The fifth of my “5 Wishes for Securities Litigation Defense” (April 30, 2016 post) is to move securities class action damages expert reports and discovery ahead of fact discovery.  This simple change would allow the defendants and their D&O insurers to understand the real economics of cases that survive a motion to dismiss, and allow the parties to make more informed litigation and settlement decisions.

Securities class actions are often labeled “bet the company” cases because they assert large theoretical damages and name the company’s senior management and sometimes the board as defendants.  In reality, however, very few securities class actions pose a real threat to the company or its directors and officers.  Most securities class actions follow a predictable course of litigation and resolution.  Nearly all cases settle before trial.  And, with the help of economists, experienced defense lawyers and D&O insurance professionals can predict with reasonable accuracy the settlement “value” of a case based on historical settlement information and their judgment.

Historically, settlement amounts were driven by an accurate understanding of the merits of the litigation and damages exposure.  Cases that weren’t dismissed on a motion to dismiss were often defended through at least the filing of a summary judgment motion and the completion of damages discovery.  This kind of vigorous defense is no longer economically rational in the lion’s share of cases, because of the high billing rates and profit-focused staffing of the typical defense firms—primarily firms with marquee names.  Those firms’ skyrocketing defense costs threaten to exhaust most or all of the D&O insurance towers in cases that are not dismissed on a motion to dismiss.  Rarely can such firms defend cases vigorously through fact and expert discovery and summary judgment anymore.

The reality of these economics is increasingly leading to mediations and settlements very early in the litigation, if a case isn’t dismissed.  But, though rational, this comes at a high price.  Early settlements are, by definition, less informed than later settlements.  Plaintiffs’ lawyers must push for a higher settlement payment to compensate for the risk that they are settling a meritorious case for too little, and to increase the baseline for a smaller percentage fee due to a lower lodestar.  Defendants and their insurers tend to be willing to overpay because they are saving on defense costs by not litigating further, and because there may be some downward pressure on the settlement amount since the plaintiffs’ lawyers will be doing less work too.

Damages considerations also loom large.  At an early mediation, before damages expert discovery, the parties typically come to the mediation only with a preliminary damages estimate that neither side has thoroughly analyzed, much less tested through intensive work with the experts and expert discovery.  Rigorous expert work often significantly reduces realistic damages exposure.  For example, stock drops that lead to a securities class action are often the result of multiple negative news items.  A rigorous damages analysis parses each item from the total stock drop to isolate the portion caused by the revelation of the allegedly hidden truth that made the challenged statements false or misleading.  A defense firm that is motivated to settle the litigation sometimes does not want to do this work, so that it can use the large bet-the-company damages figure to pressure the insurer into settling for an amount that the plaintiffs will take.  A defense lawyer might say, “Our economist says that damages are $1 billion, so the $30 million the plaintiffs are demanding is a reasonable settlement.”  But expert analysis and discovery may well push the $1 billion number down to a much lower number, which in turn would dramatically reduce a reasonable settlement amount.  Worsening this problem is the increasing unwillingness of mediators and plaintiffs’ lawyers to base settlement amounts on historical data—which places the preliminary damages analysis at the center of the negotiations.

This problem leads to my fifth wish: expert damages analysis and discovery should be the first thing we do after a motion to dismiss is denied.  This will help us know if the case is really a big case, or is a small case that just seems big.  Everyone would benefit.  Plaintiffs and defendants would be able to reach a settlement more easily, based on true risk and reward.  Insurers would know that they are funding a settlement that reflects the real risk, in terms of damages exposure.  And courts would feel more comfortable that they are approving (or rejecting) settlements based on a litigated assessment of damages.  Indeed, placing damages expert work first would help serve the core policy of our system of litigation: “to secure the just, speedy, and inexpensive determination of every action and proceeding.”  Federal Rule of Civil Procedure 1.

Although the logic of my wish would lead to full fact discovery before mediation as well, so that settlements can be fully informed, I favor a continued stay of fact discovery during early expert discovery.  Early expert discovery can be accomplished relatively quickly and efficiently, whereas fact discovery can be immediately and wildly expensive—which is primarily what drives very early settlements.  And although plaintiffs and defendants often disagree about the relevance of fact discovery on damages, the absence of fact discovery for consideration in damages analysis is a factor the parties can weigh in evaluating the damages experts’ opinions.  Unless and until the cost of discovery becomes more manageable, continuing the fact-discovery stay while expert damages discovery proceeds would strike the right balance.

Accelerating the timing of damages expert discovery would align it with the work required by damages experts to analyze price-impact issues under the Supreme Court’s 2014 decision in Halliburton Co. v. Erica P. John Fund, Inc., 134 S. Ct. 2398 (2014) (“Halliburton II“).  In Halliburton II, the Supreme Court held that defendants may seek to rebut the fraud-on-the-market presumption of reliance, and thus defeat class certification, through evidence that the alleged false and misleading statements did not impact the market price of the stock.   Unifying these two overlapping economic expert projects would create efficiencies for the lawyers and economists.  Completing both of them before fact discovery starts would avoid unnecessary discovery costs if the Halliburton II opposition defeated or limited class certification, or if the damages analysis facilitated early settlement.

I’m sure it is not lost on readers that I just argued for a fundamental reform in the procedure for securities class action litigation to fix a problem that is primarily caused by the inability of typical defense firms to efficiently and effectively defend a securities class action even through summary judgment.  To say the least, a system of litigation that can’t accommodate actual litigation is broken.  Significant change in securities litigation defense is inevitable.

I hope that this series has provoked thought and discussion about ways to re-focus our system of securities litigation defense on its mission: to help directors and officers through litigation safely and efficiently, without losing their serenity or dignity, and without facing any real risk of paying any personal funds.  Here, again, are my five wishes:

  1. Require an interview process for the selection of defense counsel, to allow the defendants to understand their options; to evaluate conflicts of interest and the advantages and disadvantages of using their corporate firm to defend the litigation; and to achieve cost concessions that only a competitive interview process can yield.  (5 Wishes for Securities Litigation Defense: A Defense-Counsel Interview Process in All Cases)
  2. Increase the involvement of D&O insurers in defense-counsel selection and in other strategic defense decisions, to put those who have the greatest overall experience and economic stake in securities class action defense in a position to provide meaningful input.  (5 Wishes for Securities Litigation Defense: Greater Insurer Involvement in Defense-Counsel Selection and Strategy)
  3. Make the Supreme Court’s Omnicare decision a primary tool in the defense of securities class actions.  Obviously, Omnicare should be used to defend against challenges to all forms of opinions, including statements regarded as “puffery” and forward-looking statements protected by the Reform Act’s Safe Harbor for forward-looking statements.  But defense counsel should also take advantage of the Supreme Court’s direction in Omnicare that courts evaluate challenged statements in their full factual context.  Omnicare supplements the Court’s previous direction in Tellabs that courts evaluate scienter by considering not just the complaint’s allegations, but also documents incorporated by reference and documents subject to judicial notice.  Together, Omnicare and Tellabs allow defense counsel to defend their clients’ honesty with a robust factual record at the motion to dismiss stage.  (5 Wishes for Securities Litigation Defense: Effective Use of the Supreme Court’s Omnicare Decision)
  4. Increase the involvement of boards of directors in decisions concerning D&O insurance and the defense of securities litigation, including counsel selection, to ensure their personal protection and good oversight of the defense of the company and themselves.  (5 Wishes for Securities Litigation Defense: Greater Director Involvement in Securities Litigation Defense and D&O Insurance)
  5. Move damages expert reports and discovery ahead of fact discovery, to allow the defendants and their D&O insurers to understand the real economics of cases that survive a motion to dismiss, and to make more informed litigation and settlement decisions.

In combination with the Delaware Court of Chancery’s decision in In re Trulia, Inc. Stockholder Litigation, 129 A.3d 884 (Del. Ch. 2016), Judge Posner’s blistering opinion In re Walgreen Company Stockholder Litigation, 2016 WL 4207962 (7th Cir. Aug. 10, 2016), may well close the door on disclosure-only settlements in shareholder challenges to mergers.  That certainly feels just.  And it may well go a long way toward discouraging meritless merger litigation.  But, as I’ve cautioned, I am concerned that we will regret it.  Lost in the cheering over Trulia and Walgreen is a simple and practical reality: the availability of disclosure-only settlements is in the interests of merging companies as much as it is in the interests of shareholder plaintiffs’ lawyers, because disclosure-only settlements are often the most timely and efficient way to resolve shareholder challenges to mergers, even legitimate ones.

I am offended by meritless merger litigation, and have long advocated reforms to fix the system that not only allows it, but encourages and incentivizes it.  Certainly, strict scrutiny of disclosure-only settlements will reduce the number of merger claims—it already has.  Let’s say shareholder challenges mergers are permanently reduced from 90% to 60% of transactions.  That would be great.  But how do we then resolve the cases that remain?  Unfortunately, there aren’t efficient and generally agreeable alternatives to disclosure-only settlements to dispose of a merger lawsuit before the closing of the challenged transaction.  Of course, the parties can increase the merger price, though that is a difficult proposition.  The parties can also adjust other deal terms, but few merger partners want to alter the deal unless and until the alteration doesn’t actually matter, and settlements based on meaningless deal-structure changes won’t fare better with courts than meaningless disclosure-only settlements.

If the disclosure-only door to resolving merger cases is shut, then more cases will need to be litigated post-close.  That will make settlement more expensive.  Plaintiffs lawyers are not going to start to settle for less money, especially when they are forced to litigate for longer and invest more in their cases.   And in contrast to adjustments to the merger transaction or disclosures, in which 100% of the cash goes to lawyers for the “benefit” they provided, settlements based on the payment of cash to the class of plaintiffs require a much larger sum to yield the same amount of money to the plaintiffs’ lawyers.  For example, a $500,000 fee payment to plaintiffs’ under a disclosure-only settlement would require around $2 million in a settlement payment to the class to yield the same fee for the plaintiffs’ attorneys, assuming a 25% contingent-fee award.

The increase in the cash outlay required for companies and their insurers to deal with post-close merger litigation will actually be much higher than my example indicates.  Plaintiffs’ lawyers will spend more time on each case, and demand a higher settlement amount to yield a higher plaintiffs’ fee.  Defense costs will skyrocket.  And discovery in post-close cases will inevitably unearth problems that the disclosure-only settlement landscape camouflaged, significantly increasing the severity of many cases.  It is not hard to imagine that merger cases that could have settled for disclosures and a six-figure plaintiffs’ fee will often become an eight-figure mess.  And, beyond these unfortunate economic consequences, the inability to resolve merger litigation quickly and efficiently will increase the burden upon directors and officers by requiring continued service to companies they have sold, as they are forced to produce documents, sit for depositions, and consult with their defense lawyers, while the merger case careens toward trial.

Again, it’s hard to disagree with the logic and sentiment of these decisions, and the result may very well be more just.  But this justice will come with a high practical price tag.

One of my “5 Wishes for Securities Litigation Defense” (April 30, 2016 post) is greater involvement by boards of directors in decisions concerning D&O insurance and the defense of securities litigation, including defense-counsel selection. Far too often, directors cede these critical strategic decisions to management.

For most directors, securities litigation is a mysterious world ruled by sinister plaintiffs’ lawyers, powerful judges, and a unique legal framework that must be navigated by fancy defense lawyers who charge exorbitant fees. Directors react to this litigation with everything from unnecessary panic to an unjustified feeling of invincibility. The right approach is somewhere in the middle: “attentive concern.” Securities litigation can pose personal risk to directors as well as to their companies, but if directors educate themselves and pay attention, this risk is almost always manageable.

Of course, part of what makes the risk manageable is D&O insurance. But in the event of a claim, independent directors share their D&O insurance with the company and its management. Despite this competition for policy proceeds, directors typically leave management to handle D&O insurance decisions. Directors need to protect their own interests by having a greater role in deciding the features of their D&O insurance program and how the company uses the policy proceeds in the event of a claim.

Greater Involvement by Directors in Securities Litigation Defense

Why Should Directors Care?

Although much of the recent discussion about securities litigation has revolved around meritless merger litigation, securities class actions and associated shareholder derivative actions have always posed greater risk than merger actions. A securities class action alleges that a company and its representatives made false or misleading statements that artificially inflated the stock price. Directors are virtually always included in Section 11 cases, which challenge statements in registered offerings, and increasingly are also named in Section 10(b) actions, which can challenge any public corporate statement. Directors are often named in “tag-along” shareholder derivative actions as well, which allege that the directors failed to properly oversee the company’s public disclosures.

Often, it is difficult to know from the initial complaint whether a securities case will pose a personal risk to directors because it is merely a placeholder. Only after the court selects the lead plaintiff and lead counsel will the plaintiffs’ attorneys draft more substantial allegations and add defendants through an amended complaint. But regardless of any personal risk, directors have a duty to oversee the significant potential liability the company faces. For these reasons, directors should treat each one of these cases as if they are personally named.

The Economics of Securities Litigation Matter

One emerging risk to companies is that ever-increasing securities defense fees no longer match the economics of most cases, and are quickly outpacing D&O policy limits. In the past, securities class actions were initiated by an oligopoly of larger plaintiffs’ firms with significant resources and mostly institutional clients that tended to bring larger cases against larger companies. But recently, smaller plaintiffs’ firms with retail-investor clients have been initiating more cases, primarily against smaller companies. Indeed, in recent years, approximately half of all securities class actions were filed against companies with $750 million or less in market capitalization. As a result, securities class actions have shrunk in size to a level last seen in 1997.

Yet at the same time, the litigation costs of most defense firms have increased exponentially. This two-decade mismatch—between 1997 securities-litigation economics and 2016 law-firm economics—creates the danger that a company’s D&O policy will be insufficient to cover the fees for a vigorous defense and the price to resolve the case. Indeed, inadequate policy proceeds due to skyrocketing defense costs is directors’ biggest risk from securities litigation—by far.

Historically, most securities defense firms have marquee names with high billing rates. Especially in cases against small-cap companies—now the lion’s share—it is more difficult for these firms to vigorously defend an action without risking that there will be too little D&O insurance left for settlement. To avoid this result, firms either cut corners or settle early for bloated amounts that make the defendants look like they did something wrong.

Quite obviously, directors should not be subjected to these hazards—which are created not by the securities class action itself, but by law-firm economics. The vast majority of securities class actions—if handled in the right way by the right defense counsel—can be defended and either won or settled, within D&O insurance policy limits, leaving no residual liability for either the company or its directors. With just a little time and effort at the beginning of the litigation, directors can put these cases on the right track.

The Importance of Directors’ Involvement in Defense-Counsel Selection

First and foremost, directors must ensure their company selects the right counsel. Securities litigation is a specialty field, and it can be nearly impossible to differentiate between the claims of expertise and experience made by the herd of lawyers that descends upon a company after a suit is filed. And it is a serious error—especially for mid-size and smaller companies—to use a law firm brand name as a proxy for quality and fit. Fortunately, many pitfalls of counsel selection can be avoided if directors keep in mind a few key principles:

  • Select a securities litigation specialist, and not a multi-discipline commercial litigator, even one who is highly regarded and/or from a marquee firm.
  • Educate yourself about the strategic differences between firms.
  • Avoid defaulting to your regular corporate firm.
  • Conduct an interview process.

An interview process is essential, in all cases. Directors should use the interview process to insist on a better alternative than the rote decision by most companies to simply retain their regular outside counsel, or a firm with a marquee name. To state the obvious, the most effective securities defense lawyers do not all work at marquee firms. Directors should insist that management interview a range of firms, including those that emphasize a combination of superior quality and reasonable cost—in other words, firms that offer good value. And directors should insist that management push for price concessions from all defense firms that management interviews.

The key is for directors to pay attention and to use the leverage of a competitive hiring process to find counsel to help them through the litigation safely, strategically, and economically.

Directors’ Oversight of D&O Insurance

As a refresher, a D&O insurance policy has three categories of coverage.

  • Side A coverage reimburses directors and officers for losses not indemnified by the company.
  • Side B coverage reimburses the company for indemnification of its directors and officers.
  • Side C coverage insures the company for its own liability.

Directors’ exposure to securities litigation has changed. Due in part to the changes in the plaintiffs’ bar noted above, directors are now much more frequent targets in securities class actions and related shareholder derivative claims—and the trend is very likely to continue. Even as directors’ involvement in securities and derivative suits is increasing, their share of the D&O insurance is effectively decreasing, due to more competition for policy proceeds.

For example, companies frequently seek D&O insurance coverage for various types of investigations, which may help the company, but can significantly erode the policy limits. Companies also deplete limits by, among other things, requesting coverage for employees beyond directors and officers, and seeking ways to avoid triggering the fraud exclusion, which can result in large defense-costs payments to rogue officers. These types of decisions might make sense in certain circumstances, but they should be subject to director oversight.

Perhaps the biggest threat to the sufficiency of directors’ D&O insurance policy is from their own lawyers, due to skyrocketing defense costs. Some insurers have a pre-set list of lawyers from which defendants are encouraged or required to choose. This means that some of the counsel-selection process is done before a claim is filed—which is another reason directors should be involved in the D&O insurance purchasing decision.

Some companies try to eliminate the competition between the company and individuals for policy proceeds by purchasing separate Side A policies that cover only individuals, but these policies do not address erosion from other individuals or by attorneys’ fees, and they only apply if the company cannot indemnify the directors. There are Side A products available specifically for outside directors, but those are infrequently purchased, probably because directors are usually not involved in D&O insurance purchasing decisions.

Independent directors don’t need to take over the process of handling the company’s D&O insurance, or spend an inordinate amount of time on these issues, in order to adequately protect themselves. Rather, they need to become more involved and understand their D&O insurance options and the realities of the claim process. They can do this simply by asking for direct access to the D&O broker and insurer, and by spending some time on D&O insurance decisions at board meetings.

Conclusion

At the same time directors’ securities litigation risk is increasing, they share an increasing percentage of their D&O insurance with the company, officers, and even their own lawyers. Directors can mitigate the risks of these trends by simply becoming more involved in purchasing their D&O insurance and overseeing the defense of securities litigation, including defense-counsel selection. In doing so, they will not only protect their own interests, but will also better oversee and manage the company’s risks as well.

In this installment of the D&O Discourse series “5 Wishes for Securities Litigation Defense,” we discuss the third of five changes that would significantly improve securities litigation defense:  to make the Supreme Court’s Omnicare decision a primary tool in the defense of securities class actions.

As a reminder, in Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund, 135 S. Ct. 1318 (2015), the U.S. Supreme Court held that a statement of opinion is only false under the federal securities laws if the speaker does not genuinely believe it, and is only misleading if it omits information that, in context, would cause the statement to mislead a reasonable investor.  This ruling followed the path we advocated in an amicus brief on behalf of Washington Legal Foundation.

The Court’s ruling in Omnicare was a significant victory for the defense bar for two primary reasons.

First, the Court made clear that an opinion is false only if it was not sincerely believed by the speaker at the time that it was expressed, a concept sometimes referred to as “subjective falsity.”  The Court thus explicitly rejected the possibility that a statement of opinion could be false because “external facts show the opinion to be incorrect,” because a company failed to “disclose[] some fact cutting the other way,” or because the company did not disclose that others disagreed with its opinion.  This ruling resolved two decades’ worth of confusing and conflicting case law regarding what makes a statement of opinion false, which had often permitted meritless securities cases to survive dismissal motions.

Second, Omnicare declared that whether a statement of opinion (and by clear implication, a statement of fact) was misleading “always depends on context.”  The Court emphasized that showing a statement to be misleading is “no small task” for plaintiffs, and that the court must consider not only the full statement being challenged and the context in which it was made, but also other statements made by the company, and other publicly available information, including the customs and practices of the relevant industry.

Omnicare governs the falsity analysis for all types of challenged statements.  Obviously, Omnicare should be used to defend against challenges to all forms of opinions, including statements regarded as “puffery” and forward-looking statements protected by the Reform Act’s Safe Harbor for forward-looking statements.  But defense counsel should also take advantage of the Supreme Court’s direction in Omnicare that courts evaluate challenged statements in their full factual context.  Evaluating challenged statements in their broader context almost always benefits defendants, because it helps the court better understand the challenged statements and makes them seem fairer than they might in isolation. Omnicare now explicitly requires courts to evaluate challenged statements—both statements of fact and statements of opinion—within their broader contexts.

Although Omnicare arose from a claim under Section 11 of the Securities Act, all of its core concepts are equally applicable to Section 10(b) of the Securities Exchange Act and other securities laws with similar falsity elements.  Due to the importance of its holdings and the detailed way in which it explains them, Omnicare is the most significant post-Reform Act Supreme Court case to analyze the falsity element of a securities class-action claim, laying out the core principles of falsity in the same way that the Court did for scienter in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (2007).  If used correctly, Omnicare thus has the potential to be the most helpful securities case for defendants since Tellabs, providing attorneys with a blueprint for how to structure their falsity arguments in order to defeat more complaints on motions to dismiss.

A good motion to dismiss has always analyzed a challenged statement (of fact or opinion) in its broader factual context to explain why it’s not false or misleading.  But many defense lawyers unfortunately leave out the broader context, and courts have sometimes taken a narrower view.  Now, this type of superior, full-context analysis is clearly required by Omnicare.  And combined with the Supreme Court’s directive in Tellabs that courts consider scienter inferences based not only on the complaint’s allegations, but also on documents on which the complaint relies or that are subject to judicial notice, courts clearly must now consider the full array of probative facts in deciding both whether a statement was false or misleading and, if so, whether it was made with scienter.   

Yet Omnicare will fail to achieve its full potential unless defense lawyers understand and use the decision correctly.  Following the Omnicare decision, many defense lawyers commented publicly that Omnicare expanded the basis for defendants’ liability, and was otherwise plaintiff-friendly.  That is simply wrong.  We have published several articles that address these misunderstandings, explain how defense counsel should use the decision, and analyze how lower courts are applying it.  The early returns show that Omnicare is already helping defendants win more motions to dismiss.

Here is a link to our most recent article, Omnicare, Inc. One Year Later: Its Salutary Impact on Securities-Fraud Class Actions in the Lower Federal CourtsCritical Legal Issues Working Paper Series, Washington Legal Foundation (No. 195, June 2016).

Today, we are launching a new blog, D&O Developments (www.DandODevelopments.com), which will report and digest appellate decisions in Private Securities Litigation Reform Act cases, and other key securities litigation decisions.  My partner Claire Davis is the editor-in-chief.  Various members of our Securities Litigation Practice Group will contribute pieces, in addition to contributions from Claire and me.  We are launching D&O Developments with reports of nine recent securities litigation appellate decisions.

We designed D&O Developments to complement D&O Discourse, which provides monthly in-depth opinion on key issues of law and practice in the world of securities and corporate governance litigation.  So we will now have two blogs: D&O Developments, designed to allow practitioners to track and understand important securities litigation decisions, and D&O Discourse, designed to provoke thought and discussion on key issues.

Thank you for your support of D&O Discourse. We hope you enjoy D&O Developments as well.

One of my “5 Wishes for Securities Litigation Defense” (April 30, 2016 post) is greater D&O insurer involvement in securities class action defense.

This simple step would have extensive benefits for public companies and their directors and officers. D&O insurers are repeat players in securities litigation, and they have the greatest economic interest in the outcome – both in particular cases, and overall.  They want the defendants – their insureds – to win.  They employ highly experienced claims professionals, many of whom have been involved in exponentially more securities class actions than even the most experienced defense lawyers.

Given insurers’ stake and expertise, defendants should involve them in key strategic decisions – working with them to help find the right defense counsel for the particular case, to help shape the overall defense strategy at the inception of the case, and to help make good decisions about the use of policy proceeds.  With such an approach, I have no doubt that directors and officers would make it through securities cases more successfully, efficiently, and comfortably.

Yet in most cases, insurers are shut out of meaningful involvement in the defense, with many defense lawyers treating them almost like adverse parties, and other defense lawyers merely humoring them as they would a rich relative.  Although this dysfunction is rooted in a complex set of factors, it could easily be fixed.

Why Are D&O Insurers Alienated?

When the general public thinks about insurance, they usually think of auto insurance or other duty-to-defend insurance, under which the insurer assumes the defense of the claim for the insureds.  In contrast to duty-to-defend insurance, public company D&O insurance is indemnity insurance, under which the insurer is obligated to reimburse the company and its directors and officers for reasonable and necessary defense costs and settlement payments, up to the policy’s limit of liability.

Indemnity insurance gives the defendants control over the litigation, including counsel selection and strategic approach, with the insurer retaining limited rights to participate in key decisions.  Although those rights give insurers a foot in the door, competitive pressures among primary D&O insurers work to minimize insurers’ involvement.  For example, an insurer faced with unreasonably high defense costs must decide whether to pay them in full to avoid conflict, or to pay only the “reasonable and necessary” amounts, as the policy specifies – an approach that  maximizes the policy proceeds for the insureds by not squandering policy limits on excessive legal fees.  But if the insurer pays only reasonable and necessary amounts, it may be criticized in the marketplace by the broker or other insurers as being stingy with claims handling – and the insureds may be left holding the bill for the unreasonable excess fees.

In general, insurers take a relatively hands-off approach to D&O claims because they assume that their customers want them to stay out of the defense of the claim.  But in my experience, this is a misconception.  The priority for most companies and their directors and officers is simply the greatest protection possible, including assurances that they will not be left to pay any uncovered legal fees or settlement payments.  In fact, not only do most insureds not want to be stuck paying their lawyers for short-pays, they don’t even want to write any checks at all after satisfying the deductible – instead preferring the insurer to take charge of the bills and pay the lawyers and vendors directly.

In other words, most public companies actually want their D&O insurance to respond more like duty-to-defend insurance.  And if given a choice between having the freedom to choose any defense counsel and having total control over the defense, and saving on their premium and giving the insurers greater rights to be involved, I’m confident most public companies would choose to save on the premium, as long as they are confident that they will still be well-defended.  This is especially so for smaller public companies, for whom the cost of D&O insurance can be a hardship, and against whom the plaintiffs’ bar is bringing more and more securities class actions.  And few companies, large or small, would knowingly spend more on their premiums just to subsidize skyrocketing biglaw partner compensation – the D&O insurance elephant in the corner of the room.

Why do insurers have this misconception?  To be sure, after a claim is filed, the insurer often gets an earful from the insureds’ lawyers and broker about the insureds’ indemnity-insurance freedoms.  But these aggressive positions are typically not the positions of the insureds themselves.  Instead, these positions are driven by defense counsel, usually for self-interested reasons: to get hired, to justify excessive billing, or to settle a case for a bloated amount because the defense is compromised by mounting defense costs or the defense lawyer’s inability to take the case to trial.

Frequently, defense lawyers will set the stage for their clients to have a strained relationship with their insurers by feeding them a number of stock lines:

  • This is a bet-the-company case that requires all-out effort by us to defend you, so we have to pull out all the stops and do whatever is necessary, no matter what the insurer has to say.
  • The insurer may ask you to interview several defense firms before choosing your lawyers. Don’t do that. They’ll just want to get some inferior, cut-rate firm that will save them money.  But you’ll get what you pay for – we’re expensive for a reason! (And don’t forget that we have stood by you, through thick and thin, since before your IPO, back when you were a partner here.  Plus, we gave you advice on your disclosures and stock sales, so we’re in this together.)
  • The business of any insurance company is to try to avoid paying on claims, so the insurer may try to curtail our level of effort, and may even refuse to pay for some of our work.  But trust us to do what we need to do for you.  You might need to make up the difference between our bills and what the insurer pays, but we can go after the insurer later to try to get them to pay you back for those amounts.
  • The insurer will ask us for information about the case.  They’ll say they want to help us, but they’re really just trying to find a way to deny coverage.
  • We’ll tell you when we think the time is right to settle the case, and for how much.  The insurer will try to avoid paying very much for settlement.  But if we say the settlement is reasonable, they won’t have a leg to stand on.
  • We’ll need you to support us in these insurance disputes.  You don’t need to get involved directly – we can work with the insurer and broker directly if you agree.  Agree?  Good.

In this way, defense lawyers set the insurer up as an adversary.  But these self-serving talking points get myriad things wrong.

First, and most importantly, D&O insurers are not the insured’s adversaries in the defense of a securities class action.  To the contrary, insurers’ economic interests are aligned with those of the insureds.  Insurers want to help minimize the risk of liability, through good strategic decisions.  Although keeping defense costs to a reasonable level certainly benefits the insurer, it also benefits the insureds by preserving policy proceeds for related or additional claims on the policy, so that the insureds will not need to pay any defense or settlement costs out-of-pocket, and will avoid a significant premium increase upon renewal.  And insurers want their insureds to have superior lawyers – inferior lawyers would increase their exposure.  Their interest in counsel selection is to help their insureds choose the defense counsel that is right for the particular case.  The key to defense-counsel selection in securities class actions, for insureds and insurers alike, is to find the right combination of expertise and economics for the particular case – in other words, to find good value.

A D&O insurer’s business is not to avoid paying claims.  D&O insurance is decidedly insured-friendly – which isn’t surprising given its importance to a company’s directors and officers.  D&O insurers pay billions of dollars in claims each year, and there is very little D&O insurance coverage litigation.  Although D&O insurance excludes coverage for fraud, the fraud exclusion requires a final adjudication – it does not even come into play when the claim is settled, and even if the case went to trial and there was a verdict for the plaintiffs, it would only be triggered under limited circumstances.  Indeed, if they are utilized correctly, D&O insurers can be highly valuable colleagues in securities class action defense.  Because they are repeat players in securities class actions, they are able to offer valuable insights in defense-counsel selection, motion-to-dismiss strategy, and overall defense strategy.  They have the most experience with securities class action mediators and plaintiffs’ counsel, and often have key strategic thoughts about how to approach settlement.  The top outside lawyers and senior claims professionals for the major insurers have collectively handled many thousands of securities class actions.  Although their role is different than that of defense counsel, these professionals are more sophisticated about securities litigation practice than the vast majority of defense lawyers.

I have achieved superior results for many clients by working collegially with insurers – from helping shape motion-to-dismiss arguments, to learning insights about particular plaintiffs’ lawyers and their latest tricks, to selecting the right mediator for a particular case, to achieving favorable settlements that don’t leave the impression of guilt.  Treating insurers as adversaries robs defendants of this type of valuable guidance.

How Can We Achieve Greater Insurer Involvement?

D&O insurers should set aside their preconceived notions about what the insureds really care about and want.  Insurers need to appreciate that their insureds often welcome their expertise and experience – especially at smaller public companies that have less familiarity with securities class actions, and a more pressing need to control their costs.  Not only is there an opportunity for greater involvement within the current D&O insurance product, but there is a market for new terms and products that allow greater insurer involvement, with corresponding premium or coverage advantages to the insureds.

Many insurers correctly address their claim-handling capabilities as part of the underwriting process.  As part of this discussion, insurers should set the expectation that the insureds will consult with the insurer about the defense-counsel selection process before the defendants select counsel.  Insurers have a unique perspective on the pros and cons of particular defense counsel, since they know the capabilities and economics of the relatively small bar of securities class action defense counsel very well.  They can help the insureds identify several defense firms that would be a good match for the substantive characteristics of the case.  For example, they might know that a particular firm has helpful experience in cases involving a particular industry or type of allegation, or has a good or bad track record with the assigned judge.  Insurers can also help match the economics of the litigation with particular firms.  They would know whether or not a particular firm is able to effectively defend a case within the limits of the D&O insurance, and conversely, they would know whether a firm has enough resources to effectively handle a large claim.

Although I am not an insurance lawyer, I believe this type of discussion is perfectly appropriate within the terms of existing insurance contracts.  But if there is any doubt, existing policy forms could be tweaked to explicitly include greater insurer involvement.  For example, the insurance contract could require the insureds to consult with the insurer about the defense-counsel process before engaging defense counsel, such as with a provision similar to the explicit requirement in D&O policies that insureds speak with the insurer before engaging in any settlement discussions.

Last, but certainly not least, I strongly believe that a public company duty-to-defend product for a “Securities Claim” would be highly attractive to many public companies, especially smaller companies.  Many companies would gladly pay somewhat less for their D&O insurance in exchange for giving insurers somewhat greater control, as long as they know that they will be defended well.  Such a policy would eliminate the risk that clients will have to make up for insurance short-pays, as they are often asked to do under indemnity insurance, while allowing the insurers to manage defense costs to help ensure that the policy proceeds will adequately cover the cost of defending and settling the litigation, and will not be needlessly expended.  As the cost of securities class action defense continues to skyrocket, even as the size of the typical securities case continues to decline, it is time for the D&O insurance industry to consider introducing a product that will provide excellent coverage at a fair price that is affordable to smaller companies.

One of my “5 Wishes for Securities Litigation Defense” (April 30, 2016 post) is to require an interview process for the selection of defense counsel in all cases.

When a public company purchases a significant good or service, it typically seeks competitive proposals.  From coffee machines to architects, companies invite multiple vendors to bid, evaluate their proposals, and choose one based on a combination of quality and cost.  Yet companies named in a securities class action frequently fail to engage in a competitive interview process for their defense counsel, and instead simply retain litigation lawyers at the firm they use for their corporate work.

To be sure, it is difficult for company management to tell their outside corporate lawyers that they are going to consider hiring another firm to defend a significant litigation matter.  The corporate lawyers are trusted advisors, often former colleagues of the in-house counsel, and have usually made sacrifices for the client that make the corporate lawyers expect to be repaid through engagement to defend whatever litigation might arise.  A big litigation matter is what makes all of the miscellaneous loss-leader work worth it.  “You owe me,” is the unspoken, and sometimes spoken, message.

Corporate lawyers also make the pitch that it will be more efficient for their litigation colleagues to defend the litigation since the corporate lawyers know the facts and can more efficiently work with the firm’s litigators.  Meanwhile, they tell the client that there is no conflict—even if their work on the company’s disclosures is at issue, they assure the company that they will all be on the same side in defending the disclosures, and if they have to be witnesses, the lawyer-as-witness rules will allow them to work around the issue.

All of these assertions are flawed.  It is always—without exception—in the interests of the defendants to take a day to interview several defense firms of different types and perspectives.  And it is never—without exception—in the interests of the defendants to simply hand the case off to the litigators of the company’s corporate firm.  Even if the defendants hire the company’s corporate firm at the end of the interview process, they will have gained highly valuable strategic insights from multiple perspectives; cost concessions that only a competitive interview process will yield; better relationships with their insurers, who will be more comfortable with more thoughtful counsel selection; greater comfort with the corporate firm’s litigators, whom the defendants sometimes have never even met; and better service from the corporate firm.

Problems with Using Corporate Counsel

A Section 10(b) claim involves litigation of whether the defendants:  (1) made a false statement, or failed to disclose a fact that made what they said misleading in context; and (2) made any such false or misleading statements with intent to defraud (i.e. scienter).

Corporate counsel is very often an important fact witness for the defendants on both of these issues.  For example, in a great many cases, corporate counsel has:

  • Drafted the disclosures that plaintiffs challenge, so that the answer to the question “why did you say that?” is “our lawyers wrote it for us.”
  • Advised that omitted information wasn’t required to be disclosed, so that the answer to the question “why didn’t you disclose that” is “our lawyers told us we didn’t have to.”
  • Reviewed disclosures without questioning anything, or not questioning the challenged portion.
  • Drafted the risk factors that are the potential basis of the protection of the Reform Act’s Safe Harbor for forward-looking statements.
  • Not revised the risk factors that are the potential basis of Safe Harbor protection.
  • Advised on the ability of directors and officers to enter into 10b5-1 plans and when to do so, and on the ability of directors and officers to sell stock at certain times, given the presence or absence of material nonpublic information.
  • Advised on individual stock purchases.

The fact that the lawyer has given such advice, or not given such advice, can win the case for the defendants.  For example, for any case turning on a statement of opinion, the lawyer’s advice that the opinion had a reasonable basis virtually guarantees that the defendants won’t be liable.  Likewise, a lawyer’s drafting, revising, or advising on disclosures virtually guarantees that the defendants didn’t make the misrepresentation with scienter, and a lawyer’s advice on the timing of entering into 10b5-1 plans or selling stock makes the sales benign for scienter purposes.

To the defendants, it doesn’t matter if the lawyer was right or wrong.  As long as the advice wasn’t so obviously wrong that the client could not have followed it in good faith, the lawyer’s advice protects the defendants.  But to the lawyer, it matters a great deal for purposes of professional reputation and liability.  Deepening the conflict is the specter of the law firm defending its advice on the basis that the client didn’t tell them everything.  The interests of the lawyer and defendant client thus can diverge significantly.

That this information may be privileged doesn’t change this analysis.  Of course, the privilege belongs to the client, who can decide whether to use the information in his or her defense, or not.  But with corporate counsel’s litigation colleagues guiding the development of the facts, privileged information is rarely analyzed, much less discussed with the client.  The reality is that most privileged information isn’t truly sensitive to the client, but instead reflects a client seeking advice—and seeking the liability protection the lawyer’s advice provides.  But from the lawyer’s perspective, there can be much to protect.  Privileged communications may reflect poor legal advice, and internal files may contain candid discussions about the client and the client’s issues that would result in embarrassment to the firm, and possible termination, if produced.

Perhaps even more importantly, regular corporate counsel’s litigation colleagues may often fail to assess the case objectively, in part because it implicates the work of their corporate colleagues, and in part because of a desire not to ask hard questions that could strain the law firm’s relationship with the client.  Sometimes the problem arises from a deliberate attempt by the lawyers to protect a particular person who may have made an error leading to the litigation, such as the General Counsel (often is a former colleague), the CFO, or the CEO—all of whom are important to the client relationship.  Sometimes, though, the failure to thoughtfully analyze a case is due to a more generalized alliance with the people with whom the law firm works regularly.  It’s hard for a lawyer to scrutinize someone who will be in the firm’s luxury box at the baseball game that night, much less report a serious problem with him or her to the board.

Yet the defendants, including the board of the corporate client, need candid advice about the litigation to protect their interests.  For example, some problematic cases should be settled early, before the insurance limits are significantly eroded by defense costs and documents are produced that that will make the case even more difficult, and could even spawn other litigation or government investigations.  Defendants and corporate boards need to know this.

Corporate firms might counter that their litigation colleagues will give sound and independent advice, because they are a separate department and will face no economic or other pressure from the corporate department.  But that undermines one of the main reasons corporate lawyers urge that their litigation colleagues be hired: that it is more efficient to use the firm’s litigators since they work closely with the corporate lawyers, if not the company itself.  The corporate firm can’t have it both ways: either the litigators are close to the corporate lawyers and the company, and suffer from the problems outlined above, or they are independent, and their involvement yields little or no benefit in efficiency.  Indeed, it is most likely that the corporate firm’s litigators will be hindered by conflict, while nevertheless failing to create greater efficiency.  Just because lawyers are in a same firm doesn’t mean that they can read each other’s minds.  They still have to talk to one another, just as litigators from an outside firm would have to do.

So Why is Corporate Counsel Used So Often?

I doubt many directors or officers would disagree with the analysis above.  So why do so many companies turn to their corporate counsel without conducting an audition process?  Several practical factors impede the proper analysis of counsel selection in the initial days of a securities class action.

The single most important factor is probably that the corporate firm is first on the scene. Many companies reflexively hire their corporate firm immediately after the initial complaint is filed, or even after the stock drop, before a complaint is even filed.  By the time the defendants start to hear from other securities defense practices, they often have retained counsel.  And then it’s very difficult from a personal and practical perspective to walk the decision back.

This decision, moreover, is often made by the legal department, sometimes in consultation with the CEO and CFO.  The board is often not involved.  Instead, the board is merely presented with the decision, which can seem natural because the firm hired is familiar to them.  The directors often aren’t personally named in the initial complaint, so they might not pay as much attention as they would if they understood if they were likely to become defendants later – either in the main securities action, especially if the case involves a potential Section 11 claim, or in a tag-along shareholder derivative action.

Initial complaints can also mislead the company as to the real issues at stake.  Regular corporate counsel and the defendants may review the first complaint and incorrectly conclude that the allegations don’t implicate the lawyer’s work.  But these initial complaints are merely placeholders, because the Reform Act specifies that the lead plaintiff appointed by the court can later file an amended complaint.  Initial filers have little incentive to invest the time or effort into making detailed allegations in the initial complaint, because they may be beaten out for the lead plaintiff role.  The lead plaintiff’s amended complaint thus typically greatly expands the case to include new alleged false and misleading statements, more specific reasons why the challenged statements were false or misleading, and more detailed scienter allegations, including stock-sale and confidential-witness allegations that most initial complaints lack.  If a conflict becomes apparent at that point, however, it can be very difficult and even prejudicial to the defendants for corporate counsel to bow out.

Regular corporate counsel will often advise their clients that there is no issue with them defending the litigation, or even that doing so makes sense because they advised on the underlying disclosures.  But even if the corporate firm is trying to be candid and look out for its client’s interests, it may have blind spots in seeing its potential conflicts—especially when the corporate lawyers are facing pressure from their firm management to “hold the client.”

The pressures that lead a company to hire its corporate firm to defend the securities litigation are very real, and sometimes this decision is ultimately fine.  But I strongly believe that it is never in a client’s interest to take its corporate counsel’s advice on these issues without obtaining analysis from other securities practices as part of a competitive interview process.

The Benefits of a Competitive Process

In addition to obtaining important perspectives about potential problems with corporate counsel’s defense of the securities class action, an interview process involves myriad benefits – including tens of thousands of dollars of free legal advice.  The only cost to the company is a few hours to select the 3-5 firms that it wants to interview, and a day spent hearing presentations from those firms and discussing their analysis and approach with them.

An interview process gives defendants the opportunity to hear from several experienced securities litigators, who will offer a range of analyses and strategies on how best to defend the case.  It also allows defendants to evaluate professional credentials and personal compatibility, which are both important criteria.  It is difficult, if not impossible, for a company to evaluate how their corporate counsel’s litigators stack up against other litigators in this specialized and national practice area, without first hearing from some other firms.  Sometimes, a company will not even meet its corporate firm’s securities litigators in person before engaging them, which obviously makes it impossible for them to make judgments about personal compatibility and trust.

An interview process, if properly structured, is highly substantive.  The firms that fare best in a new-case interview typically prepare thorough discussions of the issues, and come prepared to analyze the case in great detail.  And the best ones look beyond the issues in the initial complaint to the issues that might emerge in the amended complaint, analyzing the full range of the company’s disclosures, to forecast future disclosure and scienter allegations, and evaluating the defenses that will remain even after allegations are added.

An interview process also helps the company to achieve a better deal on billing rates, staffing, and alternative fee arrangements.  Without an interview process, a law firm is much more likely to charge rack rates and do its work in the way it sees fit—which defendants are rarely in a position to challenge without having done some comparison shopping.  Even though securities class action defense costs are covered by D&O insurance, price matters in defense-counsel selection.  It is a mistake to treat D&O insurance proceeds as “free money.”  Without appropriate cost control, defendants run the risk of not having enough insurance proceeds to defend and resolve the case.  Appropriate cost control can help the litigation from resulting in a difficult or expensive D&O insurance renewal, and can allow the company to save money if the fees are less than the deductible.

An interview process also helps get the defendants off to a better start with its D&O insurers.  In addition to appreciating the cost control that an interview process yields, insurers also appreciate the defendants making a thoughtful decision on defense counsel, including vetting the potential problems with use of the company’s corporate firm.  D&O insurers and brokers are “repeat players” in securities litigation, and know the qualifications of defense counsel better than anyone else—a seasoned D&O insurance claims professional has overseen hundreds of securities class actions.  Asking insurers and brokers to help identify defense counsel to interview may therefore not only yield helpful suggestions, but may also make it easier to develop a relationship of strategic trust with the insurers—which will make it easier to obtain consent to settle early if appropriate, and if not, to defend the case through summary judgment or to trial.

Perhaps most importantly, an interview process results in a closer relationship between the defendants and their lawyers, whoever they end up being.  Most securities class action defendants are troubled by being sued, and need lawyers that they can trust to walk them through the process.  An interview process is the best way to find the lawyers who have the right combination of relevant characteristics—including skills, strategy, and bedside manner—that will best fit the needs of the defendants.

I am committed to helping shape a system for securities litigation defense that helps directors and officers get through securities litigation safely and efficiently, without losing their serenity or dignity, and without facing any real risk of paying any personal funds.

But we are actually moving in the opposite direction of this goal, and unless some changes are made, securities litigation will pose greater and greater risk to individual directors and officers.  It is time for the “repeat players” in securities litigation defense – D&O insurers and brokers, defense lawyers, and economists – to make some fundamental changes to how we do things.  Although most cases still seem to turn out fine for the individual defendants, resolved by a dismissal or a settlement that is fully funded by D&O insurance, the bigger picture is not pretty.  The law firms that have defended the lion’s share of cases since securities class actions gained footing through Basic v. Levinson – primarily “biglaw” firms based in the country’s several largest cities – are no longer suitable for many, or even most, securities class actions.  Fueled by high billing rates and profit-focused staffing, those firms’ skyrocketing defense costs threaten to exhaust most or all of the D&O insurance towers in cases that are not dismissed on a motion to dismiss.  Rarely can such firms defend cases vigorously through summary judgment and toward trial anymore.

Worse, these high prices too often do not yield strategic benefits.  A strong motion to dismiss focuses on the truth of what the defendants said, with support from the context of the statements, as directed by the U.S. Supreme Court in Tellabs and Omnicare.  Yet far too often, the motion-to-dismiss briefs that come out of these large firms are little more than cookie-cutter arguments based on the structure of the Reform Act.  And if a motion is lost, settlements are higher than necessary because the defendants often have no option but to settle in order to avoid an avalanche of defense costs that would exhaust their D&O insurance limits.  On the other hand, if settlement occurs later, it can be difficult to keep settlement within D&O insurance limits – and defense counsel’s analysis of a “reasonable” settlement can be influenced by a desire to justify the amount they have billed.

At the same time that defense costs are continuing to rise exponentially, securities class actions are becoming smaller and smaller, with two-thirds of cases brought against companies with market caps less than $2 billion, and almost half under $750 million.  Although catawampus securities litigation economics is a systemic problem, impacting cases of all sizes, the problem is especially acute in the smallest half of cases.  Some of those cases simply cannot be defended both well and economically by typical defense firms.  Either defense costs become ridiculously large for the size of the case and the amount of the D&O insurance limits, or firms try to reduce costs by cutting corners on staffing and projects – or both.  We see large law firms routinely chase smaller and smaller cases.  From a market perspective, it makes no sense at all.

So how do we achieve a better securities litigation system?  Five changes would have a profound impact:

  1. Require an interview process for the selection of defense counsel, to allow the defendants to understand their options; to evaluate conflicts of interest and the advantages and disadvantages of using their corporate firm to defend the litigation; and to achieve cost concessions that only a competitive interview process can yield.
  2. Increase the involvement of D&O insurers in defense-counsel selection and in other strategic defense decisions, to put those who have the greatest overall experience and economic stake in securities class action defense in a position to provide meaningful input.
  3. Make the Supreme Court’s Omnicare decision a primary tool in the defense of securities class actions.  Obviously, Omnicare should be used to defend against challenges to all forms of opinions, including statements regarded as “puffery” and forward-looking statements protected by the Reform Act’s Safe Harbor for forward-looking statements.  But defense counsel should also take advantage of the Supreme Court’s direction in Omnicare that courts evaluate challenged statements in their full factual context.  Omnicare supplements the Court’s previous direction in Tellabs that courts evaluate scienter by considering not just the complaint’s allegations, but also documents incorporated by reference and documents subject to judicial notice.  Together, Omnicare and Tellabs allow defense counsel to defend their clients’ honesty with a robust factual record at the motion to dismiss stage.
  4. Increase the involvement of boards of directors in decisions concerning D&O insurance and the defense of securities litigation, including counsel selection, to ensure their personal protection and good oversight of the defense of the company and themselves.
  5. Move damages expert reports and discovery ahead of fact discovery, to allow the defendants and their D&O insurers to understand the real economics of cases that survive a motion to dismiss, and to make more informed litigation and settlement decisions.

These five changes are among the top wishes I have to improve securities litigation defense, and to preserve the protections of directors and officers who face securities litigation.  Over the next several months, I will post about each one.  Here are links to the posts in the series so far:

Wish #1:  5 Wishes for Securities Litigation Defense: A Defense-Counsel Interview Process in All Cases

Wish #2:  5 Wishes for Securities Litigation Defense: Greater Insurer Involvement in Defense-Counsel Selection and Strategy

Wish #3:  5 Wishes for Securities Litigation Defense: Effective Use of the Supreme Court’s Omnicare Decision

Wish #4:  5 Wishes for Securities Litigation Defense: Greater Director Involvement in Securities Litigation Defense and D&O Insurance

Wish #5:  5 Wishes for Securities Litigation Defense: Early Damages Analysis and Discovery

On March 24, 2015, the U.S. Supreme Court issued its opinion in Omnicare, Inc. v. Laborers Dist. Council Const. Industry Pension Fund, 135 S. Ct. 1318 (2015).  My partner Claire Davis and I are publishing a forthcoming one-year anniversary article on Omnicare.  In addition to discussing the lower courts’ application of the decision, we take apart the fallacy that Omnicare is “plaintiff-friendly” – a proposition that led to my June 2015 rant “Hey There Fellow Securities Defense Lawyers: Omnicare is GOOD for Us!”  We will post a link to the anniversary article when it’s out.  For now, I want to further explain why I care so much about Omnicare.

As a reminder, Omnicare holds that a statement of opinion is only false if the speaker does not genuinely believe it, and that it is only misleading if – as with any other statement – it omits facts that make it misleading when viewed in its full context.  The Court’s ruling on what is necessary for an opinion to be false establishes a uniform standard that resolves two decades of confusing and conflicting case law.  And the Court’s ruling regarding how an opinion may be misleading emphasizes that courts must evaluate the fairness of challenged statements (both opinions and other statements) within a broad factual context, eliminating the short-shrift that many courts have given the misleading-statement analysis.

In my tax law class in law school, my professor said that he could teach all of tax law through the U.S. Supreme Court case Old Colony Trust Co. v. Commissioner, 279 U.S. 716 (1929).  Similarly, Omnicare provides the foundation for multiple legal and strategic elements of a strong defense of a securities class action.  It is truly a case study in how to defend a securities case.  Below, I address three of those components. 

1. Omnicare’s directive that courts consider context better allows defense lawyers to show the defendants said nothing false.

Our North Star in defending any securities class action is to explain that the defendants said nothing false.  At the core of every securities class action is a person who is alleged to have lied.  Clients generally feel strongly that they did their best and told the truth.  The reasons for their belief are always the right place to start constructing the defense, and usually remain the gist of the defense after categorizing the facts under the relevant legal standards.

Sticking up for the truth of what our clients said also gives them a voice during the long initial stages of the motion-to-dismiss process.  Although the Reform Act’s prolonged introductory stages were designed to help defendants, they don’t allow defendants to tell their side of the story – which is frustrating and often harmful to the reputations of real people.

But the Reform Act, and now Omnicare’s context standard, leave securities defense lawyers with broad latitude to support the truth of what their clients said, and to attack allegations of falsity, as to both statements of fact and statements of opinion.  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.  From there, the truth of what the defendants said can be supported 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; demonstrating 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.

A good motion to dismiss has always analyzed a challenged statement (of fact or opinion) in its broader factual context to explain why it’s not false or misleading.  But many defense lawyers unfortunately leave out the broader context, and courts have sometimes taken a narrower view.  Now, this type of superior, full-context analysis is clearly required by Omnicare.  And combined with the Supreme Court’s directive in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (2007), that courts consider scienter inferences based not only on the complaint’s allegations, but also on documents on which the complaint relies or that are subject to judicial notice, courts clearly must now consider the full array of probative facts in deciding both whether a statement was false or misleading and, if so, whether it was made with scienter.  Plaintiffs can’t cherry-pick what the court considers anymore. 

2. Omnicares subjective falsity holding allows us to stick up for the truth of all of our clients’ statements.  

Opinions are ubiquitous in corporate communications.  Corporations and their officers routinely share subjective judgments on issues as diverse as asset valuations, strength of current performance, risk assessments, product quality, loss reserves, earnings forecasts, and progress toward corporate goals.  Indeed, I would guess that more than 75% of all securities class actions involve one or more statements of opinion as a core allegation.

Yet for decades before Omnicare, it was difficult to defend the truth of an opinion.  The law was hopelessly muddled.  For a full discussion, I invite you to review pages 13-19 of our Omnicare amicus brief on behalf of Washington Legal Foundation.  To argue the truth of statements of opinion, we would provide the best possible statement of the legal standard under the law of the circuit we were in, try to convince the court that the real standard should be the standard that is now the Omnicare standard, and then argue that the opinion was true and not misleading under the standard we advanced.  Now, under Omnicare, we can stick up for the truth of all of our clients’ statements, both fact and opinion, without having to first engage in a mini-argument of the law governing opinions.

3. Omnicare allows judges wider latitude to rule in defendants’ favor.

Judges want to figure out if the defendants tried to tell the truth.  The law provides wide latitude for judges to dismiss claims, and we want to give them every reason to do so.  If the judge accepts that the defendants did their best to be fair and candid in their public statements, he or she will be more inclined to accept other arguments.

So the argument against falsity, utilizing the tools Omnicare has provided, is the right place to start, even if there are stronger alternative arguments.  For example, in an earnings forecast case, the best approach is to first defend the truth of the forecast – a statement of opinion – and then use the Reform Act’s Safe Harbor as a fallback argument.  Likewise, a strong argument against scienter is best set up by a strong argument against falsity.  The element of scienter requires plaintiffs to demonstrate that the defendants said something knowingly or recklessly false – in order to do this, plaintiffs must tie their scienter allegations to each particular challenged statement.  A scienter argument that doesn’t build on a strong falsity argument is a strategic mistake.

I hope that this short guide to how to use the powerful tool the Court gave us in Omnicare is helpful.  If we in the defense bar use the decision correctly, companies and their directors and officers will have greater freedom to speak without undue fear of liability, and we will win more cases in which their opinions are challenged.

Because I continue to believe that the advent of significant cyber security shareholder litigation and SEC enforcement is near, I remain committed to helping public companies and their directors, officers, insurers, and brokers understand cyber security oversight and disclosure issues, risks, and defenses.  This spring, I will be discussing these topics at three programs:

Facets of Board Oversight of Cyber Security, National Association of Corporate Directors, Northwest Chapter, Boise, March 16, 2016

2016 Executive Risk Insights Conference, Advisen, Chicago, May 10, 2016

12th Annual D&O Liability Insurance ExecuSummit, Uncasville, CT, May 17-18, 2016

I hope you can attend one of them.