the Safe Harbor is not as safe as Congress intended.  Because they think it goes too far, and can give companies a “license to lie,” many judges go to great lengths to avoid the statute’s plain language.  Many defense lawyers’ arguments not only fail to address this judicial skepticism, but actually reinforce it.  They do this by relying solely on the Safe Harbor’s technical elements, while failing to simultaneously contend that the forward-looking statements in question also had a reasonable basis, and the company’s cautionary language was a good-faith effort to describe specific risks the company faced.  Such arguments based only on the letter of the Safe Harbor ring of “caveat emptor,” which the law has been trying to shake for centuries.

Flaws in Arguments against Scienter

Scienter allegations are of two types:  allegations pleading facts about what the defendant knew, to attempt to plead that he or she knew the challenged statements were false; and, far more prevalent, allegations that the defendant “must have” meant to lie, based on circumstantial considerations such as a defendants’ stock sales, corporate transactions, the temporal proximity of the challenged statement to the disclosure of the “truth,” and the relationship of the subject of the challenged statements to the company’s “core operations.”  As with falsity, the primary flaw in most defense arguments against scienter is with their failure to engage in a fact-specific analysis of the complaint’s allegations about what the defendants knew in regard to each specific challenged statement. All too often, defendants allow themselves to be drawn to the plaintiffs’ preferred ground of battle, focusing just on arguing about the sufficiency of the circumstantial evidence that plaintiffs use to create the impression that the defendants must have done something wrong.

Circumstantial scienter allegations are only ways to try to make an educated guess about what the speaker knew or intended.  But the Reform Act’s scienter standard requires particularized pleading yielding a “strong inference” that the defendant lied on purpose – a very high standard.  So it makes no sense for defense counsel not to approach the issue directly, by making it clear that the speaker did not lie, and holding plaintiffs to the strict standard of showing specific scienter as to each challenged statement.

For this reason, all effective motions to dismiss start by testing the complaint’s allegations that the defendants actually knew, or were intentionally reckless about not knowing, the facts establishing falsity.  This means that, for each statement and each defendant, the motion to dismiss needs to isolate the statement and the reasons that the complaint alleges it was false, and analyze what the complaint alleges each defendant knew about those facts at the time he or she made each challenged statement. Without this focus on each specific challenged statement, the scienter inquiry is vague, and becomes more about whether the defendant seems bad, or had generally bad motives, than whether he lied on purpose.  A good motion to dismiss does not let plaintiffs get away with these kinds of generalized allegations.

The problem is made worse if defense counsel approaches falsity categorically, without careful scrutiny of the reasons the complaint alleges the challenged statements were false.  Without this focus, defense counsel can’t meaningfully answer the central question in the Reform Act analysis – “scienter as to what?” – because there isn’t a sufficient nexus between the challenged statements and contemporaneous facts that made the statements false.  The scienter inquiry thus becomes unmoored from knowledge that specific statements were false.  The result is a lower burden for plaintiffs:  if they are able to plead falsity, and the defendants seemed to know something about the general subject matter, scienter is almost a foregone conclusion.

This problem is even worse under the “core operations” inference of scienter, and the “corporate scienter” doctrine.  Each of these theories allows a plaintiff to avoid pleading specific facts establishing the speaker’s scienter.  For example, the core operations inference posits that scienter can be inferred where it would be “absurd to suggest” that a senior executive doesn’t know facts about the company’s “core operations.”  Many motions to dismiss set up some formulation of this statement as a legal rule and make a simplistic syllogistic argument from it.  Such arguments devolve into “did not, did so” debates, and thus play into plaintiffs’ hands because they are detached from knowledge of falsity.

Instead, the right approach to the core operations inference is to understand that it requires a falsity so blatant that we can strongly infer that the executive had knowledge of the exact facts that made the statement false – not just the subject matter of the facts.  The most effective defense against the core operations inference thus focuses on falsity first, to show that even if a statement is false, it is at least a close call – making it hard for plaintiffs to contend that defendants must have known of this falsity.  This can’t be done effectively, of course, if the argument against falsity is categorical (i.e., embraces arguments such as “puffery,” rather than discussing the specific statements), or otherwise fails to address the falsity allegations in detail.  Of course, it is impossible to make this argument effectively if the scienter section precedes the falsity section of the brief.

***

We plan to address in greater depth some of the technical Reform Act issues in later posts, in hopes that we can improve the craftsmanship of motions to dismiss.  These are important issues to discuss as a defense bar, because each motion to dismiss that fails to maximize the Reform Act’s protections runs the risk of weakening the law for the rest of us.

 

 

Derivative Litigation Representation: Strategic and Ethical Issues

Posted in Board Oversight, Corporate Governance, Cyber Security, D&O Insurance, Defense Counsel, Delaware Courts, Securities Class Action, Shareholder Derivative Action

Shareholder litigation comes in waves.  There is a widespread belief that the next big wave will be shareholder derivative litigation – a shareholder’s assertion of a claim belonging to the corporation, typically brought against directors and officers, alleging corporate harm for a board’s failure to prevent corporate problems.

Derivative cases filed as tag-alongs to securities class actions have long been commonplace, and frequently are little more than a nuisance.  Over the years, there have been sporadic large derivative actions concerning other areas of legal compliance – typically over a very large corporate problem.   Non-disclosure derivative litigation filings recently have seemed more frequent, and there have been some large settlements that have come as a result.  And the specter of cyber liability derivative suits looms large – not surprisingly, Target shareholders just filed derivative litigation related to the recent customer data breach.  Whether the forecasted non-disclosure derivative-litigation wave materializes, or remains a sporadic occurrence in the larger world of D&O litigation, is one of the issues I’m watching closely in 2014 and beyond.

This potential wave raises issues that are unique to derivative litigation.  One key issue that has not been analyzed enough is representation: which lawyers can and should represent the company and the individual defendants in derivative litigation?

Because a derivative litigation claim belongs to the corporation, it puts the corporation in an odd spot.  A shareholder, as one of the corporation’s “owners” (usually a really, really small owner – but an owner nevertheless), is trying to force the company to bring a claim against the people who run the company.  The law says, however, that those people, the directors, get to decide whether the company should sue someone – including themselves – unless a shareholder can show that they couldn’t make a disinterested and independent decision.   Thus, to bring a derivative action, a shareholder must allege that it would have been futile to demand that the board take action, and defendants will typically challenge the lawsuit with a motion to dismiss for failure to make a demand (“demand motion”) on the basis that the demand-futility allegations aren’t sufficiently probative or particularized.

It is often said that the interests of the company and defendants are aligned through the demand motion, because they all have an interest in making sure that the shareholder follows proper governance procedures – namely, making a pre-suit demand on the board.  But this sort of statement prejudges the demand-futility allegations; it assumes that the allegations of futility are insufficient.  In Delaware and states that follow its demand law, proper corporate governance procedures require a shareholder either to make a demand or to plead demand-futility.  Only if and when the court rules that demand was required can we truly say that the interests of the company and defendants on the demand issue were aligned.  However, I don’t think this means that legal ethics require the company to be separately represented from the inception of a derivative action in all cases; the shared-interest view is arguable.   So if there are good practical reasons for joint representation from inception, and it causes no harm, so be it.  (That the primary lawyers are expensive relative to the D&O insurance limits isn’t a good reason for joint representation – it’s a good reason why those lawyers were the wrong lawyers for the matter.  But I digress.)

There’s also a compelling strategic reason to separate the representation from the beginning of the case.  A demand motion asks the court to allow the defendants to be the judge – to require the plaintiff to ask the directors to evaluate and bring claims against themselves and senior officers.  Thus, the company must overcome a judge’s skepticism that such an evaluation presents a “fox-guarding-the-chicken-coop” problem.  This is far easier to do if the company is separately represented and makes the demand motion.  It is true that courts frequently grant demand motions made during joint representation of the company and defendants.  But it is also true that joint representation always carries strategic risk, and the more serious the derivative litigation, the more unwise it is to take the risk.  Rather than make judgments in advance about which derivative litigation is serious, warranting a split, and which isn’t, allowing joint representation, I advocate splitting the representation from the outset – since the representation must be split up if demand is excused, splitting it from the outset imposes relatively little additional cost burden, if there’s appropriate coordination.

Representation between and among the defendants has strategic components, in addition to ethical considerations.  It can be strategically advantageous for individuals who aren’t accused of active wrongdoing to be separately represented from those who are.  That typically means officers and outside directors are represented separately in groups.  With this division, the court can see that the directors who would evaluate a demand don’t have the same lawyers as the people who allegedly engaged in active wrongdoing.  However, I don’t think that’s as strategically important for purposes of the demand motion as splitting up the company and defendants.  In evaluating a demand, the directors, acting as directors and not director-defendants, should be represented by counsel other than their litigation defense counsel.  Moreover, demand futility is judged at the time the suit is filed, not when the court decides the demand motion.  Thus, it isn’t technically necessary or legally accurate to send a “signal” of independence to the court through splitting up the representation further.  That said, in a very significant derivative case, and/or one in which the judge is new to derivative litigation, such an approach could be strategically advantageous.

It can sometimes be appropriate to consider even more divisions – for example, splitting the outside directors into audit-committee and non-audit-committee groups where audit-committee oversight is the main oversight allegation.  Such divisions may be ethically prudent or necessary later, but for purposes of the demand motion, they often don’t add much, if anything, since the demand motion is about the ability of a majority of the full board to consider a demand.

So, a typical case needs at least two lawyers from the outset – one for the company, and another for the individual defendants.  The type of derivative litigation we’re discussing often arises in the context of an underlying legal problem for which the company has lawyers – in a disclosure-related matter for a related securities class action, and in non-disclosure matters for other types of underlying matters (FCPA, antitrust, privacy, etc.).   To what extent should the lawyers defending the underlying matters be involved in the derivative action?

In general, I believe that the lawyers defending the underlying proceedings that created the corporate liability or harm (actual or potential) at issue in the derivative case should not defend the derivative case.  The reasons are similar to those I have written about in the context of using corporate counsel to defend a securities class action that may involve corporate counsel’s advice – there are tricky and hidden conflict issues, and the lawyers can be of better service to their clients as witnesses.

In derivative litigation, the problem can be even worse.  Corporate counsel typically advises on relevant corporate governance issues, such as compliance programs, the severity of legal risks that ultimately trigger the derivative litigation, board review of various risks, and preparation or review of board minutes.  Some companies are heavily guided in these areas by their corporate counsel, either directly in the boardroom or indirectly through advice to in-house counsel.   It is in the interests of the company and the board to be able to testify that they took a course of action, or didn’t do so, because of their lawyers’ advice.  The problem is greater than that of lawyer-as-witness – defense counsel should not be in the position of making judgments or recommendations that might be influenced by the law firm’s concerns about the public airing of its corporate work.

In derivative cases based on a disclosure problem, another representation issue arises:  whom should the securities class action defense counsel represent – the company or the defendants?   Securities class action defense counsel take different approaches to dividing derivative litigation representation.  Some will represent the company only, and have their securities class action individual defendant clients be represented by a different firm.  Others represent the individual defendants in the derivative action, and have the company represented by a different firm.   The right approach is a judgment call, but I prefer to have the securities class action defense counsel represent the individual defendants in the derivative action and have another firm represent the company.  That approach allows the lawyers in defense mode to fully remain in defense mode – they can defend the lack of merit to the charges of wrongdoing in all proceedings.   It also allows the defending lawyers to avoid the tension involved in simultaneously defending individuals in the securities class action and representing the potentially adverse company in the related derivative action.  This approach is possible with the right waivers, but I prefer the pure-defense approach.

Once the right lawyers are in place, how can and should the lawyers interact to prepare motions to dismiss and conduct other preliminary projects effectively – and cost-effectively?  The gating question is who should make the demand motion – the company or the defendants?  The company is really the right movant.  The demand motion is about the company’s corporate governance procedures, and the directors are involved not as directors but as individual defendants, so the purest approach is for the company to make the demand motion.

The same result makes sense from a strategic perspective.  The defendants have 12(b)(6) motions to make, and having them make both motions is awkward.   Although both motions say that the allegations (not the claims) aren’t good enough – the demand motion asserts that the allegations don’t raise a substantial likelihood of liability or other disabling interest sufficient to excuse demand, and the 12(b)(6) motion asserts they are not sufficient to state a claim – having the directors simultaneously assert that they could impartially consider a demand, but that the claims should be dismissed, is slicing the issues pretty finely.   If the defendants don’t make a 12(b)(6) motion, that problem is alleviated.  Many defense lawyers – including me from time to time – opine that the 12(b)(6) motions will fail if the demand motion fails, so defendants should just forego the 12(b)(6) motion entirely and make a 12(c) motion later, if necessary.  However, that foregoes the initial line of defense for the individuals.

It will be interesting to see if there is indeed a wave of more serious derivative litigation coming.  I will be on the look-out, and will write about other derivative-litigation issues that I think are of interest.

Halliburton: Is the Fix as Basic as Alleging Omissions under Affiliated Ute? Or Is That Too Cute?

Posted in Class Certification, Fraud-on-the-Market Doctrine, Litigation Reforms, Litigation Strategy, Securities Class Action, Supreme Court

Even the most experienced securities defense attorneys regularly summarize Rule 10b-5(b) as creating a cause of action for “false or misleading statements and omissions of material fact.”  Courts –including the Supreme Court – routinely use the same shorthand.   When I was a new securities litigation defense attorney, one of the first things that I learned was the importance of adding the rest of the sentence: “false or misleading statements and omissions of material fact necessary to make statements made not misleading.”

One of the most common misconceptions about the federal securities laws is that Rule 10b-5(b) creates a cause of action for omissions as well as for false or misleading statements.  But by the express terms of the rule, and Supreme Court precedent, omissions are only actionable if they cause an affirmative statement to be false or misleading because of the information that was omitted.  In other words, when a claim is based upon an alleged omission, it is not enough for a plaintiff to demonstrate that something was omitted, or even that the omitted fact was material.  Rather, in order to state a cause of action, the omitted information must have made an affirmative statement materially misleading by creating “an impression of a state of affairs that differs in a material way from the one that actually exists.” See Brody v. Transitional Hosps. Corp., 280 F.3d 997, 1006 (9th Cir. 2002).

It is understandable that plaintiffs’ attorneys would try to obscure this standard.  If all they needed to establish was that material information was omitted, it would be relatively easy to bring a successful claim.  No matter how much is disclosed, you can always find something that was omitted, and the squishy standard for materiality leaves plenty of room to make a case that the omission was material.  But the key to many successful motions to dismiss is to hold plaintiffs to the text of the rule:  whether they are alleging an affirmative lie, or a lie by omission, they must point to a statement that was false or misleading.

In the building frenzy among securities attorneys over the possible consequences of the Supreme Court’s upcoming ruling in Halliburton Co. v. Erica P. John Fund, this key distinction has been widely forgotten.  As attorneys contemplate the possible demise of the fraud-on-the-market presumption laid down in Basic v. Levinson, there is wide speculation about how, in the face of such a ruling, securities class actions might continue. (See Doug Greene’s discussion of the possible impact of Halliburton.)  One theory that has been repeatedly put forward by defense attorneys and legal commentators is that plaintiffs’ attorneys could cast their claims as alleging only material omissions, rather than false or misleading statements.  The theory is that this approach would allow plaintiffs to sidestep the formidable obstacle of proving class-wide reliance in the absence of the fraud-on-the-market presumption, by taking advantage of a Supreme Court ruling that indicated that proof of reliance was not necessary to support a claim based on omissions. See Affiliated Ute Citizens v. United States, 406 U.S. 128 (1972).

Wrote one securities litigation defense firm: if the Halliburton court rejects the fraud-on-the-market presumption, “plaintiffs could turn to the Affiliated Ute presumption, in which a plaintiff can avoid pleading actual reliance in a case framed as a material omission . . .The Affiliated Ute presumption will allow plaintiffs’ lawyers to recast their affirmative misrepresentation claims as pure omission claims, which do not need to rely on the fraud-on-the-market presumption to proceed.. . .Parties will vigorously litigate whether the crux of a case concerns affirmative misstatements, pure omissions, or both.”

But Affiliated Ute does not offer a quick fix to the potential elimination of Basic’s fraud-on-the-market presumption.  Affiliated Ute did not involve public statements or the securities markets, much less a securities class action under Rule 10b-5(b).  Rather, it involved face-to-face transactions among a relatively small group of individuals related to the allocation of Native American mineral rights.  The Affiliated Ute Court found that the defendants had failed to disclose material information to Native Americans as part of a fraudulent scheme to induce them to sell their mineral rights below market value.  The Court found that this created liability under Rule 10b-5(a) and (c), the subsections of the rule that create liability for a fraudulent “device, scheme, or artifice” or “practice or course of business.”  In these circumstances, the Court held that causation was established, and the plaintiffs did not need to prove “reliance” on the material omissions.

The Affiliated Ute ruling is thus based on the existence of a material omission as part of a fraudulent scheme.  But as the Supreme Court pointed out in Basic, and recently reaffirmed in Matrixx: “Silence, absent a duty to disclose, is not misleading under Rule 10b-5.”  Basic, Inc. v. Levinson, 485 U.S. 224, 239 n.17 (1988); Matrixx Initiatives, Inc. v. Siracusano, 131 S. Ct. 1309, 1322 (2011).  No matter how material it might be, an omission is not actionable unless there is a duty to disclose.  See, e.g., In re Time Warner, Inc. Sec. Litig., 9 F.3d 259, 267 (2d Cir. 1993) (“[A] corporation is not required to disclose a fact merely because a reasonable investor would very much like to know that fact.”).  There are specific circumstances under which such a duty to disclose might arise – for example, when there is a fiduciary relationship between the parties, if an insider is trading stock, or under Items 303 or 503 of Regulation S-K relating to public offerings.

But Rule 10b-5(b), the traditional territory of securities class actions, imposes no such requirement.  For this reason, as several courts have pointed out, the “presumption” of reliance on material omissions that developed from Affiliated Ute does not implicate core securities fraud claims.  See, e.g., Regents of the University of California v. Credit Suisse First Boston, 482 F. 3d 372, (5th Cir. 2007) (clarifying that Affiliated Ute does not apply to actions for misrepresentations under Rule 10b-5(b)). Thus, plaintiffs cannot simply recast their securities fraud allegations as “omissions,” as many commentators have suggested, and cause the parties to have to “litigate whether the crux of a case concerns affirmative misstatements, pure omissions, or both.”  Plaintiffs may only state a claim under 10b-5(b) based on an affirmative misstatement – whether that affirmative statement was misleading because of what it said, or because of what it did not say.

Under Affiliated Ute itself, the presumption of reliance on omissions is only invoked under Rule 10b-5 if there is proof of a fraudulent “course of business” or a “device, scheme or artifice that operated as a fraud” – under the Rule’s little-used subsections (a) and (c).  Do these subsections – which are not necessarily dependent upon affirmative misstatements – create a route for plaintiffs to find a way around the potential rejection of the fraud-on-the-market presumption?  Maybe in some cases, where plaintiffs are able to allege additional facts necessary to show some form of “scheme” liability under these subsections.  See Credit Suisse, 482 F.3d at 384 (“Merely pleading that defendants failed to fulfill [a duty to disclose] by means of a scheme or act, rather than by a misleading statement, does not entitled plaintiffs to employ the Affiliated Ute presumption.”). But that potential “solution” raises more questions than it answers, since the law surrounding these subsections is far less developed that the law of Rule 10b-5(b), and incorporates a number of additional complexities.*

One thing is clear.  Affiliated Ute does not offer a straightforward solution for plaintiffs’ lawyers if the Halliburton Court takes away the fraud-on-the-market presumption.   Whether they phrase their allegations as claims of affirmatively false statements or statements made false by omission, they are still claims based on statements, not omissions, and current law requires that plaintiffs find a way to show class-wide reliance.

 

* For example, the courts have established that Rule 10b-5 imposes a duty to disclose material nonpublic information on a defendant who sells stock.  But this “omission” claim is difficult for plaintiffs’ lawyers to bring, because a plaintiff must be a contemporaneous buyer to have standing – which generally means the plaintiff must have purchased stock in the few days surrounding when the defendant sold.  The standing requirement also restricts damages for such a claim to a class of contemporaneous purchasers – a much smaller group than the typical class in a securities class action arising out of a false or misleading statement, which can include purchasers of stock over a period of several years.

Practical Tips for Avoiding Securities Litigation, Understanding D&O Insurance, and Selecting Defense Counsel

Posted in D&O Insurance, D&O Insurance Brokers, Defense Costs, Defense Counsel, Indemnification, Litigation Strategy, Plaintiffs' Bar, Safe Harbor, Securities Class Action

In my last post of 2013, I thought I’d share some thoughts about how public companies can better protect themselves against securities claims – practical steps companies can take to help them avoid suits, mitigate the risk if they are sued, and to defend themselves more effectively and efficiently.  I’ll share a few thoughts in this post and expand on some of them in future posts.

How Can Companies Avoid Securities Litigation?

Companies can avoid many suits with what I’ll call “better-feeling” disclosures.  Nearly all public companies devote significant resources to accounting that conforms with GAAP, and non-accounting disclosures that comply with the labyrinth of disclosure rules.  Despite tremendous efforts in these areas, later events sometimes surprise officers and directors – and the market – and make a company’s previous accounting or non-accounting disclosures appear to have been inaccurate.

But plaintiffs’ lawyers decide to sue only a subset of such companies – a smaller percentage than most people would assume.  What makes them sue Company A, but not Company B, when both have suffered a stock price drop due to a development that relates to their earlier disclosures?  There are a number of factors, but I believe the driver is whether a company’s disclosures “feel” fair and honest.  Without the benefit of discovery, plaintiffs’ lawyers have to draw inferences about whether litigation will reveal fraud or a sufficient degree of recklessness – or show that the discrepancies between the earlier disclosures and later revelations was due to mistake or an unanticipated development.

What can companies do to make their disclosures “feel “more honest?

An easy way for companies to make their disclosures feel more honest and forthright is to improve the quality of their Safe Harbor warnings.  Although the Reform Act’s Safe Harbor was designed to protect companies from lawsuits over forward-looking statements, there are still an awful lot of such actions filed.  The best way to avoid them is by crafting risk warnings that are current and candid.  A plaintiffs’ lawyer who reads two years’ worth of risk factors can tell whether the risk factors are boilerplate, or an honest attempt to describe the company’s risks.  The latter deters suits.  The former invites them.

Another way for companies to improve their disclosures is through more precision and a greater feel of candor in the comments they make during investor conference calls.  Companies sweat over every detail in their written disclosures, but then send their CEO and CFO out to field questions on the very same subjects and improvise their responses.  What executives say, and how they say it, often determines whether plaintiffs’ lawyers sue – and, if they do, how difficult the case will be to defend.  A majority of the most difficult statements to defend in a securities class action are from investor calls, and plaintiffs’ lawyers listen to these calls and form impressions, positive and negative, about officers’ fairness and honesty.

Companies looking to minimize the risks of litigation should also take steps to prevent their officers and directors from making suspicious-looking stock sales – for obvious reasons, plaintiffs’ lawyers like to file suits that include stock sales.  If a company’s officers and directors don’t have 10b5-1 plans, companies should establish and follow an insider trading policy and, when in doubt, seek guidance from outside counsel on issues such as trading windows and the propriety of individual stock sales, both as to the legal ability to sell, and how the sales will appear to plaintiffs’ lawyers.  And even if their officers and directors have 10b5-1 plans, companies aren’t immune to the scrutiny of their stock sales – plaintiffs’ lawyers usually aren’t deterred by 10b5-1 plans, contrary to conventional wisdom. So companies should consult with their counsel about establishing and maintaining the plans, to avoid traps for the unwary.

How Can Companies Better Protect Themselves Against Securities Litigation that Does Arise?

Whether a securities class action is a difficult experience or a fairly routine corporate legal matter usually turns on the company’s decisions about directors’ and officers’ indemnification and insurance, its choice of defense counsel, and its management of the defense of the litigation.

Deciding on the right director and officer protections and defense counsel require an understanding of the seriousness of securities class actions.  Although securities class actions are a public company’s primary D&O litigation exposure,* most companies don’t understand the degree of risk they pose.  Some companies seem to take securities class actions too seriously, while others might not take them seriously enough.

The right level of concern is almost always in the middle.  A securities class action is a significant lawsuit.  It alleges large theoretical damages and wrongdoing by senior management and often the board.  But the risk presented by a securities action is usually very manageable, if the company hires experienced, non-conflicted and efficient counsel, and devotes sufficient time and energy to the litigation.  Cases can be settled for a predictable amount, and it is exceedingly rare for directors and officers to write a personal check to defend or settle the case.  On the other hand, it can be a costly mistake for a company to take a securities class action too lightly; even meritless cases can go wrong.

The right approach to securities litigation involves several practical steps that are within every company’s control.

Companies should hire the right D&O insurance broker and treat the broker as a trusted advisor.  There is a talented and highly specialized community of D&O insurance brokers.  Companies should evaluate which is the right broker for them – they should conduct an interview process to decide on the right broker, and seek guidance from knowledgeable sources, including securities litigation defense counsel.  Companies should heavily utilize the broker in deciding on the right structure for their D&O insurance program and in selecting the right insurers.  And since D&O insurance is ultimately about protecting officers and directors, companies should have the broker speak directly to the board about the D&O insurance program.

Boards should learn more about their D&O insurers.  Boards should know their D&O insurers’ financial strength and other objective characteristics.  But boards should also consider speaking with the primary insurer’s underwriting executives from time to time, especially if the relationship with the carrier is, or may be, long-term.  The quality of any insurance turns on the insurer’s response to a claim. D&O insurance is a relationship business.  Insurers want to cover D&O claims, and it is important to them to have a good reputation for doing so.  The more the insurer knows the company, the more comfortable the insurer will be about covering even a difficult claim.  And the more a board knows the insurer, the more comfortable the board will be that the insurer will cover even a difficult claim.

Boards should oversee the defense-counsel selection process, and make sure the company conducts an interview process and chooses counsel based on value.  The most important step for a company to take in defending a securities class action is to conduct an audition process through which the company selects conflict-free defense counsel who can provide a quality defense – at a cost that leaves the company enough room to defend and resolve the litigation within policy limits.  Put differently, the biggest threats to an effective defense of a securities class action are the use of either a conflicted defense counsel, defense counsel who will charge an irrational fee for the litigation, or counsel who will cut corners to make the economics appear reasonable.

Errors in counsel-selection most often occur when a company fails to conduct an interview process, or fails to consult with its D&O insurers and brokers, who are “repeat players” in D&O litigation and thus have good insights on the best counsel for a particular case.  Although the Reform Act’s 90-day lead plaintiff selection process gives companies plenty of time to evaluate, interview, and select the right defense counsel for the case, many companies quickly hire their corporate counsel’s litigation colleagues, without consulting with brokers and insurers or interviewing other firms.

The right counsel may end up being the company’s normal corporate firm, but a quick hiring decision rarely makes sense under a cost-benefit analysis.  The cost of hiring the wrong firm can substantial – the harm includes millions of dollars of unnecessary fees; hundreds of hours of wasted time by the board, officers, and employees; an outcome that is unnecessarily uncertain; and an unnecessarily high settlement – and there’s very little or no upside to the company.

On the other hand, it costs very little to interview several firms for an hour or two each, and the benefit can be substantial – free and specialized strategic advice by several of the handful of lawyers who defend securities litigation full time, and potentially substantial price and other concessions from the firm that is ultimately chosen.  The auditioning lawyers can also provide guidance to the company on whether its corporate counsel faces conflicts and, if so, the potential harm to the company and the officers and directors from hiring corporate counsel anyway.

 

* This discussion focuses on public company securities class actions. I set aside shareholder derivative litigation and shareholder challenges to mergers, which typically involve lesser risk.

Is the Demise of the Fraud-on-the-Market Doctrine Near? Be Careful What You Wish For

Posted in 5th Circuit, 9th Circuit, Class Certification, Fraud-on-the-Market Doctrine, Litigation Reforms, Plaintiffs' Bar, SEC, SEC Enforcement, Securities Class Action, Settlement, Supreme Court

At long last, the United States Supreme Court is going to address the viability and/or prerequisites of the fraud-on-the-market presumption of reliance established by the Court in 1988 in Basic v. Levinson.  Securities litigators, on both sides of the aisle, are understandably anxious, because our entire industry is about to change – either a little or a lot.

I say “change,” and not something more ominous like “be obliterated,” because the Supreme Court’s ruling in Halliburton cannot and will not do away with securities litigation.  If the Court’s ruling were to undermine class actions, the plaintiffs’ securities bar would adjust – likely through burdensome large individual and non-class collective actions, and class actions that attempt to work around whatever ruling the Court makes – and the government would act to facilitate some type of securities class action and/or expand government enforcement of the securities laws.  Worse outcomes for companies in a new no-Basic era are far easier for me to imagine than better ones.  I’ll explain why, after a quick review of how we got here.

The Fraud-on-the-Market Presumption:  From Basic to Halliburton to Amgen to Halliburton

Reliance is an essential element of a Section 10(b) claim. Absent some way to harmonize individual issues of reliance, however, class treatment of a securities class action is not possible; individual issues would overwhelm common ones, precluding certification under Federal Rule of Civil Procedure 23(b)(3).  In Basic, the Supreme Court provided a solution: a rebuttable presumption of reliance based on the fraud-on-the-market theory, which provides that a security traded on an efficient market reflects all public material information.  Purchasers (or sellers) rely on the integrity of the market price, and thus on a material misrepresentation. Decisions following Basic have established three conditions to its application: market efficiency, a public misrepresentation, and a purchase (or sale) between the misrepresentation and the disclosure of the “truth.”

Over the years, defendants have argued that, absent a showing by plaintiffs that the challenged statements were material, or upon a showing by defendants that they were not, the presumption is not applicable or has been rebutted.  And, in a twist on such arguments, defendants sometimes argued that the absence of loss causation rebutted the presumption. In Erica P. John Fund, Inc. v. Halliburton Co., the Supreme Court unanimously rejected loss causation as a condition of the presumption of reliance.

In Halliburton, the defendants did not dispute that proof of loss causation is not required for the fraud-on-the-market presumption to apply. Instead, they argued to the Supreme Court that, although the Fifth Circuit ruled on loss-causation grounds, it really ruled that the absence of loss causation means that the challenged statements were not material because the challenged statements did not impact the price of Halliburton’s stock, and a lack of materiality defeats the application of the presumption.  The Supreme Court disagreed: “Whatever Halliburton thinks the Court of Appeals meant to say, what it said was loss causation: ‘[EPJ Fund] was required to prove loss causation, i.e., that the corrected truth of the former falsehoods actually caused the stock price to fall and resulted in the losses.’ . . . . We take the Court of Appeals at its word.  Based on those words, the decision below cannot stand.”

But the Supreme Court explicitly left the door open for the argument that plaintiffs must prove materiality for the presumption of reliance to apply.  The Supreme Court granted certiorari in Amgen Inc. v. Connecticut Retirement Plans to review the Ninth Circuit’s decision that plaintiffs are not required to prove materiality for the presumption to apply, and that the district court is not required to allow defendants to present evidence rebutting the applicability of the presumption before certifying a class based on the presumption.

In a majority opinion authored by Justice Ginsburg, and joined by Chief Justice John Roberts and Justices Breyer, Alito, Sotomayor, and Kagan, the Court concluded that proof of materiality was not necessary to demonstrate, as Rule 23(b)(3) requires, that questions of law or fact common to the class will “predominate over any questions affecting only individual members.” The Court reasoned that this was because: 1) materiality was judged according to an objective standard that could be proven through evidence common to the class, and 2) a failure to prove materiality would not just defeat an attempt to certify a class, it would also defeat all of individual claims, because it is an essential element to a claim under Section 10(b).

The majority’s conclusion was dubious.  Its chief flaw was its avoidance of the central question through circular reasoning.  The materiality of a statement is an essential prerequisite for the application of the fraud-on-the market presumption that the Court developed in Basic, as a device to overcome the need to prove actual, individual reliance on a false or misleading statement – which made securities class actions all but impossible to bring.  In Basic, the Court used then-emerging economic theory to create a rebuttable presumption of reliance, based on the assumption that a security traded in an efficient market reflects all public material information, and that traders in that market rely on the market price, and thus on any material misrepresentations that are reflected in the price.  The Amgen Court did not dispute that the materiality of a misrepresentation is necessary to create the fraud-on-the-market presumption, nor that the fraud-on-the-market presumption is essential to show under Rule 23 that common questions predominate for the class.

Instead, to avoid the logical conclusion that a showing of materiality was thus necessary to certify the class, the Court reasoned backwards: because plaintiffs must also show the materiality of the alleged misstatements in order to prove the underlying merits of a Section 10(b) claim, a finding that there was no materiality would defeat claims for all plaintiffs, whether brought as a class or individually.  Therefore, the Court concluded, materiality (or the lack of it) was a “common question,” that should not be decided until summary judgment, or theoretically, trial.

As Justice Thomas wrote in his dissent (joined by Justice Scalia (in part) and Justice Kennedy), the majority essentially “reverse[d]” the inquiry.  Although class certification is supposed to be decided early in the litigation, and depends upon a showing of materiality to invoke the fraud-on-the-market presumption, the majority effectively said that that portion of the class certification inquiry can be skipped, merely because it is also a question that will be asked at the merits stage. Justice Thomas wrote: “A plaintiff who cannot prove materiality does not simply have a claim that is ‘dead on arrival’ at the merits. . .he has a class that never should have arrived at the merits at all because it failed in Rule 23(b)(3) certification from the outset.”

Perhaps the most striking part of the Amgen decision was Justice Alito’s one paragraph concurrence, which baldly called for a reconsideration of the fraud-on-the-market presumption.  Alito concurred with the majority, but only with the understanding that Amgen had not asked for Basic to be revisited. Alito thus signaled that he agreed with Thomas’s contention in footnote 4 of the dissent that the Basic decision was “questionable.”  The majority, in turn, did not come to the defense of Basic, but simply noted with apparent relief (in footnote 2) that even Justice Thomas had acknowledged that the Court had not been asked to revisit that issue.  Considered together, these three opinions put out a welcome mat for the right case challenging Basic’s fraud-on-the-market presumption, with four votes already supporting the view that the decision was “questionable,” and the other five failing to come to its defense.

As Amgen was being litigated in the Supreme Court, the parties in Halliburton were briefing the plaintiffs’ class certification motion on remand.  The district court certified a class, prior to the Supreme Court’s decision in Amgen.  Halliburton sought and obtained Rule 23(f) certification from the Fifth Circuit, which affirmed, after the Supreme Court decided Amgen.  The Fifth Circuit held that the inquiry of the challenged statements’ lack of impact on the price of Halliburton’s stock was more analogous to materiality than it is to the permissible prerequisites to the fraud-on-the-market presumption (market efficiency and a public misrepresentation).  The Fifth Circuit reasoned that while price impact is not an element, as is materiality, “a plaintiff must nevertheless prevail on this fact in order to establish loss causation.”  Thus, “if Halliburton were to successfully rebut the fraud-on-the-market presumption by proving no price impact, the claims of all individual plaintiffs would fail because they could not establish an essential element of the action.”  Because the Fifth Circuit believed that the absence of price impact would doom all individual claims, it concluded that price impact is not relevant to common-issue predominance and is therefore not relevant at class certification.

Halliburton filed a petition for a writ of certiorari, and the Court granted the petition on Friday November 15, 2013.  That day, many plaintiffs’ and defense lawyers predicted the demise of securities litigation as we know it.  One defense lawyer put it in blunt terms:  “If the Supreme Court rejects the ‘fraud-on-the-market presumption of reliance altogether, then it would effectively end securities class action litigation in the United States.”

I disagree.

What’s Next?  How Will the Supreme Court Rule?  If the Court Overrules Basic, What Will Happen?   

There are three primary possible outcomes in the Supreme Court:

1.  The Court will affirm the Fifth Circuit without overruling or adjusting Basic.  This seems unlikely.

2.  The Court will adjust Basic.

One adjustment might be to require that a putative class plaintiff show that the market for the issuer’s stock be efficient as to the specific information that the defendants allegedly misrepresented – which is Halliburton’s alternative grounds for relief, and a proposition that Amgen included in a footnote in its Supreme Court briefs.  I predict that this will be what the Supreme Court decides.  Such a decision would address the primary economic criticism of the fraud-on-the-market presumption – that market efficiency is not a binary “yes” or “no” question, and instead depends on the specific information at issue – and would preserve salutary features of private securities litigation, which long has been an important means of securities regulation.

Another adjustment might be to allow the fraud-on-the-market presumption for purposes of satisfying the element of reliance, but require proof of actual reliance on the challenged statements for purposes of recovering money damages.  This is the position taken in an amicus brief in support of cert filed by a group of prominent law professors and former SEC commissioners, primarily relying on the elements of the Exchange Act’s only express private right of action, set forth in Section 18.

3.  The Court will overrule Basic and leave nothing in its place – thus negating the primary support for securities class actions.

What would happen then?

The plaintiffs’ securities bar would adjust. 

The plaintiffs’ bar would seek to work around Halliburton in some fashion.  That would result in much uncertainty and expensive litigation of the scope of Halliburton in the district courts, circuit courts, and likely the Supreme Court.

Worse, the largest firms with large institutional investor clients – clients the Private Securities Litigation Reform Act encouraged them to court, and with which they now work closely to identify and pursue securities claims – would file large individual and non-class collective actions.  Smaller plaintiffs’ firms would also file individual and non-class collective actions.  The damages in cases filed by smaller firms would tend to be smaller, but the litigation burdens would be similar.

Non-class securities actions would be no less expensive to defend than today’s class actions, since they would involve litigation of the same core merits issues.  Non-class litigation would be even more expensive in certain respects – e.g. multiple damages analyses and vastly more complex case management.  And if securities class action opt-out litigation experience is indicative of the settlement value of such cases, they would tend to settle for a larger percentage of damages than today’s securities class actions.

In a new non-class era of securities litigation, the settlement logistics would be vastly more difficult – it’s hard enough to mediate with one plaintiffs’ firm and one lead plaintiff.  Imagine mediation with a dozen or more plaintiffs’ firms and even more plaintiffs.  One reason we sometimes oppose lead-plaintiff groups is the difficulty of dealing with a group of plaintiffs instead of just one.

Even when settlement could be achieved, it wouldn’t preclude suits by other purchasers during the period of inflation, because there would be no due process procedure to bind them, as there is when there’s a certified class with notice and an opportunity to object or opt out.  Indeed, there likely would develop a trend of random follow-up suits by even smaller plaintiffs’ firms after the larger cases have settled.  There would be no peace absent the expiration of the statute of limitations.

The government would act.

The government would not allow the securities markets to be profoundly less regulated.  So it would do something.  It might legislatively enable securities class actions.  If it did so, would it also make other adjustments, such as lessen the Reform Act’s protections?  Who knows, but I wouldn’t bet on an improvement for companies.  I strongly believe that the biggest securities-litigation threat to companies is erosion of the Reform Act’s protections.

The government might also, or instead, enhance public enforcement of the securities laws.  This would be a negative development.  Companies have much greater ability to predict the cost and outcome of today’s securities class action than they do the outcome of a government enforcement action.  Experienced defense counsel can predict how plaintiffs’ firms will litigate and resolve a case.  Defense counsel have much less ability to predict how an enforcement person with whom he or she may have never dealt will approach a case.

Finally, I must say that I am not one who thinks that the fraud-on-the-market presumption results in much injustice, especially given the protections of the Reform Act.  The Reform Act weeds out a lot of cases.  To be sure, some cases incorrectly survive motions to dismiss.  The only real policy problem with class actions regarding Basic is with the subset of these cases that also are certified as class actions at the class-certification stage but are destined to be decertified at summary judgment or trial – defendants in those cases are unjustly subjected to burdensome class action litigation.  The combination of these errors, however, isn’t frequent.  And even when it does occur, experienced plaintiffs’ and defense counsel are able to handicap the merits on both counts, i.e. the lack of merit to the claims and to the case temporarily surviving as a class action, and adjust the settlement value of the case accordingly.

This is just a start on our analysis.  We’ll certainly write more during the long wait for the Court’s ruling.

 

Is the Biggest Name Really the “Safest” Choice for Securities Class Action Defense?

Posted in D&O Insurance, Defense Costs, Defense Counsel, Litigation Strategy, Securities Class Action, Settlement

When I moved my securities litigation practice to a regional law firm from biglaw, I made a bet.  I bet that public companies and their directors and officers would be willing to hire securities defense counsel on the basis of value, i.e., the right mix of experience, expertise, efficiency, and price – just as they do with virtually all other corporate expenditures – and not simply default to a biglaw firm because it is “safer.”

My bet certainly was made less risky by the quality of my new law firm (a 135-year-old renowned firm that has produced past and present federal judges, and is full of superior lawyers); my confirmatory discussions with public company directors, officers, and in-house lawyers; my observations and analyses about the evolving economics of securities litigation defense and settlement; and my knowledge that I could recruit other talented full-time securities litigators to join me in my new practice.  But it was still a bet.

Well, so far, so good – my experience to date has confirmed my belief.  So, too, did a recent article titled, “Why Law Firm Pedigree May Be a Thing of the Past,” on the Harvard Business Review Blog Network (“HBR article”), reporting on scholarship and survey results indicating that public companies are increasingly willing to hire firms outside of biglaw to handle high-stakes matters.

The HBR article frames the issue in colorful terms:

Have you ever heard the saying: “You never get fired for buying IBM”? Every industry loves to co-opt it; for example, in consulting, you’ll hear: “You never get fired for hiring McKinsey.” In law, it’s often: “You never get fired for hiring Cravath”. But one general counsel we spoke with put a twist on the old saying, in a way that reflects the turmoil and change that the legal industry is undergoing. Here’s what he said: “I would absolutely fire anyone on my team who hired Cravath.” While tongue in cheek, and surely subject to exceptions, it reflects the reality that there is a growing body of legal work that simply won’t be sent to the most pedigreed law firms, most typically because general counsel are laser focused on value, namely quality and efficiency.

The HBR article reports that a study of general counsel at 88 major companies found that “GCs are increasingly willing to move high-stakes work away from the most pedigreed law firms (think the Cravaths and Skaddens of the world) … if the value equation is right.  (Firms surveyed included companies like Lenovo, Vanguard, Shell, Google, NIKE, Walgreens, Dell, eBay, RBC, Panasonic, Nestle, Progressive, Starwood, Intel, and Deutsche Bank.)”

The article reports on two survey questions.

The first question asked, “Are you more or less likely to use a good lawyer at a pedigreed firm (e.g. AmLaw  20 or Magic Circle) or a good lawyer at a non-pedigreed firm for high stakes (though not necessarily bet-the-company) work, assuming a 30% difference in overall cost?”

The result: 74% of GCs answered that they are less likely to use a pedigreed firm, and 13% answered the “same.”  Only 13% responded that they are more likely to use a pedigreed firm than other firms.

The second question asked, “On average, and based on your experiences, are lawyers at the most pedigreed, “white shoe” firms more or less responsive than at other firms?”

The result:  57% answered that pedigreed firms are less responsive than other firms, and 33% answered they are the “same.”  Only 11% responded that pedigreed firms are more responsive than other firms.

The survey results ring true, and are reinforced by other recent scholarship and analysis on the issue, including a Wall Street Journal article titled, “Smaller Law Firms Grab Big Slice of Corporate Legal Work” (“WSJ article”), and an article featured on www.law.com’s Corporate Counsel blog titled, “In-House Counsel Get Real About Outside Firm Value” (“Corporate Counsel article”).  As all three articles emphasize, skyrocketing legal fees are a notorious problem in general.  And corporate executives are increasingly becoming attuned to this issue.  Indeed, during the in-house counsel panel discussed in the Corporate Counsel article, a general counsel noted that in explaining outside counsel costs to the CEO and CFO of his company, “it’s very, very difficult … to say why someone should [bill] over $1,000 per hour . . . It just doesn’t look good.”  The problem is especially acute in securities class action defense, in which the defense is largely dominated by biglaw firms with high billing rates and a highly leveraged structure (i.e. a high associate-to-partner ratio), which tends to result in larger, less-efficient teams.

Now, as the economy has forced companies to be more aware of legal costs, including the fact that using a biglaw firm often results in prohibitively high legal fees, it is unsurprising that companies are increasingly turning to midsize firms.  According to the WSJ article, midsize firms have increased their market share from 22% to 41% in the past three years for matters that generate more than $1 million in legal bills.  Indeed, both Xerox’s general counsel and Blockbuster’s general counsel advocated that companies control legal costs by using counsel in cities with lower overhead costs.

Some companies, and many law firms, see securities class actions as a cost-insensitive type of litigation to defend: the theoretical damages can be very large, they assert claims against the company’s directors and officers, and the defense costs are covered by D&O insurance.

But these considerations rarely, if ever, warrant a cost-insensitive defense.  Securities class actions are typically defended and resolved with D&O insurance.  D&O insurance limits of liability are depleted by defense costs, which means that each dollar spent on defense costs decreases the amount of policy proceeds available to resolve the case.  At the end of a securities class action, a board will very rarely ask, “why didn’t we hire a more expensive law firm?”  Instead, the question will be, “why did we have to write a $10 million check to settle the case?”  Few GCs would want to have to answer:  “because we hired a more expensive law firm than we needed to.”

That takes us to the heart of the HBR article: “do we need to hire an expensive law firm?”  After all, in a securities class action, the theoretical damages can be very large, often characterized as “bet the company,” and the fortunes of the company’s directors and officers are theoretically implicated.  Certainly, when directors and officers are individually named in a lawsuit, their initial gut reaction may be to turn to biglaw firms regardless of price, if they believe that the biglaw brand name will guarantee them a positive result.

Biglaw capitalizes on these fears.  But, of course, hiring a biglaw firm does not guarantee a positive result.  The vast majority of securities class actions are very manageable.  They follow a predictable course of litigation, and can be resolved for a fairly predictable amount, regardless how high the theoretical damages.  And it is exceedingly rare for an individual director or officer to write a check to settle the litigation.  Indeed, the biggest practical personal financial risk to an individual director or officer is exhaustion of D&O policy proceeds due to defense costs that are higher than necessary.

Lurking behind these considerations are two central questions: “aren’t lawyers at biglaw firms better?” and “don’t I need biglaw resources?”

“Aren’t lawyers at biglaw law firms better?”  Not necessarily.  That’s the main point of the GC survey discussed in the HBR article.

To be sure, there are excellent securities litigators at many biglaw firms.  But the blanket notion that biglaw securities litigators are more capable than their non-biglaw counterparts is false.  And it’s not even a probative question when comparing biglaw lawyers to non-biglaw lawyers who came from biglaw.  In the WSJ article, Blockbuster’s general counsel, in explaining why his company often seeks out attorneys from more economical areas of the country, pointed out that many of the attorneys in less expensive firms came from biglaw firms.  Many top law school graduates and former biglaw attorneys practice at non-biglaw firms, not because they were not talented enough to succeed at a biglaw firm, but for personal reasons, including a desire to live in a city other than New York, the Bay Area, or Los Angeles, to find work-life balance, to have the freedom to design a better way of defending cases, or to develop legal skills at a faster pace than is usually available at a biglaw firm.

There obviously is a baseline amount of expertise and experience that is necessary to handle a case well, and there are a number of non-biglaw lawyers in the group of lawyers who meet that standard.  One easy way to judge the quality of firms is by reading recently filed briefs of biglaw and midsize firms.  While this type of analysis takes more time than simply looking up a lawyer or law firm ranking, it will be the best indicator of the type of work product to expect from a firm.  As with all lawyer-hiring decisions, the individual lawyer’s actual abilities, strategic vision for the litigation, and attention to efficiency are key considerations.  A lawyer’s association with a biglaw firm name can be a proxy for quality, but it does not ensure quality.

Indeed, the opposite can be true – by paying for the biglaw expertise and experience of a particularly accomplished senior partner (the partner likely to pitch the business), companies often end up with the majority of the work being done by senior associates and junior partners.  A company should consider the impact of the economic realities of biglaw versus non-biglaw firms.  Senior partners at biglaw firms, with higher associate-to-partner ratios, must have a lot of matters to keep their junior partners and associates busy, and thus necessarily spend less time on each matter – even if they have good intentions to devote personal time to a matter.  Biglaw firms’ largest clients and cases, moreover, often demand much of a senior partner’s time, at the expense of other cases.  And given the reality that partners practice less and less law the more senior they become, it is fair to question whether they are the right people for the job anyway.  In contrast, senior partners at non-biglaw firms typically have fewer people to keep busy, and have lower billing rates – which means that they can spend more time working on their cases, and they spend more time actually practicing law.

Further, for smaller and less significant projects that should be handled by associates, and should not require the higher billing rates of partners, biglaw is similarly unable to offer a cost-effective solution for companies.  Associates at biglaw firms typically have less hands-on experience than their counterparts at mid-sized firms.  In litigation, for example, biglaw associates generally spend their first few years solely on discovery or discrete research projects.  The end result is that many projects that could be handled by a junior or mid-level associate at a mid-sized firm would have to be handled by a senior associate or junior partner at a biglaw firm.  So, even putting aside differences in billing rates between a fifth-year biglaw associate and a fifth-year midsize firm associate, going with a biglaw firm typically means that projects are being assigned to attorneys too senior (and accordingly too costly) to be handling the assignments.

Don’t I need biglaw resources?  There are two primary answers.  First, from both a quality and an efficiency standpoint, securities litigation defense is best handled by a small team through the motion–to-dismiss process.  Prior to a court’s decision on the motion to dismiss, the only key tasks are a focused fact investigation and the briefing on the motion to dismiss.   As to both, fewer lawyers means higher quality.

If a case survives a motion to dismiss, most firms with a strong litigation department will have sufficient resources to handle it capably.  That, of course, is something a company can probe in the hiring process.   There are cases that necessarily will require a larger team than some mid-size firms can provide.  However, such cases are rare, and it is often the case that biglaw firms, in an effort to maintain associate hours at a certain level, will heavily staff associates on discovery projects such as document review.  While the exceptional case will require a team of more than around five associates, for the most part, discovery can and should be handled most efficiently by a team of contract attorneys supervised by a small team of associates – or by utilizing new technologies that allow smaller teams to review documents more efficiently and effectively.

Second, as reflected in the HBR article’s discussion of GCs’ answers to the second question, there isn’t a correlation between a firm’s pedigree and its responsiveness – which is a key facet of law firm resources.  Indeed, responsiveness is a function of effort, and it stands to reason that non-biglaw firms will make the necessary effort to give excellent client service.

The bottom line of all this is simply common sense: within the qualified group of lawyers, a company should look for value – the right mix of experience, expertise, efficiency, and cost – as it does with any significant corporate expenditure.

D&O Discourse Adds New Twitter Feature

Posted in Uncategorized

D&O Discourse is now on Twitter, @DandODiscourse.  We will tweet current securities and corporate governance litigation news and links.

You can follow us on Twitter, of course.  And you can view our tweets on the blog — there’s a feed on the lower left hand side of the website.

Our goal is to help turn the fire hose of securities litigation news into a drinking fountain, by tweeting the current developments that we find most important.  So please visit D&O Discourse for daily-ish news, in addition to our opinion-based blog posts.

Thanks very much for your support of D&O Discourse.

Falsity is Fundamental: The Case for Emphasizing Arguments against Falsity

Posted in 2nd Circuit, 7th Circuit, 9th Circuit, Confidential Witnesses, Falsity Analysis, Litigation Strategy, Safe Harbor, Scienter Analysis, Securities Class Action, Statements of Opinion

In defending a securities class action, a motion to dismiss is almost automatic, and in virtually all cases, it makes good strategic sense.  In most cases, there are only four main arguments:

  • The complaint hasn’t pleaded a false or misleading statement
  • The challenged statements are protected by the Safe Harbor for forward-looking statements
  • The challenged statements weren’t made with scienter, even if the complaint has adequately pleaded their falsity
  • The complaint hasn’t adequately pleaded loss causation

For me, the core argument of virtually every brief is falsity – I think that standing up for a client’s statements provides the foundation for all of the other arguments.  For most clients, it is important to stand up and say “I didn’t lie.”   And an emphasis on challenging the falsity allegations encompasses clients’ most fundamental responses to the lawsuit:  they reported accurate facts; made forecasts that reflected their best judgment at the time; gave opinions about their business that they genuinely believed; issued financial statements that were the result of a robust financial-reporting process; etc.

The Reform Act, and the cases which have interpreted it, provide securities defense lawyers with broad latitude to attack falsity.  In my mind, a proper falsity analysis always starts by examining each challenged statement individually, and matching it up with the facts that plaintiffs allege illustrate its falsity.   Then, we can usually support the truth of what our clients said in numerous ways that are still within the proper scope of the motion to dismiss standard:  showing that the facts alleged do not actually undermine the challenged statements, because of mismatch of timing or substance; pointing out gaps, inconsistencies, and contradictions in plaintiffs’ allegations; showing that the facts that plaintiffs assert are insufficiently detailed under the Reform Act; attacking allegations that plaintiffs claim to be facts, but which are really opinions, speculation, and unsupported conclusions; putting defendants’ allegedly false or misleading statements in their full context to show that they were not misleading; and pointing to judicially noticeable facts that contradict plaintiffs’ theory.  These arguments must be supplemented by a robust understanding of the relevant factual background, which defines and frames the direction of any argument we ultimately make based on the complaint and judicially noticeable facts.

Yet many motions to dismiss do not make a forceful argument against falsity, supported with a specific challenge to the facts alleged by the plaintiffs.  Some motions superficially assert that the allegations are too vague to satisfy the pleading standard, and do not engage in a detailed defense of the statements with the available facts.  Others simply attack the credibility of the “confidential witnesses,” without addressing in sufficient detail the content of the information the complaint attributes to them.  And others fall back on the doctrine of “puffery,” which posits that even if false, the challenged statements were immaterial.*  By focusing on these and similar approaches, a brief may leave the judge  with the impression that defendants concede falsity, and that the real defense is that the false statements were not made with scienter.

That’s risky.

It’s risky for several reasons.  First, detailed, substantive arguments against falsity are some of the strongest arguments that defendants can make.  Second, those arguments provide the foundation for the rest of the motion.  The exclusion of a strong falsity argument weakens the argument against scienter, and fails to paint the best possible no-fraud picture for the judge – which is ultimately what helps a judge to be comfortable in granting a motion to dismiss.

Failing to emphasize the falsity argument weakens the scienter argument.

The element of scienter requires a plaintiff to demonstrate that the defendant said something knowingly or recklessly false – in order to do this, plaintiffs must tie their scienter allegations to each particular challenged statement.  It is not enough to generally allege, as plaintiffs often do, that defendants had a general “motive to lie.”  When I analyze scienter allegations, I ask myself, “scienter as to what?”  Asking this question often unlocks strong arguments against scienter, because complaints often make scienter allegations that are largely detached from their allegations of falsity.  Often, this is the case because the falsity allegations are insufficient to begin with.  But many motions to dismiss are unable to point out this lack of connection, because they don’t focus on falsity in a rigorous and thorough way.

Focusing on falsity also is necessary because of how courts analyze falsity and scienter.  Although falsity and scienter are separate elements – and should be analyzed separately – courts often analyze them together.   See, e.g., Ronconi v. Larkin, 253 F.3d 423, 429 (9th Cir. 2001) (“Because falsity and scienter in private securities fraud cases are generally strongly inferred from the same set of facts, we have incorporated the dual pleading requirements of 15 U.S.C. §§ 78u-4(b)(1) and (b)(2) into a single inquiry.”).  Arguing a lack of falsity thus provides essential ingredients for this combined analysis.  Even when courts analyze falsity and scienter separately,  a proper scienter analysis requires a foundational falsity analysis, because as noted above, scienter analysis asks whether the defendant knew that a particular statement was false.  Without an understanding of exactly why that challenged statement was false, and what facts allegedly demonstrate that falsity, the scienter analysis meanders, devolving into an analysis of knowledge of facts that may or may not be probative of the speaker’s state of mind related to that statement.

The tendency to lump scienter and falsity together is exemplified by the scienter doctrines that I call “scienter short-cuts:” (1) the corporate scienter doctrine (see, e.g., Teamsters Local 445 Freight Division Pension Fund v. Dynex Capital, Inc., 531 F.3d 190, 195-96 (2d Cir. 2008) and Makor Issues & Rights, Ltd. v. Tellabs Inc., 513 F.3d 702 (7th Cir. 2008)), and (2) the core operations inference of scienter (see, e.g., Glazer Capital Management LP v. Magistri, 549 F.3d 736 (9th Cir. 2008)).  Under these doctrines, courts draw inferences about what the defendants knew based upon the prominence of the falsity allegations.  The more blatant the falsity, the more likely courts are to infer scienter.  A superficial falsity argument weakens defendants’ ability to attack these scienter short-cuts, which plaintiffs are asserting more and more routinely.

Failing to emphasize the falsity argument fails to paint the best possible no-fraud picture for the judge.

I contend that it is a good strategy for a defendant to thoroughly argue lack of falsity, even if there are better alternative grounds for dismissal, and even if the challenge to falsity is unlikely to be successful as an independent grounds for dismissal.  This is for the simple reason that judges are humans – they will feel better about dismissing a case based on other grounds if you can make them feel comfortable that there was not a false statement to begin with.  For example, courts are often reluctant to dismiss a complaint solely on Safe Harbor grounds because it is seen as a “license to lie,” so it is strategically wise also to argue that forward-looking statements were not false in the first place.  Similarly, even if lack of scienter is the best basis for dismissal, it is good strategy to defend on the basis that no one said anything wrong, rather than appearing to concede falsity and being left to contend, “but they didn’t mean to.”

Judges have enough latitude under the pleading standards to dismiss or not, in most cases.  The pivotal “fact” is, in my opinion, whether the judge feels the case is really a fraud case, or not.  A motion to dismiss that vigorously defends the truth of what the defendants said is more likely to make the judge feel that there really is no fraud there.  Conversely, if defendants make an argument that essentially concedes falsity and relies solely on the argument that the falsity was immaterial, wasn’t intentional, or is not subject to challenge under the Safe Harbor, a judge may stretch to find a way to allow the case to continue.  Put simply, a judge is more likely to dismiss a case in which a defendant says “I didn’t lie,” than when defendants argue that “I may have lied, but I didn’t mean to,” or “I may have lied, but it doesn’t matter,” or “I may have lied, but the law protects me anyway.”  Even when a complaint might ultimately be dismissed on other grounds, I think that a strong challenge to falsity is essential to help the judge feel that he or she has reached a just result.

*Many statements that defense counsel argue are “puffery” are really statements of opinion that could and should be analyzed under the standard that originated in the U.S. Supreme Court’s Virginia Bankshares decision:  in order to adequately allege that a statement of opinion is false or misleading, a plaintiff must plead with particularity not only that the opinion was “objectively” false or misleading, but also that it was “subjectively” false or misleading, meaning that the opinion was not sincerely held by the speaker.  My partner Claire Davis recently posted a discussion of statements of opinion.

Board Oversight of Cyber Security and Cyber-Security Disclosures: Answers to Some of the Key Questions

Posted in Board Oversight, Corporate Governance, Cyber Security, Delaware Courts, Director Service, Plaintiffs' Bar, SEC, Securities Class Action, Shareholder Derivative Action

Cyber security is top of mind for companies, and cyber-security oversight is top of mind for corporate directors.  I recently co-moderated a panel discussion for directors on board oversight of cyber security and cyber-security disclosures.  I thought I’d share my thoughts on some of the key issues.

What are the board’s fiduciary duties in the area of cyber-security oversight?  Board oversight of cyber security conceptually is no different than oversight of any other area of risk.  The board must take good-faith steps to ensure that the company has systems designed to address cyber-attack prevention and mitigation, and to follow up on red flags it sees.  The board’s decision-making is protected by the business judgment rule.

It is important for directors to understand that cyber-security oversight isn’t exotic.  Because cyber security is a highly technical area, some directors may feel out of their depth – which may help explain why Carnegie Mellon’s 2012 CyLab survey revealed that some boards are not sufficiently focused on cyber-security oversight.  But with the help of experts – on which directors are entitled to rely – boards can ask the same types of questions they’re used to asking about other types of risk, and gain a similar degree of comfort.

How do I pick the right experts?  Directors should be comfortable that they are receiving candid and independent advice, and need to be mindful that the company’s internal IT group may have trouble being self-critical.  So in addition to receiving appropriate reports from the IT group, directors should periodically consult outside advisors who are capable of giving independent advice.

Given the importance of cyber security, will courts impose a higher standard on directors?  Directors’ basic duties are not heightened by general political and economic concerns about cyber security, or even the magnitude of harm that the company itself could suffer from a cyber attack.  But the magnitude of potential harm does matter.  If a substantial portion of a company’s value depends on the security of its cyber assets, common sense dictates that directors will naturally spend relatively more time on cyber security.  In my experience, that’s the way directors think and work – they analyze and devote more time to their companies’ most important issues.  And from a practical perspective, directors’ actions, or inaction, will be judged against the backdrop of a really bad problem.  Judges are human beings, and often do make decisions that are influenced by the presence of particularly severe harm.

How does cyber insurance fit in to the board’s job?   Cyber insurance allows the company to shift a specific and potentially very large risk.  As such, it is important that boards consider cyber insurance among the types of expenditures appropriate to prevent and mitigate cyber attacks.  Shifting risk through cyber insurance also can help directors avoid a shareholder derivative action, by reducing the attractiveness of the suit to plaintiffs’ lawyers, or reduce the severity of an action that is filed, making it easier and less expensive to resolve.

Are there any court decisions on directors’ duties in the area of cyber security?  No.  Although a TJX Companies, Inc. shareholder brought a derivative suit following a significant data breach, Louisiana Municipal Police Employees Retirement Fund v. Alvarez, Civil Action No. 5620-VCN (Del. Ch. July 2, 2010), the case settled early in the litigation.  As a result, the court never had the opportunity to make any substantive rulings on the plaintiffs’ allegations that the board failed to adequately oversee the company’s cyber security.

What is the board’s role in overseeing the company’s disclosures concerning cyber security?  The board’s duty is the same as it is with any corporate disclosure.

Does the SEC’s October 13, 2011 guidance on cyber-security disclosures enhance the board’s oversight responsibilities?   No.  As the guidance itself notes, it does not change disclosure law, but rather interprets existing law.  The guidance does, however, put a sharper focus on cyber-security disclosures, and provides the SEC and plaintiffs’ counsel with a checklist of potential criticisms – though those criticisms would really just be based on existing law.

The sharper focus on cyber-security disclosure isn’t meaningless, however.  The SEC has issued cyber-security comments to approximately 50 public companies since issuing its guidance.  The guidance, moreover, provides another opportunity for the board to discuss cyber security with management, and the increased focus should result in incrementally better disclosure.  And the SEC may well speak again on the subject; last spring, Senator Rockefeller asked new SEC Chair Mary Jo White to further address cyber-security disclosures.  (For a good discussion of the SEC’s guidance, I recommend an article by Dan Bailey, which was reprinted in the D&O Diary, and a recent D&O Diary post discussing a Willis survey of cyber-security disclosures.)

Are there any disclosure securities class actions alleging a false or misleading statement based on failure to follow the guidance?  No.  There was a securities class action against Heartland Payment Systems for a stock price drop that plaintiffs attributed to Heartland’s alleged misstatements concerning its cyber-security protections.  In re Heartland Payment Sys., Inc. Sec. Litig., CIV. 09-1043, 2009 WL 4798148 (D.N.J. Dec. 7, 2009).  The litigation was dismissed because the plaintiffs had not sufficiently alleged that the company made a false or misleading statement or, if it had, did so with scienter.  However, that case was filed prior to the SEC’s cyber-security guidance.  At least one commentator has suggested the outcome might have been different if the SEC guidance had informed the analysis.

Is there a wave of cyber-security shareholder suits coming?  What type of suits will there be?  If there is a wave, it looks like the lawsuits primarily will be shareholder derivative actions, not securities class actions.

There has not been a wave of cyber-attack securities class actions because companies’ stock prices generally haven’t fallen significantly following disclosure of cyber attacks.  If that trend remains, shareholder litigation over cyber security primarily will take the form of shareholder derivative litigation, seeking to recover from directors and officers damages for the harm to the corporation caused by a cyber attack.

The vast majority of options backdating lawsuits were derivative actions due to the lack of significant stock drops, and many of them survived motions to dismiss and resulted in significant settlements.  However, unlike the options backdating cases, in which many motions to dismiss for failure to make a demand on the board were complicated by directors’ receipt of allegedly backdated options or service on compensation committees that allegedly approved backdated options, directors’ governance of cyber security should be judged by more favorable legal standards and with a more deferential judicial attitude.  For that reason, I anticipate that plaintiffs’ attorneys will file derivative cases mostly over larger cyber-security breaches, in which the litigation environment will help them overcome the legal obstacles, and will not routinely file over less significant breaches.

 

 

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