In my law practice, I defend particular clients in particular securities and governance cases.  My mission is to get them through the litigation safely and comfortably.

But I’ve always had a broader interest in securities law and practice as well.  After Congress passed the Private Securities Litigation Reform Act of 1995, I read and chronicled every Reform Act court decision over the next several years.  As a senior associate and, later, a junior partner, I wrote articles, helped my mentors prepare for speeches, and then started speaking myself.  I also began to discuss securities litigation issues behind the scenes with other defense lawyers, plaintiffs’ lawyers, and D&O insurers and brokers, and enjoyed the collegiality those discussions involved.

My connection with this broader group of repeat players in securities litigation was the seed of the D&O Discourse blog—my posts are basically the types of discussions I’ve had over the years.  In setting up the blog, I got good advice from mentors:  write with at least one specific person in mind; address issues I care about; and avoid trying to chronicle new developments.  That advice led to the feature of the blog people seem to like the most:  I call it like I see it.  But, to be candid about this too, I get butterflies every time I hit “enter” to send a pointed post out into the insensitive internet.

I’m grateful for the time my colleagues let me spend on the blog; for friends who generously take time to kick around draft posts; and for readers who take time to read what I write—it’s still humbling that so many people care what I have to say.

People sometimes ask me about my favorite posts.  Here is a list of one of my favorite posts from each year of the blog:

Today, my colleague Kristin Beneski and I were honored to file a US Supreme Court amicus brief on behalf of the Washington Legal Foundation (“WLF”) in Cyan, Inc. v. Beaver County Employees Retirement Fund.

In Cyan, the Supreme Court will decide whether state courts have jurisdiction over securities class actions alleging violations of the Securities Act of 1933, or if federal courts have exclusive jurisdiction.

In support of Cyan’s position that federal courts have exclusive jurisdiction, WLF argues that Congress intended that all securities class actions, both under Sections 11 and 12 of the 1933 Act as well as under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, be brought in federal court and decided under federal substantive and procedural law.  WLF agrees with the defendants’ interpretation of the statute at issue, the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”).  WLF then examines the entire statutory and judicial framework within which SLUSA operates—including the Private Securities Litigation Reform Act of 1995 (“Reform Act”), which SLUSA sought to reinforce—to argue that allowing state-court 1933 Act class actions would undermine the carefully balanced securities litigation system that Congress and the Court created and have sought to maintain.

Here is WLF’s Summary of Argument:

“WLF agrees with the textual arguments advanced by Petitioners in this case.  SLUSA’s full context reinforces them.  SLUSA is one piece of a multipart and interconnected regulatory scheme governing securities litigation.  WLF submits this brief to clarify the meaning of SLUSA by examining the broader legislative framework within which the statute was designed to operate.

SLUSA was designed to prevent plaintiffs from circumventing the Reform Act, which in turn was designed to discourage the filing of abusive, unmeritorious class actions resulting in extortionate settlements—to the ultimate detriment of shareholders and the economy as a whole.  When viewed in that context, it is overwhelmingly clear that SLUSA meant to establish exclusive federal-court jurisdiction over virtually all securities class actions, and thereby maintain a system in which related claims are consolidated and heard in the same federal forum at the same time, governed by the consistent standards established by the Reform Act.

The proper interpretation of SLUSA becomes even more clear upon examining the practical consequences of upholding Countrywide.  The same class of plaintiffs commonly asserts closely related claims for violation of Sections 11 or 12(a)(2) (under the 1933 Act) and Section 10(b) (under the 1934 Act).  These claims often challenge the very same allegedly false or misleading statements, and by definition involve identical class-wide causation issues.  The Reform Act and SLUSA envision that these intimately related claims will be consolidated and heard in the same federal forum, and would be subject to the “uniform standards” applied by all federal courts.

But under the interpretation of SLUSA adopted by Countrywide, plaintiffs can decide to split the Section 11 and 12(a)(2) claims from the 10(b) claims, filing the former in state court while the latter proceed in federal court.  Because Countrywide holds that a removal bar applies to securities class actions filed in state court, the 1933 Act claims cannot be consolidated with related 10(b) claims and must proceed in different courts, heard by different judges, subject to different procedural standards and pleading rules.  This results in wasted judicial resources, inconsistent results, and undue burdens on parties that must defend themselves on multiple fronts in already-expensive litigation.  More importantly, concurrent jurisdiction is antithetical to SLUSA’s stated purpose of preventing circumvention of the Reform Act and establishing a system of “uniform standards” governing class actions involving nationally traded securities.

Concurrent jurisdiction of 1933 Act claims would have broad ramifications for 1934 Act claims as well.  Under Countrywide’s interpretation of SLUSA, not only would the Reform Act’s protections be inapplicable to Section 11 and 12(a)(2) claims filed in state courts, but its consolidation and lead-plaintiff appointment procedure, automatic discovery stay, and heightened pleading standards would also be seriously undermined as to any related Section 10(b) claims proceeding simultaneously in federal court.  For instance, the automatic stay of discovery in a Section 10(b) case becomes a weaker shield against abusive lawsuits when discovery can proceed full bore in a closely related state-court case.  Likewise, plaintiffs who file their Section 11 and 12(a)(2) claims in state court do not have to hand control of the lawsuit to the lead plaintiff who is the “most adequate” class representative, and can more easily avoid the requirement of pleading claims that sound in fraud with particularity.

Thus, interpreting SLUSA to allow for concurrent jurisdiction of 1933 Act claims would undermine the Reform Act in a far-reaching way that Congress could not have intended.  In practical effect, allowing for concurrent jurisdiction would expand the Rule 10b–5 implied right of action beyond the limited scope Congress understood it to have.  See Stoneridge Inv. Partners, LLC v. Scientific–Atlanta, 552 U.S. 148, 165–66 (2008) (“[W]hen [the Reform Act] was enacted, Congress accepted the *** private cause of action as then defined but chose to extend it no further.”).  This would be a drastic shift.  Absent a clear directive otherwise, this Court should decline to upset the carefully balanced securities litigation framework that Congress created and sought to reinforce by enacting SLUSA.”

You can read the entire brief here.

In addition to the WLF lawyers with whom we worked, we would like to thank our colleagues Heidi Bradley, Aaron Brecher, Genevieve York-Erwin, and Taylor Washburn for their help with the brief.  We would also like to thank John McCarrick of White and Williams for his helpful strategic contributions.

How will the 2017 arrival of Justice Neil Gorsuch influence the US Supreme Court’s securities-fraud jurisprudence?

My colleague Kristin Beneski and I discuss this question in a Washington Legal Foundation Working Paper titled “US Supreme Court Securities-Fraud Jurisprudence:  An Emerging New Direction?”

In our Working Paper, we analyze whether Justice Gorsuch may urge the Court to chip away at the viability of securities class actions—such as by revisiting the Basic v. Levinson fraud-on-the-market presumption or narrowing the meaning of scienter—and whether he may push for a return to the days of caveat emptor and the puffery doctrine in evaluating the falsity and materiality of statements challenged as fraudulent.  We also question whether such possible jurisprudential shifts would be in the best interest of securities-fraud defendants.

I hope you’ll review our Working Paper (here).

 

 

SEC Commissioner Michael Piwowar recently said that the SEC is open to allowing companies that are going public to provide for mandatory shareholder arbitration in their corporate charters.  Piwowar’s remarks have prompted a firestorm of discussion of the issue of mandatory arbitration of securities class actions, including helpful analyses by Alison Frankel and Kevin LaCroix of issues that arbitration provisions would raise.

If Piwowar’s thought turns into action, there will be numerous public policy and legal issues to sort out—including whether a corporate charter can bind an individual purchaser of stock asserting an individual claim based on an offering or secondary-market purchase, as opposed to a current stockholder asserting a corporate claim in a derivative action.

I will set those tricky issues aside for now—they would be the subject of much analysis and intense battles between investor advocates and some corporate-interest advocates.

But first, we defense lawyers should sort out whether a system of securities litigation without securities class actions, including a system of arbitrations, would be helpful to defendants.

I believe the idea of mandatory securities disclosure arbitrations is a bad one—for defendants.

Our current securities-litigation system is straightforward, predictable, and manageable.  There is a relatively small group of plaintiffs’ firms that file securities class actions.  The Private Securities Litigation Reform Act provides a framework for the procedural and substantive issues.  Securities class actions rarely go to trial, and they settle for a predictable amount.  Indeed, executives who do their best to tell the truth really have nothing to fear under the securities laws.  The law gives them plenty of protection, and the predictability of the current system allows them to understand their risk and resolve litigation with certainty.  There are certainly problems with the current system, but as I recently wrote, they primarily stem from the splintered structure of the defense bar and the skyrocketing legal fees charged by the typical defense firms—not from the litigation itself.

The allure of abolishing securities class actions is that securities disclosure litigation would be greatly reduced.  But that’s a Siren song.  A system of arbitration of securities disputes would not rid us of securities disclosure claims.  Plaintiffs’ securities lawyers handle securities cases for a living, and they aren’t going to become baristas or bartenders if securities claims must be arbitrated.  They will simply initiate arbitrations on behalf of their clients.

These arbitrations would be unmanageable.  Each plaintiffs’ firm would recruit multiple plaintiffs to initiate one or more arbitrations—resulting in potentially dozens of arbitrations over a disclosure problem.  Large firms would initiate arbitrations on behalf of the institutional investors with whom they’ve forged relationships, as the Reform Act envisioned.  Smaller plaintiffs’ firms would initiate arbitrations on behalf of groups of retail investors, which have made a comeback in recent years.  We often object to lead-plaintiff groups because of the difficulty of dealing with a group of plaintiffs instead of just one.  In a world without securities class actions, the adversary would be far, far worse—a collection of plaintiffs and plaintiffs’ firms with no set of rules for getting along.

Securities-disclosure arbitrations would cost multiple times more to defend and resolve.

  • Motions to dismiss would cost more.  Some motion to dismiss arguments would be the same, but some would be different due to differences in the cases and plaintiffs’ counsel, so the total cost of motions to dismiss would increase.  The defendants would need to defeat each and every arbitration claim on a motion to dismiss to avoid discovery of the same scope faced in a securities class action that has survived a motion to dismiss.
  • Discovery burdens would increase.  More cases would involve discovery.  If any of the arbitration claims were to survive a motion to dismiss, a company would be subject to discovery, meaning that there would likely be discovery in the vast majority of securities disclosure arbitrations, as opposed to just less than half today.  Discovery would be broader too.  If multiple claims survive, defendants would face overlapping and inconsistent obligations.  It’s easy to imagine at least one arbitrator out of the many arbitrators handling similar claims allowing very broad discovery.  That single ruling would define the defendants’ discovery burdens.
  • Settlement would be more expensive.  If securities class action opt-out litigation experience is indicative of the settlement value of such cases, they would tend to settle for a larger percentage of damages than today’s securities class actions.  Settlement logistics would be vastly more difficult too.  It’s hard enough to mediate with one plaintiffs’ firm and one lead plaintiff.  Imagine mediation with a dozen or more plaintiffs’ firms, each representing multiple plaintiffs.
  • Settlement would not yield finality and peace.  Even when settlement could be achieved, it wouldn’t preclude suits by other purchasers during the period of inflation alleged in the arbitrations because there would be no due process procedure to bind them, as there is when there’s a certified class with notice and an opportunity to object or opt out.  Indeed, there likely would develop a trend of random follow-up arbitrations by even smaller plaintiffs’ firms after the larger cases have settled.  There would be no peace absent the expiration of the statute of limitations.

This parade of horribles just scratches the surface, but it suffices to show that mandatory securities arbitration is a bad idea for defendants.

We have a prominent example of how disheveled securities litigation can be without the securities class action mechanism to provide certainty and peace: limited federal-court jurisdiction under Morrison v. National Australia Bank, 561 U.S. 247 (2010).  If the post-Morrison framework is any indication of what we would face with securities arbitrations, look out—Morrison has caused the proliferation of unbelievably expensive litigation around the world, without the ability to effectively coordinate or settle it for a reasonable amount with certain releases.

These unmanageable and unpredictable economics would disrupt D&O insurance purchasing decisions and cost.  Under the current system, D&O insurers and brokers can reliably predict the risk a particular company faces based on its size and other characteristics.  A company can thus purchase a D&O insurance program that fits its risk profile.

Compounding the uncertainty of all of this would be the role of SEC and other government enforcement.  Even with the regulatory relief promised by new SEC Chair Jay Clayton, the job of the human beings who work at the SEC is to investigate and enforce the securities laws.  They aren’t going to not do their jobs just because government regulation has been eased in the bigger picture.  And they will step in to fill the void left by the inability of plaintiffs to bring securities class actions.  Experienced defense counsel can predict how plaintiffs’ firms will litigate and resolve a securities class action, but they have much less ability to predict how an enforcement person with whom he or she may never have dealt will approach a case.

The idea of abolishing securities class actions comes up from time to time.  Fortunately for defendants, it hasn’t become reality.  The world of securities litigation with securities class actions is far safer for companies and their directors and officers than it would be without them.  Predictability of the process and outcomes are key to a manageable system of resolving securities disclosure disputes.  Mandatory arbitration would disrupt both process and outcomes.

I hope the current idea blows over.

I’d like to update D&O Discourse readers on our companion blog, D&O Developments, launched last spring.

As a reminder, D&O Developments primarily reports and digests published appellate decisions in Private Securities Litigation Reform Act cases.  D&O Developments complements 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.

Various members of our Securities Litigation Practice Group contribute pieces to D&O Developments.  Over the past quarter, my colleagues have published many helpful posts:

In addition, Bret Finkelstein and I wrote an article for Washington Legal Foundation’s Legal Pulse blog about the Align Technology decision:

Please consider subscribing to D&O Developments as well as D&O Discourse, through the Subscribe function located on the right-hand side of the page of both blogs.  Just scroll down a little, enter your email address, and click “Subscribe.”

Thank you for your support of D&O Discourse.  I hope you’re enjoying D&O Developments as well.

In a matter of first impression in the Ninth Circuit, the court applied the Supreme Court’s Omnicare standard for pleading the falsity of a statement of opinion in City of Dearborn Heights Act 345 Police & Fire Retirement System v. Align Technology, Inc., — F.3d —, 2017 WL 1753276 (9th Cir. May 5, 2017).  The Ninth Circuit decision builds on the momentum for the defense bar following the 2016 Second Circuit opinion in Tongue v. Sanofi, 816 F.3d 199 (2d Cir. 2016), correctly applies the rationale of Omnicare to Section 10(b) cases, and applies the Omnicare falsity analysis to an important category of statements of opinion: accounting reserves.

My colleague Bret Finkelstein and I wrote about Align for Washington Legal Foundation’s The Legal Pulse blog.  To read our analysis, please see our post.

I am grateful for the enthusiastic feedback I’ve received on my three-part blog post “Who is Winning the Securities Class Action War—Plaintiffs or Defendants?”  I especially appreciate the time Kevin LaCroix took to write a post addressing my post in his leading blog, The D&O Diary.

With the benefit of 25 years’ experience defending directors and officers in securities class actions, shareholder derivative actions, and SEC investigations, I’ve had a front-row seat to the dynamics I described in my three-part post.  Directors and officers expect that their D&O insurance will protect them when they are sued.  They expect a high-quality defense at a cost that allows them to defend the litigation on the merits and to settle when it’s strategically smart, at a price that doesn’t bespeak guilt.

But I’m deeply concerned that directors and officers are getting far less than they expect—and it’s a double-whammy: while the cost of securities litigation defense has dramatically increased, the quality of this expensive defense has dramatically decreased.  To be sure, a handful of defense firms provide a quality defense at a price that’s appropriate for the size of the litigation, especially in the so-called “mega cases.”  However, in smaller cases, and overall, directors and officers face far greater reputational and financial risk than they appreciate.  They expect better—and deserve better—from their lawyers and D&O insurance.

So my main message is simple: for defendants, the securities class action system is broken.  The defense bar is highly splintered, comprising many dozens of firms, with multiple possible litigators within each firm.  Far too many non-specialists are hired to defend cases simply because their law firm is well-known or handles the company’s corporate work.  Although these lawyers know or can learn the basics of the law, they can never possess the things that set specialists apart, such as the years of investment necessary to build the trust of plaintiffs’ lawyers, mediators, and D&O insurers.  The quality of defense, overall, is far lower than it should be.  And, to add insult to injury, defendants typically pay a fortune for their defense, whether led by a specialist or generalist.

Securities class actions are manageable if they are defended correctly by the right lawyers for the particular case.  But securities class action defendants can’t be reasonably expected to select the right lawyers for their unique case.  The vast majority of director and officer defendants have never been through a securities class action before, and no one spends time researching whom they’d hire if they were to face a securities case someday.

Defendants are put in an awful position when a case is filed:

  • From one side, dozens of defense firms descend on them and bombard them with bold boasts.
  • From the other side, the company’s regular outside firm assures them that this is just a straightforward legal problem that their litigation department can easily handle just fine—and never mind that the law firm may have provided the legal advice on the very disclosures challenged in the litigation.

The result is near-anarchy—as I explained in Part II.

In contrast, as I explained in Part I, the plaintiffs’ bar comprises a relatively small number of full-time nationwide securities class action specialists.  Within this small group, there is nevertheless a diversity of types of firms that allows them to efficiently cover all types of cases, large and small.  The tailoring of plaintiffs’ firms to types of cases happens through self-selection inherent in firms picking particular cases to file, and through the lead plaintiff competition.  The contingent-fee nature of their cases creates further efficiency.

Defendants can’t win the securities class action war unless the defense bar can match the plaintiffs’ bar’s effectiveness and efficiency.  But to create the right defense bar, the defendants need help.  The best sources of help—indeed the only practical sources—are D&O insurers, as I explained in Part III.

Defendants are entitled to a defense that allows them to get through securities litigation safely and comfortably, and without any real financial risk.  Indeed, they already expect that their D&O insurers will take care of them.  Giving insurers a greater role in defending securities class actions will allow insurers to do exactly that.

I feel strongly about these issues and am encouraged by the agreement and enthusiasm I’ve heard from readers.  But I’ve heard a bit of skepticism too, and would like to briefly address it.

How can defendants be losing the war given the high dismissal rate and various legislative and Supreme Court successes?

The big picture.  Before evaluating individual battles, it’s useful to look at the big picture—and it’s bleak.  Securities litigation defense, as a practical matter, doesn’t even involve defending securities litigation anymore.  Settlement values as a percentage of damages are increasing.  Defense costs are skyrocketing. Cases can’t be defended through summary judgment without risking that there won’t be enough insurance limits to cover both defense costs and a settlement.  In my experience, most of the defense bar doesn’t actually defend cases past the motion to dismiss stage anymore.  If defendants lose the motion to dismiss and defense counsel aren’t prepared to press a defense through summary judgment and toward trial (because of stage fright, fear of an economic catastrophe, or both), the only rational economic approach is to settle the case—and the plaintiffs’ bar is keenly aware of that dynamic.

Indeed, the words “litigation” and “defense” in the phrase “securities litigation defense” are misnomers.  It’s hard to say that defendants are winning the war when they don’t actually fight.

Dismissal rate.  As I wrote in Part II, the relatively high dismissal rate masks the defense side’s dysfunction.  The right question to ask is how much higher the dismissal rate would be if securities class action defense bar comprised specialists, not generalists.  While there can be no accurate answer to this hypothetical, I firmly believe defendants would win more than they do now.  And I would guess it would be a lot more—maybe even 50% more.

U.S. Supreme Court.  Although defendants have technically prevailed in most of the U.S. Supreme Court securities cases over the last decade, most of the decisions haven’t been very helpful to defendants in the big picture, outside of clarifying the standards for pleading falsity (Omnicare) and scienter (Tellabs).  For example, Janus and Dura basically just restated the law; Amgen and Halliburton I were virtually meaningless; Halliburton II may well have had the lowest impact-to-fanfare ratio of any Supreme Court decision, ever; and Morrison backfired.

Legislative.  Although it has had some unintended consequences, the Private Securities Litigation Reform Act of 1995 was indeed a victory for the defense bar (as was the Securities Litigation Uniform Standards Act of 1998).

The Reform Act illustrates the benefits of a specialized defense bar.  With support from Silicon Valley securities litigators—the primary firms for oft-sued technology companies—defendants literally changed the rules of engagement.  Indeed, my ideal securities class action defense bar would be very similar to the experience and economics of the Silicon Valley defense bar as it existed in 1995—as I discussed in Part II.

Isn’t the plaintiffs’ bar splintered too, given the diversity in types of firms and target defendants?

Over the past several years, I have written extensively about the evolution of the securities class action plaintiffs’ bar—which I summarized in Part I.  The plaintiffs’ bar is indeed diverse, and the leaders of the dozen or so firms that bring cases certainly aren’t best friends.

But my point isn’t that the plaintiffs’ firms are homogeneous or friendly.  It’s that the plaintiffs’ bar is specialized and small enough that they can be cohesive.  They know who’s who, and they know who’s doing what.  And they have the capacity to appreciate what is, and isn’t, in the interests of the plaintiffs’ bar as a whole.

That type of cohesion is non-existent in the defense bar.  It is simply too splintered—as I explained in Part II.  Despite having defended securities litigation for 25 years and full time for the past 20 years, I don’t even recognize the names of many of the defense lawyers listed on the dockets.

How can insurers create better cohesion in the defense bar, given the highly competitive business of D&O insurance?

To be sure, the D&O insurance community is large and competitive, with more than 50 markets writing primary and excess policies.  Despite these issues the D&O insurance community is structurally unified.

  • The community of D&O insurers comprises a relatively small, strong, and specialized group of companies and people.  There is a small number of repeat-player primary insurers.  At the less frequent primary and excess insurers, the underwriting and claims leadership is knowledgeable and strong—some of the most prominent professionals work there.  These insurers are represented by a small and highly specialized bar of outside lawyers, who drive thought leadership across all carriers.  The leading D&O insurance brokers also drive thought leadership. Professional organizations such as Advisen and PLUS further bring people and ideas together.  This community of shared interests creates a common analytic framework, lexicon, and culture.
  • D&O insurers’ strongest structural bond is their economic incentive to win both individual securities class action battles and the securities class action war.  Indeed, they are the only group that cares both about individual cases and the big picture.  Defendants themselves only care about winning the individual cases against them.  D&O insurers share this goal, but they also care about all of the other cases as well—not just the ones they insure, but the other cases too, because they shape the legal and economic landscape and thus the risks they insure.

D&O insurers have substantial securities litigation expertise.  The leading D&O insurance professionals have multiples more experience evaluating defense and resolution strategies than even the most prominent securities defense lawyers, and can provide significant strategic insights.  Indeed, if I were sued in a securities class action and could assemble a dream defense team, I would hire a prominent D&O insurance lawyer on the team as a strategic quarterback—on securities class action issues.

Defendants’ success or failure in the securities class action war has significant implications for D&O insurance professionals.  The lack of actual litigation defense in securities class actions will eliminate the need for any real claims management.  That, in turn, will result in the death of any meaningful role by D&O insurers in the defense of securities litigation.  The role of D&O insurance claims professionals will be merely to determine when defense costs have exhausted the policy limits.  What a tragedy that would be not just for them, but also for defendants and specialized defense counsel who value their input, insight, and collegiality.

Do public companies really want their D&O insurers involved in the defense of claims?

If I had one wish concerning D&O insurance, it would be to dispel the myth that public companies distrust D&O insurers and don’t want them to stick their noses into the defense of a claim.

This myth is perpetuated by frequently contentious claims experiences, in which insureds’ representatives argue for coverage of defense costs and settlements that insurers are reluctant to pay.  But these disagreements are just a symptom of a problem—they don’t identify the underlying problem.  In my experience, the problem is most often defense lawyers, who set up their clients to have a strained relationship with their insurers, so that the lawyers have maximum freedom to do whatever tasks they want, at whatever cost they want to charge.  Most public companies have never been through a securities class action before and have no idea what tasks are required and what they should cost.  But D&O insurers do.  And that’s the root of the problem.

So, defense lawyers condition their clients to believe D&O insurers are an adversary.  But pre-claim, directors and officers don’t think that way.  As I look back on the clients I’ve defended or advised on D&O insurance procurement, I can’t think of any who believed the insurer was an adversary.  Just the opposite is true: they’ve often expressly regarded the D&O insurer as a teammate in the defense of the case.

This has been true even in my most difficult securities fraud cases.  I’ve never had an insurer even seriously threaten to deny coverage on the basis of the fraud exclusion.  An actual fraud-exclusion coverage denial is almost unthinkable under current policies, which exclude coverage only for finally adjudicated fraud in the case at hand.  Nearly all cases settle, so the fraud exclusion isn’t even in play.  And even a finally adjudicated securities fraud judgment would not often trigger the fraud exclusion, since the scienter standard under Section 10(b) is “recklessness,” not intentional fraud.  For these reasons, any concern about the need for “regular” Cumis counsel in duty-to-defend cases is misplaced; far from regular, it would be rare.

Would public companies buy a policy giving D&O insurers greater control of the defense?

I strongly believe that there would be high demand for D&O insurance that placed greater control of the defense of claims in the hands of insurers—including an optional duty to defend feature.

In exchange for a reduction in premium or the self-insured retention, such a policy would be highly attractive to public companies, especially smaller companies, for which even five- or six-figure savings can mean the difference between profit and loss, and success and failure.

I appreciate that the idea of greater insurer control of the defense of public company D&O claims is novel.  But I strongly believe it’s time for D&O insurers and brokers to re-think the structure of defense of D&O claims.

Currently, the line between indemnity and duty-to-defend is drawn at public versus private companies.  A much more commercially logical line would be smaller public companies versus larger public companies.  Just as many private companies would prefer the flexibility of indemnity insurance, many smaller public companies would prefer the certainty and efficiency of a duty-to-defend option.

Smaller public companies—say those with market capitalization of $1 billion or less—often lack larger-company infrastructure.  They need and would welcome more insurer control and less financial risk.  And with the increasing number of claims by smaller plaintiffs’ firms against smaller public companies now a permanent part of the securities class action landscape, now is a good time for insurers to make this type of change.

But even many larger companies would welcome more insurer control of claims, including a duty-to-defend option, in exchange for some reduction in the premium or self-insured retention.  I’ve never met a CFO who didn’t want to save money on insurance.  And, unfortunately for us lawyers, very few individual defendants are beholden to any particular lawyer or law firm—that type of connection typically happens at the level of in-house counsel, who unlike directors and officers, are not named as individual defendants in securities class actions.

The key for the success of a D&O policy with greater insurer control would be the quality of the defense.  As the party with the biggest financial stake in the individual case and overall, D&O insurers certainly would ensure that the quality of the defense is high, and as repeat players, they know who’s who and are better situated than defendants to pick the right lawyers.

So I strongly disagree with any assertion that public companies wouldn’t buy such a product and brokers wouldn’t sell it.  If the quality of the defense is high, and the price is lower through lower premiums and/or retentions, companies will buy it.  And if they will buy it, brokers will sell it.  It’s just basic economics.

This is the third of a three-part post that analyzes why plaintiffs are winning the securities class action war and what defendants can do about it.

At stake is a system of securities litigation that sets up one side or the other to win more cases in the long term.  It has real-world consequences for directors and officers—they expect companies, D&O insurers and brokers, and the securities defense bar to fight for a system of securities litigation defense that will allow them to get through a securities case comfortably and safely.

But despite winning many battles, defendants are losing the war.

Part I of this three-part post explained that the plaintiffs’ bar is back, and better than ever.  It comprises a small group of about a dozen firms with lead partners who are full-time national securities litigators.  Given the size and focus, the plaintiffs’ bar is specialized and has the capacity to coordinate.

Part II explained that, in contrast, the defense bar is splintered, relatively inexperienced, and highly inefficient.

This third and final part discusses how defendants can overcome these disadvantages and close the gap between the plaintiffs’ bar and defense bar.

The Potential Paths Forward

Because the current path is leading to a strategic and economic cliff—as I’ve mapped out in Part I and Part II—we need to backtrack, examine the landscape, and pick the right path forward.  What are the possible paths?

Elimination or Further Reform of Securities Class Actions

One alternative path is to try to kill securities class actions, or further undermine them.  Over the years, various constituents have sought to eliminate or reform securities cases.  Most recently, in Halliburton Co. v. Erica P. John Fund, Inc., 134 S. Ct. 2398 (2014), the U.S. Chamber of Commerce and others supported Halliburton in trying to abolish the fraud-on-the-market presumption established in Basic Inc. v. Levinson, 485 U.S. 224 (1988)—the legal mechanism that allows securities cases to proceed as class actions.  And, of course, industry groups achieved a significant legislative victory in 1995, through the Private Securities Litigation Reform Act.

Continuing to try to kill securities class actions would be an enormous error.  Securities class actions are far superior for defendants than the alternatives.  If securities class actions didn’t exist, the plaintiffs’ bar would adjust, not perish.  In place of class actions, they would file non-class securities actions that would be vastly less manageable than class actions.  For evidence of what would happen without a class action mechanism, we need look no further than the global securities class action landscape in the wake of Morrison v. National Australia Bank, 561 U.S. 247 (2010).  And without securities class actions as an enforcement safety net, the SEC would doubtless increase enforcement.  Companies are better off with one of a handful of plaintiffs’ lawyers as an adversary than an often-unknown and aggressive SEC enforcement lawyer.  (I examined this question in depth, in my post “Be Careful What You Wish For, Part II: Would Companies Be Better Off Without the Fraud-on-the-Market Doctrine?”)

Further legislative reform could be helpful.  The Reform Act mostly has helped defendants—though it has come with a steep price tag, as I mentioned in Part I.  Although I could come up with some additional defendant-friendly reforms, they would mostly be about correcting problems the Reform Act has caused (see, for example, my post ”Be Careful What You Wish For, Part I: Does the Reform Act Need Reforming?”) or improving litigation procedures (see, for example, my post “5 Wishes for Securities Litigation Defense: Early Damages Analysis and Discovery”).

Most defense lawyers would probably suggest further raising the pleading standards.  I don’t think that would help much.  I’ve always believed that the top of the plaintiffs’ bar isn’t really bothered by higher pleading burdens—at core, pleading a fraud claim involves convincing a judge that the defendants are bad-guys, and a good motion to dismiss involves convincing a judge that the defendants are good-guys.  The pleading standards are just a way to convey those arguments.  Plaintiffs’ lawyers are still able to get past motions to dismiss in a high percentage of cases and certainly in the lion’s share of difficult cases.  Even with even higher pleading standards, the plaintiffs would still file cases they think are the right ones, and I’d predict they’d defeat motions to dismiss at roughly the same rate.

Formation of Industry Groups to Oversee Securities Class Actions

Another alternative path is to form industry groups to create cohesion among groups of defendants—for example, technology companies, biotechs, retailers, etc.  Many years ago, this type of securities-litigation cohesion worked for accounting firms who, as a group, were a formidable foe.  They were represented by a small group of lawyers—there were just a few key lawyers.  Although the accounting firms were fierce competitors in the business of auditing, they took a big-picture approach to the industry’s litigation risk.  Together, they basically chased off the plaintiffs’ securities bar.  Indeed, today accounting firms are typically joined as a securities class action defendant along with its audit client only in the very largest cases.

Part of accounting firms’ success, and the reason they aren’t sued much anymore, is the Supreme Court’s abolition of aiding-and-abetting liability, in Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164 (1994).  But it’s more than that.  Auditors make statements that can still yield primary liability—most typically, by opining that a company’s financial statements conform with GAAP and the audit was performed in accordance with GAAS.  But accounting firms, with their small bar of specialized lawyers, helped to largely insulate those statements from attack under the securities laws.  And when accounting firms were sued along with their audit clients, the accounting firms’ specialized and experienced lawyers brought significant firepower to the defense group—making the claim against the main defendants, the company and their officers and directors, more difficult.  As a result, plaintiffs’ firms have sued accounting firms less and less.

Can public companies adopt this type of cohesive approach as a path forward?  Unfortunately, a number of factors suggest it wouldn’t work.  The types of companies sued in securities class actions are far more numerous and diverse than the Big-X accounting firms.  I watch the cases come over the transom, and the companies sued are a real mishmash, even if the types of cases seem to align in a dozen or so buckets.  Even the technology industry—historically the most frequently sued type of company, and the industry that primarily spurred the adoption of the Reform Act—isn’t sued with the consistency it once was.  Biotech companies are probably the best candidate for a cohesive approach, but most of those companies have their heads down working on their drug candidates, without the time or resources necessary to coordinate.

But most fundamentally, it’s hard to imagine that any group of potential-defendant companies could come together and agree on a small, focused set of securities defense specialists to defend cases against them—or to engage in enough repeat hiring that such a set would naturally develop.  Once again, one of the core problems with securities litigation defense is the hordes of lawyers who comprise the so-called “securities defense bar.”  Until that fundamental problem is fixed, the quality of defense will continue to suffer, and the cost of even the current low-quality defense will remain ridiculously high.

Greater Control by D&O Insurers Is the Only Clear Path

While there is no group of defendants that can replicate the accounting-firm model, D&O insurers can play a similar unifying role across all categories of defendants.

In nearly every securities class action, there is a group of D&O insurer representatives associated with the defense of the litigation.  D&O insurers are the only repeat players on the defense side and as a group, they see the big picture in a way no defense firm ever could.  They have the greatest economic interest in the outcome—both overall and in individual cases.  A victory for the defendants is a victory for them.  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.  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.

Given this expertise and alignment of interests, defense counsel should involve insurers in the defense of the case as part of their responsibility to their clients.  Defense counsel should involve insurers 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.  And defense counsel who involve insurers undoubtedly help their clients make it through securities cases more successfully, efficiently, and comfortably than those who don’t.

Yet insurers usually are shut out of meaningful involvement in the defense, with most 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.

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.  But public-company D&O insurance is indemnity insurance:  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 liability limit.

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, the rights are not robust or frequently exercised.

Insurers often 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, they prefer that the insurer 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, particularly if it were offered at a slightly lower price or with lower self-insured retentions.  This is especially so for smaller public companies, for which the cost of D&O insurance and the self-insured retention can be real hardships and who often lack the resources of larger companies, such as in-house counsel.  Significantly, these are the types of companies against which the plaintiffs’ bar is bringing more and more securities class actions.  Outside directors also lack intense allegiance to any particular defense firm.  Loyalty to particular law firms is typically rooted at the level of in-house counsel, who are often beholden to particular law firms for personal reasons.  In contrast, smaller public companies and outside directors typically just want to be defended well, at no cost to them.

So why do insurers mistakenly think that the insureds would rather have them stay out of the defense of the claim?  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 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 us to go all-out 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’ve 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 thing 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 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.”
  • “We’ll need you to support us in these insurance disputes.  You don’t have to get involved directly—we can work with the insurer and broker directly if you agree.  Agree?  Good.”

That’s how defense lawyers set the insurer up as an adversary, but these self-serving talking points get several key things wrong:

  1. 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.
  2. 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.
  3. 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 typically 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.
  4. If 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 they 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 from that of defense counsel, these professionals are more sophisticated about securities litigation practice than the vast majority of defense lawyers.

D&O insurers most definitely have the practical ability to effect these changes.  Although the number of insurers may seem large to many, from my perspective it is a relatively small and close-knit group.  Every major D&O insurer has highly experienced internal or external claims personnel who track securities litigation developments very closely, in individual cases and the big picture.  There is a relatively small number of primary insurers who write the lion’s share of primary D&O policies.  And there is a handful of professionals who drive thought leadership.  Without question, the D&O insurance community is well-suited to be the glue that fixes the fractured defense bar.

All that would be necessary are a few simple D&O insurance contract modifications.  A duty to defend structure for a “Securities Claim” would work best, and I am certain it would be highly attractive to smaller companies, if offered at a lower premium or with a lower self-insured retention.  Since very few cases actually involve exclusion of coverage under the fraud exclusion, the lurking problem of conflicts of interest is often not present, and in any event can be cured by Cumis counsel (i.e., an attorney employed by a defendant in a lawsuit when there is a liability insurance policy covering the claim and there is a conflict between the defendant and the insurer arising from a coverage issue).

But even within the current indemnity structure, D&O insurers could easily tweak terms to give insurers a stronger voice in three areas:

>  Select the right defense counsel for the particular case—which would tend to create a defense bar that rivals the specialization of the plaintiffs’ bar.  Insurers don’t need to choose counsel for defendants to make sure that they have the right counsel in place.  They can require insureds to conduct an interview process that includes firms that they believe would be right for the case for strategic and/or economic reasons.  Currently, insurers can’t unreasonably refuse to consent to the insureds’ choice of counsel.  Although stronger counsel-selection language could easily be added—for example, that the insurer can propose a range of firms, and the insureds can’t unreasonably refuse to consent to the insurers’ options—even the current formulation allows insurers to reasonably refuse to consent to counsel who aren’t sufficiently experienced or are too expensive for the particular case.

>  Make defendant-focused strategic and settlement decisions—which would approximate the strategic coherence of the plaintiffs’ bar.  Insurers don’t need to have an attorney-client relationship with defense counsel to have a meaningful say in strategic decisions.  The current cooperation clause already gives them this right, and it could be slightly enhanced to make clear that insurers can and should provide strategic input about the full range of decisions.  In this way, insurers could not only make a difference in individual cases, but in the big picture, similar to a portfolio manager’s investment decision-making.

>  Use policy proceeds only for defense costs that further the defendants’ interests—which would allow defendants to approach the efficiency the plaintiffs’ bar achieves through their contingent- fee structure.  Insurers should be allowed to refuse to pay defense expenses that are not in the interests of the defendants—including billing rates and staffing practices that exceed what is reasonable and necessary.  Insurers simply need the contractual right to require a defense firm to live with the insurers’ decisions and prevent a defense firm from seeking reimbursement of unpaid amounts from the defendants.  In my experience, defendants actually believe that insurers are better able to judge what is reasonable than they are and are perfectly willing to defer to the insurer.  The rancor typically comes from defense counsel, not the insureds.

Again, a duty-to-defend option would be the very best way to accomplish necessary change.  But even these types of modest changes within the current indemnity-contract framework would enable D&O insurers to greatly improve securities class action defense.

A key consideration, of course, is whether brokers would be motivated to sell policies with these modifications.  I’m absolutely certain that directors and officers would want to buy them.

And I’m confident that client-focused brokers would want to give their clients the option to purchase a policy that would help the particular client and the broader public-company community to defend securities class actions better.

Conclusion

The only way for defendants to win the securities class action war is to make the defense bar more effective and efficient.  And the only way to do so is for D&O insurers to have greater control of claims.  Defendants are entitled to a defense that allows them to get through securities litigation safely and comfortably, and without any real financial risk.  Indeed, they already expect that their D&O insurers will take care of them.  Giving insurers a greater role in defending securities class actions will allow insurers to do exactly that.

This is the second of a three-part post evaluating who is winning the securities class action war.

Part I explained that this war is not just a scorecard of wins and losses, but rather a fight for strategic positioning—about achieving a system of securities litigation that sets up plaintiffs or defendants to win more cases over the long term.  Despite winning many of the battles, defendants are losing the war because of the defense side’s lack of a centralized command, which creates a mismatch in expertise, experience, and efficiency.

The plaintiffs’ bar is relatively small, with about a dozen firms in the core group.  Their lead partners are full-time securities litigators who prosecute cases around the country.  They don’t dabble in different kinds of cases—they aren’t securities litigators on some days and antitrust or IP lawyers on others.  Because the bar is small and specialized, it has the practical ability to take common strategic, economic, and legal positions, even if they don’t always see eye-to-eye or get along personally.

Below, I contrast this small and specialized plaintiffs’ bar with the defense bar, and conclude that:

  1. The splintered structure of the defense bar creates a fundamental mismatch between plaintiffs and defendants;
  2. Defendants can only overcome this mismatch with greater centralized command; and
  3. This organizing function can only come from D&O insurers—a proposition I’ll explain in depth next week in Part III of this post.

Part II: The Defense Bar

The Defense Bar is Splintered

In contrast to the small and specialized plaintiffs’ bar, there is an army of securities defense lawyers—but one with no coordinated set of strategic goals.  Every firm in the AmLaw 200 has a securities class action defense group and conceivably could be hired to defend a securities class action.  Each firm in the AmLaw 100 has a securities team they’d tout as a “leading” or otherwise strong practice—and among most of each of those firms, there are multiple partners who hold themselves out as securities litigation defense lawyers.  The number of defense lawyers who called themselves “securities litigators” skyrocketed during the 2005-08 stock option backdating scandal, which drew in more defense lawyers for separate representations and investigations.

All in, I’d guess there are 300 white-shoe U.S. law-firm partners who would advertise themselves as securities litigators for purposes of a securities case pitch, though most of these work on other types of commercial litigation as well, such as antitrust and IP.  The number of actual securities litigation senior partners on the defense side is a tiny fraction of this population—I’d bet around 30, or 10% of the so-called “securities defense bar.”

This small, specialized group comprises my mentors and my peers.  Although it is hired in enough cases to allow it to continue to defend securities cases full-time, it doesn’t handle the number or range of cases the group’s skill and experience otherwise justify because of the jam-packed defense field overall.  As a result, the average defense lawyer handles far fewer—and a narrower range of—cases than the average plaintiffs’ lawyer.

This is just one-half of a double-whammy for companies and their D&O insurers: the sub-optimal defense comes at an enormous cost to boot.  At the same time that the number of securities class actions filed against smaller companies is increasing—indeed, a recent study said that the size of securities cases had fallen to a level last seen in 1997—the amounts that most defense firms charge to defend litigation have increased exponentially.  This mismatch between 1997 case size and present-day law-firm economics creates the danger that a company’s D&O insurance program will be insufficient to cover the fees for a vigorous defense and the attendant price to resolve the case.  Indeed, I am greatly concerned that inadequate policy proceeds due to skyrocketing defense costs is becoming the biggest risk directors and officers face from securities litigation.

The defense-cost problem is exacerbated by the scarcity of securities litigation work for the hordes of litigation partners who hold themselves out as securities litigators.  Given the large group of lawyers competing for a limited number of cases, most of them are hired only sporadically—a case every year or two, at most—which creates pressure to maximize the billing revenue on each case.  That is also a key reason why defense hourly rates have increased so dramatically—by almost 50%—in less than ten years.

To illustrate the economic squeeze in securities class actions, consider hypothetical securities class actions against two smaller companies: 1997 Co., which carries $15 million in D&O insurance limits, and 2017 Co., which carries limits of $25 million.  (Smaller-company D&O insurance limits have increased since 1997, but not markedly.)  Assume settlements of $7.5 million in 1997 and $12.5 million in 2017.  Also assume that defense costs through summary judgment were $5 million in 1997 (cases against smaller companies are nevertheless often as labor-intensive as cases against larger companies) and $15 million in 2017, or triple the 1997 figure, corresponding to the tripling (or more) of the billing rates and partner profits of large law firms (“Big Law”).

  • Big Law defense of 1997 Co. makes some economic sense: $5 million in defense costs plus $7.5 million to settle equals $12.5 million—or $2.5 million less than the D&O insurance limits.
  • Big Law defense of 2017 Co. does not make economic sense: $15 million in defense costs plus $12.5 million to settle equals $27.5 million—or $2.5 million more than the D&O insurance limits.

However, when large firms with high billing rates and high associate-to-partner ratios try to reduce the cost of one case without changing their fundamental billing and staffing structure, they end up cutting corners by forgoing important tasks, delegating important roles in the case to junior attorneys or settling prematurely for an unnecessarily high amount.

It obviously makes no sense for a firm to charge $15 million to defend a case that can settle for $15 million.  It is even worse for that same firm to attempt to defend the case for $7 million instead of $15 million by cutting corners—whether by understaffing, overdelegating to junior lawyers, or avoiding important tasks.

It is worse still for law firms to charge $2 million through the motion-to-dismiss briefing and then, if they lose, to settle for more than $15 million just because they can’t defend the case economically past that point.  And it is a strategic and ethical minefield for a defense firm to charge $15 million and then settle for a larger amount than necessary so that the fees appear to be in line with the size of the case.

Obviously, companies and their directors and officers should not be subjected to these hazards—which are created not by the securities class action itself, but by the incentives inherent in law firm economics.

So, to sum up, we have a defense bar that is both (1) under-experienced and (2) over-priced and/or that cuts corners.  Quite obviously, on the defense side, the system is broken.

Nevertheless, the Defense Bar Wins a Lot of Battles

Yet a reasonable reader would ask, “if the defense bar is so over-matched, why do defendants win so many motions to dismiss?”

The defense bar obviously wins a lot of dismissals at the pleading stage.  But those victories are short-lived if the court grants the dismissal without prejudice, allowing the plaintiffs an opportunity to more carefully replead—often with the benefit of the court’s roadmap identifying the various defects in the initial complaint.  The skeptics need look no further than the liberal law of amendment, which courts often relax further to counterbalance the Reform Act’s pleading standards.  One court put it this way: “The PSLRA requires a plaintiff to plead a complaint of securities fraud with an unprecedented degree of specificity and detail. … In this technical and demanding corner of the law, the drafting of a cognizable complaint can be a matter of trial and error.” Eminence Capital, LLC v. Aspeon, Inc., 316 F.3d 1048, 1053 (9th Cir. 2002).

Cases that survive a motion to dismiss are increasingly settled before the cost of discovery mounts.  In days gone by, if the court denied the motion to dismiss, defendants would oppose class certification and defend the litigation through a summary judgment motion—in other words, defendants would actually defend the case.  Today, given skyrocketing defense costs, cases increasingly settle soon after the court denies a motion to dismiss, to avoid the danger that a company’s D&O insurance program will be insufficient to cover the fees for a vigorous defense and a settlement later in the case.  The splintered defense bar plays a role too: because of the absence of a coordinated strategic approach to issues of class certification and summary judgment, there often appears to be little strategic benefit to using these potentially valuable mechanisms to defeat plaintiffs’ claims.  Thus, in this era of ineffective and inefficient securities defense, securities class action defense involves use of only one of three pre-trial escape hatches—the motion to dismiss—and leaves class certification and summary judgment on the table.

So motions to dismiss are the whole ballgame these days.  And while, again, defendants obviously win a lot, they would win a lot more if the defense bar were more specialized and took a better strategic approach more often.  In keeping track of pending securities cases, I read a lot of motions to dismiss in cases around the country.  Some of them are good, but a great many of them are not.  Although some of the poor motions yield a dismissal anyway, too many cases aren’t dismissed that should be—and certainly the reason for many of those is a poorly constructed motion.

Whatever success defendants have under the Reform Act’s pleading standards, it comes at a high price.  It almost always makes sense to give a motion to dismiss a shot, even if it’s a long one.  And, whether the motion is an easy or difficult one, many defense firms take advantage of the Reform Act’s defense-friendly standards to do more work than is necessary at that point, rationalizing the extra work along these lines:

“If the motion is granted, no one will really mind if we’ve billed a lot.  Plus, we’ll ‘lose’ the case before we get to bill a lot in discovery.  If the motion is not granted, the extra work we did will give us a head start on the rest of the case.”

Indeed, a cynic would say that the system is a rigged game for defense firms.  Win or lose, they “win.”  If the case is dismissed, the defense firm has done a healthy amount of work and added a victory to its win-loss record.  And if the case isn’t dismissed, the defense firm still “wins,” because the case goes into discovery, which is notoriously expensive and almost impossible for a client or insurer to capably oversee.  The opaqueness of the system is exacerbated by the swashbuckling style of many defense lawyers, who set up a criticism-free moat around themselves by dint of being a prominent partner at a powerful law firm.

So, in a nutshell, (1) the defense bar’s lack of effectiveness squanders dismissal opportunities, while (2) their lack of efficiency (to put it politely) squanders insurance resources. The Reform Act’s high pleading standards tend to mask this problem—but a problem it is.

A reasonable reader would also ask, “if the defense bar is so over-matched, how have they accomplished so many Supreme Court and Legislative victories?”

This is more complex, but also supports my lament.  The Private Securities Litigation Reform Act of 1995 was a huge victory for the defense bar.  Although many people played a hand in its passage, a key group was the Silicon Valley securities defense bar—which in 1995 was a fairly small and experienced group of lawyers, including my former firm Wilson Sonsini, who defended a very high volume of securities litigation.  Indeed, in many ways, what I am arguing for is a return to the Silicon Valley firm defense bar and economics of the 1995.

On the judicial front, I don’t think the 10-year run of Supreme Court securities decisions has been very helpful outside of Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (2007), and Omnicare, Inc. v. Laborers Dist. Council Const. Indus. Pension Fund, 135 S. Ct. 1318 (2015).  Most of the decisions have been neutral—though they all caused a huge stir, and competing claims of victory, because they were Supreme Court decisions.

Some of the decisions are an attractive nuisance.  For example, in Halliburton Co. v. Erica P. John Fund, Inc., 134 S. Ct. 2398 (2014), the Court held that a defendant may rebut the fraud-on-the-market presumption of reliance at the class certification stage with evidence that the alleged misrepresentations did not impact the stock price.  Although it is a rare case in which a price-impact class certification can make a real difference in a case, it takes a lot of impulse control for a defense lawyer to turn down the chance to take a shot.  Others are examples of “be careful what you wish for.” For example, the jurisdictional limitations the Court set in Morrison v. National Australia Bank, 561 U.S. 247 (2010), have yielded enormously expensive multi-front international litigation that can’t easily be settled.

And despite the defense bar’s successes, such as they are, there is a complete inability for any coordination about the decision to seek Congressional or judicial change.  This is in large part due to the lack of visibility by other lawyers into what is happening in cases and the lack of familiarity with each other in the defense bar.  The plaintiffs’ bar, with its smaller size and greater specialization, doesn’t have those problems, at least to the same extent.  The prominent plaintiffs’ lawyers know what’s happening across the cases and know each other, and thus can at least try to stop someone from taking a misguided strategy.

We defense lawyers don’t have the same visibility or capacity to coordinate.  Even when defense counsel support an appeal on behalf of amici, they are forced to work within a trial and appellate strategy in which they weren’t involved, and which is sometimes shaped by a defense lawyer who isn’t a true specialist.  Certainly, the nature of the clients that plaintiffs and defendants represent can come into play—for example, a large pension fund cares about the state of the law more than Acme, which might only care about the case against it.  But the splintered structure of the defense bar prevents these discussions from even happening.

The Solution: Greater Insurer Control

These problems—a splintered, relatively inexperienced, and highly inefficient defense bar—are fundamental and structural.  There is a simple solution: in every securities class action, there is a group of D&O insurer representatives associated with the defense of the litigation.  As a group, D&O insurers see the big picture in securities class action in a way no defense lawyer ever could, and could easily provide input that would help solve these problems.

Although the number of D&O insurers may seem large to many, from my perspective it is a relatively small and close-knit group.  Every major D&O insurer has highly experienced internal or external claims personnel who track securities litigation developments very closely, in individual cases and the big picture.  There is a relatively small number of primary insurers who write the lion’s share of primary D&O policies.  And there is a handful of professionals who drive thought leadership.  Without question, the D&O insurance community is well-suited to be the glue that fixes the fractured defense bar.

Next week, I’ll explain in detail why and how the D&O insurance community can perform this critical function.  Please stay tuned.

 

The securities class action war is about far more than the height of the pleading hurdles plaintiffs must clear, the scorecard of motions to dismiss won and lost, or median settlement amounts.  It is a fight for strategic positioning—about achieving a system of securities litigation that sets up one side or the other to win more cases over the long term.  How this war plays out has real-world consequences for the people sued in securities class actions.

Defendants win a lot of battles.  The Private Securities Litigation Reform Act of 1995 was an enormous victory for the defense bar, imposing high pleading burdens on plaintiffs and establishing a safe harbor for forward-looking statements that, in Bill Lerach’s famous words, gives defendants “license to lie.”  The rate of dismissal is markedly higher than the dismissal rate in other types of complex federal litigation.  And cases that survive motions to dismiss typically settle for predictable amounts.

But despite their success in battle, defendants are losing the war.  The root of the problem is the defense side’s lack of a centralized command, which creates a mismatch in expertise, experience, and efficiency.

  • While the plaintiffs’ bar is relatively small, with about a dozen firms that dominate, the defense bar is highly splintered, comprising many dozens of firms that can credibly pitch a case, with multiple possible lead partners within each firm—some qualified and some, frankly, not qualified.  As a result, the average plaintiffs’ partner is many times more experienced than the average defense partner.
  • While the plaintiffs’ bar’s specialized composition and small size yield a unified approach, the splintered nature of the defense bar makes this impossible for defendants.
  • While the defense bar has achieved significant legislative and judicial success, it has come with costly collateral consequences.
  • While the plaintiffs’ bar’s contingent-fee structure incentivizes efficiency, the defense bar is wildly inefficient due to hourly billing and the view that D&O insurance reimbursement is “free money.”  This penalizes the defense firms’ clients—both in individual cases and on the whole—by leaving less insurance money for a vigorous defense and settlement.

How can the defense bar approximate the plaintiffs’ bar’s advantages?  Given the competitive legal environment and large-firm economics, the defense bar can’t achieve a centralized command on its own.  The only way to do so is to give greater control to D&O insurers, the player with the greatest economic and strategic stake in both individual cases and on the whole.

Winning the securities litigation war isn’t an abstraction or a dispute about allocation of money between law firms and insurance companies. It’s about the safety and comfort of real people who face securities litigation.  At the core of every securities case are people accused of doing something wrong—not just directors and officers, but also hard-working company employees who find themselves at the center of a securities suit.  Just the idea of securities class actions makes businesspeople uncomfortable.

So the most fundamental question we on the defense side must ask ourselves is: how does the system of securities litigation defense position directors and officers to withstand securities litigation safely and comfortably?

To state the obvious, defendants are entitled to a system that allows them a fair fight with sufficient insurance resources.

I have divided this analysis into three blog posts.  In this post (Part I), I explain how and why the plaintiffs’ bar is stronger than ever.  In my next post (Part II), I’ll analyze the current state of the defense bar and explain why defendants are losing the war despite winning many battles.  In the last post (Part III), I’ll explain why and how the solution to solving the current mismatch between counsel for plaintiffs and defendants lies in giving D&O insurers greater control of securities class action defense.

Part I: The Plaintiffs’ Bar Is Back—and Better than Ever

When I was a young lawyer, most of my cases were against Milberg Weiss Bershad Hynes & Lerach.  I still remember the San Diego office’s phone number by heart (619-231-1058)—remember when we had to call people to communicate with them?  Of course, there were several other strong plaintiffs’ firms and prominent lawyers, including some of my favorite lawyers in the plaintiffs’ bar—though from my vantage point, Lerach and Weiss loomed large.

The downfall of Lerach and Weiss is well-known, so I won’t recount it here.  Many defense lawyers still discuss it with odd glee.  To me, it was sad and unfortunate.  My direct contacts with them made huge impressions on me.  For example, one of Bill Lerach’s oral arguments remains the most impressive advocacy I’ve ever witnessed.  And I’ll always remember the throng of defense lawyers at the first IPO Securities Litigation hearing turning to watch Mel Weiss enter the Daniel Patrick Moynihan U.S. Courthouse Ceremonial Courtroom, on September 7, 2001.

Lerach and Weiss helped shape and police our system of disclosure and governance, and our markets, corporate governance, and retirement savings are better off for it.  I believe that most public company disclosure deciders see the image of Bill Lerach when they decide whether or not to disclose something.

So their exit naturally left a void in the plaintiffs’ bar.  But a remarkable thing has happened: their protégés, who are my contemporaries and counterparts—as well as other senior plaintiffs’ lawyers and their protégés, plus some new entrants into the plaintiffs’ securities class action market, described below—have not only filled the gap, but have bolstered the bar.  The plaintiffs’ bar is now back, and better than ever.

Looking back, several things converged to cause this.  The first was the stock options backdating scandal, which began with a study by University of Iowa professor Eric Lie that showed an unusually large number of stock option grants to executives at stock price lows.  Since few of the companies exposed in the scandal suffered stock-price drops, the vast majority of the dozens of options cases were filed as shareholder derivative claims, on behalf of the company, alleging breaches of fiduciary duty and proxy-statement misstatements.

At the time, the most prolific securities class action firm was Coughlin Stoia Geller Rudman & Robbins, the successor of Bill Lerach’s firm and the predecessor of Robbins Geller Rudman & Dowd.  If they filed a derivative suit on behalf of a company, it meant they could not sue the company in a securities class action.  For this simple reason, many people, including me, did not think they would file many options backdating derivative cases.

But they did—and they filed a lot of them.  Not only did they file a lot of them, they defeated motions to dismiss and achieved settlements involving unprecedented types of corporate governance reforms and plaintiffs’ attorneys’ fee awards.  Their large fee awards increased the fee awards of smaller plaintiffs’ firms.  By the time they were finished, the plaintiffs’ firms that filed options backdating cases made a mint.

Then, toward the end of the options backdating scandal, the credit crisis happened and started a new wave of shareholder litigation, this time both securities class actions and shareholder derivative actions.  The plaintiffs’ bar had a war chest and was ready for battle.  The larger plaintiffs’ firms won lead plaintiff roles in the mega securities class actions and also represented plaintiffs in large individual actions.

While that was going on, the Chinese reverse-merger scandal happened.  That created a new breed of securities class action plaintiffs’ firms.  Historically, the Reform Act’s lead plaintiff provisions incentivized plaintiffs’ firms to recruit institutional investors to serve as plaintiffs.  For the most part, institutional investors have retained the larger plaintiffs’ firms, and smaller plaintiffs’ firms have been left with individual investor clients who usually can’t beat out institutions for the lead-plaintiff role.  At the same time, securities class action economics tightened in all but the largest cases, placing a premium on experience, efficiency, and scale.  As a result, larger firms filed the lion’s share of the cases, and smaller plaintiffs’ firms were unable to compete effectively for the lead plaintiff role, or make much money on their litigation investments.

The China cases changed this dynamic.  Smaller plaintiffs’ firms initiated the lion’s share of them, as the larger firms were swamped with credit-crisis cases and likely were deterred by the relatively small damages, potentially high discovery costs, and uncertain insurance and company financial resources.  Moreover, these cases fit smaller firms’ capabilities well; nearly all of the cases had “lawsuit blueprints” such as auditor resignations and/or short-seller reports, thereby reducing the smaller firms’ investigative costs and increasing their likelihood of surviving a motion to dismiss (and thus reducing the likelihood of dismissal and no recovery).  The dismissal rate was indeed low, and limited insurance and company resources prompted early settlements in amounts that, while on the low side, yielded good outcomes for the smaller plaintiffs’ firms.

With these recoveries, these firms built up momentum that kept them going even after the wave of China cases subsided.  For the last several years, following almost every “lawsuit blueprint” announcement, a smaller firm has launched an “investigation” of the company, and they have initiated an increasing number of cases.  Like the China cases, these cases tend to be against smaller companies.  Thus, smaller plaintiffs’ firms have discovered a class of cases—cases against smaller companies that have suffered well-publicized problems (reducing the plaintiffs’ firms’ investigative costs) for which they can win the lead plaintiff role and that they can prosecute at a sufficient profit margin.

As smaller firms have gained further momentum, they have expanded the cases they initiate beyond “lawsuit blueprint” cases—and they continue to initiate and win lead-plaintiff contests primarily in cases against smaller companies brought by retail investors.  The securities litigation landscape now clearly consists of a combination of two different types of cases: smaller cases brought by a set of smaller plaintiffs’ firms on behalf of retail investors, and larger cases pursued by the larger plaintiffs’ firms on behalf of institutional investors.  This change is now more than five years old, and appears to be here to stay.

Plaintiffs firms thus have us surrounded—no public company can fly under the radar anymore.  Plaintiffs’ firms of all types have made a lot of money over the past decade.  They’re now filing a record number of cases, even subtracting out the federal-court merger cases.  And on the whole, they’re strong lawyers, with some genuine superstars among them.

Yet, though expanded, the number of firms is small, with about a dozen in the core group.  This gives them the practical ability to take common strategic, economic, and legal positions—even if they don’t always see eye-to-eye or get along.

***

Next week, in Part II, I’ll analyze the current state of the defense bar and explain why defendants are losing the war despite winning key legislative and judicial battles.  And the following week, in Part III, I’ll discuss why and how giving greater control of securities class action defense to D&O insurers would solve the current mismatch between counsel for plaintiffs and defendants.

Note:   I later published a wrap-up post in response to questions and comments I received.