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Directors and Officers Liability Update: Risk Trends for D&O Insurers
1. INTRODUCTION
With reinsurance and primary insurance capacity continuing to grow, the premiums charged for directors and officers liability insurance in 1999 dropped for the fourth consecutive year.1 The 1999 premium decrease averaged seven percent, and this latest decline followed a thirteen percent drop in 1998. Bucking this downward trend were premiums charged for high-tech and biotech companies with recent initial public offerings ("IPO's"). Such companies sometimes saw substantial premium increases. As in years past, the downward pressure on premium prices was accompanied by less restrictive policy language (e.g. higher limits of liability, lower deductibles and multi-year policies), and increases in the average claim cost of shareholder and employee claims (which continue to be the most frequent sources of D&O claims). Increased claim costs in a soft market invariably create the danger of adverse loss ratios and shrinking profit margins for D&O insurers. Given the downward pressure on premium rates and the upward pressure on the cost of D&O claims, thorough and comprehensive risk analysis is more important than ever. This paper will analyze the risks undertaken by D&O insurers by reviewing recent trends in securities class action and employment litigation, and by focusing special attention upon what many perceive is the increased risk presented by high-tech and Internet companies who have recently gone public.
2. RECENT DEVELOPMENTS IN SECURITIES CLASS ACTIONS
A. Initial Public Offerings: Dark Cloud on the Horizon for D&O Insurers? IPO's appear to present substantial risk for investors, and for the insurers of such companies. On Wall Street magazine reports that, despite an average aftermarket return of 104.1 percent for the 275 Internet-related IPO's in 1999, the actual returns ranged from -86.9 percent to +1,353.6 percent, with a standard deviation of nearly 205 percent.2 Nevertheless, investor's seem oblivious to such volatility, and have exhibited a huge appetite for such investments. In 1999, there were some 510 IPO's, which broke the 1996 record of 502, and which exceeded by 147 the 363 IPO's in 1998.3 Similarly, while the "risk factors" portion of an Internet company's prospectus will often run from 15 to 20 pages (contrasted with a historical norm of 10 pages or less), such disclosures seem to matter very little to potential investors.4 Cobalt Networks recently ran this risk disclosure, "[w]e cannot guarantee that..we will ever achieve or maintain significant revenues...[,]" and yet saw their share price skyrocket 75% since its initial offering.5 Market analysts are concerned that investor interest in IPO's is stoked by several questionable practices. For example, 59 of the 101 IPO's offered this year had their terms raised at least once prior to the offering.6 This practice stirs up investor appetite for the IPO, raising first day stock price increases to 157% as compared to the average for all IPO's of only 113%.7 However, the fall from first day levels is higher amongst the "bumped up" stocks: 19% as compared to 13%. In securities class actions, where large stock drops can precipitate a lawsuit, such practices can be risky business. Also, some of the Internet companies are believed to be engaging in questionable accounting practices. Since few Internet companies have yet to show a profit, there is great pressure on Internet companies to show a steady increase in revenues.8 As a result, some analysts believe that dot.coms have resorted to "creative accounting" in an attempt to show ever-increasing revenue.9 This includes such practices as recording barter deals as sales revenue, recording gross sales as revenue instead of net sales, and recording discounts and coupons as "marketing expenses" so that such expenses are not reflected in the net sales figures.10 These practices have so concerned SEC regulators that they have identified twenty problems associated with Internet company filings, and have asked the Financial Accounting Standards Board (a private group which oversees the "Generally Accepted Accounting Principles," or "GAAP") to develop guidelines to eliminate them.11 Another practice that could increase the risk of IPO-related litigation is the failure or inability of many Internet companies (as is the case with many start-ups) to create an independent and/or diverse board of directors.12 Many believe that an independent board of directors helps a corporation maintain its standards for objective and fair reporting of financial results. According to the Investor Responsibility Research Center, the board of an average dot.com company has 7.3 members, only half of which are not inside officers of the company.13 This is to be contrasted with the board of the average S&P 500 company, which typically has a board of 12 directors, eight of which do not work for the company.14 Moreover, the outside directors of dot.com's often have substantial business dealings with the company, such that they cannot truly be considered independent.15 Finally, there is disturbing anecdotal evidence about the attitudes that some of the dot.coms are bringing to these initial offerings. Randy Komisar, former head of Lucas Arts Entertainment, was prescribed a typical meeting between "e-businessmen" and venture capitalists in the current market: "[p]eople walk into a VC presentation and their first line is about exit strategy. They're not talking about investors--they're talking about themselves. How will they cash out?"16 With stock prices skyrocketing without any relation to corporate earnings, many believe that there is strong motivation for principals to "cash-out" before the share price begins to decline.17 Certainly, securities class action plaintiffs counsel look for insider sales immediately preceding or during a downturn in share price when deciding whether or not to file a case. Nonetheless, the risks posed by IPO's have not necessarily led to the filing of more securities class actions. In 1996, 15 of the 114 securities class actions filed in federal court that year involved an IPO, or 13% of the total filings.18 However, since 1996, the percentage of total class actions involving an IPO has fallen to 6% in 1997 (11 out of 181), 4.2% in 1998 (9 out of 244), and 7.4% in 1999 (16 out of 216).19 In short, while IPO's appear to present substantial risks for investors, and while D&O premiums appear to have increased substantially for some high-tech and biotech companies in order to reflect this perceived risk, surprisingly the increasing IPO activity has not yet resulted in greater percentages of securities class action litigation arising from IPO's. However, given the large number of initial public offerings in 1999, it will be interesting to observe whether this trend will continue, or whether 2000 will see a significant increase in the number of cases that arise from an IPO.
B. Federal Filings Declined Slightly, State Court Actions Are Prospectively Eliminated, More Cases Are Being Dismissed, Fewer Cases Are Settling, and the Size of the Average Settlement Rose.
1. Federal Filings Have Declined. For the first time since the passage of the Private Securities Litigation Reform Act of 1995 (the "Reform Act"), the number of class actions filed in federal court has actually declined. In 1999, thirty fewer federal class action cases were filed than in 1998. One of the primary purposes of the Reform Act was to reduce the number of securities class action filings. Until last year, the number of securities class actions filings had increased every year. In 1996, 114 securities class actions were filed in the federal courts. In 1997, that number increased to 181, and in 1998 that number increased again to highest ever 244. However, in 1999, 216 securities class action cases were filed in federal courts, down somewhat from the 1998 record.20
2. The End of Class Action Securities Litigation in the State Courts. In order to avoid the requirements of the Reform Act, a substantial portion of the class action litigation initially shifted to the state courts. It is estimated that, since the passage of the Reform Act, more than half of the securities class action lawsuits have been filed in state courts.21 However, on November 3, 1998, Congress passed the Securities Litigation Uniform Standards Act of 1998 ("SLUSA"). SLUSA prospectively preempts all securities cases of fifty or more plaintiffs filed on or after January 1, 1999, and requires that those cases be filed in (or removed to) the federal court system so that the objectives of the Reform Act can be met.22 On the other hand, SLUSA is not retroactive, does not apply to class actions involving less than 50 persons, does not apply to state and local governmental agencies or their pension funds, and does not apply to claims which do not involve the purchase or sale of "covered securities."23 Therefore, securities class actions filed in state courts falling outside the ambit of SLUSA continue to present significant risk to those insurers who issued policies prior to 1999. It is important to be aware of recent state court decisions which have set forth rules regarding the reach of state Blue Sky laws. In that regard, the California Supreme Court held that out-of-state investors could sue publicly traded California companies under California Corporations Code Sections 25400 and 25500.24 Diamond Multimedia Systems, Inc. v. Superior Court, 19 Cal.4th 1036 (1999). The Court rejected arguments that the Blue Sky statutes were intended to be limited to intrastate transactions, and that such state court actions were preempted by the federal securities laws. The Court held that, as drafted, the statutes precluded wrongful conduct taking place within California (e.g. the issuance of false statements), and therefore the law was not being applied extraterritorially, even if purchases were conducted outside of the state.25 On May 27, 1999, the California Supreme Court issued its ruling in Stormedia Inc. v. Superior Court, 20 Cal.4th 449. In Stormedia, the Court extended the reach of Sections 24500 and 25500 to situations where the defendant never offered securities for public sale. In that case, Stormedia administered an employee stock option program through which employees could purchase shares of Stormedia stock at 85% of the market price. Id. at 457-458.26 Stormedia argued that the employee stock option transactions were not on the "open market" and therefore could not subject it to liability under Sections 24500 and 25500. Id. at 458. The California Supreme Court disagreed, finding that the definitions of "sale" and "offer" of California Corporations Code Section 25017 were not limited to open market transactions.27 Id. at 457-458. Therefore, the Court held that an employee stock option incentive plan is a "sale" or "offer to sell" sufficient to subject a corporation to liability under Corporations Code Sections 25400 and 25500. Id. at 461. The Court rejected Stormedia arguments that a defendant must actually intend to induce a purchase or sale of the security in which it is dealing to be liable for its false or misleading statements. Id. at 461-462. It reiterated the finding in the Diamond Multimedia decision that no actual sale is necessary to confer liability. Id. at 462. The Court noted that the existence of the employee stock option program was sufficient to establish that Stormedia was dealing in the stocks for purposes of Section 24500. Id. The Court further noted that Section 24500 has no privity requirement. Id. "The defendant need not have sold stock to the party to whom the false or misleading statement was made[...] [i]t is enough that the statement was made for the purpose of inducing any person or persons to purchase or sell stock." Id. As such, public purchasers of Stormedia stock who could not purchase any share from Stormedia itself may sue the corporation for false or misleading statements which might have induced its employees to exercise stock options. On April 27, 2000, the California Court of Appeal for the Fourth District, in Roskind v. Morgan Stanley Dean Witter & Co., 2000 Cal.App.LEXIS 326,*, held that, except to the extent it has been subsequently modified by SLUSA, federal law supplements (and does not preempt) state regulation and remedies. In Roskind, the plaintiff instructed his broker, Morgan Stanley Dean Witter & Co., to sell 14,000 shares of Netscape stock. Id. at 2-3. However, instead of selling plaintiffs shares in a timely fashion, Morgan Stanley "traded ahead" by selling its own large block of Netscape stock first. Id. As a result of Morgan Stanley's delay and trading ahead, plaintiff lost more than $34,000 which he would otherwise have gained if his stock had been sold in a timely fashion. Id. Plaintiff then filed a complaint for violation of California's unfair competition law (Business and Professions Code section 17200, et seq.) and breach of fiduciary duty on behalf of himself and all others similarly situated. Id. at 4-5. The Superior Court dismissed the complaint at the pleading stage, accepting Morgan Stanley's argument that the federal securities laws preempted plaintiff's claims. Id. The California Court of Appeal reversed the dismissal of the complaint, ruling that federal law does not generally preempt California’s unfair competition law. Id. at 22. Implicit in the Court's ruling was that the plaintiff's complaint was outside the ambit of SLUSA. Id. at 16-22.
3. More Cases Are Being Dismissed. Anecdotally, many practitioners in the securities class action area believe that more securities class action complaints are being dismissed as a result of the higher pleading standard required by the Reform Act. This view is supported by a University of Michigan study which found that 60% of securities class actions were dismissed in 1996 and 1997, compared with 40% in 1991 and 1992.28 Whether this trend will continue may ultimately be determined by the standard for scienter adopted by the U.S. Supreme Court. The Reform Act itself requires that: (1) allegations pleaded on information and belief must state "with particularity all facts on which that belief is founded"; and (2) plaintiffs must "state with particularity facts giving rise to a strong inference that defendant acted with the requisite state of mind." However, the Circuit Courts of Appeal have interpreted the pleading requirements for scienter in at least three different ways. The most permissive test has been adopted by the Second and Third Circuits.29 Without comment on congressional intent or legislative history, the Second Circuit ruled that the Reform Act merely codified that Circuit’s previous pleading requirements of (1) facts showing motive and opportunity to commit fraud; and (2) facts showing strong circumstantial misbehavior or recklessness. Press v. Chemical Investment Services, 166 F.3d 529, (2d.Cir. 1999). The Third Circuit adopted the Second Circuit standard, stating:
We believe Congress's use of the Second Circuit’s language compels the conclusion that the Reform Act establishes a pleading standard approximately equal in stringency to that of the Second Circuit. In Re Advanta Corp. Securities Litigation, 180 F.3d 525 (3d Cir. 1999).
The Sixth Circuit disagreed with the Second and Third Circuits, ruling in In Re Comshare, Inc. Securities Litigation, 183 F.3d 542, 550 (6th Cir. 1999) that allegations of "motive and opportunity" are not alone sufficient to establish scienter. The Eleventh Circuit agreed with the Sixth Circuit and expressly rejected the Second Circuit standard, holding:
We quantify scienter as encompassing a showing of severe recklessness, and although motive and opportunity to commit fraud may under some circumstances contribute to an inference of severe recklessness, we decline to conclude that they, standing alone, are its equivalent. Bryant v. Avado Brands, Inc., 187 F.3d 1271, 1285-1286 (11th Cir. 1999).30
Finally, the Ninth Circuit has held that the Reform Act requires plaintiffs to meet an even higher pleading standard. In re Silicon Graphics, Inc. Securities Litigation, 183 F.3d 970 (9th Cir. 1999), request for en banc hg. denied, 195 F.3d 521 (9th Cir. 1999), the Ninth Circuit held that only evidence of willful conduct on behalf of defendants will support a complaint for securities fraud. Id. at 977. The Court describes the minimum standard as "deliberate recklessness", and requires specific facts which "strongly suggest actual intent" to defraud. Id. at 979. As of this date, the U.S. Supreme Court has not granted certiorari to a Post-Reform Act securities case in order to resolve the conflict between the Circuits.
4. Fewer Cases Are Settling. Securities class actions are taking longer to resolve since the passage of the Reform Act. This appears to be occurring because: (1) the heightened pleading standards and the automatic discovery stay, for all practical purposes, discourages the parties from discussing settlement until the disposition of a motion to dismiss, and (2) a lack of appellate decisions interpreting the provisions of the Reform Act makes it difficult for litigants to predict the outcome of a given lawsuit. As a result, it is in the interest of all parties to file cases and wait for appellate decisions to provide guidance before settling the case. Because class actions are taking longer to resolve, there appears to be a growing backlog of cases that, at some point in the future, will settle or be dismissed by motion. This backlog of cases greatly increases the tail for this class of business, and makes it increasingly difficult to predict the real exposure created by class actions. The potential magnitude of the problem can be seen as follows. If one assumes that 650 cases have been filed since the passage of the Reform Act since 1995, and if one assumes that only half those cases have been disposed of by settlement or otherwise, then some 325 cases remain to be resolved. If one assumes further that 80% of the 325 remaining cases will be resolved by settlement and that the average settlement for such cases is 8.5 million (see below), then it will take over $2.2 billion dollars to settle these back-logged cases.
5. Average Settlement Costs Have Risen. The positive trends regarding the number of filings and the more frequent dismissal of class action complaints is unfortunately offset by the fact that the cost of settling the average shareholder class action rose to $8.67 million in 1999 from $7.16 million in 1998.31 The reason for this increase is unclear. Some argue that, post-Reform Act, more cases are dismissed and that the cases that survive a motion to dismiss have more merit and thus more settlement value. Others argue that the increase in settlement numbers simply reflects the fact that the bull market has greatly increased the market capitalization of many companies, such that the potential damages that class action plaintiffs now claim is much higher than in previous years.
6. The SEC's Scrutiny of Accounting Standards Continues. In September 1998, SEC chairman Arthur Levitt expressed concern about the integrity of financial statements and the practice of "earnings management."32 The SEC Chairman specifically identified the misuse of materiality standards as an example of the way in which certain companies manipulated their earnings. He explained that while "[m]ateriality is another way we build flexibility into financial reporting" through recognition that "some items may be so insignificant that they are not worth measuring and reporting with exact precision," some companies misuse the concept of materiality by "intentionally record[ing] errors with a defined percentage ceiling." Other targeted practices include improper revenue recognition, and the use of so-called "Cookie Jar" reserves, where current earnings are set aside as reserves and drawn on during subsequent quarters when earnings need a "boost." Taking their cue from the SEC, plaintiffs class action counsel have focused upon alleged accounting irregularities as a way to avoid motions to dismiss. Allegations of accounting "irregularities" are now found in approximately 60% of the securities class action complaints that are filed.33 The continued popularity of such allegations results, at least in part, from the SEC's current preoccupation with the quality of financial reporting, and the concern of many commentators and analysts that companies true operating results are masked by "legal" but questionable accounting practices, or one time events that skew operating results. Examples of the latter include gains from the sales of stock holdings in other companies, and gains recorded for the rising value of a company's pension funds. Examples of the former include rosy assumptions about the depreciation of assets, the failure of some companies to disclose the portions of their sales that they finance, and insider purchases of goods.34
3. RECENT DEVELOPMENTS IN EMPLOYMENT LITIGATION
From a claim frequency point of view, the greatest area of exposure for D&O insurers involves employment-related matters.35 Twenty-seven percent of all D&O claims arise from employment disputes, with discrimination being the most common complaint.36 Thus, the initial question when evaluating risk is whether the number of employment-related claims are increasing or decreasing. In 1989, 108,405 charges were filed with the Equal Employment Opportunity Commission ("EEOC"). In 1994, this figure rose to 155,612. However, since 1994, the number of charges filed with the EEOC has declined slightly. For example, in 1998, 145,192 charges were filed. Similarly, while in 1992 the EEOC filed 532 court cases,37 by 1999 that figure had declined to 294.38 Moreover, while all filings in United States District Courts (including both governmental and private filings) increased from 10,771 in 1991/92 to 23,735 in 1997/98, the number of employment filings in district court has remained relatively flat since 1994/95.39 On the other hand, employment-related verdicts appear to have risen dramatically in the last five years, both in size and frequency. Verdicts for wrongful termination averaged $735,785 in 1994, but in 1998 the average verdict was $1,809,594. In 1994, plaintiffs prevailed in such cases 41.5% of the time, compared with 1998 plaintiffs secured verdicts nearly 60% of the time. Sexual harassment verdicts averaged $141,884 and plaintiffs prevailed 61% of the time in 1994. However, by 1998 the average verdict for sexual harassment had increased to $415,931 if the harassed employee had not been terminated, and $1,060,448 if a termination also occurred. In such cases, plaintiffs began prevailing at trial at a 70% clip. Even greater award increases were recorded for verdicts based upon violation of the ADA ($504,328 in 1994 to $2,513,706 in 1998).40 Moreover, the average cost to settle an employment claim rose to $306,000 in 1999, a 6.6 percent rise from the 1998 average of $287,000. Thus, while claim frequency for employment- related claims has leveled out, verdict and settlement amounts have increased substantially in the last five years. Thus, employment-related claims remain an area of significant and increasing exposure for D&O insurers.
4. RECENT DEVELOPMENTS RE ALLOCATION OF UNCOVERED CLAIMS AND PARTIES
1. Proportionate Liability Absent a knowing violation, the Reform Act eliminates joint and several liability for those who violate the securities laws. Subject to some narrow exceptions that apply when others responsible for the plaintiffs' losses are insolvent, a person or entity generally may be held liable only for that portion of a judgment that corresponds to his/its percentage of responsibility for the plaintiffs'losses. The Reform Act's elimination of joint and several liability arguably invites a re-examination of the allocation decisions in Nordstrom, Inc. v. Chubb & Sons, Inc., 54 F.3d 1424 (9th Cir. 1995), and Caterpillar, Inc. v. Great American Insurance Co., 62 F.3d 955, 961 (7th Cir. 1995). In those cases, the 9th and 7th Circuits adopted the "larger settlement rule" for allocation between covered and uncovered parties. Because each defendant was legally obligated to pay the entirety of the settlement, the Court reasoned that there should be no allocation of the settlement among the various defendants. However, since the Reform Act requires an allocation of actual fault between defendants, the theoretical underpinning for the larger settlement rule is now suspect. However, the Tenth Circuit recently refused to rule on the issue of the effect of the Reform Act on the larger settlement rule, holding that the action was not ripe for declaratory relief, and that any ruling on the issue would be advisory. Stauth v. National Union Fire Insurance Co. of Pittsburgh, Pa., 1999 U.S.App.LEXIS 14006. Similarly, two other securities-related allocation cases have been decided in the last year, with both adopting the larger settlement rule. In Piper Jaffray Companies, Inc. v. National Union Fire Insurance Co. of Pittsburgh, Pa., 38 F.Supp.2d 771, 775-776 (Minn.Dist. 1999), the U.S .District Court for the District of Minnesota applied the larger settlement rule to a post-Reform Act case, but did not analyze the effect of the Reform Act on allocation. Worse yet, in Level 3 Communications, Inc. v. Federal Insurance Co., 1999 U.S.Dist.LEXIS 13338, *, 12-15 and fn.3 (N.Dist.Ill.1999), the District Court applied the "larger settlement rule" while noting that, in light of the Reform Act and the Tenth Circuit's reasoning in Stauth, such a determination is appropriate where the underlying case settled prior to trial. Therefore, while there is some recognition that the Reform Act may "preempt" the "larger settlement rule," the only court to expressly consider the issue has ruled that lack of joint and several liability under the Reform Act does not require a re-examination of the larger settlement rule in the context of a settlement. Since 80% of all securities class action cases settle, this is a discouraging decision. Unfortunately, it may be some time before any Circuit Court of Appeal makes a definitive statement on this issue.
5. CONCLUSION
While the soft market continues unabated, there are reasons to be guardedly optimistic about the risk trends for D&O claims. IPO's do not as yet constitute a significant percentage of securities class action cases, and, for the first time since the Reform Act was passed, the number of class actions filed in federal court has declined. Moreover, the enactment of SLUSA has, on a going-forward basis, eliminated the state court end run around the Reform Act, and the Reform Act does appear to be resulting in the dismissal of more class action securities complaints. On the other hand, less encouraging is the news that the average class action settlement rose by approximately $1.5 million in 1999, and that the SEC continues its campaign for better accounting practices. In the employment area, claim frequency has leveled-out or decreased, but verdict and settlement amounts have increased substantially in the last five years. Thus, employment-related claims remain an area of significant and increasing exposure for D&O insurers. Finally, the Reform Act explicitly eliminated joint and several liability in securities actions, with the result that settlements or judgments should be allocated based upon the proportionate liability of each defendant. However, only one case has expressly analyzed the effect of the Reform Act on the larger settlement rule. Any future effect of the Reform Act on allocation issues is yet to be determined.
END NOTES:
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1 See, e.g. the Tillinghast-Towers Perrin Report released on February 4, 2000 (the "Tillinghast Report").
2 DeGraw, Irv: On Wall Street, "IPO Watch Riskless Internet IPO's: Institutions’ access and Flipping Privileges can be used to eliminate any Internet IPO Aftermarket Risk" (5/1/2000).
3 Chang, Sarah: IPO Maven (ipomaven.123jump.com), "1999 IPO Year-In - Review: The Best and the Worst" (1/3/2000).
4 Ewing, Terzeh: The Wall Street Journal, "Small Stock Focus: IPOs More Boldly Disclose Risk Factors" (4/3/2000).
5 Ibid.
6 Krantz, Matt: USA Today, "Bumped-up IPOs Get Riskier" (3/20/2000).
7 Ibid.
8 Kahn, Jeremy: Fortune, "Presto Chango & Sales Are Hugg." (3/20/2000), p. 90.
9 Ibid.
10 Ibid.
11 Ibid.
12 Elkind, Peter: Fortune, "The New Role of Directors." (3/20/2000), p. 116.
13 Ibid.
14 Ibid.
15 Ibid. Many Internet companies will not be able to meet new NYSE and NASD standards which require three independent directors on an audit committee simply because they do not have three independent directors on their entire board.
16 Useem, Jerry, Fortune, "New Ethics , Or No Ethics," (3/20/2000), p. 82.
17 Ibid., See Also, Gemen, Mark: Fortune, "To Cash Out? or Not To Cash Out?" (3/20/2000), p. 110.
18 Authors analyzed data obtained from Stanford Securities Class Action Clearinghouse ("Stanford Clearinghouse").
19 Ibid.
20 Stanford Clearinghouse. In the year 2000, 78 class actions have been filed through May 11, 2000. Assuming that class actions are filed at the same rate for the rest of the year, approximately the same number of securities class actions will be filed in 2000 as in 1999. Ibid.
21 Grundfest, Joseph and Michael A. Perino: Stanford Clearinghouse, "Securities Class Action Litigation in Q1 1998: A Report to NASDAQ from the Stanford Law School Securities Class Action Clearinghouse," (6/2/1998). See also, W. Maguire: New York Law Journal, "Securities Litigation Reform Act Fails to Fulfill Promise or Confirm Fears," (12/24/1998).
22 Antagonism to state court actions is not limited to Congress. On May 10, 2000, U.S. District Judge John Nangle of Saint Louis, who presides over the federal class action litigation of the Bank of America/Nationsbank merger, issued an injunction of the parallel California state court action, Desmond v. BankAmerica, Corp. In doing so, he blasted the Milberg-Weiss firm, stating that the "Desmond case is nothing more than a thinly veiled attempt to circumvent federal law," and that the "Desmond plaintiffs, and the law firm behind them, do not have the best interests of the class at heart and have proved themselves wholly inadequate to control conduct of this suit." Milberg Weiss countered by arguing that the parallel state court case was proper because the cases were filed prior to the enactment of SLUSA.
23 Under SLUSA, "covered securities" do no include private placements, or transactions involving the stock of non- public companies. Coffee, J. Jr.: New York Law Journal, "A Primer on Uniform Standards Act," (12/17/98).
24 California Corporations Code Section 25400 provides in part:
It is unlawful for any person, directly or indirectly, in this state:
(a) . . . [to create] a false or misleading appearance of active trading in any security or a false or misleading appearance with respect to the market for any security, . . .
(b) To effect, alone or with one or more other persons, a series of transactions in any security creating actual or apparent active trading in such security or raising or depressing the price of such security, for the purpose of inducing the purchase or sale of such security by others.
(c) If such person is a broker-dealer or other person . . . to induce the purchase or sale of any security by the circulation or dissemination of information to the effect that the price of any such security will or is likely to rise or fall . . . for the purpose of raising or depressing the price of such security.
(d) If such person is a broker-dealer or other person . . . to make, for the purpose of inducing the purchase or sale of such security by others, any statement which was, at the time and in the light of the circumstances under which it was made, false or misleading with respect to any material fact, or which omitted to state any material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, and which he knew or had reasonable ground to believe was so false or misleading.
(e) For a consideration, received directly or indirectly from a broker-dealer or other person . . . to induce the purchase or sale of any security by the circulation or dissemination of information to the effect that the price of such security will or is likely to rise or fall . . . for the purpose of raising or depressing the price of such security.
Section 25500 provides in pertinent part:
Any person who willfully participates in any act or transaction in violation of Section 25400 shall be liable to any other person who purchases or sell any security at a price which was affected by such act or transaction for the damages sustained by the latter as a result of such act or transaction. . . .
25 The California Court of Appeals for the Fourth District has recently ruled that Diamond Multimedia is limited to fraudulent acts which occur in California. Norwest Mortgage, Inc. V. Superior Court, 72 Cal.App.4th 214 (1999). The plaintiff alleged that defendant Norwest engaged in unfair business practices in violation of California Business and Professions Code Section 17200 in administering a Forced Placement Insurance ("FPI") program. Id. at 216. Norwest, while selling the FPI program to California residents, administered the program from its Iowa headquarters. Id. at 217-218. The FPI insurance was purchased from American Security Insurance Company of Georgia through a Norwest subsidiary in Minnesota, and administered from service centers in North Carolina, Michigan, Maryland, Illinois, Arizona, and Ohio. Id. at 218.
The appeals court recognized that the largest category of the purported "class" consisted of non-California plaintiffs who did not suffer any unfair business act by Norwest with any connection to California. Id. at 222. As a result, the court held that the California unfair competition laws were not intended to regulate conduct wholly unconnected to California, and that the "linchpin of Diamond’s analysis is that state statutory remedies may be invoked by out-of-state parties when they are harmed by wrongful conduct occurring in California." Id. at 224-225. California law cannot protect out-of-state parties against extra-territorial conduct. Id. at 225.
26 Stormedia was also subject to certain "put-options" that had been issued to insiders, which, when exercised, required Stormedia to repurchase shares from the option holders. Id. at 453. However, the only securities sales made to the public were personal sales by insiders, and did not involve the corporation. Id.
27 California Corporate Code Section 25017(a) states in relevant part:
"Sale" or "sell" includes every contract of sale of, contract to sell, or disposition of, a security or interest in a security for value. "Sale" or "sell" includes any exchange of securities and any change in the rights, preferences, or restrictions of or on outstanding securities.
Section 25017(b) states in relevant part:
"Offer" or "offer to sell" includes every attempt or offer to dispose of, or solicitation of an offer to buy, a security or interest in a security for value.
28 The University of Michigan report analyzed 100 rulings on motions to dismiss in 280 class actions filed during 1996 and 1997. Sixty were granted in some form. Fifteen were granted with prejudice, thirty-four were granted with leave to amend, and eleven were granted in part and denied in part Levine, David M. and Adam C. Pritchard: The Business Lawyer, "The Securities Litigation Uniform Standards Act of 1998: The Sun Sets on California's Blue Sky Laws," 54 Bus. Law. 1 (11/1998).
29 Ironically, prior to the Reform Act, the Second Circuit had been regarded as the court with the highest pleading standards for securities class action complaints. Princi, Anthony and Alan Arkin: "Which State is Best for You," Del.Corp.Lit.Rptr., Vol. 14, No.8, p. 13 (2/28/2000).
30 This same reasoning was adopted, in turn, by the First Circuit in Greebel v. FTP Software, Inc., 194 F.3d 185. 197 & 200-201 (1st Cir. 1999). The Fourth Circuit has endorsed this approach in dicta, but has yet to rule on the issue. See, e.g., Phillips v. LCI International, Inc., 190 F.3d 609, 620-621 (4th Cir. 1999).
31 Total settlements for securities class actions topped $1.79 billion in 1999, excluding a $1.027 billion NASDAQ settlement and settlement payments made in stock. Investor Research Bureau, Inc.: Securities Class Action Alert (www.irbc.com), "1999 Settlement Totals" (1/2000).
32 Speech of Arthur Levitt at New York University Center for Law and Business (Sept. 28, 1998).
33 Stanford Clearinghouse.
34 In one example of insider sales enhancing performance, Webvan Group, an internet grocer, announced that its revenues for Q4 1999 were $9.1 million, up 136% from the previous quarter. However, a closer review of Webvan's earnings release showed that $750,000 worth of the revenue gain (approximately 8.3% of the quarter’s revenues) came from purchases by the company's executives and affiliated companies of goods that were then donated to charity. New York Times, "Levitating Company Earnings: An Act, or a Fact?" 5/14/2000.
35 The Tillinghast Report.
36 Ibid.
37 The EEOC files complaints under Title VII of the Civil Rights Act of 1964 ("Title VII"), the Americans with Disabilities Act of 1990 (the "ADA"), the Age Discrimination in Employment Act of 1967 (the "ADEA"), and the Equal Pay Act of 1963 (the "EPA").
38 Interestingly, while the EEOC recovered approximately $71 million in 1992 for the 500 plus actions it filed that year, it recovered approximately $92 million for the approximately 300 actions filed in 1998.
39 In 1994/95, 23,152 cases were filed in the United States District Courts. In 1996/97, that number had only increased to 23,796.
40 Not all employment and discrimination cases have increased in value, however. Verdict amounts actually declined for age and gender discrimination cases. In 1994, the average verdict for an age discrimination case was $1,823,160, while in 1998 it had declined to $1,419,583. In 1994, the average verdict for gender discrimination was $256,764; by 1998 it had declined to $100,544.
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