Over the years, I’ve bemoaned the lack of “litigation” in “securities litigation.”  In this post, I discuss the same problem in “derivative litigation:” why don’t we litigate derivative cases anymore? 

Derivative litigation – in which a stockholder asserts claims that belong to the company – takes multiple forms: tag-along cases to securities class actions; stand-alone claims related to other types of alleged legal or business problems; and challenges to mergers and acquisitions.  In this post, I focus on tag-along derivative claims.   

For the first 15+ or so years after tag-along derivative litigation became ubiquitous, we frequently filed motions to dismiss for failure to make a demand on the board – and won the vast majority of them.  But about 10 years ago, most defense counsel started to forego demand motions and, instead, began to negotiate stay agreements with derivative plaintiffs or moved for stays. 

Given the high success rate of demand motions, why did this shift happen?   

There are several culprits:

  • One reason is the perceived lack of a safety net if the demand motion fails.  That perception has roots in then-Vice Chancellor Leo Strine’s notorious 2003 decision in In Re Oracle Corp. Derivative Litigation, 824 A.2d 917 (Del. Ch. 2003), in which he held that the Oracle board’s SLC lacked sufficient independence from CEO Larry Ellison – the “too much vivid Stanford Cardinal red” decision.  Ever since Oracle, boards have hesitated to form SLCs.  The more recent Oracle SLC case, in which the SLC decided to let the shareholders take over the litigation, didn’t help boards’ confidence in SLCs.  On top of the perceived substantive risk, SLC investigations are often very expensive.
  • Stays seem smart in light of two additional trends: (1) confidence that the defendants will prevail on the securities class action motion to dismiss; and (2) reflexive settlement if the defendants lose the securities motion to dismiss.  Why take a risk that you’ll lose the demand motion, the thinking goes, when you’ll win the underlying securities motion to dismiss and will just settle if you don’t.  Stays seem more efficient than spending money on a demand motion.  As defense costs have consistently risen, companies and carriers have seen this as a place to save money.
  • Delaware forum bylaws have split apart the forums for securities class actions and derivative actions.  Before Delaware forum bylaws, federal derivative cases were frequently filed in or transferred to the securities class action forum, coordinated, and handled by the same judge.  And state court derivative cases were handled by judges in the same city as the federal judge, which tended to create sufficient coordination and cohesion. We thus could make sure that if we made a demand motion, it would lag behind the securities class action motion to dismiss.  Now, that’s more difficult to accomplish – creating the risk that the demand motion could be decided (and denied) before the securities class action motion to dismiss is decided. 

Failure to make demand motions has consequences.  Most significantly, the number of derivative cases overall and in individual cases continues to rise – if you’re a derivative plaintiffs’ lawyer, there’s little downside to filing a case or making a board demand if you find a client.  While there is only one derivative claim no matter how many plaintiffs’ lawyers file a case (or make a board demand), as a practical matter, the more derivative plaintiffs there are, the more difficult it is to obtain voluntarily dismissals if the securities motion to dismiss is granted or to settle if it is denied. 

What should we do about it?  I don’t think we should go back to routine demand motions.  There are good reasons, in particular cases and overall, to stay derivative cases.  Instead, I think we need to start at least making a deliberate, strategic decision whether to make a demand motion or agree to or move to stay based on the circumstances. 

But we definitely should not sell demand motions short.  They are a high-percentage motion, and they can (and usually should) be straightforward and utilize the already-developed securities class action arguments when arguing against a substantial likelihood of director liability.  The risk that a Delaware court could decide the demand motion first is a significant factor that needs to be weighed, but with good case management and communication with the court, it’s a manageable risk in many cases.  And even if a demand motion fails, an SLC is an effective procedure and doesn’t need to break the bank, as I’ve written. 

The key, as in so many areas of securities and derivative litigation, is improved strategic analysis and collegiality among the defendants, defense counsel, the insurers, and the broker.  Together, we can make good judgment calls and improve outcomes.   

Five years ago, we surveyed a decade’s worth of federal district court decisions on motions to dismiss securities claims brought against development-stage biotech companies to answer an important question: are these cases more likely to survive a motion to dismiss—and therefore riskier to insure against—than other securities class actions, as D&O insurers have traditionally assumed?

The answer was a resounding no: our analysis showed that securities claims brought against small, clinical-stage biotech companies were actually more likely to be dismissed at an early stage than other types of securities class actions between 2005 and 2017.  These companies have historically been considered attractive targets for securities actions given the inherent risks of the industry and the volatility of their stock prices, and, as a result, often have relatively limited D&O insurance options.  But our study found the assumptions that have acted to limit their options to be incorrect—biotech startups do not in fact pose greater securities class action risk than other companies.

This spring we set out to analyze another 5 years’ worth of data to see whether the patterns we observed in our prior study have held true in more recent years.  Not surprisingly, they have.

Our article analyzing the decisions has been published in the PLUS Blog and The D&O Diary.

I am evangelical about the importance of defense counsel working collegially with D&O insurers and brokers – the repeat players in securities and governance litigation – in the defense of litigation against our common clients.  In the big picture, this type of collegiality is the key to putting “litigation” back in “securities litigation” and to improving the effectiveness and efficiency of securities litigation defense, through better case evaluation and strategic and economic planning.  But, of course, the big picture is made up of individual cases, and each individual case comprises countless communications, and instances of lack of communication, amongst the triad of insurers, brokers, and defense counsel.

With a focus on four areas of communication – (1) a pre-motion to dismiss initial merits assessment and post-motion to dismiss strategic summit, (2) periodic updates from defense counsel, including an initial kick-off call, (3) insurer-insured relations around coverage issues, coverage letters, and deductions based on insurers’ billing guidelines, and (4) mediation and settlement – this post discusses how we can collectively improve our communication for the benefit of our common clients.

  1. Initial Merits Assessment and Overall Case Strategy

The most fundamental failure of communication is the absence of a meaningful merits assessment at the outset of the litigation.  In days gone by, a thorough but targeted initial background review and merits assessment was de rigueur.  It is not an internal investigation but instead a focused, tailored, and balanced effort that can be done in the low six figures in all but the largest cases.  We would ask the company for a set of key internal documents, assemble and review relevant public documents, identify a handful of people to interview, and assess the strengths and weaknesses of the claim.  We would discuss the outcome with management and the board, as well as the D&O broker and insurers.  This allowed for thoughtful strategic planning through the motion to dismiss and beyond: the company could understand the risk it faced, the insurers could calibrate their involvement and set reserves, and defense counsel could defend the case with the right amount of effort and cost.

But today, far too often, this type of review does not occur.  There are multiple causes, including a low cap or budget offered to secure the engagement; the (incorrect) view that a motion to dismiss is mostly a matter of identifying what the complaint does not allege, as opposed to an affirmative narrative that sticks up for the defendants’ honesty and good faith; and understandable backlash over some firms’ use of the background review to do a full-blown internal investigation.

Whatever the causes, the lack of initial merits assessment has eroded the effectiveness of securities litigation defense, for several reasons:

  • Motions to dismiss are not as strong if defense counsel don’t know the real facts.  While we can’t use internal facts on a motion to dismiss, knowing them allows for arguments based on inferences that we can make if we know the asserted inference to be true, and ethically can’t if we don’t.  This is substantively critical; the Supreme Court’s Omnicare and Tellabs decisions require courts to consider context and draw inferences, so failing to know the real facts weakens a motion to dismiss.
  • Motions to dismiss are just the first step in the litigation and are subject to the vagaries of the judicial process, such as judicial experience in Reform Act cases and clerk resources.  Some motions to dismiss are granted that probably shouldn’t be, and vice versa.  We file motions and they go into the judicial vortex, and it’s impossible to predict when we’ll get a decision.  So the decision usually comes as a surprise, and if the decision is a denial, it is jarring.  At that point, the reflex of everyone – the defendants, defense counsel, the broker, and the insurers – is to try to settle.  So we go into a mediation to resolve a claim that is untested on class certification, discovery, or summary judgment – without even holding a strategic summit to decide how to proceed.
  • Defense counsel can take a credibility hit if a motion to dismiss is denied, absent early and candid counseling of the risk of a denial.  After a year or more of positivity about the motion’s prospects, conveyed to get the engagement and/or due to lack of a good up-front merits evaluation, the defendants are understandability extra disturbed when the motion to dismiss is denied.  Defense counsel feels pressure to just resolve the case since, at that point, it’s hard to methodically analyze the merits when the focus is making a plan to respond to plaintiffs’ document requests.  The insurers too can feel adrift because of the lack of true communication about the merits.  Everyone thus becomes extra conservative due to a lack of informed communication up front.  The reflexive reaction is to simply settle.  For insurers, reflexive settlements are especially counter-cultural – insurance claims adjustment is about risk assessment, and without good communication about the real risks, the process becomes purely practical.  Or, worse, defense counsel goes through the burdens and expense of document production without knowing where it should lead – with a settlement red-flag thrown up only later, after many millions of dollars in fees.

These are just some of the consequences of the lack of early merits assessment and communication about the risks.  An early case assessment that helps everyone align and sets a strategic summit after a denial of motion to dismiss ruling would solve a lot of problems.  Here’s an overview:

Initial case assessment.  This does not need to break the bank but it shouldn’t be done on a shoestring budget either.  Ideally, in each case, the clients would give defense counsel an overview and a set of key documents (e.g., forecasts in an alleged false forecast case).  Defense counsel can develop AI-based searches for key emails from the emails of 3-5 people, yielding a relatively small number of documents to use in targeted and focused interviews.  If we prime the AI-pump properly, the process should identify problematic emails, and we can include them in our case analysis from the beginning rather than millions of dollars later.  Ideally, the initial case assessment should include an initial damages estimate and an assessment of areas for further work during class certification and expert discovery that would help defeat or mitigate materiality, loss causation, and damages.  Based on this work and discussions with management, the board, and the broker and insurers, the group can rough out what the defense might look like if the motion to dismiss is denied, including a strategic summit to decide how to proceed.

Post-motion to dismiss strategic summit.  My vision for this is to meet in person or virtually within two weeks, before discovery gets revved up.  Defense counsel can amplify their merits assessment, and also discuss class certification opposition issues and class structure – an especially significant issue in short-seller report cases and in cases in which plaintiffs’ counsel stretches the class forward or backward, and to take advantage of the series of Supreme Court class certification cases.  And defense counsel can discuss whether the structure of the litigation makes summary judgment a realistic opportunity.  It is in everyone’s interest to see if it makes sense to take advantage of one or both of these two further pre-trial opportunities to limit or eliminate the litigation.

  1. Periodic Updates

It is equally critical for defense counsel to provide periodic updates to insurers.  First, there should be an introduction call among the company, defense counsel, the broker, and insurers shortly after defense counsel is hired.  Most defense counsel and claims handlers don’t have a pre-existing relationship, and it’s helpful for them and the broker to get to know each other, explain how they typically work, and develop expectations for communication.  In my kick-off calls, I walk through our to-do list through the motion to dismiss and explain what we’re doing and why.  I also ask the insurers for their communication preferences and clarify how the broker and I will work together to make sure the insurers get the information they need in a timely way.

With this foundation of communication, as the litigation proceeds, we’re able to have more efficient and effective updates at natural points, e.g., when the lead-plaintiff is appointed, the consolidated and amended complaint is filed, and the motion to dismiss is being briefed.  And, if defense counsel conducts an initial case assessment, that should the subject of another call.

In periodic updates, defense counsel should call it like they see it.  Too often, defense counsel’s updates go from bullish to bearish on a dime.  Whether out of loyalty to the defendants or lack of knowledge of the case, defense counsel often fails to share the realistic risks.  The most frequent reason given for this stark shift is negative-sounding emails.  But sound bites in emails are par for the course in any litigation, and one of the main skills of litigation defense is to contextualize them.  So, not surprisingly, insurers can be suspicious about a quick shift from optimism to pessimism based solely on email sound bites; it can feel pretextual.  So we defense counsel need to be candid about the real risks from the beginning.

And it’s important for insurers to ask questions and share their views of the litigation.  With email sound bites, for example, insurers should put on their defense-counsel caps and ask probing questions.  While defense counsel’s judgment is entitled to some amount of deference on assessment of the merits, probing questioning is often necessary to determine the true content and foundation of that judgment.  In my experience, one of the fundamental truths about insurance claims professionals is that, while they play a different role in the defense of claims, they have overseen myriad more claims than most defense counsel have handled, and their instincts are typically excellent.  It benefits our common clients for insurers to trust their instincts and ask probing questions.  If a claim on which defense counsel wants to throw in the towel is actually defensible, it is short-sighted for anyone to overpay for a quick settlement.  We are all in this together for our common clients, in our respective roles, so please push us.

It’s worth noting, however, that defense counsel’s views on the safety of sharing case assessments with insurers varies widely.  My view is that I don’t need to share truly privileged information with them to provide a meaningful case assessment – i.e., I don’t need to say that the CEO said this, the CFO said that, etc.  Instead, I share my impressions based on what we’ve learned in the context of my experience, which is attorney work product that is not waived if I disclose it to someone aligned with my clients.  Other lawyers play it super safe and don’t share attorney work product.  Others are in the middle.

  1. Insurer-Insured Relations

There are a few common, communication-based forces that can disrupt good insurer-defense counsel relationships.

Reservation of rights letters.  Reservation of rights letters can get the litigation off on the wrong foot.  Of course, there are relatively few true coverage problems in securities class action litigation, especially given state-of-the-art final adjudication of the conduct exclusions, but the reservation of rights letter makes many clients feel uneasy – like the insurer is on the plaintiffs’ side or their coverage is actually in doubt.  While the most experienced securities litigators prepare their clients for ominous-sounding reservation of rights letters, many lawyers engaged to defend securities class actions are generalists and some, unfortunately, seem to use the letter to turn the insurers into adversaries.  Most insurers have softened their letters to address this problem.  I suggest that everyone look at their forms and see if there is room for further improvement.

Coverage issues.  If there is a true coverage issue, I suggest insurers raise it right up front as part of the initial case assessment conversation discussed above, so that everyone can include it in their litigation strategic thinking and the company can determine whether it needs coverage counsel.  Without this type of proactive approach, companies tend to default to hiring coverage counsel.  I embrace engagement of coverage counsel when it’s necessary, but resist it when it’s not, since it changes the tone of the relationship with the carriers; it turns them from friend to (perceived) foe.  A candid discussion of these issues early on can prevent unnecessary tension.

Deductions.  Last but certainly not least are deductions based on billing guidelines.  This is a perennial problem, and it has many unintended potential consequences in individual cases and overall.  Setting aside whether guidelines are part of the insurance contract, as a default rule, I accept insurer deductions (subject to discussion/appeal).  It is incumbent on me to understand the guidelines and follow them.  If they are unreasonable as applied – such as a limit on lawyers at a hearing or internal discussions that are meant to generate ideas and strategies and updates that otherwise require a memo – I discuss the issue and rarely have had a problem.  Billing discussions are often really about time entries and projects touching on case evaluation and strategy, so I use them as an opportunity to discuss the case.  But I suspect my approach is the exception, and the result overall can be unnecessary friction for often relatively minor savings.  In the bigger picture, securities defense practices can suffer due to lower realization than other practices, which lowers internal clout within firms, which in turn affects the practice’s ability to get the right talent and firm resources.

Deductions also impact the defendants, since most defense counsel looks to the company to make up short-pays.  This can drive a wedge between the company and insurers and make the defendants worry whether the insurers will be there for them.  Experienced defense counsel should help the defendants understand the process, even if they look to the company to make up short-pays, but common sense says that the insurers are often scapegoated.

I don’t presume to understand whether insurers’ cost savings is worth enduring these types of consequences.  And to be sure, I support deductions for wasteful lawyer time and administrative costs that should not be on the bill in the first place – these simply are not reasonable defense costs, and most public companies long ago stopped paying for them.  But I know we’d all be happier – insurers, defense counsel, and our common clients – if deductions were taken more sparingly.  Of course, I’m sympathetic about runaway law firm economics, but that’s a different problem that typically can’t be effectively addressed by deductions – and over-deducting in those situations just intensifies the tension between the insurers and the company/defense counsel, given the large deductions defense counsel asks the company to make up.  (One solution to bad billing and bloated fees, about which I’ve written, is the formation of small, collegial panels of full-time securities defense lawyers who operate on volume economics and a system of trust.)

  1. Mediation and Settlement

Defense-counsel friends: everything we need to know about insurer relations during the mediation and settlement process, we learned in kindergarten.  When there is an event as important as mediation, at which we plan to ask our insurer colleagues to fund the settlement, we must involve them in all aspects of the discussion and not just tell them when you want to mediate, with whom, and provide (often insufficient) notice.

With an initial case assessment and discussion between the company, insurers, and broker, the path to mediation will naturally come up.  Does mediation during the motion to dismiss process make sense?  If so, why?  If the motion to dismiss plays out, we will discuss mediation at the post-motion to dismiss strategic summit: is this a good time to mediate or should we test the economics of plaintiffs’ proposed class on market efficiency, price-impact, and/or classwide damages through the class certification process?  And if the plaintiffs’ case is structurally weak, should we mediate late in the case, after summary judgment is pending?

But even if we don’t have an initial case assessment meeting or strategic summit, in each and every case, we need to discuss the mediation pathway and strategy with the insurers and seek their views.  To leave them out of the process is impolite, to say the least, and fails to maximize the effectiveness of our clients’ insurance protection – which includes not just the limits themselves but the strategic input we can get from the insurers’ claims professionals and their ability to help our clients better when they have sufficient lead time and information to support obtaining funding when the time comes.

Another point of friction in the insurer-defense counsel relationship is over settlement value and negotiation.  While it’s an over-simplification, most defense lawyers just want to reach a settlement, and most insurers want to pay the right amount (with that amount confounded by the problems I’ve discussed).  This set-up can lead to friction and strategic positioning between them with express or implied threats of bad faith by defense and/or coverage counsel.

But we’d all be better off, in individual cases (in my experience) and overall, with clear communication and collegiality.  There are few cases in which insurers will not fund a good settlement, especially if defense counsel has provided meaningful analysis in advance and set a target or range for the settlement amount.  Many D&O insurance professionals are, to a large extent, mediation specialists, and it’s wrong to jettison their judgment.

The solution to this is good two-way communication, as discussed above.  Defense counsel should call it like they see it, and insurers should ask probing questions along the way.  Together, we can reach good outcomes.  Sometimes that means not settling and continuing to litigate.  Sometimes that means a walk down the hallway with the carrier whose money is in play and explaining why this is a case whose settlement value isn’t the product of liability risk and our economist’s best estimate of damages, but instead the lowest amount the plaintiffs’ lawyers will take.  There are some such cases.  But we need to improve our communication so we can know which is which.

The most frequent question I’ve been asked about the SEC’s proposed SPAC rules concerns the provision that would make unavailable the Private Securities Litigation Reform Act’s safe harbor for forward-looking statements with respect to de-SPAC transactions: would this change increase the risk that SPACs and de-SPACs face in securities litigation?

Not much. Public companies understandably believe that the Reform Act’s safe harbor protects them from liability for their guidance and projections if they simply follow the statute’s requirements. But, as a practical matter, the safe harbor is not so safe; some judges think the Reform Act goes too far, so they go to great lengths to avoid the statute’s plain language. This is one significant reason why we always have advocated an approach to defending forward-looking statements that does not depend solely on the safe harbor, even when the statute’s plain language would indicate that it applies. Thus, while SPACs and de-SPACs are certainly better off with the safe harbor than without it, its loss should not be as consequential as some may think.

The safe harbor was a key component of the Private Securities Litigation Reform Act. Congress sought “to encourage issuers to disseminate relevant information to the market without fear of open-ended liability.” H. R. Rep. No. 104-369, at 32 (1995), as reprinted in 1995 U.S.C.C.A.N. 730, 731. The safe harbor straightforwardly says that a forward-looking statement is not actionable if it (1) is “accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statement,” “or” (2) is immaterial, “or” (3) is made without actual knowledge of its falsity. 15 U.S.C. § 77z-2(c)(1); 15 U.S.C. § 78u-5(c)(1) (emphasis added).

Yet courts’ application of the safe harbor has been anything but straightforward. Indeed, courts have committed some basic legal errors in their attempts to nullify it. Foremost among these is the tendency to collapse the three prongs—essentially reading “or” to mean “and”—and to hold that actual knowledge that the forward-looking statement is false means that the cautionary language can’t be meaningful. Courts also engage in other types of legal gymnastics, such as straining to convert forward-looking statements into present-tense declarations, in order to take statements out of the safe harbor.

Beyond prominent instances of judicial error, judges frequently evade the safe harbor by simply avoiding defendants’ safe harbor arguments, choosing either to treat the safe harbor as a secondary issue or to avoid dealing with it altogether. The safe harbor was meant to create a clear disclosure system; if companies have meaningful risk disclosures, they can make projections without fear of liability. When judges avoid the safe harbor, companies’ projections are judged by legal rules and pleading requirements that result in less-certain and less-protective outcomes, even if judges get to the right result on other grounds. And if companies come to realize that they cannot rely on the clear safe harbor protection Congress meant to provide, they will make fewer and/or less meaningful forward-looking statements, to the detriment of investors.

The root of these problems is that many judges don’t like the idea that the safe harbor allows companies to escape liability for knowingly making false forward-looking statements. Indeed, some courts have explicitly questioned the safe harbor’s effect. For example, in In re Stone & Webster, Inc. Securities Litigation, the First Circuit called the safe harbor a “curious statute, which grants (within limits) a license to defraud.” 414 F.3d 187, 212 (1st Cir. 2005). This judicial antipathy for the safe harbor won’t change until the Supreme Court establishes a standard that resonates with lower-court judges. (In an article on the Quality Systems case and our amicus brief on behalf of Washington Legal Foundation in support of Quality Systems’ cert petition, we explained these problems (and our suggested solution) in more detail.)

For these reasons, we take a dual approach to defending forward-looking statements.

  1. A forward-looking statement is also an opinion under the Supreme Court’s decision in Omnicare, Inc. v. Laborers Dist. Council Const. Industry Pension Fund, 135 S. Ct. 1318 (2015), so we start by arguing that the forward-looking statement is not false in the first place. Omnicare held that a statement of opinion is false under the federal securities laws only if the speaker does not genuinely believe it, and it is misleading only if it omits information that, in context, would cause the statement to mislead a reasonable investor. See generally “Omnicare, Five Years Later: Strategies for Securities Defense Lawyers’ More Effective Use of the Decision.”

Lack of falsity defeats the claim regardless of the safe harbor’s application, but we have found that judges who believe that the forward-looking statements are not false (and are thus assured that they were not knowingly dishonest) also are more comfortable applying the safe harbor.

  1. We then argue the safe harbor as an additional basis for dismissal and use that discussion to demonstrate that the company’s safe harbor cautionary statements show that it really did its best to warn of the risks it faced. Judges can tell if a company’s risk factors aren’t thoughtful and customized. Too often, the risk factors become part of the SEC-filing boilerplate and don’t receive careful thought with each new disclosure; risk factors that don’t change from period to period, especially when it’s apparent that the risks have changed, are less likely to be found meaningful. And even though many risks don’t fundamentally change every quarter, facets of those risks often do, or there might be another, more-specific risk that could be added. We can help convince judges of the defendants’ candor and good faith, as well as the applicability of the safe harbor, by demonstrating the thoughtful evolution of tailored risk factors over time.

Ultimately, the least effective arguments are those that rest on the literal terms of the safe harbor, which create the impression that defendants are trying to skate on a technicality. It is these types of arguments—lacking sophisticated supporting analysis of either the context of the challenged forward-looking statements or the thoughtfulness of the cautionary language—that cause courts to try to evade what they see as the unjust application of the safe harbor. Effective defense counsel should appreciate that safe harbor “law” includes not only the statute and decisions interpreting it but also the skepticism with which many judges evaluate safe harbor arguments.

So, while SPACs and de-SPACs would be better off with the safe harbor, effective use of Omnicare is the primary protection for forward-looking statements anyway.

This week, my team and I again had the honor of writing for Washington Legal Foundation’s Legal Backgrounders series.

In this article, Zach Taylor, Gen York-Erwin, and I discussed the Second Circuit’s recent decision in Arkansas Pub. Emps. Ret. Sys. v. Bristol-Myers Squibb Co., 28 F.4th 343 (2d Cir. 2022).

Here is a link to the full article:

Three Key Takeaways from Second Circuit’s Latest Section 10(b) Securities Class-Action Decision

After discussing the court’s important rulings on falsity and scienter, we identify three key takeaways:

“Bristol-Myers provides several insights that are helpful to defendants and defense counsel. First, use of contemporaneous public materials reflecting the market’s perception of a company’s public statements is crucial for providing the necessary context to undermine falsity. In this case, the Second Circuit affirmed the district court’s taking judicial notice of certain analyst reports presented by Defendants (and not cited in the complaint) for the proposition that market players equated the company’s statements concerning ‘strong’ expression with 5% PD-L1 expression. The court explained:

The Complaint refers to analyst reports that predicted a variety of possible PD-L1 expression thresholds higher than 5%, to argue that Bristol-Myers misled the market by describing a 5% threshold as capturing a population of strong expressors. The fact that other reports, relying on the same public information, correctly predicted Bristol-Myers’s use of a 5% threshold is relevant to that argument and properly considered on this motion to dismiss.

Second, the decision underscores the importance of the holdings in Omnicare and Tellabs that challenged statements must be evaluated in the context of market information and the customs and practices (and understandings) of the relevant industry. Falsity and scienter cannot be pleaded in a vacuum. Courts must reach outside the complaint to determine whether a challenged statement was false or misleading in context, and whether defendants acted with the requisite intent to defraud.

Third, the decision strengthens the defense that stock sales executed pursuant to 10b5-1 plans do not support an inference of scienter. As a general matter, the case law surrounding use of 10b5-1 plans as a defense was not particularly well-developed or unanimous. Bristol-Myers states definitively that ‘sales conducted pursuant to a 10b5-1 trading plan or [that] were executed for procedural purposes . . . could not be timed suspiciously.’ While courts have more or less taken that position when 10b5-1 plans are adopted prior to the beginning of the alleged fraud, Bristol-Myers addressed a 10b5-1 plan adopted during the class period. Courts typically do not find 10b5-1 plans adopted during the time of the alleged fraud a proper scienter defense because they may have been adopted in a way to capitalize on the alleged fraud. The Second Circuit explained, however, that even where a 10b5-1 plan is adopted during the class period, plaintiffs are still required to plead facts sufficiently alleging ‘that the purpose of the plan was to take advantage of an inflated stock price’ or that the plan was not ‘given or entered into in good faith.'”

In 2012, I started the D&O Discourse blog to have a discussion among the repeat players in securities and corporate governance litigation:  insurers, brokers, mediators, economists, plaintiffs’ counsel, and defense counsel.  I share opinions from the defense-counsel perspective, but I call it like I see it.  For example, in a post in anticipation of the Supreme Court’s decision in Halliburton II, I advocated for the usefulness of the fraud-on-the-market presumption of reliance at a time when fellow defense counsel sported pitchforks.  My palms were sweaty, literally, when I pushed enter and sent my post forever into the internet.  But I felt strongly that the fraud-on-the-market presumption creates a superior securities-litigation system for everyone, including, counterintuitively, public companies and their officers, directors, and insurers, by facilitating collective resolution of securities matters.  I believed I was right, and still do.

I love being part of the D&O liability community.  It gives me great satisfaction to team up with brokers and insurers to help our mutual clients safely through the thicket of securities and derivative litigation.  For us repeat players, each case follows a fairly predictable course, but most of the clients we guide through it are newcomers, and connecting with them and keeping them comfortable requires more listening than talking, and more EQ than IQ.  While we’re proud when we strategize smart arguments—e.g. that substantive law trumps procedural law on motions to dismiss—our #1 metric is that clients feel like the litigation was a Sunday drive rather than a rollercoaster ride.

These are the things I write about.  Over the years, my posts have fallen into several general categories:

If you’re new to the blog, I invite you to browse the categories in one of the drop-down menus on the right.  If you’ve followed along over the years, I invite you to take a look back through the posts and categories.

This post is the first of a new quarterly series on the state of securities and governance litigation, which will take a big-picture view of these subjects.

This specific post focuses on the state of securities class actions.

So where are we?

More than any other time in my career, securities law and practice is super stable: we have seminal, defendant-friendly Supreme Court decisions on the primary motion to dismiss issues—falsity (Omnicare), materiality (Matrixx), scienter (Tellabs), and loss causation (Dura)—and on class certification (Halliburton I, Amgen, Comcast, Halliburton II, Goldman Sachs).  The circuits’ scienter standards are settled, uniform, and high bars.  The number of stock-drop securities class action filings each year varies, but centers around 200.  Motion to dismiss practice is relatively routine and rhythmic, with the primary doctrinal arguments mostly the same, customized for each case, and the Reform Act’s discovery stay continues to stabilize litigation activity and defense costs through the motion to dismiss stage in most cases.

But, despite this stability and defendant-friendly law, plaintiffs’ lawyers are doing well.  The longstanding securities plaintiffs’ firms continue to thrive, with increasingly large settlements.  The so-called “emerging firms” that hit their stride during the Chinese reverse merger cases and never looked back have now, in fact, emerged.  They win a lot of lead plaintiff contests, get past their fair share of motions to dismiss, and achieve settlements that creep higher and higher as a percentage of alleged damages.  All securities class action plaintiffs’ firms are adept at crafting a fraud narrative in their complaints and oppositions to motions to dismiss—that is their core skill.  And all plaintiffs’ firms have a negotiating trump card in mediations: the defense side rarely has sufficient insurance resources and/or resolve to defend a case through trial, so the settlement value in every case isn’t its actual settlement value, but instead is the lowest amount the plaintiffs will take.

In contrast, the issuer securities defense bar is increasingly splintered.  There remains a small group of full-time issuer-focused securities defense lawyers, but that group is shrinking as a great many cases are defended by a larger group of lawyers with more varied practices of which securities litigation is just one component.

This splintering has consequences.  One is the lack of lineage to practice before and through the Reform Act.  Fewer and fewer securities defense lawyers have defended cases brought by Bill Lerach and Mel Weiss, whose philosophies and tendencies will always shape the plaintiffs’ bar.  And fewer and fewer defense lawyers appreciate just how revolutionary the Reform Act was.  It’s a securities-litigation Fabergé egg and, unfortunately, some defense lawyers don’t sufficiently respect and protect it, partly due to lack of first-hand knowledge of pre-Reform Act practice.

Another consequence of the splintered defense bar is a loss of emphasis on early case investigation and development of a defense narrative.  Motions to dismiss increasingly consist of simple exercises in pointing out facts the complaint doesn’t allege, rather than crafting a narrative of good faith with the confidence that can only come from knowing the real story.  Some of this approach may be defense lawyers’ reaction to pricing pressure, and while I applaud their efforts to be efficient, we’d all be better off with better defense narratives and motions to dismiss.

Beyond the motion to dismiss, securities litigation defense increasingly involves very little actual litigation.  Cases that survive a motion to dismiss typically settle before class certification, merits and expert discovery, and summary judgment—much less trial.  To add insult to injury, the lack of early fact development means that these early settlements are not rooted in the merits.

This trend away from actually litigating securities litigation cases started about 10 years ago, and it has become part of the culture of securities litigation.  I will always favor more litigation in the right cases, so those who support my effort to put “litigation” back in “securities litigation” should not fear that I’ve given up.  I’m going to continue to advocate for greater efficiency and collegiality among insurers, brokers, and defense counsel, so that defendants’ policy proceeds stretch farther.  I’m going to continue to advocate for greater involvement by insurers and brokers in defense-counsel selection, to help defendants engage the right lawyers for the particular case.  I’m going to continue to advocate for use of contingent-liability policies in securities class actions, so that defendants with the resolve to defend cases through trial have the right resources and their own trump card.  But, if our securities litigation system remains one solely of motions to dismiss, I’m going to press for prioritizing class certification and damages analysis up front, so that plaintiffs’ one-sided assertions on those important issues don’t continue to dominate mediations.  And I’m going to begin to advocate for limited, focused fact inquiry in advance of mediations to make them more merits-based—stay tuned.

Since 2014, I have had the privilege of working with D.C. public-interest law firm and policy center Washington Legal Foundation on several securities litigation amicus briefs, including in Omnicare, and numerous articles on key securities litigation issues.

In our latest collaboration with WLF, my colleagues Zachary Taylor and Genevieve York-Erwin and I write about the Ninth Circuit’s recent decision on Section 11 standing in the Slack Technologies securities class action:

Pirani v. Slack Technologies, Inc., et al.: Ninth Circuit Cuts Securities Plaintiffs Slack on Standing

It was a great honor to moderate a Professional Liability Underwriting Society D&O Symposium panel on the ability of Contingent Liability (CL) insurance to improve outcomes in securities class actions (SCA).

Randy Hein, President of Berkley Transactional (Berkley Professional Liability), pioneer of CL for SCAs; Kara Altenbaumer-Price, executive risk broker at McGriff; Paul Bessette, co-chair of King & Spalding‘s securities litigation group; and Elizabeth Neumann, AXIS‘s head of professional liability claims, discussed how SCA outcomes are worsening for defendants and how CL for SCAs can help improve them.

Until 10-15 years ago, defendants often defended an SCA that survived a motion to dismiss (MTD) through class certification and summary judgment. Now, most SCAs settle soon after an unsuccessful MTD—a practice that inflates settlement amounts because defendants lack the leverage that litigation on the merits creates. As a result, the settlement value of every SCA has become simple to calculate: it is the lowest amount the plaintiffs will take. That amount continues to escalate as a percentage of plaintiff-style damages, especially in SCAs against companies with a market capitalization under $2 billion—a cohort perennially comprising more than 50% of all SCAs.

This lack of litigation owes to a variety of factors, including two important financial considerations:

  • Due to escalating defense costs, defendants often can’t defend an SCA past the MTD through class certification or summary judgment, much less trial, while still preserving sufficient D&O proceeds to settle later–a problem especially acute in the large cohort of sub-$2 billion market cap SCAs; and
  • Defendants fear an improbable but non-zero risk of a potentially catastrophic financial loss.

The insurance industry has a long history of resolving such large but improbable financial risks. In the right situations, Transactional Risk underwriters may be able to provide enough capacity to remove the risk of (improbable) catastrophic financial loss, enabling defendants the freedom to defend themselves in such litigation. This protection would better promote more vigorous litigation and better align settlement amounts with the merits.

Many thanks to Symposium co-chair Justin Kudler of AXA XL for his collegiality and insights as we planned the panel, and to Megan Moore and Cary Hepp for their help and support.

Randy Hein and I wrote a paper for PLUS Journal on CL for SCAs, which we also submitted for the D&O Symposium: A Free-Market Solution to Meritless Securities Litigation (at p. 23).

The history of securities litigation is marked by waves: from the IPO laddering cases, to the Sarbanes-Oxley era corporate scandal cases, to stock options backdating, to the credit crisis, to the Chinese reverse-merger cases, to event-driven/lawsuit blueprint cases, certain types of cases have predominated at different times.

Are we entering a wave of COVID-19 cases? My view is:

  1. We will not see a wave of cases challenging pre-COVID-19 disclosures and governance triggered by the fallout from COVID-19 in February, March, and April 2020.
  2. But companies and their directors and officers who are not hyper-vigilant about what they say and how they say it and/or whose boards are not highly attentive will face shareholder suits if and when they suffer problems in the next several years precipitated or exacerbated by COVID-19.

First, why don’t I think there will be a wave based on the economic downturn over the past two months? Everyone is in the same boat, so it’s difficult for plaintiffs to identify and prove that any particular company’s disclosures or governance problems caused economic harm. And plaintiffs need to choose extra-wisely, because many judges would be offended by accusations of fraud and poor oversight over problems caused by a pandemic – it would feel opportunistic.

But going forward, disclosure and governance will be judged far differently – almost in the polar-opposite way.  Moving forward, judges will have no patience for companies whose disclosures are not careful or boards whose oversight fails to meet the moment. The legal standards governing disclosure and governance litigation are judged from inferences drawn in context by judges who are themselves living the context. They will be critical of disclosures that feel exaggerated and governance that feels lax. Company-specific stock drops and governance failures will be easy for the plaintiffs’ bar to spot in the coming months and years.

So, how does a company and its directors and officers stay out of category (2) – how do they avoid securities and governance suits in the next several years based on disclosures and governance in the next several quarters? The tools the law gives companies to win shareholder suits allow them to avoid them or prevail if they’re sued incorrectly. I break it down by type of shareholder suit.

Securities Class Actions

Under Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5 under it, a plaintiff must show (1) a false or misleading statement (2) made with intent to defraud (scienter), among other elements. The Private Securities Litigation Reform Act of 1995 (Reform Act) protects forward-looking statements if the statement is accompanied by meaningful cautionary language.

The U.S. Supreme Court’s Omnicare decision says that courts must examine the full factual context to determine whether a statement was false or misleading, and its Tellabs decision says that courts must weigh competing inferences, both fraudulent and non-fraudulent, from the full set of contextual facts to determine whether any false or misleading statement was made with scienter.

The full-context rule helps defendants win more cases, because it lessens litigation-by-soundbite – defendants almost always fare better if what they said is examined in a broader frame. And it allows defendants to avoid being sued in the first place through thoughtful disclosure that reduces investor surprise and deters plaintiffs’ lawyers from suing or, if one does, from piling on.

Here are practical tips to reduce the risk of making false or misleading statements, and failing to obtain safe-harbor protection:

  • Speak factually. This seems obvious, but companies must be more factual than ever in their disclosures. Although statements of opinion receive heightened protection under Omnicare, in the current environment, companies should be careful with words like “significantly” or “improving” when they can use facts and figures, and when they use those sorts of terms, they need to give more context than usual.
  • Show your work. Create the context under which your statements will be judged by explaining yourself. Investors are listening to every word and interpreting, extrapolating, and perceiving hopeful overtones. Investors will create the context if you don’t.
  • Describe your real risks. The Reform Act’s safe harbor for forward-looking statements only applies if a company’s cautionary statements are “meaningful.” In ordinary times, judges hesitate to apply the safe harbor unless the company’s risk disclosures feel like the real and dynamic risks the company faces and are not boilerplate or static. In these times, companies need to lay out their risks extra-authentically to have a decent shot at safe harbor protection. Here too, investors will hear hope in risk disclosures that aren’t extremely candid.

Here are practical tips to reduce the risk of a plaintiff’s lawyer or judge feeling like any false statement was made with intent to defraud:

  • Avoid unnecessary discretionary stock sales. A director or officer should not unnecessarily sell significant amounts of stock outside of 10b5-1 plans absent an understandable reason, which the company should disclose so their securities class action defense lawyer can use it to combat allegations of a motive for fraud. In these times, large, unexplained stock sales are more likely to be viewed as suspicious by judges.
  • Avoid executive compensation increases. Executives should be careful about taking new, enhanced, or special compensation. While I believe judges decide motions to dismiss based on whether they think executives are honest, and not whether they are well compensated, increased compensation during this time is perilous. Executive compensation cuts are a personal and company-specific matter, and I don’t think judges should or will judge an executive negatively based on failure to take cuts.
  • Let your candor shine. Candid, abundant, and generous disclosure will help executives avoid scienter allegations even if they said something that is technically inaccurate or misleading in context. Generous disclosure will help the judge see that executives were doing their best to be honest in challenging circumstances and find a way to dismiss the litigation. (For a discussion of the relationship between the falsity and scienter elements, please see my post “Falsity is Fundamental.”)

Shareholder Derivative Litigation

In general, directors will not be liable for harm to their corporations if they are engaged, informed, inquisitive, and avoid or appropriately address conflicts. As with corporate disclosures, governance will be judged by judges who understand that COVID-19 is a big deal for all people and companies, and directors who are engaged in genuine and documented ways will fare best.

Here are practical tips to avoiding governance problems and suits or, if one is filed, setting up a successful defense:

  • Trust your intuition. Companies set up processes for board engagement and often appropriately filter things to directors. That is perfectly fine for normal times, but in this environment, directors need to trust their intuition about what their companies need from them, and then engage in ways that make sense in the circumstances. This should be an explicit discussion: boards and management should decide together what information board should receive during this unprecedented time. Many judges are going to take almost a strict liability approach for directors, and fine distinctions between director and management duties aren’t going to predictably carry the day.
  • Don’t worry about liability. Just govern. Directors who are engaged and working hard have less to worry about than directors who worry that greater involvement will expose them to greater liability. I believe judges will apply the spirit of Good Samaritan laws – relieving good-faith helpers from liability – to director liability in this environment. Many directors and their advisors say, “nose in, fingers out.” In this crisis environment, I think directors need to have the courage to stick their fingers in – and toes too – if it’s helpful to management.
  • Be a trusted advisor to management. Be there for your executives holistically. They need your kindness, courage, and creativity – and maybe basic friendship – now more than ever.

The chance to help Washington Legal Foundation with a U.S. Supreme Court amicus brief in the Omnicare case was an honor.  Statements of opinion are ubiquitous in corporate communications on issues as diverse as asset valuations, strength of current performance, risk assessments, product quality, loss reserves, and progress toward corporate goals.  Many of these opinions are crucial to investors, providing them with unique information and insight.

Yet, for the first 20 years of my securities litigation career, the law governing evaluation of opinions was a tangle.  Omnicare gave me the opportunity to help improve the law in this important area, and our amicus brief shaped the Court’s standard for what makes an opinion false or misleading – a standard the Court said is “no small task” for a plaintiff to meet.

In the five years since the decision, Omnicare has helped defendants win more cases.  But we in the defense bar can use Omnicare better, as my colleagues and I explain in this WLF Legal Backgrounder:

Omnicare, Five Years Later: Strategies for Securities Defense Lawyers’ More Effective Use of the Decision