2011 Year in Review
Aon Financial Services Group is pleased to present the eighth annual Year in Review publication. 2011 continued the fast-paced evolution in the landscape of executive liability. As we noted last year, the massive Dodd-Frank Act passed by Congress in 2010 dramatically impacted the liability landscape for directors, officers and companies.
The Act required the implementation of nearly 250 new regulations, studies, and determinations. As reflected in this Year in Review , we tracked the laborious, but significant, progress of efforts made to implement the Act, from new say-on-pay rules to aggressive whistleblower rules that are changing the liability landscape. Much remains to be completed and we will continue to track these efforts.
The Supreme Court was very active in issuing decisions of interest. As summarized herein, the Court issued significant opinions that impact class certification in employment practices claims (Wal-Mart) and shareholder class action litigation (Halliburton).
The Court also addressed pleading requirements for securities fraud allegations for parties with “ultimate authority” (Janus) , and a “statistical significance” bright-line rule regarding materiality (Matrixx).
In 2012 we will track the impact, if any, of these decisions on pending and future claims.
Frequency
Federal Securities Class Action Litigation
2001–2011
250
200 180*
224
192
228
150
100
50
191
0
2001 2002 2003
Chinese Reverse Merger Filings
M&A Filings
Options Backdating Filings
2004
2001–2010
Average (187) *
182
179
120
24
96
177
9
39
129
2005 2006 2007
Ponzi Filings
Auction Rate Securities Filings
All Other Credit-Crisis Filings
223
20
80
115
167
18
52
89
176
9
40
13
113
2008 2009
All Other Filings
2010
188
33
43
109
2011
*Excludes 312 IPO Allocation filings in 2001
Source: Cornerstone Research Securities Class Action Filings 2011 Year in Review
The number of federal securities class action (SCA) filings in 2011 represented some interesting developments.
According to Stanford Law School Securities Class Action Clearinghouse (Stanford), in cooperation with Cornerstone
Research, there were 188 federal SCA suits filed in 2011 compared with 176 suits filed in 2010. While this number is consistent with the ten-year (2001-2010) trailing average, it is 9% greater than the 5-year (2006–2010) trailing average number (173) of SCA suits filed. An interesting new trend is that 43 of the 188 federal SCA suits were filed upon the announcement of a merger or acquisition (M&A). These M&A suits have been dramatically increasing over the past several years, but historically have been filed in state court, not federal court. We tracked over 200 M&A state court suits filed in each of the past two years. Additionally, according to Stanford, only 13 percent of the 188 suits were filed against defendants in the financial sector as compared with 47 percent of suits filed in 2009.
2011 Year in Review Legal News and Developments in Executive Liability 3

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Severity
D&O Settlements 2001 to 2011
Dollars in Millions
$20.00
$0.00
Number of
Settlements
$100M+ *
Median *
Average **
St. Dev **
$140.00
$120.00
$100.00
$80.00
$60.00
$40.00
2001
134
6
$5.43
$19.69
$48.46
2002
160
7
$5.53
$20.94
$59.09
2003
171
11
$5.73
$22.06
$56.60
2004
118
11
$7.00
$31.70
$70.92
2005
146
15
$8.75
$27.47
$61.27
2006
111
13
$7.75
$52.89
$133.82
2007
114
8
$7.73
$26.25
$70.35
2008
107
6
$8.88
$34.58
$117.85
2009
102
8
$8.50
$30.81
$76.21
2010
104
6
$10.05
$28.40
$71.26
2011***
78
10
$7.50
$45.69
$101.16
* Includes settlements of $1B or greater
** Excludes settlements of $1B or greater
*** In 2011, several large subprime/auction rate/mortgage certificate settlements caused the average settlement size to spike dramatically in comparison to 2010.
Source: Aon Financial Services Group, ISS Securities Class Action Services
Note: Settlement information generally reflects settlements as of the date a settlement is announced. As additional parties settle and settlements become final, settlement values and dates occasionally change. Aon FSG adjusts settlement figures in this chart to reflect these changes.
SCA severity for 2011 produced some interesting statistics. The average SCA settlement, as reflected in the above chart, jumped substantially to $45.6 million as compared with an average settlement in 2010 of only
$28.4 million. Interestingly, the median settlement in 2011 dropped 25% from 2010 to $7.5 million, the lowest median settlement value since 2004. There were nine SCA settlements of $100 million or more in 2011 (which contributes to the spike in average value), but there were no outlier settlements in excess of $1 billion.
Also noteworthy is that the size of potential damages (disclosure dollar loss following disclosure of alleged wrongful conduct) of SCA suits in 2011 represented an upward trend. In 2011, according to Cornerstone
Research Securities Class Action Filings 2011 Year in Review, the average disclosure dollar loss was $864 million as compared with $687 million in 2010. The size of potential losses likely will have an impact on settlement values as these cases progress through the next several years.
As we have stated many times before, upward trends in severity only concern us when coupled with increases in frequency.
Aon Financial Services Group Legal & Claims Practice

Coverage Litigation
The amount of coverage litigation involving executive liability insurance in 2011 remained high. A significant number of serious coverage defenses and disputes were litigated in 2011. As we have previously observed, much of the coverage litigation continues to involve excess insurers after primary carriers have tendered their limits in a claim. Increases in claims severity and further softening of excess rates in this favorable pricing environment cause us to believe this pattern will continue.
Pricing
Quarterly Index of D&O Pricing
Q1-2002 Through Q4-2011 | Base Year: 2001
2.50
2.25
2.48
2.00
2.02
1.98
1.75
1.70
1.58
1.50
1.25
1.00
1.00
Baseline = 1.00
1.28
1.23
1.19
1.02
1.07
0.95
0.98
0.86
0.75
2001 2002 2003 2004 2005 2006 2007 2008 2009 Q1 Q2
2010
Q3 Q4 Q1
0.95
0.84
Q2
2011
Q3
0.91
Q4
Pricing in the D&O marketplace continued to soften over the course of 2011. After four more quarters of year-over-year declines (Q1: 15.7% down, Q2: 11.2% down, Q3: 11.6% down, Q4: 7.1% down), we are now seeing prices at their lowest level in 11 years. Specifically, pricing for the full year 2011 was down 10.9% as compared to 2010. It should be noted that this rate of decrease is slowing rather significantly as 2010 pricing was down 15.1% compared to 2009.
We hope you enjoy the 2011 Year in Review . As always, we look forward to reporting the events and trends of 2012. Thank you for your continued interest and support in our report.
Michael D. Rice II
Chairman
Aon Financial Services Group
Steve Shappell, Esq.
Senior Managing Director
Aon Financial Services Group Legal & Claims Practice
2011 Year in Review Legal News and Developments in Executive Liability 5

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General News
Paper Casts Doubt on Alleged Myopic Behavior of Public Companies
Relative to Short Term Earnings
A frequent criticism of the public company oriented U.S. financial system is that it pressures companies to focus excessively on short term quarterly earnings, thereby causing public firms to behave in a myopic manner. A recent paper takes this criticism head on, but fails to find evidence to support the criticism. The authors, Sreedhar Bharath of the Department of Finance at Arizona State University, Amy Dittmar of the Department of Finance at the University of
Michigan, and Jagadeesh Sivadasan of the Business Economics Department at the University of
Michigan, hypothesize that if capital markets pressure publicly traded companies to be myopic in a way that impacts efficiency, then going private (when myopia is eliminated) would cause those companies to improve their productivity relative to a peer control group of companies.
The authors found no evidence that this was the case, stating, “[o]ur key finding is that while there is evidence for substantial within-establishment increases in productivity after going private, there is little evidence of difference-in-differences efficiency gains relative to peer groups of establishments constructed to control for industry, age, size at the time of going private, and the endogeneity of the going private decision effects.” The authors also noted the lack of evidence that myopic markets lead to under-investment at the establishment level and, in fact, stated, “[w]e find that after going private, firms shrink capital and employment, and close plants more quickly, relative to peer groups.” The paper concluded by stating,
“[o]ur findings cast doubt on the view that public markets cause listed firms to make suboptimal, productivity-decreasing choices, or under invest at the establishment level.”
SEC Issues Final Rule on Say-On-Pay and Other Executive Compensation
In January, the Securities and Exchange Commission (SEC) issued final rules to implement the provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) mandating advisory shareholder votes on executive compensation provisions such as the socalled “say-on-pay” votes, “say-when-on-pay” votes, and “golden parachute” arrangements.
The rules provide a two-year exemption for smaller reporting companies allowing them to defer a say-on-pay or say-when-on-pay vote until their first meeting held on or after January
21, 2013. The final rules will become effective sixty days after they are published in the Federal
Register, but the requirements to hold the say-on-pay and say-when-on-pay votes take effect now, and companies generally may rely on the final rules until the effective date. A summary of the rules is as follows: 1) Say-on-Pay: The SEC’s final rules implement the Dodd-Frank sayon-pay provisions through a new rule (Rule 14a-21) that requires the say-on-pay advisory vote to be included in the first proxy statement relating to a meeting of shareholders at which directors are to be elected on or after January 21, 2011 for which disclosure of executive compensation is required. The rule does not specify a required form for the shareholder resolution, although the rule provides a non-exclusive example; 2) Say-When-on-Pay:
Dodd-Frank also requires issuers to include in their proxy statements an additional separate resolution to determine whether the say-when-on-pay vote will occur every one, two, or three years. This say-when-on-pay vote must occur at the first shareholder meeting held after
January 20, 2011 and, thereafter, not later than the meeting held in the sixth calendar year after the last say-when-on-pay vote. In the release setting forth its final rules, the SEC reiterates its view that the say-when-on-pay vote, like say-on-pay, will be nonbinding despite Dodd-
Frank’s description of the vote as “determin[ing]” frequency of say-on-pay; and 3) Disclosure and Vote on Golden Parachute Compensation Arrangements: Dodd-Frank requires that any proxy solicitation material for a meeting of shareholders at which shareholders are requested to approve an acquisition, merger, consolidation, or proposed disposition of all or substantially all the assets of an issuer include specified disclosures relating to compensatory agreements
“We find that after going private, firms shrink capital and employment, and close plants more quickly, relative to peer groups.”
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… the class action lawsuit did not allege a breach of fiduciary duty or a
“Wrongful Act” as defined in the underlying Zurich fiduciary liability policy.
or understandings with named executive officers that are based on or relate to the business combination being voted on (i.e., golden parachute compensation arrangements), as well as the amounts payable under such agreements or understandings. The proxy solicitation material must also include a separate resolution subject to shareholder vote to approve such agreements or understandings and compensation as disclosed, unless such agreements or understandings have been subject to a say-on-pay shareholder vote. This vote on so-called golden parachutes, like say-on-pay and say-when-on-pay, is advisory and nonbinding. The
SEC’s rules require disclosure with respect to golden parachute compensation arrangements between the target company or the acquiring company, on one hand, and the named executive officers of either the target or the acquirer, on the other hand.
Cases of Interest
No Coverage for ERISA Complaint that Alleges Settlor Liability Rather than a Breach of Fiduciary Duty
Federal Insurance Company (Federal) provided an excess fiduciary policy to International
Business Machines (IBM) that followed form to a Zurich American Insurance Group (Zurich) underlying fiduciary liability policy. The Zurich policy provided coverage for “all Loss for which the Insured becomes legally obligated to pay on account of any Claim first made against the
Insured … for a Wrongful Act,” and defined “Wrongful Act” as “any breach of the responsibilities, obligations or duties by an Insured which are imposed upon a fiduciary of a
Benefit Program by the Employee Retirement Income Security Act of 1974 [ERISA] … .” Kathi
Cooper, an IBM Personal Pension Plan (Plan) participant, filed a class action lawsuit against IBM and its Plan alleging that certain Plan amendments violated the age discrimination provisions of
ERISA. Eventually, the parties effectuated a settlement for class members who earned pension benefits between January 1, 1995 and June 30, 1999. Thereafter, Federal sought a declaratory judgment that IBM and the Plan were not entitled to indemnification for any amounts incurred in connection with the class action lawsuit. The trial court granted summary judgment in favor of IBM and the Plan for a breach of contract. On appeal, the New York Supreme Court,
Appellate Division, Second Department, reversed and ruled in favor of Federal, finding that the class action lawsuit did not allege a breach of fiduciary duty or a “Wrongful Act” as defined in the underlying Zurich fiduciary liability policy. To this end, the appellate court specifically determined that IBM and the Plan were acting solely in a settlor capacity, and not in a fiduciary capacity, when the ERISA age discrimination provisions were allegedly violated after the Plan was amended. The court, therefore, concluded that Federal had no obligation to indemnify
IBM or the Plan for any amounts incurred in connection with the class action lawsuit. Fed. Ins.
Co. v. Int’l Bus. Machs. Corp., 2010 U.S. App. LEXIS 23683 (N.Y. App. 2010).
Prior Knowledge Exclusion in E&O Policy, Which Includes the Policy Term “Might,”
Is Unambiguous
Westport Insurance Corporation (Westport) issued a claims made and reported E&O policy to The Markham Group, Inc., P.S., a law firm, and one of its members, Mark Kamitomo
(collectively The Markham Group). The Westport policy contained an exclusion for claims arising out of “any act, error, omission, circumstance or personal injury occurring prior to the effective date of this policy if any insured at the effective date knew or could have reasonably foreseen that such act, error, omission, circumstance or personal injury might be the basis of a claim.” Nearly a year prior to the Westport policy’s inception, The Markham Group knew that, due to errors on its part, a client’s wrongful death case had been dismissed and could not be refiled. More importantly, the trial court in the underlying wrongful death case awarded
Rule 11 sanctions against The Markham Group. The Markham Group appealed the trial court’s
Aon Financial Services Group Legal & Claims Practice

underlying dismissal of the wrongful death suit; however, during the policy period, the dismissal was upheld. The Markham Group then notified Westport of a potential malpractice claim. Westport filed a declaratory judgment action in the U.S. District Court for the Eastern
District of Washington. In response, The Markham Group filed a motion for summary judgment, arguing the policy term “might” was ambiguous, which negated the prior knowledge exclusion. The trial court agreed and found that the exclusion reasonably could be interpreted to apply only when there were no longer any meaningful avenues to cure the adverse ruling, such as a successful appeal. The 9 th Circuit reversed the trial court’s decision, concluding that the prior knowledge exclusion was unambiguous and that “any reasonable insured would have recognized that the errors in question,” which led to a client’s case being dismissed with no opportunity to refile and court sanctions imposed against it for filing a baseless claim without proper investigation, “‘might’ result in a claim.” In addition, the 9 th Circuit rejected The Markham Group’s contention that the claim was covered under a prior policy irrespective of the lack of notice provided to the earlier policy because, under Washington law, the notice-prejudice rule does not apply to claims made policies. Specifically, “while [the notice-prejudice] rule is applied to occurrence policies, claims made policies are fundamentally different in character.” Importantly, if one were to apply the notice-prejudice rule to a claims made policy, that “application would provide coverage the insurer did not intend to provide and the insured did not contract to receive.” In fact, “it would negate the inherent differences between occurrence and claims made policies, and would rewrite the insurance contract.”
Westport Ins. Corp. v. Markham Group, Inc., 2010 U.S. App. LEXIS 423683 (9 th Cir. 2010).
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Specifically, “while [the notice-prejudice] rule is applied to occurrence policies, claims made policies are fundamentally different in character.”
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Criminal Claim Need Not Allege “Loss” to Trigger Defense Coverage;
Personal Profit and Dishonesty Exclusions Necessitate Fact Adjudication
This matter involves a long, drawn-out coverage dispute. The Kansas Bankers Surety Co.
(KBS) provided a D&O liability policy to Sinclair National Bank (SNB) for the relevant time period. Susan Wintermute (Wintermute), a former SNB director, had been convicted of two criminal counts for filing false statements in connection with the purchase of the bank and was acquitted of four other counts for bank fraud related to subsequent loan transactions.
Wintermute sought coverage for defense expenses for the counts on which she was acquitted.
In the coverage litigation, she appealed the district court’s grant of summary judgment in favor of KBS. The district court focused its discussion on a “claim for Loss.” It reasoned that a “claim,” which was not defined in the policy, is a demand for money or something owed.
Because a criminal indictment, absent a count for restitution, is not a demand for money, the district court determined that Wintermute did not have a claim for Loss made against her to trigger KBS’ obligation to defend or indemnify her under the policy. On appeal, KBS argued the criminal charges did not seek “Loss” and the policy only provided coverage for a “claim for Loss.” Moreover, KBS argued the policy’s insuring agreement mandated KBS to “indemnify” each director for “Loss which the director … is legally obligated to pay by reason of any
Wrongful Act solely in their capacities of Directors.” The policy defined “Loss” as any amount which the director is “legally obligated to pay … for a claim … made against the Directors … for
Wrongful Acts, and shall include but not be limited to damages, judgments … and defense of legal claims.” The Eighth Circuit pointed out that the problem with the district court’s and
KBS’ reasoning was that the plain language of the policy provides coverage for loss a director is obligated to pay for a claim made against a director for a wrongful act. The policy language does not preface coverage on a claim for loss, only a claim for a wrongful act. In the coverage litigation, the parties did not dispute that the criminal actions alleged in Wintermute’s indictment were claims against Wintermute for a wrongful act, and they did not dispute that the attorneys’ fees she expended in defending herself are an amount she is legally obligated to pay stemming from that claim for a wrongful act. Accordingly, the Eighth Circuit held the covered counts of the criminal indictment were claims for a wrongful act against Wintermute,
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2011 Year in Review Legal News and Developments in Executive Liability 9

New York’s interest in deterring fraud and theft within its borders would be undermined by application of Bermuda law, which does not recognize a cause of action for constructive fraud and does not recognize the faithless servant doctrine.
and KBS must indemnify Wintermute for any loss she became obligated to pay by reason of the criminal indictment. Having found coverage, the Eighth Circuit looked at the exclusion provisions to see if any precluded coverage for the legal expenses incurred on the acquitted counts. The policy includes a prefatory statement to the exclusion provisions that provides:
“[KBS] shall not be liable to make any payment or provide any defense in connection with any claim for Loss made against the Bank or Directors.” It then goes on to list several types of excluded claims. Wintermute argued that none of the exclusions can apply because there is not a “claim for Loss” made against her, only criminal misconduct charges of which she was acquitted. Wintermute’s argument is the inverse of KBS’ previous argument on the coverage issue where KBS argued that there is no coverage absent a “claim for Loss.” Wintermute argued that none of the exclusions applied because there must first be a “claim for Loss” as stated in the prefatory language before any one of the exclusions is triggered. The appellate court first addressed the personal profit exclusion, which was grounded on a director “gaining in fact” profit to which she was not entitled. The court held that the pleadings in the underlying matter could not control application of the exclusion, and that a factual determination in the coverage action was required. The court rejected KBS’ contention that its holding created a
“final adjudication” requirement, noting that such provisions are read more narrowly than “in fact” provisions because an “in fact” finding could be made in either the underlying case or a separate coverage action. The court then turned to the dishonesty exclusion, which similarly did not apply to any director “who was not involved in the dishonest acts.” The court found that the dishonesty exclusion “serve[d] the same purpose as the ‘in fact’ language contained in the personal profit exclusion,” and required a factual determination based on evidence beyond the underlying allegations in order to be applied. Because the district court improperly considered only the allegations in the complaint in determining that the exclusions applied, and because issues of material fact remain concerning whether Wintermute in fact received a personal gain to which she was not entitled or whether Wintermute was involved in any dishonest acts, the Eighth Circuit reversed the district court’s grant of summary judgment and remanded the case for further proceedings. Wintermute v. Kan. Bankers Sur. Co., 2011 U.S. App.
LEXIS 174 (8 th Cir. 2011).
Court Applies NY Internal Affairs Doctrine Despite Entity Being Incorporated in Bermuda
Tyco, a company incorporated in Bermuda at that time, sued its former Chairman and
CEO, Dennis Kozlowski (Kozlowski), seeking to recover under various theories, including constructive fraud, which is recognized under New York law, but not under Bermuda law.
Kozlowski asserted counterclaims, seeking payment under various deferred compensation agreements as well as indemnification relating to suits filed by third parties against him. Tyco contended that the compensation agreements were void as fraudulently induced and that they represented compensation that Kozlowski must forfeit under New York’s “faithless servant doctrine.” This doctrine is not recognized under Bermuda law. Under New York’s choice of law principles, the court ruled the claims were governed by New York law, not Bermuda law, because New York had the greatest interest in the litigation. The court determined that both the tortious conduct and the injury (since the claims alleging fraud and constructive fraud involved falsification of business records) occurred in New York. The claim for constructive fraud was a “conduct regulating” claim because it involved concealment of large-scale thefts from Tyco. Similarly, Tyco’s claim that Kozlowski was required to forfeit his compensation as a remedy for his disloyalty and as a defense to Kozlowski’s counterclaims was “conductregulating” because the primary purpose of the “faithless servant doctrine” is to deter disloyal conduct. The court stated that New York’s interest in deterring fraud and theft within its borders would be undermined by application of Bermuda law, which does not recognize a cause of action for constructive fraud and does not recognize the faithless servant doctrine.
Tyco Int’l, Ltd. v. Kozlowski, 2010 U.S. Dist. LEXIS 127185 (S.D.N.Y. 2010).
10 Aon Financial Services Group Legal & Claims Practice

SEC Filings
|
SEC Settlements
• The SEC filed insider trading and fraud charges against Daniel J. Burns, former chairman of the board of directors for CytoCore, Inc.
The SEC is seeking disgorgement, prejudgment interest, penalties, and a bar prohibiting Burns from serving as an officer or director of a public company.
• The SEC filed insider trading charges against
George H. Holley, co-founder and former chairman of the board of Home Diagnostics, Inc. The SEC is seeking disgorgement, prejudgment interest, penalties, and a bar prohibiting Holley from serving as an officer or director of a public company.
• The SEC filed accounting fraud charges against
Todd C. Crow, former CFO of NutraCea.
The SEC is seeking penalties and a bar prohibiting Crow from serving as an officer or director of a public company.
• The SEC filed market manipulation charges against
Pantera Petroleum, Inc. and Christopher S. Metcalf, president and CEO. The SEC is seeking disgorgement, prejudgment interest, penalties, and a bar prohibiting Metcalf from serving as an officer or director of a public company.
• Final judgment was entered on fraud charges against
Enzyme Environmental Solutions, Inc. (EES), and its sole director and officer, Jared E. Hochstedler.
EES was ordered to pay disgorgement of $346,135 plus prejudgment interest, and a penalty of $25,000.
Hochstedler was ordered to pay disgorgement of
$1,445,000, plus prejudgment interest.
• The SEC settled charges of financial fraud against two senior officers at Equipment Finance, LLC.
Joseph M. Braas, VP and COO, was ordered to pay disgorgement and prejudgment interest of
$1,489,024, and Michael J. Schlager, EVP, was ordered to pay disgorgement and prejudgment interest of $1,121,302. Both Braas and Schlager were barred from serving as officers or directors of a public company.
• The SEC settled insider trading and fraud charges against CytoCore, Inc., and Robert F. McCullough,
Jr., CEO and CFO. McCullough was ordered to pay a penalty of $100,000, and was suspended for one year from association with a broker-dealer or investment advisor.
• The SEC settled insider trading and financial fraud charges against Joseph Radcliffe, a “consultant” of
Image Innovations Holdings, Inc., and his son
Michael Radcliffe, a director and COO. Joseph
Radcliffe was ordered to pay disgorgement of
$955,000, prejudgment interest of $299,541, and a penalty of $175,000. Michael Radcliffe was ordered to pay disgorgement of $10,000, prejudgment interest of $3,060, and a penalty of $75,000.
• The SEC settled accounting fraud charges against two former executives of NutraCea.
Bradley D.
Edson, former CEO, was ordered to pay a penalty of $100,000, and was barred from serving as an officer or director of a public company. Margie
Adelman, former SVP and secretary, was barred from serving as an officer or director of a public company for five years.
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General News
Comments Filed with SEC on Private Right of Action Reveal a Split after
Morrison v. National Bank of Australia
As reported last year, the Dodd-Frank Act directs the Securities and Exchange Commission
(SEC) to solicit public comments and conduct a study to determine the extent to which private rights of action under the antifraud provisions of the federal securities laws should be extended to cover transnational securities fraud. The SEC complied and received many comments which can be found at its website: http://www.sec.gov/comments/4-617/4-617.
shtml. Several comments are worth highlighting. First, 42 professors who teach and write in the areas of securities and financial market regulation filed a joint comment. They opened their letter by noting, “We differ in our views of private rights of action: some of us have significant doubts about the efficacy of securities class actions, while others believe shareholder litigation rights should be strengthened. Nevertheless, as a group we believe reform efforts should be applied consistently and logically to both domestic and affected foreign issuers, and we therefore support extending the test set forth in Section 929P of the Dodd-Frank Wall Street
Reform and Consumer Protection Act of 2010 to private plaintiffs.” However, the opposite position was taken by the European Commission’s Director General of Internal Market and
Services Jonathan Faull who stated, “Extraterritorial application of the antifraud provisions of the United States’ securities laws, as envisaged by the Dodd-Frank Act regarding the public enforcement by the U.S. government and the SEC, to cases involving a private right of action regarding alleged misconduct in connection with securities, where the nexus is stronger with a foreign jurisdiction, is liable to violate the E.U.’s and its Member States’ sovereignty, and to impede the proper development of E.U.’s securities regulation. As such we strongly urge the SEC to advise against such an extension. On the contrary, in relation to private rights of action, we believe that the ‘transactional’ test established by the U.S. Supreme
Court in Morrison v. Nat’l Bank of Australia, is in accordance with the principles of comity and international law, and helps to ‘… avoid unreasonable interference with sovereign authority of other nations.’ In the context of the increasing integration of securities markets, we believe that our common objective of investor protection can be more effectively achieved by developing coordinated approaches to transnational securities-fraud public enforcement in a process of constructive discussions between U.S. authorities, the Commission, the European
Securities and Markets Authority, and the European regulators.” There have been numerous dismissals of federal shareholder suits based upon the application of Morrison v. Nat’l Bank of
Australia, and many more are expected. We will continue to monitor this critical discussion.
Equity Executive Compensation and the Impact on Stock Price
The use of equity compensation such as stock and option-based compensation increased dramatically during the 1990s, believed to be a desirable tool for aligning the interests of managers and shareholders by exposing managers’ wealth to their firms’ stock prices. The widespread use of equity-based compensation coincides with corporate scandals and the recent financial crisis. This has led many, including regulators, to question whether the large portfolios of stocks and options held by managers were a cause in these financial disasters.
There is an argument that the high sensitivity of managers’ wealth to stock price afforded by stock option holdings motivates managers to engage in short-term behavior to inflate current share prices at the expense of long-term firm value. This equity-based compensation approach is the subject of a soon-to-be published study, CFOs versus CEOs: Equity Incentives and Crashes, by Jeong-Bon Kim, Professor of Accountancy at City University of Hong Kong; Yinghua Li of the Accounting Department at Purdue University; and Liandong Zhang of the Department of Accountancy at City University of Hong Kong. The authors reviewed the impact of equity
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There have been numerous dismissals of federal shareholder suits based upon the application of Morrison v.
Nat’l Bank of Australia, and many more are expected.
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The Airgas decision does not provide carte blanche authority for boards to “just say no” or “just say never.” incentives on an issuer’s stock price risk and argued that equity incentives motivate managers to conceal bad news about growth opportunities and to choose suboptimal investment policies to support the pretense. The authors theorized that the accumulation of bad news within a firm leads to a severe overvaluation and subsequent crash in the stock price. The study sought to measure the strength of executive equity-based incentives by calculating the dollar change in the value of the stock or option holdings of the executives given one percentage point increase in the company’s stock price. Using a sample of U.S. companies during 1993 to 2009, the authors found that the strength of CFO option incentives is significantly and positively related to future stock price crash risk. This, they concluded, was in contrast to only weak evidence that the strength of CEO option incentives is positively related to crash risk.
The study asserts that CFO option incentives dominate CEO option incentives in determining future crash risk when both CFO and CEO option incentives are included in the regression.
This result indicates CFOs are more influential in firms’ bad news hoarding decisions. The study has some implications in the design of executive compensation and suggests the board take special caution in using equity incentives, particularly stock options. Finally, the results serve to rationalize the SEC’s recent requirement that firms disclose their CFO compensation packages.
Highly Publicized “Poison Pill” Upheld by Delaware Chancery Court
In Air Products & Chemicals, Inc., v. Airgas, Inc., the Delaware Chancery Court recently issued its long-awaited post-trial decision in the ongoing takeover battle between two public companies. For nearly a year, the Airgas board of directors relied on a shareholder rights plan, which included a “poison pill,” to fend off an unsolicited Air Products offer that was believed by the Airgas board to undervalue the company. At the same time, Air Products launched a public tender offer and continually bumped up its offer price only to have Airgas announce through its SEC filings and press releases that the consideration was inadequate. Air Products and certain shareholder plaintiffs tried to remove these defenses as part of their hostile tender offer. Air Products nominated three directors for election at the Airgas 2010 annual meeting and proposed three bylaws designed to aid its takeover attempt. The Airgas board responded by amending its bylaws to delay the 2010 annual meeting. Several months later when the meeting took place, the three Air Products’ nominees to the Airgas board were elected and the three Air Products’ bylaw proposals were adopted. Three months later, the Airgas board, including the three newly elected members nominated by Air Products, unanimously rejected
Air Products’ “best and final” $70 per share offer as inadequate. In a lengthy opinion, Vice
Chancellor Chandler found in favor of Airgas and its board of directors and confronted the fundamental corporation law question of “who gets to decide when and if the corporation is for sale?” After reviewing almost a quarter of a century of Delaware precedent, Vice Chancellor
Chandler concluded that “the answer must be that the power to defeat an inadequate hostile tender offer ultimately lies with the board of directors.” The Airgas decision does not provide carte blanche authority for boards to “just say no” or “just say never.” Instead, a board that acts in good faith and establishes an appropriate process may reasonably determine that there is a threat to the corporation in the form of a materially inadequate price.
14 Aon Financial Services Group Legal & Claims Practice

Cases of Interest
Plaintiffs’ Attorney Fees Award in Derivative Suit Covered by D&O Policy, but Definition of Securities Claims Bars Coverage for Fee Award in Claim
Alleging Only Breach of Fiduciary Duties
The insurers commenced this action seeking a declaration they were not obligated to provide coverage to Loral Space & Communication Inc. (Loral) for the award of plaintiffs’ attorney fees from two lawsuits (derivative and shareholder) regarding a transaction involving a controlling shareholder who agreed to provide Loral with $300 million in exchange for preferred stock that was convertible into common stock. Both suits alleged the board of directors breached its fiduciary duties in approving the transaction because it was not entirely fair to the company. The Delaware Chancery Court consolidated the matters and held a trial; however, it did not make any findings concerning the fault of the officers and directors.
Following the trial, counsel for the shareholders applied for awards of attorneys’ fees. Loral stipulated to an award of almost $8.8 million for counsel in the derivative action. Using the lodestar method, the Chancery Court awarded the other counsel about $10.7 million for fees and expenses, concluding that although there had not been a creation of a common fund, the litigation had produced a substantial benefit to the company, thus warranting an award of fees under the “corporate benefit doctrine.” Loral then sought coverage for these fees from its insurers. The insurers argued that Loral had not suffered a covered loss because the Delaware Chancery Court found no liability against Loral and had only ordered a restructuring of the transaction. As the resulting restructure actually provided a benefit, albeit nonmonetary, the insurers argued that Loral did not suffer a loss. The fees, the insurers extrapolated, simply reduced the benefit that Loral received. The court rejected these arguments noting that in an ordinary derivative suit, there is often a monetary settlement and attorneys’ fees are traditionally taken out of those settlement funds. In cases where the corporate defendant has insurance, the policy often helps fund the settlement. Had the
Delaware Court instead rendered a monetary judgment in favor of minority shareholders, the insurers would be unlikely to contest coverage. Here, the Delaware Chancery Court crafted an equitable remedy and, as part of this equitable judgment, also rendered a monetary judgment for the derivative plaintiff’s attorneys’ fees, which the court concluded, placed this amount squarely in the “other amounts” portion of the definition of “Loss.” The court also observed that the “policy covers a Securities Claim ‘brought derivatively on behalf of the Company by a security holder of such Company’” and that the award of attorney fees is typical in a derivative suit where the plaintiff has prevailed. “To declare that Loral has no coverage for derivative plaintiff’s attorneys’ fees would deprive Loral of the coverage for derivative lawsuits that it paid for and expected to receive. Had the insurers meant to exclude derivative plaintiff’s attorneys’ fees, they could have limited the definition of ‘Loss,’ limited the definition of ‘Securities Claim’ or drafted an exclusion.” However, the court reached a different conclusion on the fees related to the shareholder class action, finding that the award of fees does “not fall within coverage because they do not involve a ‘Securities Claim.’ These claims are not derivative claims and did not otherwise allege a violation ‘of any federal, state, local regulation, statute or rule regulating securities.’ Rather, they allege only breach of fiduciary duty by the company’s directors.” Loral’s argument that both Delaware actions were based on the “entire fairness rule” that governs securities transactions was rejected by the court as being without merit, noting “[t]he entire fairness rule is not a rule regulating securities. It is a standard to review corporate transactions where, as here, the plaintiff has rebutted the presumption of fairness arising from the business judgment rule. The clear language of the policy does not encompass losses arising from an action brought against the company and its directors claiming only common-law breach of fiduciary duty.” XL Specialty Ins. Co., et al., v. Loral Space & Communication, Inc., 2011 N.Y. App. Div. LEXIS 1104 (N.Y. App. Div. 2011).
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The court found that the statute mandates that notice provisions be treated as covenants, such that failure to abide by them constitutes a breach of the policy sufficient for the statute to require the disclaiming insurer to prove prejudice.
Maryland Court Rules Notice Prejudice Statute Applicable to
Claims Made and Reported D&O Policy
In this lengthy treatise-like decision, the Maryland Supreme Court revisited Maryland’s insurance contract claim notice-prejudice law, which is a body of law that has lain dormant for years. The appeal considers a ruling in favor of Great American Insurance Company (Great
American), concluding that Great American acted properly in denying coverage under a third-party D&O liability policy because the insureds failed to notify the carrier of claims made against them within the required ninety days of the expiration of the policy period. On appeal, the court noted that Great American’s entitlement to judgment was not dependent on it demonstrating how it may have been prejudiced by the tardy notice. The Maryland Court of Appeals reversed the trial court’s decision and held that Great American was required to demonstrate how it was prejudiced by the late notice, pursuant to Maryland Code, Insurance
Article § 19-110 (“Disclaimers of coverage on liability policies”), which provides that “[a]n insurer may disclaim coverage on a liability insurance policy on the ground that the insured … has breached the policy … by not giving the insurer required notice only if the insurer establishes … that the lack of … notice has resulted in actual prejudice to the insurer.” The court held this to be the case notwithstanding that the policy at issue is a “claims made policy.”
Nationwide, courts’ holdings regarding the applicability of notice-prejudice rules to claims made and reported policies have been uniform; “[i]n those jurisdictions that have examined the distinction between claims made and claims made and reported policies, the courts have uniformly relieved the insurers from any requirement to prove prejudice under the latter form of coverage.” In rejecting this position, the court began by stating, “To the extent the parties attempt to squeeze a square peg—that is, Maryland’s notice-prejudice statute, as embodied in
§ 19-110, and our jurisprudence—into a round hole—that is, the notice-prejudice jurisprudence of other states and jurisdictions—they are unpersuasive.” The court ruled, after detailed analysis, that § 19-110 does apply to claims made policies in which the act triggering coverage occurs during the policy period, but the insured does not comply strictly with the policy’s notice provisions. The court found that the statute mandates that notice provisions be treated as covenants, such that failure to abide by them constitutes a breach of the policy sufficient for the statute to require the disclaiming insurer to prove prejudice. The court ended its analysis by stating, “[l]est one think that this opinion places Maryland’s jurisprudence at odds with the majority of other jurisdictions to decide a similar question, we think it important to emphasize that Maryland’s notice-prejudice jurisprudence was ‘at odds’ with most other jurisdictions’ jurisprudence well before the filing of this opinion. As noted supra, of the more than threedozen states adopting a notice-prejudice rule, we are aware of only two other states that did so legislatively, Massachusetts and Wisconsin. Further, neither the Massachusetts nor the
Wisconsin statutes require a breach of the policy as a pre-condition to the applicability of their respective statutes. Ultimately, we are guided only—to the exclusion of other states’ noticeprejudice jurisprudence—by the text of, and the policies underlying, § 19-110. Of course, ‘[i]f the General Assembly did not so intend, it can amend or repeal the statute.’” Sherwood Brands,
Inc. et al. v. Great Am. Ins. Co., 2011 Md. LEXIS 80 (Md. 2011).
16 Aon Financial Services Group Legal & Claims Practice

“Shaved” Underlying Layers of D&O Policies Are Exhausted and
Trigger Excess Carrier’s Coverage
This is a significant insurance coverage case involving the interpretation of a directors’ and officers’ excess liability policy’s exhaustion clause, along with choice of law questions involving which state has the most significant relationship with a “D&O” policy: the state where corporate headquarters is located, or the state of incorporation. The Mills Limited Partnership
(Mills) had a layered insurance program covering its directors and officers. Due to the alleged directors’ and officers’ misconduct, Mills sustained a loss well above the limits of liability of the entire D&O insurance tower. The primary and lower-tier excess carriers settled for less than the policy limits. When Mills reached Liberty’s coverage level, they refused to pay. In the ensuing coverage action, Liberty claimed that by settling with the lower-tier carriers, the insured did not exhaust those policies and, therefore, under the Liberty policy’s terms, Liberty was not obligated to pay. The court began its analysis by noting, “[t]here are two conflicting lines of authority on the coverage question. One holds, in essence, that as long as the actual loss reaches a policy’s attachment point, it does not matter how the lower tiers settled. The other requires all lower tiers’ exhaustion by full payment before the higher-level policy is triggered.
And so, the court must consider which line of authority Delaware follows.” Mills argued that when they settled with the five underlying insurers, they “functionally exhausted” the underlying policies. Liberty claimed that its policy did not attach because settling with the underlying carriers for less than their policy limits means the insureds did not actually exhaust the underlying policies and full payment by the underlying carriers is expressly required by its policy. Liberty asserted that this is true, even if, like here, the insured’s loss reaches and exceeds Liberty’s policy. Liberty asserted that “[t]he lower excess carriers’ failure to pay their full policy limits bars Plaintiffs’ claims against Liberty Mutual in this action.” Liberty claimed that Mills “could have bargained for a contract under which Liberty Mutual agreed to pay liabilities over $60 million, even if the underlying excess carriers did not actually pay the entire settlement.” The Delaware court rejected these arguments and observed, “[t]he federal court’s approval of the $190 million settlement in effect … held the underlying insurers liable to pay the full amount of their liability. … The fact that the amount that the insured collected was less than the full amount of liability does not offend the Liberty Mutual policy.” The court also noted “there is no business reason offered to explain why it should make a difference to Liberty
Mutual if Mills settled with the underlying carriers, so long as the Liberty Mutual policy was going to be reached even if Mills had collected every cent under its underlying policies.”
Inserting a touch of reality for Liberty, the court stated that presumably, like the underlying carriers did, Liberty Mutual will now ask Mills to compromise its claim, and Liberty Mutual will be relieved that Mills does not have to insist on full payment by Liberty Mutual for fear of sacrificing its claim against the next excess carrier. The court concluded by stating that “the court holds that Mills’s settling with the underlying insurance companies, under the circumstances presented, exhausted the underlying policies as a matter of law.” Mills, Ltd. P’ship v. Liberty Mut. Ins. Co., 2010 Del. Super. LEXIS 563 (Del. Super. Ct. 2010).
… “the court holds that
Mills’s settling with the underlying insurance companies, under the circumstances presented, exhausted the underlying policies as a matter of law.”
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“… the Netherlands and the Federal policies insure different risks. Therefore, the ‘other insurance’ clause is inapplicable in this case, and Federal’s insurance is not ‘excess’ to the Netherlands’ insurance coverage.”
“Other Insurance” Clause in D&O Policy Allows Contribution from CGL Carrier
This matter arises out of a dispute among Federal Insurance Company (Federal), Firemen’s
Insurance Company of Washington, D.C. (Firemen’s), and The Netherlands Insurance Company
(Netherlands), regarding each insurer’s obligation to provide insurance coverage for a suit against mutually insured entities. Federal (the D&O insurer) allegedly paid fees defending the insureds in the underlying claim and asserted that its policy gave them the right to seek recovery from other insurance carriers covering relevant losses. According to Federal, both
Firemen’s and Netherlands (the CGL insurers) were obligated to cover the expenses of the underlying claim as primary insurers, pursuant to the “other insurance” provisions in their respective policies, allegedly making Federal’s coverage excess to the primary coverage of the
Netherlands’ and Firemen’s policies. Federal contended that it was only obligated to provide coverage after Netherlands and Firemen’s provided coverage up to their liability limits, which did not occur in this case. However, both Firemen’s and Netherlands denied coverage for the underlying claim. At issue in this case is the “Other Insurance” clause featured in the Federal policy. According to Federal, the “Other Insurance” clause states that if “any Loss under this
Coverage Section is insured under any other valid and collectible insurance policy(ies), prior or current, then this Coverage Section shall cover such Loss … only to the extent that the amount of such Loss is in excess of the amount of such other insurance whether such other insurance is stated to be primary, contributory, excess, contingent or otherwise, unless such other insurance is written only as specific excess insurance over the Limit of Liability provided in this Coverage Section.” The court first had to decide if the other carriers’ policies provided coverage before it could address how the “other insurance” clause would apply. The court stated, “[i]n determining whether a liability insurer has a duty to provide its insured a defense in a court suit, two … questions ordinarily must be answered: 1) What is the coverage and what are the defenses under the terms and requirements of the insurance policy? 2) Do the allegations in the court action potentially bring the claim within the policy’s coverage?”
Concluding that all policies were triggered, the court then analyzed the “other insurance” clause by first noting that the Netherlands policy was a CGL policy, while Federal was a D&O policy. The court found that “… the Netherlands and the Federal policies insure different risks.
Therefore, the ‘other insurance’ clause is inapplicable in this case, and Federal’s insurance is not ‘excess’ to the Netherlands’ insurance coverage.” As to Federal’s claim for contribution, the court concluded by holding that “Federal’s policy is not ‘excess to’ the Netherland’s policy but that Federal is entitled to contribution from the Netherlands.” Fed. Ins. Co. v. Firemen’s Ins. Co.,
2011 U.S. Dist. LEXIS 13432 (S.D. Md. 2011).
18 Aon Financial Services Group Legal & Claims Practice

SEC Filings
• The SEC filed securities fraud charges against DHB
Industries, Inc. n/k/a Point Blank Solutions, Inc.
(DHB), alleging “pervasive accounting and disclosure fraud.” The SEC also charged three of
DHB’s former outside directors, Jerome Krantz,
Cary Chasin, and Gary Nadelman, with facilitating
DHB’s fraud. The SEC is seeking disgorgement, prejudgment interest, penalties, and officer and director bars.
• The SEC filed securities fraud charges against
Michael W. Perry, former CEO; and A. Scott Keys, former CFO, of IndyMac Bancorp.
The SEC is seeking disgorgement, prejudgment interest, penalties, and officer and director bars.
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SEC Settlements
• Final judgment was entered on fraud charges against
Rodney B. Johnson, former CFO of Fischer Imaging
Corporation.
Johnson was ordered to pay disgorgement of $36,671, prejudgment interest of
$23,268, and was barred from acting as an officer or director of a public company for five years.
• The SEC settled fraud charges for illegal stock sales against Robert Olins, former CEO of SpatiaLight,
Inc. (SpatiaLight), and his wholly-owned company,
Argyle Capital Management Corporation (Argyle).
Olins and Argyle were ordered to pay disgorgement of $2,400,000, prejudgment interest of nearly
$900,000, and a $5,000 penalty. Additionally, unrelated to the illegal stock sales, the SEC settled fraud charges for forging auditor consents on two
SpatiaLight registration statements and insider trading charges. Olins was ordered to pay a
$180,000 penalty, and was permanently barred from acting as an officer or director of a public company.
• Final judgment was entered against David E. Watson, a former EVP of American Italian Pasta Co.
Watson was ordered to pay disgorgement of $397,113, prejudgment interest of $189,464, a $75,000 penalty, and was barred from acting as an officer or director of a public company for five years.
• Final judgment was entered against James N. Turek, former president and CEO of Plasticon
International, Inc.
Turek was ordered to pay disgorgement of $2,600,000, and prejudgment interest of $557,836. Further, Turek was barred from serving as an officer or director of a public company for five years.
• The SEC settled charges of violating the FCPA against
Tyson Foods, Inc. (Tyson).
Tyson was ordered to pay disgorgement and prejudgment interest of more than $1,200,000.
• The SEC settled fraud charges against Neal R.
Greenberg, former CEO and majority owner of
Tactical Allocation Services, LLC.
Greenberg was found liable for disgorgement of $3,941,185, plus prejudgment interest.
• The SEC settled fraud charges against S. Blair
Abernathy, former CFO of IndyMac Bancorp.
Abernathy was ordered to pay disgorgement of
$25,000, prejudgment interest of $1,592, and a
$100,000 penalty. Additionally, Abernathy was suspended from appearing or practicing before the SEC as an accountant.
* Source: http://www.sec.gov/litigation
2011 Year in Review Legal News and Developments in Executive Liability 19
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20 Aon Financial Services Group Legal & Claims Practice

General News
Paper Suggests the Legal Theory of Unconscionability Could Be Used to
Challenge Excess Executive Pay
A recent Iowa Law Review paper by Lawrence A. Cunningham of George Washington
University Law School takes on the issue of lucrative pay to corporate managers. Cunningham asserts that executive pay remains controversial yet continues to evade judicial scrutiny for legitimacy. Although many arrangements would likely pass the most rigorous scrutiny, it seems equally clear that some would not. Cunningham explains why and how the traditional contract law theory of unconscionability (whether the circumstances existing at time of making a contract involved gross overall one-sidedness as to be unfair or unreasonable) could and perhaps should be used to create a degree of judicial scrutiny to strike excessive pay contracts and preserve legitimate ones. He states, “[f]or those outraged by lopsided corporate executive compensation, this article offers an appealing new legal theory of contractual unconscionability to police them. Those who see no or few problems with contemporary pay arrangements, or who are outraged by federal regulatory schemes like the Dodd-Frank
Act, will welcome how this proposal is narrowly tailored using common law to address the most obnoxious cases.” Cunningham’s argument is premised on the concept that some agreements are not the product of arm’s-length bargaining and therefore executives become focused on short-term stock prices. The consequence is the potential destruction of long-term business value and misalignment of executive-shareholder interests. The article notes that, in theory, these compensation agreements are open to judicial review under corporate law, and shareholders challenging pay contracts face: 1) formidable procedural hurdles in derivative litigation; and 2) substantive obstacles from the traditional corporate law business judgment rule and the anemic doctrine of waste. Cunningham opines that under this “unconscionability” approach, pay contracts that are the product of managerial domination of the process and formed on terms favoring the executive will be stricken. This, he asserts, will follow direct shareholder lawsuits in state courts where the contract is made or performed, applying that state’s contract law. This new application of contract law would circumvent current approaches that Cunningham states are always upheld in derivative shareholder lawsuits when applying corporate law and sets no meaningful limits on executive pay. Cunningham emphasizes that this proposal creates new but modest pressure on Delaware from sister states to take greater responsibility for the effects its production of corporate law have on a national basis.
SEC Targets Independent Directors Who Fail to Respond to Red Flags
The Securities and Exchange Commission (SEC) targeted four independent directors at two publicly traded companies who allegedly failed to act in response to red flags signaling fraud.
According to a recent report by Gibson Dunn & Crutcher LLP, these actions are consistent with the SEC’s “continued interest in bringing enforcement actions against the directors of publicly traded companies when they personally violate securities laws or egregiously disregard their duties.” In a federal complaint filed on February 28, 2011, the SEC alleged that Jerome Krantz,
Cary Chasin, and Gary Nadelman, as former board members of DHB Industries, Inc. (DHB), failed to thwart DHB’s securities violations by willfully turning “a blind eye to numerous, significant, and compounding red flags.” The Director of the SEC’s Division of Enforcement,
Robert Khuzami, stated in a press release announcing its action against DHB, “[w]e will not second-guess the good-faith efforts of directors. But in stark contrast, Krantz, Chasin, and
Nadelman were directors and audit committee members who repeatedly turned a blind eye to warning signs of fraud and other misconduct by company officers.” In a second action announced on March 1, 2011, the SEC brought an administrative cease-and-desist proceeding against Rajat K. Gupta, a former independent director of The Goldman Sachs Group and
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… it is “only when there is both materiality and a duty to disclose that a company may be held liable for omitting information from a registration statement or prospectus.”
Proctor & Gamble Co. The SEC claims Gupta participated in insider trading when he allegedly disclosed nonpublic financial results and news of a substantial impending investment to
Raj Rajaratnam, founder and manager of the hedge fund Galleon Management. The report details these two cases as indicative of the SEC’s continued interest in independent directors of publicly traded companies who commit securities violations and fail to investigate and respond to warning signs of corporate impropriety. Consequently, Gibson Dunn & Crutcher
LLP highlighted in their report the “importance of directors: 1) establishing procedures for handling and following up on complaints or allegations against management; 2) appropriately responding to warning signs of possible management misconduct; 3) consulting with counsel when questions arise; and 4) ensuring that, when investigations of management conduct are undertaken, they are independent and thorough.”
Court Issues Strong Ruling on Trend Disclosures in Public Filings
In a recent decision by the U.S. Court of Appeals for the Second Circuit, Litwin v. Blackstone
Group, the court suggested that companies with multiple business units should disclose known trends that are reasonably likely to materially impact revenues or income and, in making the decision to disclose, consider the impact of such trends on all material aspects of a firm’s business. The Second Circuit declined to find immaterial as a matter of law: 1) alleged omissions concerning known adverse trends, events or uncertainties related to two portfolio investments, each of which individually accounted for less than 5 percent of the firm’s total assets under management, but were significant to the firm’s corporate private equity segment, which accounted for approximately 37 percent of the firm’s total; and 2) alleged omissions concerning known downward trends affecting the firm’s residential real estate holdings, which amounted to at most 15 percent of its real estate segment assets under management, which, in turn, comprised approximately 23 percent of the firm’s total assets under management. The
Second Circuit concluded that “[e]ven where a misstatement or omission may be quantitatively small compared to a registrant’s firm-wide financial results, its significance to a particularly important segment of a registrant’s business tends to show its materiality.” Despite this language, the Second Circuit reiterated that the concept of materiality is still capable of “some defined boundaries,” that not all aspects of a company’s business will be deemed material, and that it is “only when there is both materiality and a duty to disclose that a company may be held liable for omitting information from a registration statement or prospectus.”
22 Aon Financial Services Group Legal & Claims Practice

Cases of Interest
Third Circuit Clarifies the “Fraud-On-The-Market” Presumption to “Scheme Liability” Claims
Against Secondary Actors under Section 10(b) of the Securities Exchange Act
DVI, Inc. was a publicly-traded healthcare finance company that extended loans to medical providers to facilitate the purchase of diagnostic medical equipment. In 2003, following revelations of fraud within the company, DVI filed for bankruptcy. A group of investors filed a putative securities class action against Clifford Chance, DVI’s former outside securities counsel, and the company’s accountants, bankers, officers and directors, and several employees alleging the defendants participated in a scheme to artificially inflate the price of DVI’s stock. The shareholders asserted claims against Clifford Chance under Section 10(b) of the
Securities Exchange Act and Rule 10b-5(a) and (c), alleging that Clifford Chance participated in a deceptive scheme to conceal information about the company’s financial condition from investors. The investors’ claims focused on the legal advice Clifford Chance provided concerning the company’s evaluation of whether it must disclose that its external auditor included, in its management letter, a material weakness in internal controls. The shareholders contended that Clifford Chance orchestrated a “scheme” to enable the company to avoid disclosing the material weakness, which they contended would have revealed financial weaknesses within DVI. Clifford Chance argued it had no knowledge of any improprieties at DVI and that it based its advice that the finding need not be disclosed on an interpretation of the relevant disclosure rules. When the shareholders moved to certify a class on behalf of affected investors, they sought to invoke the “fraud-on-the-market” presumption, under which courts may presume that, in an efficient market, materially misleading statements are incorporated into the share price on which investors rely in deciding to purchase securities. Relying upon
Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, Inc., the U.S. District Court for the Eastern District of Pennsylvania concluded that the shareholders could not invoke the presumption because none of Clifford Chance’s allegedly deceptive conduct had been publicly disclosed. Without this presumption, the court would have to examine the individual claims of investors, rather than consider them together as a class. Accordingly, the trial court denied the shareholders’ motion for class certification concerning Clifford Chance. On appeal, the shareholders contended the trial court misinterpreted the Stoneridge decision concerning Clifford Chance’s conduct on two principal grounds: 1) the 10-Q did not disclose the material weakness; and 2)
Clifford Chance was involved in the “investment sphere” of the company. The U.S. Court of
Appeals for the Third Circuit rejected these arguments and affirmed the trial court’s decision, without reaching the factual disputes as to whether there had in fact been a deceptive scheme.
To this end, the Third Circuit adopted the Second Circuit’s middle-ground approach on the relevance of price impact to the class certification inquiry stating, “we believe rebuttal of the presumption of reliance falls within the ambit of issues that, if relevant, should be addressed by district courts at the class certification stage. … Moreover, we agree with the Second Circuit that a defendant’s successful rebuttal demonstrating that misleading material statements or corrective disclosures did not affect the market price of the security defeats the presumption of reliance for the entire class, thereby defeating the Rule 23(b) predominance requirement.”
In short, the Third Circuit clarified the application of the “fraud-on-the-market” presumption to “scheme liability” claims against secondary actors under Section 10(b) of the Securities
Exchange Act, holding that courts will not presume investors relied on allegedly deceptive conduct by secondary actors unless the deceptive conduct was publicly disclosed and publicly attributed to the secondary actor. In re DVI Sec. Litig., 2011 U.S. App. LEXIS 6302 (3 rd Cir. 2011).
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… the stockholder must illustrate their necessity by articulating in more specific and convincing fashion why the incremental information is reasonably required to evaluate the board’s demand-refusal decision.
Delaware Section 220(b) Books and Records Request Is Proper
If It Reasonably Relates to a Stockholder
The Louisiana Municipal Police Employees Retirement System (LAMPERS) demanded that the board of directors for Morgan Stanley & Co., Inc. (Morgan Stanley) take action to remedy misconduct allegedly committed by certain officers and directors concerning Morgan Stanley’s participation in the auction rate securities market (Litigation Demand). Simpson Thacher and
Bartlett LLP (Simpson Thacher) sent LAMPERS a response eight months later (the Demand
Refusal Letter) in which the Morgan Stanley Board refused to take any action in response to the Litigation Demand. The Simpson Thatcher letter detailed the board’s process by which it arrived at its decision not to act. LAMPERS responded to the Demand Refusal Letter by requesting that Morgan Stanley make certain books and records available for inspection.
Morgan Stanley refused to produce the records and LAMPERS filed a Section 220 complaint in the Delaware Court of Chancery. Morgan Stanley then filed a motion to dismiss the complaint on the grounds that LAMPERS failed to state a proper purpose and sought books and records outside the scope of its stated purpose. In deciding the motion, the Delaware Court of
Chancery initially indicated that “[e]xploring whether a litigation demand was wrongfully refused is a proper purpose for using Section 220.” The court cited Delaware law and refused to be persuaded by Morgan Stanley’s contention that a stockholder who makes a demand concedes the independence or disinterestedness of the board for purposes of demand refusal. Importantly, “[t]he question of whether a corporation should sue its directors and senior officers puts directors in a difficult position.” As a result, the court concluded that
“[b]asic notions of accountability require that stockholders be able to use Section 220 to evaluate whether the demand-refusal decision was made in good faith, after a reasonable investigation,” or whether the board had some different, ulterior motivation. Accordingly,
Morgan Stanley cannot vanquish a stockholder’s right to use Section 220 to investigate demand refusal by merely sending a self-serving letter describing the board’s process. Since
LAMPERS stated a proper purpose for its demand, the court then examined the proper scope of inspection, acknowledging that “[a] stockholder’s inspection is limited to those books and records that are necessary to accomplish the stated.” The court held that LAMPERS stated a claim showing such necessary books and records to include: 1) the minutes of any meeting of the board or the audit committee where the Litigation Demand was discussed or evaluated; 2) the [counsel’s] written report and presentation to the audit committee in connection with the firm’s recommendation to refuse the Litigation Demand; 3) the audit committee’s report and presentation to the board; and 4) any documents and other records upon which the board relied. The court stated that LAMPERS was entitled to obtain a report previously prepared by
Skadden Arps concerning its 2007 and 2008 investigation into Morgan Stanley’s involvement with auction rate securities as well as both law firms’ engagement letters. Finally, the court concluded that LAMPERS’ other books and records requests were not proper. To obtain additional books and records, the stockholder must illustrate their necessity by articulating in more specific and convincing fashion why the incremental information is reasonably required to evaluate the board’s demand-refusal decision. The court noted, however, that LAMPERS is free to attempt such a showing in a future Section 220 demand based on the materials it obtains from this request. La. Mun. Police Emples. Ret. Sys. v. Morgan Stanley & Co., 2011 Del. Ch.
LEXIS 42 (Del. Ch. 2011).
24 Aon Financial Services Group Legal & Claims Practice

Prior Knowledge Provision Is an Unambiguous Condition Precedent to Coverage to Which the Innocent Insured Provision Is Inapplicable
In a recent decision by the U.S. Court of Appeals for the Fourth Circuit, the court found there is no coverage under an accountants’ professional liability insurance policy where the policy’s prior knowledge provision, which is an unambiguous condition precedent to coverage, was not satisfied. The court further held that the policy’s innocent insured provision could not be used to expand the scope of the policy’s coverage and therefore was inapplicable. The insurer issued a claims-made-and-reported accountants’ professional liability policy for the policy period of July 1, 2008 to July 1, 2009. The policy stated that the insurer would provide coverage for claims by reason of an act or omission in the performance of professional services, pursuant to certain terms and conditions, including that “prior to the effective date of this policy, none of you had a basis to believe that any such act or omission, or interrelated act or omission, might reasonably be expected to be the basis of a claim.” The policy defined “you” to include the named insured and all of its employees. The policy contained a dishonesty exclusion, which excluded coverage for “any claim based on or arising out of a dishonest, illegal, fraudulent, criminal or malicious act” by any insured. In addition, the policy contained an “innocent insured” provision, which stated, in relevant part, that “[i]f coverage under this policy would be excluded as a result of any criminal, dishonest, illegal, fraudulent, or malicious acts of any of you, we agree that the insurance coverage that would otherwise be afforded under this policy will continue to apply to any of you who did not personally commit, have knowledge of, or participate in such” acts or in the concealment of such acts from the insurer. In February 2009, the insured discovered that one of its employees had been stealing money from clients’ accounts beginning in 1999. The clients asserted claims against the insured, and the insured sought coverage under the policy. The insurer denied coverage for the claims because an insured (the employee who had stolen funds) had a basis to believe that her acts might reasonably be expected to be the basis of a claim and, thus, the policy’s prior knowledge provision, which was a condition precedent to coverage, had not been met and the policy’s coverage agreements had not been triggered. The insured contested the denial and coverage litigation ensued. The insured argued that the policy’s prior knowledge provision was an exclusion to coverage (vs. a condition precedent) and that, because the employee was the only insured with prior knowledge of her thefts, the policy’s innocent insured provision saved coverage for all other insureds. The Fourth Circuit held that the policy’s prior knowledge provision is a clear and unambiguous condition precedent to coverage which provides that, if any insured had knowledge as of the policy’s inception of an act or omission that might become the basis for a claim, any claims arising from such acts or omissions are not covered under the policy. The court concluded that, based on the employee’s thefts, which predated the policy, the employee, who was an insured, had a basis to believe at the time the policy incepted that her acts might reasonably be expected to be the basis of a claim. Thus, the policy’s prior knowledge provision had not been met, and the policy’s coverage agreements had not been triggered. The court further held that the innocent insured provision was inapplicable. The court stated that the innocent insured provision appeared to be an exception to the dishonesty exclusion. It further noted that, in any event, the provision could not be used to expand the scope of the policy’s coverage and, therefore, was inapplicable where the policy’s prior knowledge provision, which was a condition precedent to coverage, had not been satisfied in the first instance. Finally, the court rejected the insured’s argument that the policy language was ambiguous, concluding that “a plain reading of the pertinent policy language reveals that it is not susceptible to more than one meaning. Because the language of the prior knowledge provision is unambiguous and structured as a condition precedent to the coverage agreement, we will not contort the language to find an ambiguity.” Bryan Bros., Inc. v. Cont’l Cas. Co., 2011 U.S. App. LEXIS 6131
(4 th Cir. 2011).
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The Fourth Circuit held that the policy’s prior knowledge provision is a clear and unambiguous condition precedent to coverage …
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2011 Year in Review Legal News and Developments in Executive Liability 25

On appeal, the Delaware
Supreme Court concluded the Court of Chancery’s bright-line rule “[did] not comport with existing
Delaware law or with sound policy” because stockholder-plaintiffs are encouraged to utilize
Section 220 to obtain facts sufficient to plead demand futility before filing a derivative action.
Stockholder-Plaintiff May File a Delaware Section 220 Request to Inspect Books and Records Even If a Derivative Lawsuit Is Filed First
VeriFone Systems, Inc. (VeriFone) acquired Lipman Electronic Engineering (Lipman) and then a short time later announced that it would have to restate its financial results due to accounting errors relating to the integration of Lipman’s inventory systems. Following the announcement, VeriFone’s stock price fell by almost fifty percent. The next day, VeriFone shareholders filed a class action in the U.S. District Court for the Northern District of California, asserting federal securities fraud claims against VeriFone and its officers. Charles King, a
VeriFone stockholder, (King) then filed a derivative action against VeriFone’s officers and directors alleging breaches of fiduciary duty and corporate waste seeking indemnification on behalf of the company for costs incurred in resolving the securities suits. Three additional derivative actions followed. The four cases were consolidated, and the California Federal
Court appointed King as the lead plaintiff. The California federal court eventually dismissed the derivative complaint for failure to allege particularized facts that would excuse pre-suit demand. The federal court granted King leave to amend his complaint, and suggested he utilize Section 220 of the Delaware Code to obtain facts that might aid in pleading demand futility. King then submitted a Section 220 demand to VeriFone and received documents responsive to all but one of his requests. VeriFone declined to produce an audit committee report, which contained the results of an internal investigation of VeriFone’s accounting and financial controls conducted after the restatement. King then filed a Section 220 complaint seeking an order allowing him to inspect the audit committee’s report. The Delaware Court of Chancery dismissed King’s Section 220 complaint concluding that he lacked a proper purpose under Section 220 because he elected to litigate the derivative action prior to conducting a pre-suit investigation, including use of the Section 220 process. Significantly, the Court of Chancery indicated that [s]tockholders who seek books and records in order to determine whether to bring a derivative suit should do so before filing the derivative suit. Once a plaintiff has chosen to file a derivative suit, it has chosen its course and may not reverse course and burden the corporation (and its other stockholders) with yet another lawsuit to obtain information it cannot get in discovery in the derivative suit. On appeal, the Delaware Supreme Court concluded the Court of Chancery’s bright-line rule “[did] not comport with existing Delaware law or with sound policy” because stockholder-plaintiffs are encouraged to utilize Section 220 to obtain facts sufficient to plead demand futility before filing a derivative action. While the decision to file a derivative complaint before using the
Section 220 inspection process is “ill-advised,” it is not “fatal” to a stockholder-plaintiff’s right to seek books and records pursuant to Section 220. The Supreme Court outlined several situations in which Delaware courts dismissed derivative complaints, and recommended that stockholder-plaintiffs utilize Section 220 as a tool to obtain facts to re-plead demand futility.
The key component in each case hinged on the fact that the dismissals were without prejudice and with leave to amend. Accordingly, the Supreme Court concluded that a stockholderplaintiff seeking books and records under Section 220 does not lack a proper purpose simply because the stockholder-plaintiff filed a derivative action first, which was dismissed for failure to adequately plead demand futility. Despite its ruling, the Supreme Court made clear that it was not endorsing the way King chose to pursue his litigation strategy, which “may well prove imprudent and cost-ineffective.” The Supreme Court also noted the Chancery
Court’s “prophylactic cure” was not supported by law and instead needed to be taken up by the Delaware legislature. In short, if the “rush to the courthouse” is indeed a problem, the
Supreme Court noted it is up to the plenary court to craft solutions, which could include selection of other lead counsel, dismissal as to the named plaintiff, or awarding attorneys fees for the motion to dismiss. King v. VeriFone Holdings, Inc.
2011 Del. LEXIS 60 (Del. 2011).
26 Aon Financial Services Group Legal & Claims Practice

SEC Filings
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SEC Settlements
• The SEC filed fraud charges against Robert A.
DiGiorgio, and his company, Radius Capital
Corporation (Radius).
The SEC is seeking disgorgement, prejudgment interest, and penalties, jointly and severally, against Radius and DiGiorgio.
• The SEC filed fraud charges against three executives of Fair Finance Company, Timothy S. Durham, CEO;
James F. Cochran, chairman; and Rick D. Snow, CFO.
The SEC is seeking disgorgement, prejudgment interest, penalties, and officer and director bars.
• The SEC filed fraud charges against St.
Anselm Exploration Co.
its three principals,
Michael A. Zakroff, Anna M.R. Wells, Mark S.
Palmer; and Steven S. Etkind, VP of corporate development. The SEC is seeking disgorgement, prejudgment interest, and penalties.
• The SEC settled FCPA violation charges against
International Business Machines Corporation
(IBM).
IBM was ordered to pay disgorgement of
$5,300,000, prejudgment interest of $2,700,000, and a penalty of $2,000,000.
• The SEC settled insider trading charges against
Kim Ann Deskovick, a former director of
First Morris Bank and Trust. Deskovick was ordered to pay a penalty of $68,277, and was barred from serving as an officer or director of a public company for five years.
• The SEC settled insider trading charges against
Daniel F. Wiener, II, a former executive of BAE
Systems, Inc. (BAE).
Wiener was ordered to pay disgorgement of $67,687, prejudgment interest of $8,323, and a penalty of $25,000.
• The SEC settled fraud charges against Aerokinetic
Energy Corporation (Aerokinetic), and Randolph
E. Bridwell, president. Aerokinetic and Bridwell were ordered to pay disgorgement of $555,000 jointly and severally, prejudgment interest of $59,571, and penalties of $250,000 and $130,000 respectively.
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* Source: http://www.sec.gov/litigation.shtml
2011 Year in Review Legal News and Developments in Executive Liability 27

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28 Aon Financial Services Group Legal & Claims Practice

General News
SEC Proposed Rules Requiring Listing Standards for
Compensation Committees and Consultants
On March 30, 2011, the Securities and Exchange Commission (SEC) proposed rules to implement certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection
Act of 2010 addressing the independence of compensation committee members, the authority and funding of the compensation committee, and compensation adviser selection. The rules direct U.S. national securities exchanges to adopt listing standards that require each member of a company’s compensation committee to be independent, however, the proposed rules do not define “independence.” According to the SEC, each exchange will be required to establish a definition that considers “the sources of compensation of a director, including any consulting, advisory or compensatory fee paid by the company to such member of the board of directors,” and “whether a member of the board of directors of a company is affiliated with the company, a subsidiary of the company, or an affiliate of a subsidiary of the company.” The SEC’s proposed rules would also require exchanges to adopt listing standards so the compensation committee of a listed company may, at its discretion: 1) seek the advice of a compensation adviser; 2) be responsible for the appointment, payment and oversight of such advisers; and
3) be appropriately funded by the listed company. According to the SEC, the compensation committee may select compensation consultants, legal counsel or other advisers only upon consideration of the following five independence factors: “1) whether the compensation consulting company employing the compensation adviser is providing any other services to the company; 2) how much the compensation consulting company who employs the compensation adviser has received in fees from the company, as a percentage of that person’s total revenue; 3) what policies and procedures have been adopted by the compensation consulting company employing the compensation adviser to prevent conflicts of interest;
4) whether the compensation adviser has any business or personal relationship with a member of the compensation committee; and 5) whether the compensation adviser owns any stock of the company.” The SEC’s rules exempt the following companies from the above independence requirements: controlled companies, limited partnerships, companies in bankruptcy proceedings, open-end management investment companies registered under the Investment
Company Act of 1940, and any foreign private issuer that discloses in its annual report that it does not have an independent compensation committee. Additionally, the SEC’s proposed rules integrate a requirement that any proxy or information statement concerning an annual shareholder meeting at which directors are to be elected disclose whether the compensation committee has retained the advice of a compensation consultant and whether the work of the compensation consultant raised any conflict of interest. The exception from the disclosure requirement for services that are limited to consulting on broad-based plans and the provision of non-customized benchmark data would be eliminated; however, the fee disclosure requirements, including exemptions from such requirements, would be retained.
Early Results from “Say on Pay” and “Say on Frequency” Rules
The SEC issued final rules of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 mandating advisory shareholder votes on executive compensation provisions such as “say on pay” (SOP) and “say on frequency” (SOF) votes. Within the first 30 days of the new rules, 95 companies, including TARP recipients, held SOP votes and 92 companies held SOF votes. Named Executive Officer (NEO) compensation was approved by an overwhelming percentage of votes cast by shareholders at 93 of the 95 companies, contradicting a widespread fear of negative voting prior to this year’s proxy season. Conversely, frequency recommendations did not receive nearly as much support. The statistics from the first 30 days following the implementation of SOP and SOF rules resulted in several takeaways as
According to the SEC, each exchange will be required to establish a definition that considers “the sources of compensation of a director, including any consulting, advisory or compensatory fee paid by the company to such member of the board of directors,” …
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2011 Year in Review Legal News and Developments in Executive Liability 29

“We saw multiple opportunities in largecap companies that could benefit from our constructivist approach.
Now we can target them more easily.” companies prepare for the 2011 proxy season. According to an article from the Harvard Law
School Forum on Corporate Governance and Financial Regulation, “companies should assess their NEO compensation practices well in advance of filing the proxy statement in order to determine whether they are at risk of a negative SOP vote and, following from that assessment, what pay practices, if any, should be modified.” Additionally, in order to mitigate the risk of a negative SOP vote, companies “should consider whether their CD&A adequately and clearly communicates compensation decisions, philosophy and terms,” and “if last year’s CD&A did not have an executive summary, one should be considered for this year.” On the topic of frequency, shareholders thus far have been partial to an annual SOP vote. According to the article, “early voting results underscore that a biennial or triennial SOP vote recommendation will in many cases be a hard sell.” Many large pension funds, along with Institutional
Shareholder Services, have expressed support for annual SOP votes, which likely played a role in the recent frequency votes at larger companies. As part of determining its frequency recommendation and assessing how shareholders may vote, the article recommends the board take into account: “1) the company’s investor base; 2) general shareholder voting patterns;
3) shareholder voting history on compensation committee members and compensation matters; 4) the company’s compensation programs and philosophy; 5) peer group frequency recommendations and shareholder votes, if yet known; and 6) investor relations goals.”
Activists Target Companies with a Market Capitalization Over $50 Billion
In a recent speech to the Council of Institutional Investors, billionaire Nelson Peltz said changes in corporate governance will enhance his ability to make activist investments in companies with a market capitalization over $50 billion, which he referred to as “untouchables.”
According to data compiled by Bloomberg, there are approximately 57 U.S. companies with a market capitalization that equals or exceeds $50 billion, ranging from the largest estimated value of $421 billion (Exxon Mobil Corporation) to the smallest market value of $50.2 billion
(Apache Corporation). Peltz believes new governance rules, such as revisions to corporate election rules requiring that directors receive a majority of ballots cast, provide activists with additional tools to gain board seats. According to Martin Lipton of the firm Wachtell, Lipton,
Rosen & Katz, “activist investors with significant records of success will be able to use the new governance rules to convince institutional investors, like the members of the Council of
Institutional Investors, to join them in pressuring companies to change their business strategies to those advocated by the activists, whether or not they are in the best interests of the longterm success of the companies and their long-term investors.” Peltz stated that when he formed the hedge fund manager Trian Fund Management LP, “We saw multiple opportunities in large-cap companies that could benefit from our constructivist approach. Now we can target them more easily.” Following a significant increase in activist investments and hostile takeover activity this year, Lipton believes that if “the present favorable market conditions for this activity continue, there will be a further increase.” Peltz also noted that larger companies may provide greater profit opportunities for activism than smaller companies. According to
Lipton, this emphasizes the need for all companies, even the very largest, to “have up-to-date plans for dealing with activists and strategies to avoid inviting the notice of activists.”
30 Aon Financial Services Group Legal & Claims Practice

Cases of Interest
“Loss” Does Not Include Statutory Civil Damages Because They Are Akin to a “Penalty”
In this coverage litigation, Flagship Credit Corporation (Flagship) and Indian Harbor Insurance
Company (Indian Harbor) disputed the insurer’s obligation to indemnify Flagship for a settlement. The underlying class action suit alleged violations of the Texas Business and
Commerce Code concerning consumer notices sent in the context of repossession and resale of vehicles. The suit sought only statutory damages calculated without reference to any actual harm suffered by a claimant. Indian Harbor issued an E&O policy to Flagship, which defined loss to mean “damages, judgments, settlements or other amounts,” but excluded, among other items, “fines, penalties or taxes imposed by law.” Indian Harbor agreed to advance defense costs for the underlying class action suit but refused to indemnify any settlement amounts. In support of its position, Indian Harbor argued the statutory damages were punitive and not associated with any harm sustained by the underlying plaintiffs. In other words, Indian Harbor believed the statutory damages were a “penalty” under the policy.
Flagship, relying on Black’s Law Dictionary, argued that the damages sought in the underlying class action lawsuit cannot be “penalties imposed by law” because a “penalty’ is “generally understood to be an amount imposed as punishment by, and payable to, a governmental body.” The court rejected Flagship’s argument because Black’s goes on to specifically define a “civil penalty” as a “fine assessed for a violation of a statute or regulation,” and a “statutory penalty” as a “penalty imposed for a statutory violation; esp., a penalty imposing automatic liability on a wrongdoer for violation of a statute’s terms without reference to any actual damages suffered.” When the court applied the broader definition of penalty, it found the recovery sought was not based on actual damages, but rather a “penalty.” Flagship set forth a second argument that because “penalties” appeared between “fines” and “taxes,” one must construe the term to mean only penalties payable to governmental entities. The court concluded that “[u]nder the plain language of the definition, fines imposed by law, penalties imposed by law, and taxes imposed by law are all excluded from the definition of ‘Loss,’ whether the fines, penalties, or taxes are payable to governmental bodies or not.” Finally, the court found the provision was not ambiguous, noting Flagship failed to pose a reasonable construction of the policy definition to afford coverage. Flagship Credit Corp. v. Indian Harbor Ins.
Co., 2011 U.S. Dist. LEXIS 46279 (S.D. Tex. 2011).
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“[u]nder the plain language of the definition, fines imposed by law, penalties imposed by law, and taxes imposed by law are all excluded from the definition of ‘Loss,” …
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2011 Year in Review Legal News and Developments in Executive Liability 31

Federal’s continued reliance on a reasonable interpretation of the policy during the pending coverage litigation did not give rise to a claim for bad faith.
Bad Faith Does Not Encompass Reasonable Dispute over Policy Interpretation
After several securities class action lawsuits were filed against Abercrombie & Fitch, Inc.
(Abercrombie) and before Abercrombie purchased an Extended Reporting Period (ERP) from
Federal Insurance Company (Federal), Abercrombie renegotiated its policy with National
Union Insurance Company (National Union), providing that new coverage would be excess to Federal’s primary coverage under the ERP. The agreement between National Union and
Abercrombie was later included in an endorsement. The SEC then initiated an investigation against Abercrombie. Disputes began over coverage in connection with the securities class action lawsuits brought against Abercrombie, as well as the SEC investigation. Federal asserted that Abercrombie breached the terms of the insurance policy, which relieved it of any obligations under the policy. The district court found that Abercrombie did not breach the policy terms. Subsequently, the United States Court of Appeals for the Sixth Circuit affirmed the district court’s ruling. Federal paid its full $10 million limit of liability and sought to dismiss
Abercrombie’s previously-filed bad faith and breach of contract claims. Abercrombie asserted a bad faith claim against Federal because after the initiation of coverage litigation, the insurer continued to refuse to pay any portion of the defense costs associated with the lawsuits and the SEC investigation. Abercrombie contended that Federal’s position constituted bad faith retaliation and, therefore, Federal lacked reasonable justification for refusal to pay. The court in the current ruling disagreed and rationalized that a reasonable person could have interpreted the policy in the same manner as Federal in light of the Sixth Circuit’s dissenting opinion that Abercrombie did not breach the insurance policy. Accordingly, Federal was not alone in the belief that it was discharged from performing its contractual obligations once it learned that Abercrombie had entered into the National Union agreement as evidenced by the Sixth
Circuit’s dissenting opinion. “Even independently of the dissent in the direct appeal, the lower court was of the view that a reasonable person could have taken Federal’s position as to the interpretation of the contract.” Therefore, the court further concluded that Federal’s continued reliance on a reasonable interpretation of the policy during the pending coverage litigation did not give rise to a claim for bad faith. The court went on to hold that Abercrombie’s request for a declaration of its rights under the policy did not present an actual controversy because
Federal paid its policy limits. The court, however, did not dismiss Abercrombie’s breach of contract claim because there was sufficient evidence to determine whether Federal owed prejudgment interest. Abercrombie & Fitch Co. v. Fed. Ins. Co., 2011 U.S. Dist. LEXIS 34302 (S.D.
Ohio 2011).
32 Aon Financial Services Group Legal & Claims Practice

The Phrase “Full Reservation of Rights” Is Sufficient for Insurer to Seek Reimbursement of
Settlement Payments from the Insured and Excess Carrier
Synopsys, Inc. (Synopsys) filed suit against Magma Design Automation, Inc. (Magma) alleging infringement of three patents. Subsequently, Magma’s shareholders filed a securities class action and a derivative action against Magma. In both actions, shareholders sought damages as a result of the alleged failure to disclose Magma’s risk of liability for patent infringement because the patented inventions at issue were designed by Magma’s chief scientist while he was employed at Synopsys. Magma tendered the two shareholder actions to its primary D&O carrier, Executive Risk Indemnity, Inc. (ERII) and its excess carrier, Genesis Insurance Company
(Genesis). Genesis filed litigation seeking: 1) a declaration that it had no obligation to provide coverage to Magma under its excess policy; and 2) equitable subrogation from National Union
Fire Insurance Company of Pittsburgh, PA (National Union), which issued an excess policy under a different policy period’s extended reporting provision. The district court determined that there was a potential for coverage during Genesis’ earlier excess policy period. The United
States Court of Appeals for the Ninth Circuit reversed, finding that there was no potential for coverage. However, Genesis had already paid $5 million toward Magma’s settlement of the two shareholder class action lawsuits. Genesis sought reimbursement of the $5 million it paid in settlement, plus interest, claiming that it expressly reserved the right to seek reimbursement of any portion of the settlement payment attributable to non-covered claims. Magma alleged that Genesis waived its right to seek reimbursement by failing to make an express reservation of rights under California law. The district court disagreed and referenced numerous letters from Genesis to Magma stating that the carrier was funding the settlement subject to a “full reservation of rights.” Moreover, Magma accepted Genesis’ $5 million settlement contribution even though it knew that Genesis might seek to claw back that payment. Because there were issues of fact concerning whether Magma relied on Genesis’ conduct and reasonably believed Genesis planned to seek contribution only from National Union, the district court rejected Magma’s claim. The district court concluded that Genesis was entitled to equitable subrogation from National Union under California law because: 1) Genesis paid Magma’s $5 million settlement to protect its own rights and avoid a bad faith claim; 2) Genesis’ payment was not “voluntary;” 3) because of the Ninth Circuit’s opinion, Genesis was not primarily liable to pay the $5 million; 4) Genesis paid the entire amount; and 5) subrogation would not be an injustice against National Union, which owed the $5 million under the terms of its policy.
Genesis Insurance Co. v. Magma Design Automation Inc., Case No. C 06-05526 JW (N.D. Cal. 2011).
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… the court concluded that Genesis is entitled to equitable subrogation from National Union …
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2011 Year in Review Legal News and Developments in Executive Liability 33

… “the Sixth Circuit recognized that the recusal effectively constituted an admission of bias” …
One SLC Member’s Recusal Taints the Recommendation to Dismiss and Proves the SLC Was Not an Independent Committee
Abercrombie & Fitch Co. (Abercrombie) shareholders filed a derivative suit against various officers and directors alleging they caused the corporation to disseminate misleading public statements. In response, Abercrombie formed a Special Litigation Committee (SLC) under
Delaware law to investigate the derivative claims and make a recommendation as to whether the claims should be pursued. The SLC consisted of two board members who retained a renowned national law firm to help conduct the investigation in which numerous interviews were completed and thousands of pages of documents and records were reviewed. Upon completion of its sixteen-month investigation, the SLC issued a 144-page report, which concluded there was no evidence to support the derivative claims and recommended that
Abercrombie seek dismissal of the action. During the investigation, one of the committee members, Allan Tuttle (Tuttle), abstained from considering the claims against Robert Singer
(Singer), Abercrombie’s COO, and did not attend Singer’s interview. The district court determined that Abercrombie met the Delaware law criteria supporting the dismissal of a derivative action based upon the SLC’s recommendation, including: 1) the committee was independent; 2) it conducted its investigation in good faith; 3) it had reasonable bases for its conclusion; and 4) the decision to dismiss the lawsuit was not inconsistent with business judgment. The district court also commented on Tuttle’s independence and opined that the fact that Tuttle previously worked with Singer and considered Singer a friend was insufficient under Delaware law to show a lack of independence. The district court highlighted that
“… Tuttle took the additional cautionary step of abstaining from investigation or consideration of Plaintiffs’ claims directed against Defendant Singer.” The United States Court of Appeals for the Sixth Circuit concluded that Tuttle’s abstention, purportedly as an “additional cautionary” measure, actually proved that the SLC was not independent. Importantly, the Sixth Circuit noted, “[h]ad Tuttle not recused himself from considering the claims against Singer, we might agree with the district court’s conclusion that he was independent.” Instead, the Sixth Circuit recognized that the recusal effectively constituted an admission of bias, or “[a]t the very least,” created “a perception that Tuttle was not independent.” Consequently, Tuttle’s “bias” tainted the SLC’s recommendation because Singer was the central figure in the wrongdoing.
Accordingly, the Sixth Circuit concluded that Tuttle could not impartially consider whether the corporation should pursue the claims against any of the defendant directors because it would necessarily implicate Singer. Therefore, the SLC lacked the necessary independence.
Moreover, because Abercrombie’s board constituted a two-person SLC and Tuttle’s recusal left only one committee member to consider the claims, the SLC’s recommendation was ineffective. Ultimately, the Sixth Circuit noted that this was “one of those rare situations where
Abercrombie had every opportunity to create an independent special litigation committee,” despite the “latitude” afforded under Delaware law. A dissenting opinion noted that the majority failed to rely upon any authority for its conclusion concerning the outcome of
Tuttle’s recusal. The dissenting opinion took issue with the majority’s view that Tuttle’s recusal confirmed a lack of independence. Agreeing with the district court’s conclusion that Tuttle’s recusal “attempted to expel any doubt regarding the independence of” the special litigation committee, the judge referenced several Delaware decisions finding that friendships or business relationships often are not sufficient to raise a reasonable doubt regarding a director’s independence. The Booth Family Trust v. Jeffries, 2011 U.S. App. LEXIS 6814 (6 th Cir. 2011).
34 Aon Financial Services Group Legal & Claims Practice

SEC Filings
• The SEC filed financial fraud charges against
Brian D. Fox, former chairman, CEO, and CFO of
Powder River Petroleum International, Inc.
(Powder River).
The SEC is seeking disgorgement, prejudgment interest, penalties, and a permanent officer and director bar.
• The SEC filed fraud charges against Inofin, Inc.;
Michael Cuomo, president, treasurer and director;
Kevin Mann, secretary, CEO and director. The SEC is seeking disgorgement, prejudgment interest, and penalties.
• The SEC filed fraud charges against AIC, Inc.
and Nicholas D. Skaltsounis, president and CEO.
The SEC is seeking disgorgement, prejudgment interest, and penalties.
• The SEC filed fraud charges against mUrgent
Corporation and three of its executives,
Boris Bugarski, CEO; Walter Bugarski, CFO; and Aleks Bugarski, COO. The SEC is seeking disgorgement, penalties, and permanent officer and director bars.
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SEC Settlements
• The SEC settled antifraud and registration violation charges against Joseph J. Glusic, former CEO and president of Magnum d’Or Resources, Inc.
Glusic was ordered to pay disgorgement of $1,878, prejudgment interest of $231, a penalty of $50,000, and was permanently barred from acting as an officer or director of a public company.
• The SEC settled fraud charges against Brian Crombie, former CFO of Biovail Corporation.
Crombie was ordered to pay a penalty of $100,000, and was barred from serving as an officer or director of a public company for five years
• The SEC settled fraud charges against J. Kenneth
Stringer III, former CEO of Flir Systems, Inc.
Stringer was ordered to pay a penalty of $90,000, and was permanently barred from serving as an officer or director of a public company.
• The SEC settled fraud charges against the sole officers of Neurotech Development Corporation.
Bernard Artz, chairman, CEO and CFO, was ordered to pay disgorgement of $131,414, prejudgment interest of $32,017, and a penalty of $10,000.
Lawrence Artz, VP, was ordered to pay disgorgement of $57,130, prejudgment interest of $79,847, and a penalty of $5,000.
• The SEC settled charges of FCPA violations against
Comverse Technology, Inc. (Comverse).
Comverse was ordered to pay disgorgement of $1,249,614 and prejudgment interest of $358,887.
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* Source: http://securities.stanford.edu/
2011 Year in Review Legal News and Developments in Executive Liability 35

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General News
Conflicts between Institutional and Individual Investors in Securities Class Actions
In a paper titled The Plight of the Individual Investor in Securities Class Actions, author David H.
Webber, Associate Professor of Law at Boston University Law School, examines how federal and Delaware law favors institutional investors as lead plaintiffs in securities and transactional class actions, as well as reviewing the inherent conflicts between institutional and individual investors. While there is no question that institutional investors as lead plaintiffs have benefited class members, Webber believes their influence marginalizes the interests of individual investors. Webber identifies four ongoing sources of conflict between institutional and individual investors, to include “derivatives trading, corporate governance reform, conflicts between selling and holding plaintiffs, and, in the transactional context, conflicts created when institutional investors own a stake in both target and bidder companies.” Webber asserts that individual investors are disproportionately harmed by the existing treatment of derivatives because such trading is omitted from the largest financial interest calculation, resulting in the appointment of lead plaintiff applicants who lack the largest financial interest in the litigation.
Additionally, even when derivatives trading is properly accounted for, derivatives traders may be “atypical and inadequate class representatives,” requiring unique defenses that may ultimately disqualify them at the class certification stage and produce additional costs for the class. Next, Webber argues that following a fraud disclosure, individual investors are more likely to sell their shares, while institutional investors fear the infliction of further harm on the share price and consequently hold their comparatively large stakes. He claims that while selling plaintiffs “want to maximize compensation for the class, driving it a dollar short of bankruptcy,” holding plaintiffs “may be more interested in corporate governance reform or other outcomes that are more likely to safeguard their ongoing investments in the defendant.” Therefore, the interests of selling plaintiffs are minimized because institutional lead plaintiffs are nearly always holding plaintiffs who are consequently more interested in corporate governance reform that will protect their own investments. Lastly, Webber addresses the dilemma of institutional investors who own a stake in both target and bidder companies. Such investors are often granted lead plaintiff status for a class of target shareholders with little consideration of their stake in the bidder, resulting in the representation of shareholders by an entity that may not be desirous of maximizing the price paid for the target. Even so, Webber argues that “rigid application of a rule barring lead plaintiffs with a stake in both the target and the bidder is undesirable, as it could disqualify many institutional investors.” He recommends instead that
“institutions with a higher stake in the bidder than the target ought to be disqualified from representing a class of target shareholders.” Individual investors with three or four stocks on average are much less likely to hold shares in target and bidder companies, furthering
Webber’s contention that a gap in motivation exists between individual and institutional investors. Webber concludes that the conflicts between institutional and individual investors often lead institutional plaintiffs to be deficient class representatives and suggests that, as a solution, courts should appoint individual investors as co-lead plaintiffs. Ideally, individual colead plaintiffs should be sellers who have not engaged in derivatives trading; and in a merger or acquisition scenario, they should not own shares in the bidder. “Individuals will have an interest in maximizing compensation for the class and they will help stabilize the lead plaintiff group in light of the unpredictability caused by ongoing legal uncertainty over derivatives trading. They will also re-inject into the lead plaintiff group an uncompromised voice for sellers seeking maximum compensation, or for maximum share price at the transactional level.”
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… Webber argues that
“rigid application of a rule barring lead plaintiffs with a stake in both the target and the bidder is undesirable, as it could disqualify many institutional investors.”
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Regulatory agencies have voiced serious concerns about the daunting logistical pressures and deadlines imposed by the
Dodd-Frank Act …
Growing Paper Trail from Dodd-Frank Overhaul
According to a Wall Street Journal article, the growing paper trail formed by the passage of the
Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act) is “20 times taller than the Statue of Liberty, 15 times longer than ‘Moby Dick’ and would take the average reader more than a month to read, even if you hunkered down with it for 40 hours a week.” Intended to drastically alter the U.S. financial regulatory system, the Dodd-Frank
Act consists of 16 distinct titles on a variety of subjects that will directly and materially affect all U.S. financial institutions. President Obama’s signing of the Dodd-Frank Act incited a race among lobbyists, banks, and lawyers to influence how regulators would implement more than
500 rules, conduct 81 studies, and submit 93 reports over the next few years. The process of implementing the various provisions has produced more than three million words in the
Federal Register, and according to the law firm Davis Polk & Wardwell, about 62 percent of the 387 sets of rules required by the law haven’t even been proposed yet. In fact, not a single
U.S. agency met the 26 deadlines set for April 2011. “I count my blessings every day that I’m no longer a commissioner,” claimed Joseph Grundfest, a Stanford University law professor who served the Securities and Exchange Commission (SEC) from 1985 to 1990. Regulatory agencies have voiced serious concerns about the daunting logistical pressures and deadlines imposed by the Dodd-Frank Act, and politics and lobbyists have further complicated the process. According to the Wall Street Journal , “Delays of a few months or so aren’t expected to make much of a difference, but the Obama administration has repeatedly vowed to fight efforts by some Republicans to cause a longer freeze or attempt to undo some of the changes required under the law.” Scott O’Malia, a commissioner at the Commodity Futures Trading
Commission (CFTC), said in an interview that the need to “get the rules right” is more critical than meeting Congress’s “unrealistic” deadlines. Margaret Tahyar, a partner at Davis Polk &
Wardwell, refers to the 849 pages of legislation contained in the Dodd-Frank Act as “Sarbanes-
Oxley on steroids.” For comparison’s sake, the Sarbanes-Oxley Act contains only 66 pages. The
Dodd-Frank Act is an “exponentially greater volume of regulation” and the “sheer number of rules still in the pipeline makes it almost inevitable agencies will miss an increasing number of deadlines over the next year.” 145 additional rule-making procedures are supposed to be completed by U.S. agencies by the end of 2011; however, the SEC, which is responsible for more Dodd-Frank-related regulations than any other agency, still has 50 outstanding regulations and has missed 11 deadlines. John Nester, an SEC spokesman, said the agency is “working hard to meet the deadlines, with an emphasis on getting the rules right,” but
SEC Chair Mary Schapiro admitted the agency is “stretched incredibly thin.” As a result of criticism from the financial industry and some Republican lawmakers that the process was moving too quickly, the CFTC halted many of its draft rules and extended the comment period on provisions that address a regulatory overhaul of the derivatives market. Earlier this year,
Republicans introduced a bill that would delay new derivatives rules by 18 months. Additional delays resulted from intense lobbying by retailers and manufacturers protesting, for example, the costs and practicality of implementing a requirement to annually disclose whether goods contain “conflict minerals” from war-torn central Africa. Banks with billions of dollars in revenue at stake have also been campaigning against new fee limits proposed for debitcard transactions, which was the subject of another rule that missed an April 2011 deadline.
Grundfest, the former SEC commissioner, claims the “problem is not just the number of rules, it’s the complexity of them, and it’s the political power of the various constituencies who are affected by those rules.”
38 Aon Financial Services Group Legal & Claims Practice

SEC Adopts Final Whistleblower Rules in Controversial Vote
In a controversial 3-2 vote, the SEC adopted the much-anticipated final rules implementing the whistleblower provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act). Considered one of the most contentious requirements of the
Dodd-Frank Act, the new rules will allow corporate whistleblowers to collect between 10 and 30 percent of the penalties when they report violations of securities laws, even if they bypass their employers and report the wrongdoing directly to the SEC. SEC Chair Mary
Schapiro claimed that despite the protections afforded by the Sarbanes-Oxley Act, “too many people remain silent in the face of fraud” and the SEC’s new rules “are intended to break the silence of those who see a wrong.” The business community aggressively voiced its concerns that the new rules will weaken internal compliance procedures by allowing whistleblowers to circumvent their employers, and the U.S. Chamber of Commerce claimed the SEC’s rules put “trial lawyer profits ahead of effective compliance.” David Hirschmann, president and CEO of the U.S. Chamber of Commerce’s Center for Capital Markets
Competitiveness, said in a statement, “Not informing the company of a potential fraud and waiting for the SEC to act is the equivalent of not calling the firefighters down the street to put out a raging fire.” In her dissent, SEC Commissioner Kathleen Casey agreed that the measure “significantly underestimates the negative impact on internal compliance programs and significantly overestimates our capacity to effectively triage and manage whistleblower complaints.” Whistleblower advocates, however, praised the new rules. “Today, investors and whistleblowers scored a major victory,” National Whistleblowers Center Executive Director
Stephen M. Kohn said. Although the SEC declined to propose rules that would have required whistleblowers to first report violations internally via corporate compliance programs, the rules are designed to “incentivize whistleblowers to utilize their companies’ internal compliance and reporting systems when appropriate.” Schapiro remarked that “incentivizing—rather than requiring—internal reporting is more likely to encourage a strong internal compliance culture.” The new rules support internal reporting programs by increasing the amount of an informant’s award if he or she voluntarily participates in a company’s internal reporting process and by awarding smaller amounts to informants who obstruct or interfere with such internal procedures. Additionally, the new rules aim to protect from employment retaliation any whistleblower who reports to the SEC a reasonable belief that a possible securities law violation has occurred, is occurring, or is about to occur. Lastly, the rules make it unlawful for anyone to interfere with a whistleblower’s efforts to communicate with the SEC.
Cases of Interest
U.S. Supreme Court Rules that Proof of Loss Causation Is Not Required to Obtain
Class Certification of a Federal Shareholder Class Action Fraud Suit
The U.S. Supreme Court addressed a pressing issue in federal securities litigation regarding pleading requirements for class certification. To prevail on the merits in a private securities fraud action, investors must demonstrate that the defendant’s deceptive conduct caused their alleged economic loss. This requirement is commonly referred to as “loss causation.”
The question presented in this case was whether securities fraud plaintiffs must also prove loss causation in order to obtain class certification. As anticipated, the Supreme Court held that they need not. In order to certify a class, a court must decide a number of issues to ascertain whether “the questions of law or fact common to class members predominate over any questions affecting only individual members.” Therefore, class members in securities class actions have traditionally relied upon the “fraud on the market” theory to create a presumption of reliance. The theory simply states that the market is efficient and takes into account all available public information in arriving at stock prices. Thus, investors are
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“ incentivizing—rather than requiring—internal reporting is more likely to encourage a strong internal compliance culture.”
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2011 Year in Review Legal News and Developments in Executive Liability 39

… the required elements to establish defamation and invasion of privacy do not require proof of fraudulent or dishonest conduct … presumed to act on all available market information by purchasing or selling on the price of a stock alone. The Supreme Court stated that most courts require plaintiffs to prove the alleged misrepresentations were publicly known, that the stock traded in an efficient market, and that the relevant transaction took place after the misrepresentation and before the corrective disclosures were made. The Fifth Circuit took the rebuttable presumption of reliance further by requiring that loss causation must be proven as well to invoke the presumption of reliance necessary for class certification. Loss causation in securities fraud cases requires the plaintiff to show the causal connection between the material misrepresentation and the plaintiff’s economic loss. The Supreme Court rejected this additional requirement of pleading loss causation to obtain class certification. Chief Justice John Roberts, writing for a unanimous
Court, stated that the Fifth Circuit’s requirement (based upon a prior Supreme Court ruling in
Basic Inc. v. Levinson) of proof of loss causation in order to invoke the rebuttable presumption of reliance under the fraud-on-the market theory “contravenes Basic’s fundamental premise— that an investor presumptively relies on a misrepresentation so long as it was reflected in the market price at the time of his transaction. The fact that a subsequent loss may have been caused by factors other than the revelation of a misrepresentation has nothing to do with whether an investor relied on the misrepresentation in the first place, either directly or presumptively through the fraud-on-the market theory. Loss causation has no logical connection to the facts necessary to establish the efficient market predicate to the fraud-onthe-market theory.” Erica P. John Fund, Inc., fka Archdiocese of Milwaukee Supporting Fund, Inc. v.
Halliburton Co., et al.
131 S. Ct. 2179 (2011).
Punitive Damage Award Does Not Trigger Fraud and Dishonesty Exclusion in D&O Policy
This coverage dispute involved whether a primary D&O policy issued by Executive Risk
Indemnity, Inc. (Executive Risk) and an excess D&O policy fully reinsured by Employers
Reinsurance Corporation (ERC) provided coverage to Charleston Area Medical Center (CAMC) for a settlement after a jury verdict. A jury found in favor of the plaintiff and against CAMC for the plaintiff’s defamation and invasion of privacy claims, awarding $5 million as compensation for the claims, and $20 million in punitive damages. Following the jury award, the parties settled the claims for $11.5 million, consisting of $2 million in compensation, $8 million in punitive damages, and the remaining amount in interest and fees. The first part of the case concerned whether a portion of the settlement was excluded by the Dishonest/Fraudulent
Acts exclusion. Executive Risk argued that the jury’s findings awarding punitive damages established that CAMC acted in bad faith and supported its partial denial. The court rejected
Executive Risk’s argument, reasoning that the verdict dealt with damages and attorneys’ fees, not liability, which was addressed in a different section of the jury form. According to the court, the required elements to establish defamation and invasion of privacy do not require proof of fraudulent or dishonest conduct, and therefore, the jury could not have found that CAMC committed a dishonest or fraudulent act or omission to fall within the exclusion. The second part of the case concerned whether CAMC was covered under the ERC excess policy for the
$3 million excess punitive damages award. The limit of liability under Executive Risk’s Punitive
Damages Endorsement was $5 million, and therefore, insufficient to cover the entire $8 million punitive damages settlement. Relevant to this case, ERC agreed under Group II of the policy to cover CAMC’s “Ultimate Net Loss in excess of the Underlying Limit(s) of Liability as set forth in the Schedule of Underlying Insurance.” The ERC policy’s schedule of underlying insurance listed two policies, the $10 million Executive Risk primary policy and a $10 million excess policy issued by National Union. The National Union excess policy adopted the terms and conditions of the Executive Risk policy, including the same $5 million cap for punitive damages.
CAMC explained that it sought coverage under the ERC policy rather than the National Union policy because it is “standard industry practice” for punitive damages coverage to exhaust simultaneously under both the Executive Risk primary policy and National Union excess follow-
40 Aon Financial Services Group Legal & Claims Practice

form policy once the single $5 million limit is met. The court rejected this argument and held that since CAMC failed to show that the National Union policy limits were exhausted, it was not entitled to coverage under Group II of the ERC policy. Finally, the court rejected CAMC’s argument that it was entitled to coverage under Group III of the ERC policy, reasoning that the risk at issue fell under the D&O coverage in Group II. Executive Risk Indemnity, Inc. v. Charleston
Area Medical Center, Inc., 2011 U.S. Dist. LEXIS 51239 (S.D. W. Va. 2011).
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Insured Sues Excess Carrier for Alleged Violations of a Consumer Protection Law
The insured, America Service Group (ASG), purchased excess D&O insurance and “sought full coverage without a prior acts endorsement.” The court noted that if the excess policy had a prior acts endorsement, it would only cover a claim that arose out of events that occurred after the policy period commenced. A policy without a prior acts endorsement would not have this limitation. Zurich issued ASG a proposal for excess coverage that, according to ASG,
“omitted any reference to a prior acts endorsement.” ASG claims to have accepted this offer for excess coverage. Zurich then issued an insurance “binder” related to the excess policy, which indicated that it would be limited by a prior acts endorsement. According to ASG, the binder indicated, however, that “Zurich would remove the prior acts endorsement upon receipt of a warranty letter from ASG within ten business days” and that “Zurich could remove the prior acts endorsement upon receipt of the warranty letter at any time, including after expiration of the ten-day period.” The court noted that the warranty letter, in essence, was to represent that, as of the effective date of the excess policy, ASG had no knowledge of any conduct that might give rise to a claim under the excess policy. ASG maintains that, throughout their relationship,
Zurich “continued to lead ASG and/or the brokers to believe that the prior acts endorsement would be removed after receipt of the warranty letter.” Zurich and ASG renewed the excess policy for another year and, during the negotiations regarding the renewal, “Zurich again indicated its willingness to remove the prior acts endorsement from the excess policy when it received a warranty letter back to the original inception date of the first policy with Zurich.”
The stock price fell, and at about the same time that suits began to get filed, the insured sent the backdated warranty to Zurich. Zurich issued its coverage position, barring coverage due to the prior acts endorsement. The legal question presented was whether Zurich could be sued for violating the Tennessee Consumer Protection Act (TCPA) by employing “unfair and/ or deceptive practices” in denying the claim for excess coverage after the policy premium was paid and for “refusing to accept the warranty letter” after previously treating the letter as a “pro forma, nonmaterial requirement.” An “unfair or deceptive” act or practice is a “material representation, practice or omission likely to mislead a reasonable consumer.” The court noted that this standard applies equally in the insurance context; that is, while insurance company conduct is covered by the TCPA, the “mere denial of a claim is insufficient” to bring a suit under the TCPA. An insured must prove “deceptive or unfair conduct by the insurer … shown through violations of policy terms, deception about the terms of the policy, or other unfair conduct.” America Service Group, Inc., v. Zurich American Insurance Company, 2011 U.S. Dist. LEXIS
53576 (M.D.T. 2011).
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Zurich “continued to lead
ASG and/or the brokers to believe that the prior acts endorsement would be removed after receipt of the warranty letter.”
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2011 Year in Review Legal News and Developments in Executive Liability 41

“[W]hen the liability insurance policy only provides direct coverage to the directors and officers, courts generally hold that the proceeds are not property of the estate.”
D&O Policy Providing Corporate Indemnity and Corporate Liability Coverage
Is an Asset of the Estate of Debtor in Adversary Proceeding Brought by Trustee
An adversary proceeding was commenced against directors and officers of the debtor alleging breach of fiduciary duty and negligence. The directors and officers requested relief from the automatic stay so the insurer could advance proceeds to pay defense costs resulting from the adversary proceeding. They argued that the policy proceeds were not property of the estate and that even if the proceeds were property of the estate, cause existed for lifting the automatic stay. The trustee responded that the proceeds are property of the estate and the request for a lift of the stay should be denied. The court highlighted several interesting principles worth noting, “While the majority view is that insurance policies qualify as property of the estate, courts differ in their treatment of insurance proceeds. … Cases determining whether the proceeds of a liability insurance policy are property of the estate are controlled by the language and scope of the specific policies at issue. … However, most courts require, as a starting point, a debtor to have a direct interest in the proceeds in order for proceeds to qualify as property of the estate. … [W]hen the liability insurance policy only provides direct coverage to the directors and officers, courts generally hold that the proceeds are not property of the estate. … [W]hen a policy provides coverage only to directors and officers, courts will generally rule that the proceeds are not property of the estate. … Typically, the proceeds of a directors and officers liability insurance policy are not considered property of a bankruptcy estate.” In the present matter, the court went on to note that if both the debtor and directors and officers have direct interests in the proceeds, the proper result becomes less clear observing that several courts have stated the standard in this situation is “the proceeds will be property of the estate if depletion of the proceeds would have an adverse effect on the estate to the extent the policy actually protects the estate’s other assets from diminution.” The court further stated that “[i]f the debtor’s coverage is limited to indemnification coverage, then some courts have found that policy proceeds are not property of the estate if “indemnification ‘either has not occurred, is hypothetical, or speculative.’”
The court concluded that if the directors’ and officers’ defense costs exhaust the policy limit, then a debtor could be forced to use other assets to satisfy any potential claims and, therefore,
“[u]nder these circumstances, it appears that the Policy meets the standard articulated above, and the insurance proceeds constitute property of the estate.” On the issue of lifting the stay in light of the court’s determination, the trustee argued that the proceeds were property of the estate and that the directors and officers have no right to receive insurance proceeds to satisfy their defense costs because the ultimate effect would be the same as a debtor indemnifying them for the costs of defending against a debtor’s claims. The court found cause existed to grant relief from the stay, noting that courts faced with similar situations have commonly granted relief from the stay to allow directors and officers to receive payment for their defense costs commenting, “Debtor purchased the Policy for the purpose, in large part, of insulating its directors and officers from personal liability for the costs they incurred in defending actions.” In re: Beach First National Bancshares, Inc., 2011 Bankr. LEXIS 1622 (Bkr. D. SC 2011).
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SEC Filings
|
SEC Settlements
• The SEC filed fraud charges against the co-founders,
Angelo Cuomo and George Garcy, of E-Z Media,
Inc. The SEC is seeking disgorgement, prejudgment interest, penalties, and an order permanently barring
Cuomo and Garcy from acting as officers or directors of any public company.
• The SEC charged Advanced Optics Electronics, Inc.
(ADOT), its former chairman, Leslie S. Robins;
JDC Swan, Inc. (JDC), and its former president,
Jason Claffey, with participating in an unlawful public offering of ADOT’s securities. The SEC is seeking disgorgement, prejudgment interest, and penalties.
• The SEC filed fraud and insider trading charges against four executives at Steel Technologies, Inc.,
Patrick Carroll, William Carroll, David Mark Calcutt and David Stitt, VPs of sales. The SEC is seeking disgorgement, prejudgment interest and penalties.
• The SEC filed fraud charges and alleged violations of a tender offer rule against AWMS Acquisition, Inc. d/b/a Sterling Global Holdings (Sterling), a shell company, and Allen E. Weintraub, Sterling’s sole owner, officer, director, and employee. The SEC is seeking disgorgement, prejudgment interest, and penalties.
• The SEC settled fraud charges against Thor
Industries, Inc. (Thor), and Mark C. Schwartzhoff, former VP of finance at Dutchmen Manufacturing,
Inc., a subsidiary of Thor. Thor was ordered to pay a penalty of $1 million; and Schwartzhoff was ordered to pay disgorgement of $299,805, prejudgment interest of $95,025, and was permanently barred from acting as an officer or director of a public company.
• The SEC settled fraud charges against UBS Financial
Services, Inc., and ordered it to pay disgorgement of $9,606,543, prejudgment interest of $5,100,637, and a penalty of $32.5 million.
• The SEC settled insider trading charges against
Mary Beth Knight, former SVP at Choice Hotels
International, Inc.
Knight was ordered to pay disgorgement of $140,400, and a penalty of $185,111.
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* Source: http://www.sec.gov/litigation.shtml
2011 Year in Review Legal News and Developments in Executive Liability 43

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General News
U.S. Supreme Court Rules for Wal-Mart and Rejects Class Certification of Employment Practices Claim
On June 20, 2011, the U.S. Supreme Court rejected the class certification of 1.5 million female
Wal-Mart employees alleging gender discrimination in Wal-Mart Stores v. Dukes.
The Court was tasked with deciding if the plaintiffs, current and former female employees of Wal-Mart, could proceed as a class. The suit alleged that local managers, while exercising their discretion over pay and promotions, discriminated against women in violation of Title VII. Of particular note, Wal-Mart’s official policies forbid gender discrimination and the company imposes penalties for denials of equal employment opportunity. Therefore, the only corporate policy that the plaintiffs alleged justified class certification was Wal-Mart’s “policy” of giving local supervisors discretion over employment matters. The Court highlighted that the crux of this case was commonality—the rule requiring a plaintiff to show that “there are questions of law or fact common to the class.” Justice Scalia, writing for the 5-4 majority, concluded that the plaintiffs failed to provide proof of a common companywide policy of discrimination, which is necessary to certify a class under the applicable rules. In its analysis, the Court noted that class actions are “an exception to the usual rule that litigation is conducted by and on behalf of the individual named parties only” and that in order to justify a departure from that rule, “a class representative must be part of the class and ‘possess the same interest and suffer the same injury’ as the class members.” Scalia asserted that the women could not show that Wal-Mart
“operated under a general policy of discrimination,” because “Wal-Mart’s announced policy forbid sex discrimination” and, as Scalia sees it, in giving local managers so much discretion in making personnel decisions, Wal-Mart actually established “a policy against having uniform employment practices.” The plaintiffs relied on the statistical evidence of their sociological expert who alleged that “Wal-Mart has a ‘strong corporate culture’ that makes it ‘vulnerable’ to ‘gender bias,’” but the Court rejected this purported statistical evidence to establish commonality because the expert himself stated his statistical approach could not calculate whether “0.5 percent or 95 percent” of Wal-Mart’s employment decisions were influenced by gender stereotypes. The Court ultimately held there was not one “common question” that applied to all of the plaintiffs that would satisfy the commonality test of the class certification requirements. This frail majority decision is seen as a major victory for employers in class action litigation. Robin S. Conrad, executive vice president of the United States Chamber of
Commerce’s National Chamber Litigation Center, stated, “We applaud the Supreme Court for affirming that mega-class actions such as this one are completely inconsistent with federal law.
Too often the class-action device is twisted and abused to force businesses to choose between settling meritless lawsuits or potentially facing financial ruin.” We will monitor how this ruling may be used in other areas of the law and in future class action litigations.
U.S. Supreme Court Limits Securities Suit against Mutual Fund Management Companies
A heavily divided U.S. Supreme Court issued its long awaited decision regarding exposure of mutual fund investment advisers for federal securities fraud private actions in Janus Capital
Group, Inc., et al. v. First Derivative Traders.
This case addressed the issue of whether a mutual fund investment adviser can be held liable in a private action under the Securities and
Exchange Commission (SEC) Rule 10b–5 for false statements included in its client mutual funds’ prospectuses. The Court ruled that shareholders could not sue Janus Capital Group Inc.
(JCG), the publicly traded parent, and a subsidiary for helping produce allegedly misleading prospectuses for the Janus mutual funds. Justice Clarence Thomas, writing for the majority, said the shareholders were seeking to “create the broad liability that we rejected” in the 2008 case, Stoneridge Investment Partners, LLC v. Scientific Atlanta.
The majority said that the funds are
The Court ultimately held there was not one
“common question” that applied to all of the plaintiffs that would satisfy the commonality test of the class certification requirements.
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… the Court’s majority noted that the corporate formalities were observed and reapportionment of liability in light of this close relationship is properly the responsibility of Congress, not the courts.
separate legal entities and that neither the parent company nor the subsidiary was responsible for the prospectuses. The Court concluded that because the false statements included in the prospectuses were made by Janus Investment Fund, not by JCM, JCM and JCG cannot be held liable in a private action under Rule 10b–5. In analyzing whether to recognize a private right of action in this situation, the Court began by observing that “although neither Rule 10b–5 nor the statute it interprets, §10(b) of the Act, expressly creates a private right of action, such an action is implied under §10(b).” For Rule 10b–5 purposes, the maker of a statement is the person or entity with ultimate authority over the statement, including its content and method of communication. Without control, a person or entity can merely suggest what to say, not
“make” a statement in its own right. The Court rejected the contention that “make” should be defined as “create,” thereby allowing private plaintiffs to sue a person who provides the false or misleading information that another person puts into a statement. With regard to the uniquely close relationship between a mutual fund and its investment adviser, the Court’s majority noted that corporate formalities were observed and reapportionment of liability in light of this close relationship is properly the responsibility of Congress, not the courts. The
Court further observed that liability based upon this close relationship would read into Rule
10b–5 a theory of liability similar to—but broader than—control-person liability under §20(a).
The majority concluded that although JCM may have been significantly involved in preparing the prospectuses, it did not itself “make” the statements at issue for Rule 10b–5 purposes. Its assistance in crafting what was said was subject to Janus Investment Fund’s ultimate control.
Cases of Interest
Investigative and Special Litigation Committee Expenses Covered under D&O Policy
This widely watched coverage dispute centered on investigation costs coverage, derivative litigation coverage, and independent consultant coverage, which arose out of financial regulators’ investigations into MBIA’s alleged accounting misstatements. MBIA sought coverage for costs associated with these claims as losses under the policies. The insurers did not believe they were liable for these claims and litigation ensued. As part of a larger investigation into certain accounting practices in the insurance industry, the SEC issued a formal order of investigation, and later, it began serving subpoenas to produce all documents.
The New York Attorney General (NYAG) issued similar subpoenas. After these investigations came to light, two shareholders sent separate demand letters to MBIA asking the board to file suit against its directors and officers for the alleged wrongdoing being investigated by regulators. MBIA set up a committee of independent directors, the “Demand Investigation
Committee” (DIC), to investigate these demands. The shareholders filed two derivative lawsuits. When the derivative lawsuits were filed, MBIA reconstituted the DIC as the “Special
Litigation Committee” (SLC) to determine whether maintaining these lawsuits was in MBIA’s best interests. The SLC hired outside counsel to investigate this issue and determined that the lawsuits were not in MBIA’s best interests. Thereafter, the SLC filed a motion to dismiss the complaints, and the lawsuits were terminated. The insurers argued the SLC expenses were not covered because the SLC was “independent” of MBIA and, therefore, not an “Insured
Person” under the policy. The Second Circuit highlighted that “MBIA formed the SLC to determine MBIA’s response to this litigation, and the SLC decided to terminate the litigation.
The SLC entered appearances for MBIA and filed motions to dismiss on its behalf in both the state and federal cases.” Because “the dismissal of the suits was MBIA’s decision, undertaken pursuant to the powers granted to MBIA under Connecticut law,” the Second Circuit rejected the insurers’ argument that the SLC was not an “Insured Person” under the policy. The insurers then argued that because the SLC was required by law to operate “independently” of
MBIA, it took on a separate identity and operated separately from MBIA. The Second Circuit characterized this argument as “sleight of hand,” because “independent” in this circumstance
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means “independence of judgment,” or more simply a “lack of conflict of interest.” The court made clear that “independence of judgment does not generate a new source of authority to terminate derivative litigation; that authority is still exercised by the corporation, which can only act through its agents.” Thus, the court rebuffed the insurers’ contention. The insurers then attempted to argue that the policy’s $200,000 investigative cost sublimit precluded payment of the SLC’s expenses. The court, however, concluded the policy’s sublimit applied only to pre-litigation demands. Because the SLC was formed to conduct post-litigation activities, the general policy provisions concerning litigated matters controlled, rather than the narrow sublimit language, which applied only to pre-litigation demands. The Second
Circuit also rejected the insurers’ contention that the post-settlement consultant’s investigation expenses were not covered. In a detailed factual analysis, the court concluded that Federal and ACE had been given sufficient notice of these expenses and the manner in which MBIA provided the carriers with information concerning these expenses had not violated any of the policies’ notice or settlement consent requirements. The court also addressed the issue of investigative cost coverage. The Second Circuit agreed with the district court’s “sensible intuition that a businessperson would view a subpoena as a ‘formal or informal investigative order’ based on the common understanding of these words,” adding that in any event a
“subpoena is a ‘similar document’ to those listed in the definition of a ‘Securities Claim’ because it is similar to other forms of investigative demands made by the regulators.” The court rejected the insurer’s “crabbed view” that a subpoena is a “mere discovery device” that is “not even ‘similar’ to an investigative order.” Rather, it is the “primary investigative implement in the NYAG’s toolshed.” In addition, the Second Circuit rebuffed the insurers’ arguments that because the investigative documents connected with these matters were produced voluntarily by oral request rather than by subpoena or other formal process, there was no coverage in connection with the related investigation. The Second Circuit found this argument “meritless” since the investigations were connected with the formal order. The court highlighted that the
“insurers cannot require that as an investigation proceeds, a company must suffer extra public relations damage to avail itself of coverage.” MBIA Inc., v. Fed. Ins. Co.
, 2011 U.S. App. LEXIS
13402 (2d Cir.).
Excess Policy Provisions Requiring Each Underlying Carrier to Admit Liability and Pay Full Amount of Liability Enforced to Deny Coverage
JP Morgan Chase & Co., (JPMC) as successor to Bank One Corporation, sought coverage under excess Bankers Professional Liability and Securities Claim coverage for defense costs and settlement, which together far exceeded the $175 million limits of the Bank One Program.
JPMC settled with two of the ten excess insurers. The settlement agreement between JPMC and Zurich included other claims and provided that the $17 million dollar settlement fully exhausted the limits of the Zurich policies. Twin City, which sat immediately above Zurich’s layer, filed a motion to dismiss the complaint arguing that JPMC failed to establish that Zurich either “duly admitted liability” or “paid the full amount of its respective liability” as required by the limit of liability provision in the Twin City policy. The court granted the motion to dismiss holding that the Twin City policy is unambiguous and that JPMC failed to present a reasonable alternative interpretation of the Twin City policy. The court first reasoned that the settlement did not exhaust Zurich’s $15 million dollar limit as required by the Twin City policy since the $17 million settlement payment resolved more than $28 million in claims, and Zurich
“deliberately chose not to allocate those payments between different policies involved in different underlying lawsuits.” The court next rejected JPMC’s argument to support coverage that Twin City was not being asked to “drop down” below its attachment point, or to increase its coverage obligations, and held that “where, as here, exhaustion is defined, the insured is bound by such language.” JPMC’s public policy and “reasonable expectation of the insured” arguments fail for the same reason that courts will enforce clear policy language defining
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The court highlighted that the “insurers cannot require that as an investigation proceeds, a company must suffer extra public relations damage to avail itself of coverage.”
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2011 Year in Review Legal News and Developments in Executive Liability 47

The court rejected the attempt to attack the
“tie-in” of limits provision of the policy as ambiguous and unenforceable … exhaustion. The court further reasoned that Twin City’s Limit of liability provision was not inconsistent with other provisions of the policy since the other provisions dealt with solvency, which was not at issue in the JPMC case. Finally, the court held that the breach of the Twin City policy was material since “the attachment point for triggering coverage of each excess insurer is clearly material, and the excess insurers have an interest in enforcing these provisions.” With respect to the excess carriers other than Twin City, the court held that although the relevant language in each policy differed somewhat from the language in the Twin City policy, the carriers were entitled to deny coverage based on the analysis of Twin City’s limit of liability policy provision. JP Morgan Chase & Co. v. Indian Harbor Ins. Co., 2011 N.Y. Misc. LEXIS 2767 (N.Y.
Sup. Ct. 2011).
“Tie-In” of Limits of Liability Language in Private Equity Policy and
Portfolio D&O Policies Enforceable
This action arises out of the private equity fund’s (PE) request to place $20 million in excess
D&O insurance. The private equity fund retained an insurance broker to place separate insurance programs for the PE and the PE’s portfolio companies. This court’s decision is the culmination of a long complex claim over how much insurance was available under multiple policies for the underlying suits. The court in this case had to determine whether the amount of coverage afforded to the PE by its policy was limited by a “tie-in” of limits of liability provision, also referred to as an “anti-stacking” provision. Following notice of the underlying suits, AIG (the PE and portfolio company’s insurer) notified the insureds that based on a “tiein” of limits of liability clause in the PE’s policy, the combined limit of liability for this claim was $20 million for both policies. AIG took the position that based on this provision, its maximum aggregate limit for all losses arising out of this claim was $20 million. The PE settled the underlying action for $33.5 million and AIG paid $6.9 million defending the suit, which was deducted from the limits of the portfolio company policy. The total losses for the PE and its portfolio company amounted to $40,400,000. AIG paid the full $15 million policy limit under the portfolio policy, and pursuant to its claim that the tie-in provision, capped the PE’s coverage at $5 million (the amount remaining out of the $20 million coverage), paid that amount and refused to pay anything more. The PE settled its dispute for limits with AIG, which left the PE $6 million short of the $20 million of excess D&O coverage that it maintained its broker was supposed to procure. The court rejected the attempt to attack the “tie-in” of limits provision of the policy as ambiguous and unenforceable, finding there was no issue of fact as to the applicability of the tie-in provision, there was no ambiguity in the provision, and the provision clearly limited the liability of AIG when it and another AIG company provide coverage for the same claim. Bruckmann, Rosser, Sherrill & Co., L.P., et al., v. Marsh USA, Inc., et al.
2011 NY Slip Op 5578; 2011 N.Y. App. Div. LEXIS 5453 (2011).
48 Aon Financial Services Group Legal & Claims Practice

Suit by Trustee in Bankruptcy Does Not Trigger Bankruptcy Exclusion or IvI Exclusion
The court-appointed trustee for Heartland Memorial Hospital filed two lawsuits in the Chapter
11 bankruptcy proceeding against several former directors alleging mismanagement and breach of fiduciary duty. Heartland’s D&O carrier, Executive Risk, denied coverage based on the bankruptcy exclusion and the Insured vs. Insured (IvI exclusion). The court first held the bankruptcy exclusion was unenforceable under section 541(c) of the Bankruptcy Code, which invalidates contract provisions “that are conditioned on the insolvency or financial condition of the debtor [or] on the commencement of a bankruptcy case.” Because Executive Risk’s bankruptcy exclusion was conditioned on the commencement of a bankruptcy case, the exclusion was found invalid. Next, the court held that coverage was not barred by the IvI exclusion. Since the underlying plaintiff filed suit in his capacity as a court-appointed trustee, not as a debtor-in-possession, and was working on behalf of creditors and under the authority of the bankruptcy court, the court reasoned that the trustee and debtor hospital were not the same entity for purposes of the IvI exclusion. Yessenow v. Executive Risk Indem., Inc.
, 2011 Ill. App.
LEXIS 713 (Ill. App. Ct. 1 st Dist., 2011).
SEC Filings
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SEC Settlements
• The SEC filed insider trading charges against Phillip
E. Powell, former chairman of the board of First Cash
Financial Services, Inc.
The SEC is seeking disgorgement, prejudgment interest, penalties, and an officer and director bar.
• The SEC filed fraud charges against Lee B. Farkas, former chairman and majority owner of Taylor,
Bean and Whitaker Mortgage Corp.
The SEC is seeking disgorgement, prejudgment interest, penalties, and an officer and director bar.
• The SEC filed accounting fraud charges against two former executives of Basin Water, Inc.,
Peter L. Jensen, former CEO, and Thomas C. Tekulve,
Jr., former CFO. The SEC is seeking disgorgement, prejudgment interest, penalties, and an officer and director bar.
• The SEC settled fraud charges against Mark Meyer
& Associates, Inc. (MMAI) and its owner, Mark
Meyer. Meyer and MMAI were ordered to pay disgorgement in the amount of $1,162,729, prejudgment interest of $565,204, and penalties of $600,000 and $120,000 respectively.
• The SEC settled fraud charges against Brian J. Smart and his company Smart Assets, LLC (Smart Assets).
The court ordered Smart and Smart Assets to pay disgorgement of $2,059,077, prejudgment interest of $597,426, and a penalty of $2,059,077.
• The SEC settled charges of misrepresentation in connection with a synthetic collateralized debt obligation (CDO) against J.P. Morgan Securities
(J.P. Morgan).
J.P. Morgan was ordered to pay
$153.6 million in fines and penalties (disgorgement of $18.6 million, prejudgment interest of $2 million, and a penalty of $133 million).
• The SEC settled fraud charges against Morgan
Keegan Funds (Morgan), James Kelsoe, the funds chief portfolio manager, and Thompson Weller, controller and head of the funds valuation committee. Morgan was ordered to pay $200 million in fines and penalties (disgorgement and prejudgment interest of $25 million, a penalty of
$75 million, and pay $100 million into a state fund).
Kelsoe was ordered to pay a penalty of $500,000, and was barred from the securities industry.
Weller was ordered to pay a penalty of $50,000.
* Source: http://www.sec.gov/litigation.shtml
2011 Year in Review Legal News and Developments in Executive Liability 49
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General News
Structuring Corporate Boards for Optimal Advising
While the structure of “corporate boards for effective oversight of top management” has attracted significant attention and regulation in recent years, “how best to structure the board for optimal advising” continues to be a critical but less researched topic. The characteristics and effects of directors dedicated to providing strategic counsel to the CEO are the subjects of a report titled Advisory Directors by Olubunmi Faleye of Northeastern University, Rani Hoitash of Bentley University, and Udi Hoitash of Northeastern University. The authors studied more than 4,000 companies between 2000 and 2009 with a focus on acquisition performance, corporate innovation, and firm value. They found that “advisory directors are associated with better acquisition returns, shorter time to deal completion, increased corporate innovation, and higher firm value.” Further, the “positive value effects are greater when the company has greater advising needs and when the CEO is more amenable to board influence on strategy.
These results demonstrate the importance of directors’ advisory role” in ensuring effective governance; however, “reform efforts and the adverse publicity of monitoring failures have tended to shift directors away from strategic advising and toward managerial oversight.”
The authors suggest that this intense focus on managerial oversight is detrimental to the board’s overall effectiveness and “the desire for more intense monitoring must be balanced against the need for directors to advise management and the benefits of a supportive board that reduces managerial myopia and risk aversion.” The authors concluded that the board’s advising functions are optimally performed by a “distinct class of independent directors minimally involved in monitoring management” as such directors are “best positioned for effective advising because their minimal involvement in monitoring enables them to develop a trusting relationship with the CEO and provides the time needed to focus on strategic issues.”
According to the authors, this structure facilitates the exchange of information between the independent directors and the CEO, making him/her more likely to seek their opinions, while providing a sounding board for important strategic proposals. The structure proposed by the authors “provides an avenue for achieving this balance by explicitly dedicating some directors to board advising.”
Dodd-Frank Act: One Year Later
July 21, 2011, marked the one year anniversary of the Dodd-Frank Wall Street Reform and
Consumer Protection Act (Dodd-Frank Act), the financial service industry’s largest regulatory overhaul since the Great Depression. The bill (passed by Congress and signed into law by
President Barack Obama) is nearly 2,400 pages, twice as long as the previous three regulatory bills combined (the Sarbanes-Oxley Act of 2002, the Securities Exchange Act of 1934, and the
Securities Act of 1933). To transform the bill into enforceable regulation, several agencies, such as the Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission
(CFTC), the Federal Deposit Insurance Corporation (FDIC), the Federal Reserve, and the Office of the Comptroller of the Currency (OCC), were tasked with creating roughly 400 different rules, 163 of which had deadlines within the first year. The complexity of these regulations and the sheer volume expected from each agency has already led to substantial delays. According to the law firm Davis, Polk & Wardwell LLP, regulators completed fewer than 20 percent of the
163 required rules for the July 21, 2011 deadline. The SEC missed more than 75 percent of its rulemaking deadlines, and the CFTC missed 88 percent. Further complicating the process, the
Congressional Budget Office estimated that it could cost $2.9 billion over the next five years to implement the various provisions of the Dodd-Frank Act, while other estimates put the total closer to $1 trillion. The result has been more than two dozen additional bills introduced by lawmakers in order to delay and even eliminate some of the bill’s provisions to limit costs. Earlier
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…“advisory directors are associated with better acquisition returns, shorter time to deal completion, increased corporate innovation, and higher firm value.”
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2011 Year in Review Legal News and Developments in Executive Liability 51

The size of the claw back will be determined through an evaluation of an executive’s role in the shareholders’ overall losses after liquidation.
this year, Congress imposed deep cuts on agency budgets using the annual appropriations process, including a fifteen percent cut to the CFTC budget and a seven percent cut to the
Treasury Department. Combining the fiscal limitations placed on regulatory agencies with the proposals from Congress to alter regulation, and add along with the reported $50 million the financial services industry spent this year on lobbyists, and the reasons for the stagnation become clearer. On July 22, the U.S. Court of Appeals ruled that the SEC did not properly conduct a cost-benefit analysis before finalizing one of the proxy rules it proposed. This ruling creates a potential slippery slope wherein all future rules proposed by regulators may be challenged. According to Hal Scott, Nomura professor and Director of Harvard Law School’s
Program on International Financial Systems, “the entire Dodd-Frank implementation is at heavy risk because if any of these rules are challenged by the courts, they won’t survive.” When asked about the pace at which Dodd-Frank is being implemented, Dean Baker, co-director of the Center for Economic and Policy Research, said, “as the process drags on, we get further removed from the public sentiment behind reform, this means that the only people in the room will be the people from the financial industry. This will allow them to write the rules in a way that minimizes the impact of the regulation.” One year after its introduction, it is widely believed that the Dodd-Frank Act has not yet created the reform within the financial services industry that it was intended to create. Regulation is behind schedule and substantial opposition exists from both industry and government in an effort to limit the bill’s oversight power.
FDIC Adopts Rule to Claw Back Executive Compensation
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank
Act) appointed the Federal Deposit Insurance Corporation (FDIC) as receiver for collapsing financial institutions that may adversely affect the stability of the U.S. economy. The FDIC’s authority was expanded from winding down failed banks to unraveling the affairs of nonbanks when they collapse. The Dodd-Frank Act gives the FDIC broad authority to operate and liquidate a company, resolve its liabilities, sell its assets, and recoup the compensation of certain executives and officers of failed financial firms. In July 2011, the FDIC unanimously adopted a final rule under the Dodd-Frank Act allowing it to “claw back” compensation from senior executives and directors who are “substantially responsible” for a financial company’s failure. Senior executives or directors will be deemed “substantially responsible” for a company’s failure if it is determined they failed to conduct their responsibilities with “the degree of skill and care an ordinarily prudent person in a like position would exercise under similar circumstances.” Such individuals are presumed to be “substantially responsible” for the company’s failure if they served as chairman of the board of directors, CEO, president,
CFO, or a similar position, prior to the date of receivership. The size of the claw back will be determined through an evaluation of an executive’s role in the shareholders’ overall losses after liquidation. Executive compensation, both direct and indirect, may be clawed back for the two years preceding receivership, or for an unlimited period of time if fraud is involved in the company’s collapse. Parts of the rule have been described as “fundamentally unjustifiable and counterproductive” in a comment letter from representatives of some of the largest banking trade groups, such as J.P. Morgan Chase and Goldman Sachs.
52 Aon Financial Services Group Legal & Claims Practice

Cases of Interest
Shareholder-Nominated Proxy Rule Vacated by the District of Columbia Circuit
This case addressed the validity of Exchange Act Rule 14a-11 (the Rule), which required public companies, including investment companies, to provide shareholders with information about, and their ability to vote for, shareholder-nominated board candidates. In a critical opinion, the District of Columbia Circuit vacated the Rule. The court first found fault with the SEC’s failure to properly assess the costs and benefits for operating companies. Regarding the costs associated with opposing the shareholder’s nominee, the court referred to the SEC’s prediction that directors may choose not to incur the costs to oppose the nominee as “mere speculation.” Rather, “if the shareholder nominee is determined to be not as appropriate as the board nominee, then the board will be compelled by its fiduciary duty to make an effort to oppose the shareholder nominee.” Further, the court found the SEC failed to consider how shareholders with special interests, such as union and state pension funds, might use the Rule to gain concessions unrelated to increasing shareholder value that increase costs.
Regarding the benefits from the Rule, the court found the SEC did not sufficiently support its conclusion that the Rule may result in improved board and company performance and shareholder value. Additionally, the SEC failed to address whether and to what extent the Rule may replace traditional proxy contests, and as a result, it was unclear whether the Rule would facilitate enough elections to be of net benefit. The court also addressed the application of the Rule to investment companies. According to the court, the SEC failed to explain why the
Rule would provide the same benefits for shareholders of investment companies as it would for shareholders of operating companies in light of the “regulatory protection” provided to investment companies. The SEC also failed to address the concern that the Rule may impose greater costs upon investment companies by disrupting board structures with multiple, separate board meetings and making governance less efficient. Finally, the court found that the SEC failed to adequately consider that less frequent use of the Rule by shareholders of investment companies also reduces the expected benefits. Business Roundtable v. SEC, 2011 U.S.
App. LEXIS 14988 (D.C. Cir.).
PSLRA Bars All RICO Claims Premised Upon Acts of Securities Fraud
This opinion examined whether MLSMK Investment Company’s (MLSMK) claim that JP Morgan
Chase & Co. (JPMC) conspired with Bernie Madoff in violation of RICO was barred by Section
107 of the Private Securities Litigation Reform Act (PSLRA). Section 107 of the PSLRA, often referred to as the RICO amendment, states that “no person may rely upon any conduct that would have been actionable as fraud in the purchase or sale of securities to establish a violation of RICO.” Here, MLSMK alleged that JPMC violated RICO by aiding and abetting Bernie
Madoff’s securities fraud scheme. Of note, there is no private right of action under the securities fraud laws for aiding and abetting securities fraud. Thus, the court analyzed whether the RICO amendment applies to all civil RICO claims based on allegations of securities fraud, or as MLSMK argued, there is an exception to the RICO amendment where the plaintiff has no private right to file a securities fraud claim against the defendant. The Second Circuit first discussed the split among the district court judges on the scope of the RICO amendment’s bar.
The court then resolved the divide and held that all civil RICO claims alleging acts of securities fraud, even those claims where a plaintiff itself cannot pursue a securities fraud claim against the defendant, are barred under the amendment. The Second Circuit examined the plain language of the RICO amendment and found that it “does not require that the same plaintiff who sues under RICO must be the one who can sue under securities laws.” Rather, the RICO amendment is worded broadly (i.e., “no person”) and neither the language nor the legislative
The court then resolved the divide and held that all civil RICO claims alleging acts of securities fraud … are barred under the amendment.
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2011 Year in Review Legal News and Developments in Executive Liability 53

National Union argued the jury’s verdict triggered the
“in fact” element of the policy’s conduct exclusions concerning fraud, criminal conduct, and illegal profits or advantages. history indicates that Congress intended for the applicability of the RICO amendment to be dependent upon the plaintiff’s ability to bring a private securities law action against a particular defendant. MLSMK Inv. Co. v. JP Morgan Chase & Co., 2011 U.S. App. LEXIS 13822 (2d Cir.).
D&O Policy’s “In Fact” Exclusion Does Not Require Exhaustion of Appellate Remedies
The insured individual in this coverage dispute, charged with conspiracy to commit and committing bank, wire, and securities fraud, was the former chairman and majority shareholder of a bankrupt entity with a D&O policy. National Union agreed to advance up to $1 million in defense expenses, subject to a reservation of rights. After a criminal trial, the jury found the insured guilty of all 14 fraud and conspiracy counts. Thereafter, National Union argued the jury’s verdict triggered the “in fact” element of the policy’s conduct exclusions concerning fraud, criminal conduct, and illegal profits or advantages. Accordingly, National
Union would no longer fund the individual insured’s defense costs and would consider seeking reimbursement for the defense costs already advanced. The individual insured asked the court to require National Union to reimburse defense costs through the appeals. In rejecting the individual insured’s request, the court commented on the basis of the “in fact” conduct exclusion and highlighted that courts have found similar exclusions containing the “in fact” element that became effective with “some pertinent factual finding” that the insured’s behavior fell within the exclusion. The court also noted that some courts required even less evidence to trigger an “in fact” exclusion, including mere allegations made against the insured that fall within the exclusion. Under this “some pertinent factual finding” standard, the court concluded that the multiple convictions for conspiracy and bank, wire, and securities fraud clearly triggered the policy’s “in fact” exclusion (noting that, to convict, the jury had to find that the evidence of fraud met the high evidentiary standard of “proof beyond a reasonable doubt”). That finding, the court stated, constituted far more than “some pertinent factual finding” of fraudulent conduct and fully supported the conclusion that the conduct exclusions apply. Lee Bentley Farkas v. Nat’l Union Fire Ins. Co. of Pittsburgh, PA, 2011 U.S. Dist. LEXIS 75972
(E. D. VA. 2011).
“Derivative” Exception to Professional Services Exclusion in D&O Policy Not Applicable
This coverage dispute arises from an investigation conducted and a claim asserted against the insureds by the Office of the Attorney General of the State of New York (AG) which revealed that staff falsified a patient’s records. The AG later demanded around $600,000 as part of a monetary settlement. Landmark refused to defend or indemnify against the AG’s claim because it argued that the claim alleged professional errors and was thus excluded from coverage under the policy by the professional service exclusion. The exclusion contained a carve out, which “provided, however, this exclusion shall not be applicable to any derivative or shareholder class action claims against any Insured, which allege a failure to supervise those who performed or failed to perform the medical or professional service in question.”
The insureds argued that the AG’s claim was a covered “derivative” claim because its liability was derived from the acts of its staff, and was thus within the policy’s management carve backs. Landmark responded that the AG’s claim was not a “derivative” claim because, when read in the context of a directors’ and officers’ liability policy, the word “derivative” in the phrase “derivative or shareholder class action claims” can only be interpreted to mean suits brought in the name of a company against that company’s directors or officers. The court agreed with Landmark and concluded common legal usage, New York statutory law, and other policy provisions dictates that the phrase “derivative or shareholder class action claims” only reasonably could mean derivative claims brought in the name of the corporation or direct shareholder class action claims brought by shareholders to enforce some other law. Hollis Park
Manor Nursing Home v. Landmark Am. Ins. Co., 2011 U.S. Dist. LEXIS 79353 (E. D. NY 2011).
54 Aon Financial Services Group Legal & Claims Practice

SEC Filings
• The SEC filed fraud charges against Windham
Securities, Inc., its owner and principal, Joshua
Constantin, and former managing director, Brian
Solomon. The SEC is seeking disgorgement, prejudgment interest and penalties.
* Source: http://www.sec.gov/litigation.shtml
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SEC Settlements
• The SEC settled fraud charges against Schwab
Funds, and ordered it to pay disgorgement, prejudgment interest and penalties of $118,944,996.
• A final judgment, following a jury trial, was entered in connection with fraud charges against Ran H.
Furman, former CFO of Island Pacific, Inc.
Furman was ordered to pay a penalty of $75,000, and was barred from acting as an officer or director of a public company for seven years.
• The SEC settled anti-bribery, books and records, and internal controls charges against Armor Holdings,
Inc. (Armor).
Armor was ordered to pay disgorgement of $1,552,306, prejudgment interest of $458,438, and a penalty of $3.68 million. In a related matter, Armor will pay a $10.29 million fine to the U.S. Department of Justice.
• The SEC settled fraud charges against Locke Capital
Management, Inc. (Locke) and Leila C. Jenkins, its founder and sole owner. Locke and Jenkins were ordered to pay, jointly and severally, disgorgement of $1,781,520, prejudgment interest of $110,956, and a penalty of $1,781,520.
• The SEC settled fraud and misrepresentation charges against John Raffle and David Applegate, both of whom are former SVPs of ArthroCare Corporation.
Raffle was ordered to pay disgorgement of
$1,782,742 and prejudgment interest of $329,230.
Applegate was ordered to pay disgorgement of
$621,755 and prejudgment interest of $106,470.
Additionally, Raffle and Applegate were barred from serving as officers or directors of public companies for five years.
• The SEC settled fraud charges against J.P. Morgan
Securities (LLC) and ordered it to pay disgorgement of $11,065,969, prejudgment interest of $7,620,380, and a penalty of $32.5 million.
• Judgments were entered against five former executives of Brooke Corporation (Brooke), and two subsidiaries, Brooke Capital Corporation
(BCC) and Aleritas Capital Corporation (Aleritas) for financial and disclosure fraud charges. Michael S.
Lowry, former CEO and Aleritas board member, was ordered to pay disgorgement of $214,500, prejudgment interest of $24,005, and a penalty of
$175,000. Michael S. Hess, former CEO and Aleritas board member, was ordered to pay a penalty of
$250,000. Travis W. Vrbas, former CFO of Brooke and
BCC, was ordered to pay a penalty of $130,000.
Robert D. Orr, founder and former chair of the board of Brooke, former CEO and chair of the board of
BCC, and former CFO of Aleritas; and Leland G. Orr, former CEO, CFO and vice-chair of the board of
Brooke and former CFO of BCC, will both be ordered to pay disgorgement and penalties (amounts to be determined). Additionally, the SEC barred all former executives from serving as officers or directors of public companies.
2011 Year in Review Legal News and Developments in Executive Liability 55
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General News
Revealing Bad Earnings News Early May Reduce Litigation Risk
Does revealing bad earnings news early reduce the incidence of securities litigation and/or the costs of resolving lawsuits that occur? In a report titled The Timeliness of Bad Earnings News and
Litigation Risk, by Dain Donelson, John McInnis, and Yong Yu, of the University of Texas at Austin, and Richard Mergenthaler of the University of Iowa, the authors explore this relationship. They cite previous research on this topic suggesting that early revelation of bad news reduces the expected costs of litigation because the perception that management “hid the truth” is diminished when the news is made public sooner. Early exposure may also serve to reduce damages by shortening the class period. Such former research was conducted by using measures based on management earnings “warnings” or “pre-announcements” via a press release to measure early disclosure. This study, however, employed a new measure to capture data based on the evolution of the consensus analyst earnings forecast for a sample of sued and non-sued firms. According to the authors, their “innovation is a new measure of the timeliness of total earnings news, which captures how quickly earnings news is revealed to the market using the evolution of analysts’ consensus earnings forecasts,” which allows “for a stronger test of the litigation reduction hypothesis.” First, this measure captures all bad earnings news delivered via companies’ press releases, analyst conference calls, presentations, webcasts, private communications, and analyst research. Second, this measure allows for larger sample tests by using machine-readable data sources rather than the time-consuming and costly method of hand-collecting disclosure data. The authors studied 423 securities class action lawsuits from 1996-2005 and used a matched sample research design to ensure that sued and non-sued firms have similar total earnings news over the same time period. As expected, their analysis confirmed that earlier revelation of bad news reduces the expected incidence of and costs associated with litigation. However, unlike prior studies that only hinted at a correlation between the timeliness of bad earnings news and the likelihood of litigation, the authors of this report found robust evidence that earlier revelation does, in fact, deter litigation.
Report Details CEO Succession Planning
CEO succession planning lies primarily with the board. Organizational, political, psychological, and cultural issues can, however, lead boards to neglect succession planning. Boards can overcome these issues if they are willing to follow a process and integrate it into their responsibilities for “governance, business oversight, risk management, and strategic decision making.” The 2011 CEO Succession Report, by Matteo Tonello, director of corporate governance for The Conference Board, Inc., and Jason Schloetzer of Georgetown University, documents and analyzes 2009-2010 succession events regarding the CEOs of S&P 500 companies and includes, where appropriate, historical comparisons with data from the last decade. Schloetzer stated, “[o]ne of the most important strategic risks that a corporation must manage is the succession of its chief executive officer. … This is true today, more than ever, due to the recent challenges posed by a variety of economic factors. To make an informed decision, the board should understand not only the technical knowledge and experience necessary to effectively lead the company into the future, but also the context and practices of the succession planning process.” Among several key findings, the rate of CEO succession in 2010 was 10.3 percent, with 51 CEOs in the S&P 500 leaving their positions (consistent with the average number of announcements from 2000 through 2009). Predictably, the probability of CEO succession is greater following bad performance than good performance. Also, the likelihood of CEO succession is greater for CEOs who are at least 64 years of age than for younger CEOs.
The average incoming CEO was 52 years old in 2010, and when promoted from inside, the incoming CEO worked with the company an average of 15 years. They reported a declining
“One of the most important strategic risks that a corporation must manage is the succession of its chief executive officer” …
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The implementation of these new rules highlights the need for companies to carefully review their internal compliance programs and policies … trend in CEO retirements, which the authors believed “suggests a corresponding increase in the number of disciplinary successions.” The authors noted that “from 2006 through 2009, which is roughly the period of the financial crisis, approximately 80 percent of all succession events were associated with CEO dismissals.” However, in recent months the rate of CEO retirements increased. In addition to analyzing succession events in the historical context of the last two decades, the report discussed several noteworthy cases of recent CEO successions based on press announcements and other public information. For a list of the report’s key findings, please visit https://www.conference-board.org/governance/index.cfm?id=7586.
SEC’s Whistleblower Rules Now in Effect
As reported in the May 2011 Month in Review, the Securities and Exchange Commission (SEC) adopted controversial final rules implementing the whistleblower provisions of the Dodd-
Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). Considered one of the most contentious requirements of the Dodd-Frank Act, the new rules will allow corporate whistleblowers to collect between 10 and 30 percent of the penalties when they report violations of securities laws, even if they bypass their employers and report the wrongdoing directly to the SEC. The new whistleblower program officially became effective on August 12,
2011 and the SEC launched a new website (www.sec.gov/whistleblower) for whistleblowers to report violations and apply for financial awards. The new website includes information on eligibility requirements, directions on how to submit a tip or complaint, instructions on how to apply for an award, and answers to frequently asked questions. Among other criteria, to be eligible for a financial award, the whistleblower’s information must lead to a successful SEC enforcement action involving more than $1 million in monetary sanctions. “Early and quick law enforcement action is the key to preventing securities fraud and avoiding investor losses, and the whistleblower program gives us the tools to help achieve that goal,” said Robert Khuzami, director of the SEC’s division of enforcement. Sean McKessy, chief of the SEC’s office of the whistleblower, added, “Securities fraud is not a victimless crime. That’s why it is so important for people to step forward when they witness an ongoing securities fraud or learn about one that has taken place or is about to occur. Our new whistleblower award program makes it easier for people to take that step.” The implementation of these new rules highlights the need for companies to carefully review their internal compliance programs and policies, including the need to raise awareness of the incentives for potential whistleblowers to first report information internally in accordance with such programs and policies.
Cases of Interest
Coverage Available for Employees Subpoenaed but Not Named in SEC Lawsuit
An insured sought coverage under a second level excess D&O policy issued by Travelers for fees and costs incurred representing the insured’s current and former employees as part of a lawsuit brought by the SEC. The employees were not named as parties in the SEC lawsuit, but were subpoenaed to give deposition testimony. The court first examined whether the employees were “Directors and Officers” as defined by sub-paragraph 2 in the underlying primary policy: “to the extent any Claim is for … a Securities Law Violation, all persons who were, now are, or shall be employees of the Company.” The “Directors and Officers” definition was amended by endorsement with the addition of sub-paragraph 5: “employees of the
Company. However, coverage for employees who are not directors or officers shall only apply when an employee is named as a co-defendant with a director or officer of the Company.”
The court found sub-paragraphs 2 and 5 were independent provisions and the employees were “Directors and Officers” under sub-paragraph 2. Alternatively, the court held that the primary policy’s definition of “Directors and Officers” was ambiguous and ruled in favor of the
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insured on the issue of whether the employees were “Directors and Officers” under the policy.
The court next addressed coverage under the relevant insuring agreement, which stated
“Underwriters shall pay … Loss which the Company is required … to pay as indemnification to any of the Directors and Officers resulting from any Claim first made against the Directors and Officers.” The insured argued that the insuring agreement was triggered because either it incurred loss by indemnifying the employees resulting from a claim made against the
“Directors and Officers” named in the SEC suit, or the subpoenas were Claim[s] first made against the employees as “Directors and Officers.” Travelers argued there was no coverage because a claim was never asserted against the employees. Ultimately, the court found that based on the facts of the case, the insuring agreement was ambiguous and ruled in favor of the insured on the issue of coverage under the insuring agreement. Gateway, Inc. v. Gulf Ins. Co.
(acquired by Travelers), 2011 U.S. Dist. LEXIS 91063 (S.D. Cal. 2011).
Derivative Action Dismissed for Failure to Allege Demand Futility with Particularity
This case involved a derivative action that alleged the board of directors: 1) created illegal
“business strategies;” and 2) failed to take action regarding “red flags” for possible illegal activity. The court held that the plaintiffs failed to adequately allege demand futility with the
“particularity required under California law.” With respect to the board allegedly creating illegal “business strategies,” the test for proving demand futility for a claim involving a board transaction is “whether the facts show a reasonable doubt that 1) the directors are disinterested and independent, and 2) the challenged transaction was otherwise the product of a valid exercise in business judgment.” Here, the plaintiffs’ allegations of a “culture of noncompliance” did not sufficiently identify the challenged transaction that could form the basis for an active mismanagement claim. Additionally, even if there was an adequately alleged transaction, the court reasoned the plaintiffs did not sufficiently allege “facts specific to each director as to whether that particular director could or could not be expected to fairly evaluate the plaintiffs’ claims.” The court next held that the plaintiffs failed to allege demand futility with respect to the alleged inaction by the board. The test for demand futility for failure to act is whether the alleged facts create a reasonable doubt that when the complaint was filed, “the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand.” The plaintiffs relied on the following allegations to argue against independence: 1) the board’s failure to identify past issues; 2) director membership on the compensation committee; 3) the threat of personal liability against the directors; 4) the existence of another lawsuit naming the directors as defendants; and 5) personal relationships between and among the various directors. The court found that none of these allegations excused demand on the board. Finally, the court rejected the plaintiffs’ request that they be allowed to conduct discovery to establish demand futility, reasoning that a plaintiff must establish the procedural requirement of adequately alleging the reasons for not making a demand prior to conducting discovery. Shapiro v. Kennedy, 2011 Cal. App. Unpub.
LEXIS 6127 (Cal. App. 4 th Dist. 2011).
Excess Insurers’ Payment Obligations Not Triggered if an Insured Accepts a Compromise
Payment from Primary Carrier for Less than Full Primary Limit
This coverage dispute involved a multi-layered insurance program that provided a total of
$200 million in coverage. The insureds sought coverage from their carriers in connection with a series of class action lawsuits that eventually settled for $243 million. While the insureds provided timely notice of the claims, they later allegedly settled the matters without the consent of their insurers, prompting an initial denial of coverage from each of the insurers in the tower. The insureds eventually entered into a settlement with their primary carrier, which paid only $15 million of its $50 million limit. The excess insurers refused to pay and the insured initiated coverage litigation. During coverage litigation, the insureds settled with the insurers
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Here, the plaintiffs’ allegations of a “culture of noncompliance” did not sufficiently identify the challenged transaction that could form the basis for an active mismanagement claim.
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The court declined to read any ambiguity into the policies by virtue of the fact that the excess insurance policies at issue contained different language.
in the second layer and continued the coverage dispute against insurers in the third layer. The lower court granted summary judgment in favor of the insurers, holding that their obligations did not attach until the primary insurer paid its full limits. The excess policies mandated the
“full amount,” “total,” or “all” of the underlying insurers’ limits of liability be exhausted before the excess limits attached. On appeal, the insureds urged the Fifth Circuit to apply the rule of Zeig v. Mass. Bonding & Ins. Co., which holds that if an excess insurance policy ambiguously defines “exhaustion,” then settlement with an underlying insurer constitutes a “functional” or “constructive” exhaustion of the underlying policy for purposes of determining when the excess limits attach. The court declined to read any ambiguity into the policies by virtue of the fact that the excess insurance policies at issue contained different language. To this end, the Fifth Circuit refused to follow the “Zeig rule,” stating that “we conclude that the plain language of the policies dictate that the primary insurer pays the full amount of its limits of liability before the excess coverage is triggered.” Citigroup, Inc. v. Fed. Ins. Co., et al., 2011 U.S.
App. LEXIS 16316 (5 th Cir. 2011).
Court Rejects Collective Knowledge to Plead “Scienter” Under PSLRA
The plaintiffs in this case filed a 10b-5 suit based on securities fraud claims that arose out of alleged price fixing revealed when the Department of Justice and FBI executed search warrants, which resulted in the insured issuing a statement acknowledging the investigation. Shortly thereafter, the insured announced that “its revenue and earnings were not sustainable” and its stock price plummeted. The Third Circuit agreed with the lower court’s decision to dismiss all claims against several corporate defendants and five officers and directors for securities fraud under the heightened pleading rules of the Private Securities Litigation Reform Act (PSLRA).
The court mentioned it was not going to “retrace all of the ground the court so ably covered,” and instead highlighted that the PSLRA puts “a weighty burden on plaintiffs” to plead sufficient facts, when considered in their totality, to raise a strong inference of scienter. The Third Circuit concluded that the City of Roseville failed to meet the PSLRA’s standard because it couldn’t show that any individual made an actionable statement with scienter, and, therefore, failed to plead scienter against the insured. The plaintiffs asserted they could successfully plead scienter against the corporate entity without successfully pleading a claim against any individual. The
Third Circuit did not consider this argument because “[a]lthough the price fixing conspiracy at Horizon was long-lasting and affected a substantial portion of Horizon’s business … [e]ven if … it were possible to plead scienter against a corporation without pleading scienter against an individual, the facts alleged [by the plaintiff] would not survive a motion to dismiss.” In response to a dissenting opinion, the majority noted that “the dissent focuses not on the district court’s analysis of each of these allegations but rather on the brevity of the court’s explicit discussion of the totality of the facts related to scienter. That specific section of the court’s opinion was brief, but it followed a lengthy discussion as to why each scienter-related allegation added little, if anything, to plaintiff’s side of the scienter scale. The court did not need to explain at length that the total weight of these allegations was also scant. To put it succinctly, it does not take much to explain that zero plus zero equals zero.” City of Roseville
Employees’ Retirement Sys. v. Horizon Lines, Inc., et al., 2011 US App. LEXIS 17701 (3d Cir. 2011).
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IvI Exclusion Carve-Out Inapplicable
An insured sought coverage under its D&O policy for losses arising from fraud allegedly committed by two executives of a subsidiary. Specifically, the insured asserted that the executives misrepresented facts prior to the asset purchase of their company and failed to disclose their misrepresentations after they were hired by the subsidiary. The court rejected the insured’s attempt to convert the D&O policy into a policy to cover business losses resulting from the misrepresentations and held there was no coverage. According to the court, there was no claim against any insured that was covered by the policy. The insured’s lawsuit against the purchased company and the executives was barred by the Insured v. Insured (IvI) exclusion.
The insured attempted to avoid the IvI exclusion by arguing that two letters issued by the insured to Travelers were “Security Holder Derivative Claims.” Derivative claims were explicitly carved out of the IvI exclusion. The court rejected this argument reasoning that the two letters did not allege “Security Holder Derivative Claims,” but instead were demands to Travelers for the policy limit. Further, there was no logical reason for the insured or any other shareholder to make a derivative demand since the insured had already filed a complaint against the executives. Greenman-Pedersen, Inc. v. Travelers Cas. & Sur. Co. of Am., 2011 U.S. Dist. LEXIS 90202
(S.D.N.Y. 2011).
The court rejected the insured’s attempt to convert the D&O policy into a policy to cover business losses …
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SEC Filings
• The SEC filed fraud charges against Immunosyn
Corporation (Immunosyn) and Argyll
Biotechnologies, LLC (Argyll).
The SEC also charged two former executives of Immunosyn,
Stephen D. Ferrone, former CEO; and Douglas
McClain, Jr., former CFO; and two former executives of Argyll, Douglas McClain, Sr., former CSO; and James T. Miceli, former CEO. The SEC is seeking disgorgement, prejudgment interest, penalties, and an order barring Ferrone, McClain, Jr.,
McClain, Sr., and Miceli from serving as officers or directors of a public company.
• The SEC filed insider trading charges against
H. Clayton Peterson, a former board member of Mariner Energy, Inc.
The SEC is seeking disgorgement, prejudgment interest, penalties, and an order barring Peterson from serving as an officer or director of a public company.
• The SEC filed fraud charges against Stifel, Nicolaus
& Co., Inc., and David W. Noack, former SVP.
The SEC is seeking disgorgement, prejudgment interest, and penalties.
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SEC Settlements
• Final judgments were entered in connection with fraud charges against Westmoore Management,
LLC, Westmoore Investment, L.P., Westmoore
Capital Management, Inc., Westmoore Capital,
LLC, (collectively Westmoore defendants), and Matthew Jennings, former CEO and general partner of the Westmoore defendants. The court ordered the Westmoore defendants to pay disgorgement and prejudgment interest in an amount to be determined, along with the appointment of a permanent receiver over their assets. Jennings was ordered to pay disgorgement and prejudgment interest of $362,265 and a penalty of $130,000 and was barred from serving as an officer or director of any publiclytraded company for a period of five years.
• Final judgments were entered against Pharma
Holdings, Inc., Edward Klapp IV, CEO, and
Edward Klapp, Jr., CFO. Klapp IV was ordered to pay disgorgement of $1,180,683, prejudgment interest of $65,407, and a penalty of $130,000.
Klapp, Jr. was ordered to pay disgorgement of
$504,697, prejudgment interest of $27,959, and a penalty of $130,000.
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* Source: http://www.sec.gov/litigation.shtml
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General News
Mens Rea Legal Protection for Directors and Officers Weakened by Expanding Criminal Code
A fundamental principle of criminal law is that a crime must consist of both an act (actus reus) and an intentional state of mind (mens rea), such as intent, recklessness, or willful blindness. In other words, people must know they are doing something wrong before they can be found guilty. According to a recent Wall Street Journal article, the legal protection of mens rea, Latin for a “guilty mind,” is “being eroded as the U.S. federal criminal code dramatically swells.” The article suggests Congress has enacted numerous provisions imposing criminal liability that
“weaken or disregard the notion of criminal intent,” and therefore, “what once might have been considered simply a mistake is now sometimes punishable by jail time.” Accordingly, it is essential for corporate directors and officers, who are often targeted for matters in which they were neither involved nor aware, to consider the implications of such criminal provisions. For example, the article discusses white collar crime and cites the enactment of certain provisions of the Sarbanes-Oxley Act (SOX) that make it “easier for prosecutors to bring obstruction of justice cases related to the destruction of evidence.” The article suggests that in cases such as the drafting of SOX, lawmakers often pass such legislation without appropriately considering the implications of omitting criminal intent provisions. According to Jay Apperson, former Chief
Counsel to the House Judiciary Subcommittee on Crime, Terrorism, and Homeland Security,
“Lots of members don’t think about it, not out of a malevolent motive … they just don’t think about it.” Frank Bowman, a University of Missouri law-school professor who advised the Senate
Judiciary Committee during the creation of SOX, believes such a “slapdash approach to drafting was pretty rife throughout the period.” The SOX provision, however, is only one of many judicial events that may result in corporate officials being held legally accountable without culpability. In fact, a separate Wall Street Journal article recently addressed how federal regulators have stepped up their use of the “responsible corporate officer doctrine” to hold executives personally and criminally responsible for violations of U.S. food and drug laws.
This doctrine “lets prosecutors go after executives for misdemeanor violations of the Food,
Drug, and Cosmetic Act, even if the executives weren’t aware of violations.” Among other concerns, the enactment of these types of provisions may also result in a higher frequency of
D&O coverage disputes as such policies typically do not provide coverage for resulting fines, penalties, and disgorgement.
Pay Following CEO Turnover in Excess of Contractual Rights
Executive pay is an important component of corporate governance and, therefore, a topic of interest for shareholders, regulatory agencies, and academia. Compensation contracts can often be indicative of a board’s desire to either act in the best interests of its shareholders or acquiesce to its CEO’s demands. In a report titled Contractual Versus Actual Severance Pay
Following CEO Turnover, Eitan Goldman of the Department of Finance at Indiana University and Peggy Huang of the Department of Finance at Tulane University analyze the bargaining game that takes place between departing CEOs and the board to determine discretionary pay in excess of existing severance obligations. The authors discovered that about 40 percent of departing S&P 500 CEOs receive separation payments in excess of contracted amounts with average discretionary pay in the neighborhood of $8 million, nearly 242 percent of their annual compensation. The report seeks to reveal the motivation and rationale behind such pay and finds that it generally represents a governance problem in voluntary CEO departures.
However, in the event of forced departures, excess discretionary pay instead serves to facilitate
… it is essential for corporate directors and officers, who are often targeted for matters in which they were neither involved nor aware, to consider the implications of such criminal provisions.
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… Federal could rescind the policy as to the CFO and SafeNet because the
CFO … admitted that she caused the public filings to be inaccurate.
a smooth transition from the ex-CEO to a new CEO. The authors contend that “discretionary separation pay [in forced departures] can be viewed as an attempt by the board of directors to try and avoid a long, contentious battle with the departing CEO which can cause further deterioration of shareholder value.” Overall, the authors’ results show that “severance pay and discretionary separation pay, while seemingly reflecting poor governance, may actually play a critical role in the efficient replacement process of poorly-performing CEOs.” This component of executive compensation “can provide interesting details about how the board and the
CEO interact” and “shed light on the dual role played by severance compensation and on the bargaining game played between the board and the departing executive.”
Cases of Interest
D&O Policy Rescinded Following CFO’s Guilty Plea
This opinion addressed coverage available to SafeNet and its executives under an excess policy for several lawsuits and enforcement actions alleging backdating of options and fraudulent recognition of revenue. SafeNet’s CFO pled guilty to securities fraud relating to the backdating of options; therefore, the court held that the CFO’s guilty plea triggered the fraudulent acts exclusion, effectively barring coverage for the individual officer. The court then addressed the fraudulent acts exclusion and the personal profit exclusion to determine if those provisions would bar coverage for SafeNet because the policy imputed the CFO’s conduct to the insureds.
The exclusionary language required a final judgment against the insureds, while the policy only imputed “facts” and “knowledge” possessed by the CFO to the insureds, not a judgment.
Since no final judgment was entered against SafeNet and the CFO’s guilty plea could not be imputed to SafeNet, the court could not declare that the policy’s conduct exclusions barred coverage for SafeNet. The court then analyzed the policy’s consent to settle provision and found that SafeNet, by not conferring with or advising Federal before settling, was not excused from complying with the provision because Federal had not fully denied coverage. As a result, Federal was not liable for the settlement amount. Finally, the court held that Federal could rescind the policy as to the CFO and SafeNet because the CFO, who signed the public filings, admitted that she caused the public filings to be inaccurate. Finally, because the policy imputed the CFO’s knowledge to the entity and because SafeNet was not permitted to prove it lacked knowledge of the inaccurate facts, the court declared “the policy was void … as to
SafeNet.” Fed. Ins. Co. v. SafeNet, Inc., 2011 U.S. Dist. LEXIS 101845 (S.D.N.Y. 2011).
Excess D&O Insurers Not Required to Drop Down or
Otherwise Pay Due to Insolvency of Underlying Insurer
In this coverage dispute, excess insurers sought a determination that their D&O policies were not triggered by an underlying claim. At the time of its bankruptcy filing, Commodore had in place a D&O insurance tower that provided coverage by six different insurance companies.
Due to the insolvency of Reliance (first and third excess) and Home Insurance (fourth excess),
Commodore was not reimbursed for claims filed under those policies. Due to Reliance’s insolvency, the insured directors and officers were unable to obtain advance defense costs from Federal, the excess insurer above Reliance. The two excess insurers’ insolvency, and in particular Reliance, presented two issues: 1) whether the excess insurers are required to “drop down” and advance defense costs that would have been provided but for the insolvency of the underlying insurers; and 2) whether the excess policies are triggered once the aggregate amount of covered losses exceeds each policy’s attachment point, or whether the underlying
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policies are only exhausted by the actual payment of claims by the underlying insurers. While there was some dispute as to which jurisdiction’s law would apply, the court concluded that choice of law did not impact the merits due to New York’s and Pennsylvania’s clear rejection of an automatic drop-down rule. The court rejected the insureds’ argument that sophisticated insurance companies such as Federal and Travelers have the ability to draft policy language that expressly indicates what should occur in the event of circumstances such as the insolvency of an underlying insurer. The court found the policies expressly stated that if the insureds fail to maintain underlying insurance, the insurers “shall not be liable to a greater extent than if this condition had been complied with.” The court concluded that this language “expressly demonstrates that the coverage provided by the [e]xcess [i]nsurers will not be enlarged to compensate for gaps in underlying coverage.” In consideration of the insureds’ argument that the excess carriers should nevertheless be required to provide coverage once the aggregate amount of covered losses exceeds each policy’s attachment point, although the court recognized contrary case law, it ultimately concluded that “the express language of these policies establishes a clear condition precedent to the attachment of the [e]xcess [p] olicies. In each policy, the excess coverage is not triggered until the underlying insurance is exhausted ‘solely as a result of payment of losses thereunder.’” Based upon this determination, the insureds would never be able to access excess limits even if their losses exceed the entire tower’s limits of liability. Fed. Ins. Co. v. The Estate of Irving Gould, et al., 2011 U.S. Dist. LEXIS
114000 (S.D.N.Y. 2011).
Dishonesty Exclusion and Rescission Used to Deny Coverage under D&O Insurance Policy
This dispute involved individual directors and officers, as well as a trust formed in bankruptcy, seeking coverage under a D&O insurance policy for both civil and criminal claims. Gulf
Insurance Company (Gulf) issued the primary policy providing $5 million of coverage, and tendered its limits. Great American Insurance Company (Great American) provided an additional $5 million of excess coverage. Great American argued that criminal convictions establish grounds for denying coverage, namely: 1) rescission of the policy because Poulsen’s
(a principal executive) false representations in the policy application rendered the contract void ab initio; and, 2) the policy’s “dishonesty exclusion” excluded from coverage a loss brought about by an insured’s deliberately fraudulent actions. The insureds countered that the Great American policy contained no provision allowing the insurer to rescind the policy as void ab initio, and further, the insurer waived its right to rescind when it accepted the premium payment for tail coverage. They also argued that to the extent the dishonesty exclusion had been triggered, the adverse interest exception to agency law protects their right to coverage, such that a principal’s fraud should not be imputed to them. The court noted that, “If Great
American is correct, this would have a broad sweep, excluding all insureds from coverage, not just those (the Principals and the Trust) denied coverage by the dishonesty exclusion.”
Regarding rescission, the court noted that as a threshold matter, it had little difficulty in concluding Poulsen made misrepresentations of material fact in the proposal form and that the proposal form specifically required and incorporated the company’s three most recent annual financial statements along with its latest interim financial statement. The court noted that the convictions clearly established that the data upon which the statements were based was entirely fabricated, and Poulsen knew this since he was the one who ordered the data be falsified. The court also pointed out that it was uncontroverted these representations were material to the underwriting of the policies. Under Ohio law, to render a policy void ab initio, statements must satisfy two criteria. First, they must “either appear on the face of the policy or in another instrument specifically incorporated into the policy.” Second, “the terms
“In each policy, the excess coverage is not triggered until the underlying insurance is exhausted ‘solely as a result of payment of losses thereunder.’”
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The court agreed with
Great American that the criminal convictions triggered the dishonesty exclusion and excludes such insureds from coverage for both criminal and civil cases.
of the policy must ‘clearly and unambiguously’ provide that a misstatement by the insured shall render the policy void ab initio.” The court concluded that both criteria were met. The court then considered the critical issue of whether severability language in the policy would protect the “innocent” insured persons. The excess policy actually contained its own flawed severability language, which provided non-imputation language for representation, “except for material facts or circumstances known to the person who subscribed this Proposal Form … .”
Significantly, Poulsen was the signor. The court stated that “[o]ther courts interpreting the exact same contractual language agree that it is unambiguous and imputes the signor’s knowledge of material facts or circumstances to other directors and officers.” Therefore, rescission, if not waived, would void all insureds’ coverage. On the issue of whether Great
American had waived its right to rescind coverage, the court found that if Great American in fact knew of Poulsen’s deception, it could not treat the tail coverage as effective for purposes of earning the premium, yet later take the legal position that the policy never existed.
Accordingly, the court found that there remains a genuine issue of material fact concerning whether Great American waived its right to rescission. The court agreed with Great American that the criminal convictions triggered the dishonesty exclusion and excludes such insureds from coverage for both criminal and civil cases. The trust agreed that the convicted individuals should lose their coverage, but argued that their conduct cannot be imputed to the trust (in the shoes of the entity) due to the adverse interest exception, whereby conduct is not imputed if the agent acted adversely to the principal and entirely for his own, or another’s purpose. In rejecting this argument, the court found that the fraudulent conduct must be imputed to the entity and its subsidiaries and therefore the trust for purposes of excluding those entities from coverage under the policy’s dishonesty clause. The Unencumbered Assets, Trust, v. Great Am. Ins.
Co., et al., 2011 U.S. Dist. LEXIS 106153 (S.D. Ohio 2011).
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Use of a Computer Software Program Constitutes Insurance Services under E&O Policy
This case involves a long-standing insurance coverage dispute under an insurance company professional liability policy issued to Grange Mutual Casualty Company (Grange) by Chubb
Custom Insurance Company (Chubb). In 2005, Grange, along with hundreds of other insurance companies, was named as a defendant in a class action lawsuit filed in Texarkana,
Arkansas, Hensley et al. v. Computer Sciences Corp., et al.
(Hensley). The plaintiffs in the Hensley action asserted a number of legal claims challenging Grange’s use of Colossus, a computer software program designed to adjust bodily injury claims. Grange tendered the claim to
Chubb for coverage under the policy, which provided coverage for losses arising from “any
Wrongful Act committed by the Insureds … while performing Insurance Services including the alleged failure to perform Insurance Services.” “Wrongful Act” was defined under the policy to include any “error, misstatement, misleading statement, act, or omission, neglect or breach of duty committed, attempted, or allegedly committed … [in the performance of] Insurance
Services.” Included in the definition of “Insurance Services” were “those services rendered or required to be rendered by or on behalf of the Insureds solely in the conduct of the Insureds’ claims handling and adjusting … .” Eventually, the Hensley plaintiffs dismissed Grange without prejudice. Prior to the dismissal of the Hensley action, a second class action lawsuit, styled
Gooding, et al. v. Grange Indem. Ins. Co.
, et al.
(Gooding), was filed solely against Grange.
Shortly thereafter, the Gooding action was settled pursuant to a stipulation submitted to the
Arkansas court. Chubb received a copy of the stipulation, and Grange sought indemnification for payments made in connection with the stipulation in the Gooding action, in addition to reimbursement of defense costs incurred in both the Hensley and Gooding actions. A few days later, Chubb sought a declaratory judgment that Hensley, Gooding, and the stipulation were not covered under the policy, arguing that Grange made a business decision to purchase and implement Colossus as part of an overall expense reduction plan implemented by the company. Even though there was no dispute that the Hensley plaintiffs’ claims arose from
Grange’s use of Colossus in adjusting their claims, Chubb took the position that the Loss was attributable instead to a business decision made outside the claims handling process.
In response, Grange asserted a counterclaim for bad faith and punitive damages. The court found in favor of Grange and expressly rejected Chubb’s argument that the business decision to implement Colossus, which predated Grange’s actual use of the software program, could invalidate coverage for claims arising from Grange’s subsequent use of the software program during its claims handling process. Chubb also argued that by using the software, Grange
“saved” millions of dollars in connection with the payment of general damages for bodily injury claims. Chubb reasoned that these “savings” resulted from the underpayment of benefits.
The court disagreed and highlighted that the settlement class members had already settled their general damages bodily injury claims with Grange, and therefore no amounts were “due” or “allegedly due.” In the final analysis, “Chubb did not demonstrate that the plaintiffs in the
Hensley and Gooding Actions were seeking ‘any amounts which constitute benefits, coverage or amounts due or allegedly due’ from Grange as their insurer.” The court then deferred ruling on Grange’s bad faith counterclaim and the issue of whether Grange is entitled to additional defense costs payments. Chubb Custom Ins. Co. v. Grange Mut. Cas. Co ., 2011 U.S. Dist. LEXIS
111583 (S.D. Ohio 2011).
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Chubb took the position that the Loss was attributable instead to a business decision made outside the claims handling process.
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… the court concluded the claims of the original and amended cross-complaints were “Interrelated
Wrongful Acts.”
D&O Policy’s “Interrelated Wrongful Acts” Precludes Coverage for
Amended Pleading with New Facts, Parties, and Liability Theories
In this coverage dispute, Illinois Union Insurance Company (Illinois Union) issued a D&O policy to ZF Solutions for claims first made and reported during the policy period. The policy stated that “[m]ore than one Claim involving the same Wrongful Act or Interrelated Wrongful Acts shall be deemed to constitute a single Claim and shall be deemed to have been made at … the time at which the earliest Claim involving the same Wrongful Act or Interrelated Wrongful Act is first made … .” Moreover, “Interrelated Wrongful Acts” were defined to mean “more than one Wrongful Act which have as a common nexus any fact, circumstance, situation, event or transaction or series of facts, circumstances, situations, events or transactions.” David Feldman is the president and CEO of ZF Solutions, successor to ZF Devices, which designed, marketed and sold semiconductor devices. ZF Solutions sued National Semiconductor (National) for failing to produce devices in accordance with the parties’ contract. Before the Illinois Union policy incepted, National filed a cross-complaint for breach of contract against ZF Solutions and ZF Devices for failure to pay for the devices as the parties agreed. The cross-complaint alleged that ZF Devices assigned the National contract and assets to ZF Solutions “for the fraudulent purpose of escaping liability of ZF Devices’ debts, particularly the debt to [National] under the Agreement.” A year later, during Illinois Union’s policy period, National filed an amended cross-complaint, naming for the first time Feldman as a cross-defendant on new causes of action for breach of fiduciary duty, fraudulent conveyance and violation of the
California Unfair Competition Law. The amended cross-complaint described in more detail
National’s efforts to assist ZF Devices in remaining financially viable and elaborated on the interactions by Feldman and others designed to defraud National. Feldman tendered the amended cross-complaint to Illinois Union, which denied coverage because the National claim had been made when the original cross-complaint was filed, which pre-dated the inception of the Illinois Union policy, and the “Interrelated Wrongful Acts” provision deemed the claim first made at the time of the original cross-complaint. Feldman then sued
Illinois Union, arguing that the coverage declination was erroneous because the amended pleading alleged “new and different wrongful acts,” which were “not causally connected and independent of the wrongful acts alleged in the cross-complaint.” The trial court granted summary judgment to Illinois Union based on the “Interrelated Wrongful Acts” language.
The court analyzed the allegations of National’s original complaint and the first amended complaint to determine if National’s claim involved “Interrelated Wrongful Acts” or was
“first made” during Illinois Union’s policy period. To establish if National’s claims involved
“Interrelated Wrongful Acts,” the court compared the allegations of its original complaint to its first amended complaint. The court found that although the amended cross-complaint included new facts, defendants, and causes of action, these new allegations related to the alleged fraudulent assignment and transfer of assets from ZF Devices to ZF Solutions, which was alleged in National’s original cross-complaint. Thus, the court concluded that the claims of the original and amended cross-complaints were “Interrelated Wrongful Acts,” and, therefore, constituted one claim made at the time of the filing of the original cross-complaint, which predated the inception of the Illinois Union policy. Feldman v. Illinois Union Ins. Co., 2011 Cal. App.
LEXIS 1161 (Cal. App. 2011).
68 Aon Financial Services Group Legal & Claims Practice

SEC Filings
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SEC Settlements
• The SEC filed fraud charges against Diane Glatfelter,
Robert Rice, Robert Anderson, and two entities controlled by Glatfelter and Rice, K2 Unlimited, Inc.
and 211 Ventures, LLC, for participating in fraudulent schemes involving the promotion and sale of fictitious financial instruments and trading programs. The SEC is seeking disgorgement, prejudgment interest, penalties, and a bar prohibiting Glatfelter from serving as an officer or director of a public company.
• The SEC filed fraud charges against Doris E. Nelson, owner of the Little Loan Shoppe in connection with a massive Ponzi scheme. The SEC is seeking disgorgement and penalties.
• The SEC settled insider trading charges against
Robert Feinblatt, co-founder and former principal of
Trivium Capital Management LLC.
Feinblatt was ordered to pay disgorgement of $829,765, prejudgment interest of $186,023, and a penalty of
$1,659,530.
• The SEC settled fraud charges against Kyle L. Garst, former CEO of Brooke Capital Corporation.
Garst was ordered to pay a penalty of $130,000, and was barred from serving as an officer or director of a public company.
• A judgment was entered against Donald R.
McKelvey, former president of Telco-Technology,
Inc. (Telco).
McKelvey was ordered to pay disgorgement of $266,780, prejudgment interest of
$127,711, and a penalty of $50,000. Additionally,
McKelvey was barred from serving as an officer or director of a public company.
• The SEC settled fraud charges against Larry Lee
Crawford, former CFO of Escala Group, Inc.
Crawford was ordered to pay a total of $164,584 in disgorgement, prejudgment interest, and penalties, and was barred from serving as an officer or director of a public company for 3 years.
• The SEC settled insider trading charges against Suni
Bhalla, a former senior executive of Polycom, Inc.
Bhalla was ordered to pay a penalty of $85,000, and was barred from serving as an officer or director of a public company for 5 years.
• The SEC settled charges against J. Michael Kelly, former CFO of AOL Time Warner, Inc., and Joseph
A. Ripp, former CFO of the AOL Division of AOL Time
Warner. Kelly was ordered to pay disgorgement of
$200,000 and a penalty of $60,000. Ripp was ordered to pay disgorgement of $130,000 and a penalty of $20,000.
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* Source: http://www.sec.gov/litigation.shtml
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General News
SEC Issues Cybersecurity Disclosure Guidance
In light of public companies’ increased dependency on digital technology, as well as the frequency and severity of cyber incidents, the SEC’s Division of Corporation Finance recently provided guidance concerning disclosure obligations in connection with cybersecurity risks and cyber incidents. Since costly cyber attacks may adversely affect customer or investor confidence, the SEC determined it would be “beneficial to provide guidance that assists registrants in assessing what, if any, disclosures should be provided about cybersecurity matters in light of each registrant’s specific facts and circumstances.” Although there are currently no disclosure requirements that explicitly refer to cybersecurity risks, federal securities laws compel disclosure of timely and accurate information about risks that a reasonable investor would consider important to an investment decision. Accordingly, the SEC recommends that registrants review, “as with other operational and financial risks … the adequacy of their disclosure relating to cybersecurity risks and cyber incidents.” Specifically, the SEC suggests that registrants: 1) disclose the risk of cyber incidents if such incidents would make an investment in the company risky; 2) address cybersecurity risks and incidents in their
MD&A if the costs or other consequences may have a material effect on the registrant’s results of operations, liquidity, or financial condition, or would cause reported financial information not to be indicative of future operating results or financial condition; 3) provide disclosure in the “Description of Business” section if one or more cyber incidents materially affect products, services, relationships with customers or suppliers, or competitive conditions; 4) disclose information regarding litigation in their “Legal Proceedings” disclosure if a material pending legal proceeding involves a cyber incident; 5) consider various accounting principles that may be implicated in the event of a cyber incident, such as loss contingencies, cash flow diminution and customer payments and incentives that may result from a registrant seeking to mitigate damages; and 6) disclose conclusions on the effectiveness of disclosure controls and procedures. The SEC’s guidance highlights the need for companies using digital technologies to routinely review cybersecurity measures, be prepared to address vulnerabilities that may have a material impact on the company’s operations, and assess the effects and financial implications of cyber incidents.
Cases of Interest
Court Denies Waiver Argument of Insureds and Rejects Insurer’s
Attempt to Interrelate E&O Claim to Prior Claim
This coverage dispute involved errors and omissions (E&O) coverage under a Lloyds of London
(Lloyds) policy for brokers/agents who allegedly sold the plaintiffs unsuitable investment and/ or insurance products, including variable life insurance and annuities, and “churned” and continuously traded or swapped variable annuities. The unsuitable “churning” and swapping of insurance and annuity products resulted in the commencement of three arbitrations, all of which Lloyds argued arose out of “Interrelated Wrongful Acts” as defined by the policy and, accordingly, constituted a single claim first made over a year before the Lloyds policy’s inception date. The policy provided that “[a]ll Claims based upon or arising out of the same
Wrongful Act or Interrelated Acts shall be considered a single Claim.” Lloyds contended it was entitled to a judgment that the current arbitration was not covered under the E&O policy because the multiple arbitrations represented a single claim that was made prior to the policy period. The insureds initially urged the court to find that Lloyds waived its right to assert any relation-back defense because it did not reference the defense generally in any of its reservation of rights letters. Applying New York law, the court noted that waiver was “a
2011 Year in Review Legal News and Developments in Executive Liability 71
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Applying New
York law, the court noted that waiver was “a voluntary and intentional relinquishment of a known right.” voluntary and intentional relinquishment of a known right.” The court ruled that when an insurer reserves its right to deny coverage, estoppel and waiver may not be inferred and “the doctrine of waiver is inapplicable where the defense at issue is the existence or nonexistence of coverage … where the policy in question never provided coverage of that type of claim or of the particular insured, coverage can not be created through equitable estoppel solely because the insurer failed to make a timely disclaimer.” Next, the court addressed Lloyds’ contentions that the three arbitrations should all be treated as a single “Claim” as defined by the policy, resulting in an accrual date that falls outside the policy period. The court previously held that in order for claims to be interrelated, they must share a “sufficient factual nexus.” One of the factors considered was whether the “wrongful acts” were contemporaneous, and whether there was a common scheme or plan underlying the acts. The court “evaluates an inclusion based on the underlying facts rather than the legal theories pleaded or additional defendants named.” In this case, the court found the various claims did not allege the same individual insureds acted as a team or that there was any common scheme or plan. The court stated,
“[w]hile Lloyds attempts to minimize this distinction, the Court finds it significant; otherwise, any claim involving the sale of unsuitable securities involving fraud, misrepresentation or failure to supervise that arose prior to the Lloyds’ Policy Period would be deemed interrelated.”
Brecek & Young Advisors, Inc. v. Lloyds of London Syndicate 2003, 2011 U.S. Dist. LEXIS 116173 (D.
Kan. 2011).
EEOC Lawsuit Does Not Constitute an EPL Claim
Following an investigation by the Equal Employment Opportunity Commission (EEOC) of ten current and former employees’ allegations of harassment and discrimination, the EEOC filed a lawsuit against Cracker Barrel Old Country Store (Cracker Barrel), a national restaurant chain. Cracker Barrel incurred over $700,000 defending itself and eventually settled the lawsuit by paying $2 million into a settlement fund to be allocated by the EEOC. When
Cracker Barrel requested insurance coverage for the settlement and its defense costs from its employment practices liability (EPL) carrier, Cincinnati Insurance Company (Cincinnati), the carrier relied on its definition of “Claim” to decline coverage, concluding that the lawsuit was brought solely on behalf of the EEOC, not an employee. The Cincinnati policy defined a “Claim” as “a civil, administrative or arbitration proceeding commenced by the service of a complaint or charge, which is brought by any past, present or prospective ‘employee(s)’ of the
‘insured entity’ against any ‘insured’” for a wrongful employment-related act. Cracker Barrel objected, arguing that the EEOC brought the lawsuit on behalf of the employees and “the proceeding must merely be commenced by a complaint or charge brought by an employee.”
The court, however, sided with Cincinnati, noting that “the complaint that commenced the
EEOC lawsuit was not brought by an employee, and, therefore, even under [Cracker Barrel’s] interpretation … the lawsuit is not a ‘claim’ under the Policies.” Cracker Barrel asserted that such a finding “flies in the face of common sense” since it purchased EPL insurance to protect itself from exactly the type of liability that results from EEOC actions, which it contends is the
“very purpose” of such coverage. In spite of this, the court stated it was “confined to the plain language of the contract bargained for by two entities with presumably equal bargaining power,” and found that the EEOC lawsuit did not give rise to Cincinnati’s duty to defend against it or indemnify Cracker Barrel for the resulting settlement. Cracker Barrel Old Country
Store, Inc. v. Cincinnati Ins. Co., 2011 U.S. Dist. LEXIS 89784 (M.D. Tenn. 2011).
72 Aon Financial Services Group Legal & Claims Practice

Failure to Exhaust Primary D&O Policy Bars Coverage Under Excess Policy
The Goodyear Tire & Rubber Company (Goodyear) sought coverage under its directors’ and officers’ liability policies for reimbursement of legal costs, amounting to approximately $30 million, incurred in defending numerous securities class action and derivative lawsuits, along with a SEC investigation. The primary insurer settled during the coverage litigation for 66 percent of its limits. The first excess insurer, Federal Insurance (Federal), denied coverage arguing: 1) The excess does not attach because the primary policy was not fully exhausted;
2) The disputed fees did not “result solely” from a “claim” against an insured; 3) The “related claims” provision does not create coverage for Goodyear’s internal investigation or the SEC investigation; 4) Goodyear did not seek or obtain consent to incur the disputed fees; and
5) The disputed fees incurred for Goodyear’s overseas internal investigation were not reasonable and necessary to the defense of the litigation or SEC investigation. The court began its analysis of these complicated issues by observing that the excess policy coverage attached
“only after the insurers of the underlying insurance shall have paid in legal currency the full amount of the underlying limit for such policy period.” Goodyear argued that the exhaustion provision is unenforceable, because the interest in enforcing it is outweighed by the strong
Ohio public policy favoring settlements. Goodyear further argued that settlement for an amount less than the full limits of the underlying limits is a failure of a condition precedent, which can result in the forfeiture of coverage only where the excess insurer is prejudiced.
Goodyear contended that Federal was not prejudiced by the settlement with the primary for less than the full limit. In its analysis, the court disagreed and concluded that Federal was indeed prejudiced because it had been required to litigate the coverage denial. The court did not address the other pressing coverage issues due to its decision that failure to exhaust the primary barred coverage. In a final comment on the fairness of applying the language of the policy, the court noted, “Goodyear and Federal are commercial enterprises of such size and quality as to presumably possess a high degree of sophistication in matters of contract.
Each has the ability to retain highly competent counsel, skilled in negotiating and/or drafting insurance contract terms and advising on the impact of inserting or deleting coverage provisions. Additionally, in this free market society, Goodyear could have ‘shopped around’ to other excess insurance providers for a different, broader exhaustion clause.” The Goodyear Tire
& Rubber Co. v. Fed. Ins. Co., 2011 U.S. Dist. LEXIS 121866 (N.D. Ohio 2011).
… the court disagreed and concluded that
Federal was indeed prejudiced because it had been required to litigate the coverage denial.
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… the policy defines
“Wrongful Act” to include both actual negligent acts and alleged negligent acts, and, therefore,
Mutual had knowledge of the alleged negligent acts prior to the HCC policy’s inception.
Defense Costs Responding to SEC Investigation Not Covered Under D&O Policy
As previously reported in the October 2010 Month in Review, the Southern District of Florida ruled that the defense expenses incurred by Office Depot, Inc. (Office Depot) in responding to a SEC investigation were not covered under its D&O policy. In this opinion, the 11 th U.S.
Circuit Court of Appeals upheld the district court’s ruling. The court first reasoned that the
SEC’s request for voluntary cooperation was an “investigation” rather than an “administrative or regulatory proceeding,” and therefore, the requests were not “Securities Claims” as defined by the policy. Office Depot next argued that the SEC letters qualified as a “Claim” under the policy’s indemnification insuring agreement. The court rejected this argument, reasoning that the letters only requested information and did not allege any violations or identify specific individuals who could be charged in future proceedings. Further, because “Defense Costs” were limited to reasonable and necessary fees and costs resulting solely from a “Claim,” the court found that the investigation costs for potential claims were not covered under the policy.
Finally, Office Depot argued that the costs incurred between the notice of circumstances and when the “Claim” was made were covered pursuant to the policy’s notice/reporting provisions, which allowed the “Claim” to “relate back” to the date Office Depot filed the original notice of circumstances. The court disagreed, claiming that the notice/reporting provisions determine the policy period that “Claims” are “considered made,” rather than expand coverage to the costs incurred prior to the “Claim.” Office Depot, Inc. v. Nat’l Union Fire Ins. Co. of Pittsburgh, Pa.,
2011 U.S. App. LEXIS 20759 (11 th Cir. 2011).
No Coverage for Claim Made Prior to Policy Period
This opinion addressed what constitutes a “Claim” and “Wrongful Act” under an E&O policy issued by Houston Casualty Company (HCC) to Mutual Real Estate Holdings, LLC (Mutual).
Before the HCC policy period began, a Mutual agent received a letter that alleged he made certain misrepresentations and requested liability insurance information. Mutual failed to disclose the letter on the HCC insurance application. Subsequently, a complaint was filed against Mutual during the HCC policy period, and HCC denied coverage. The court held there was no coverage for Mutual because the “Claim” was first made, and Mutual had knowledge of the “Wrongful Act,” prior to the inception of the HCC policy. Specifically, “Claim” was defined under the policy as a “written demand … for compensation of monetary damages.”
Mutual argued that a “Claim” was limited to a lawsuit, arbitration, or something similar, and as a result, the “Claim” was first made against Mutual when the lawsuit was filed during the
HCC policy period. The court rejected this argument, reasoning that the demand letter was a
“Claim” because it identified: 1) alleged wrongdoing; 2) monetary damages; and 3) insurance as a source of compensation for those damages. The court also rejected Mutual’s argument that a “Claim” was limited to only “legitimate” or “valid” claims. As an additional reason to bar coverage, the court found that Mutual had knowledge of its “Wrongful Act” prior to the
HCC policy period. Mutual responded that because it believed the demand letter did not have merit, Mutual had no knowledge of a “Wrongful Act” until the lawsuit was filed. The court rejected this argument, reasoning that the policy defines “Wrongful Act” to include both actual negligent acts and alleged negligent acts, and, therefore, Mutual had knowledge of the alleged negligent acts prior to the HCC policy’s inception.
Mut. Real Estate Holdings, LLC v.
Houston Cas. Co., 2011 U.S. Dist. LEXIS 100072 (D.N.H. 2011).
74 Aon Financial Services Group Legal & Claims Practice

Acquisition of Subsidiary Owned by the Acquiror’s Controlling Shareholder
Does Not Satisfy the Entire Fairness Review
The Delaware Chancery Court recently awarded $1.26 billion in damages in a derivative lawsuit challenging a transaction in which the controlling shareholder proposed the purchase of a 99% stake in a different company. The board of directors formed a special committee to evaluate the proposal, and had no express powers to negotiate or explore other strategic alternatives. The committee retained financial and legal advisors, conducted its evaluation, and finally recommended an arrangement in which the company would purchase a stake with a market value of $3.12 billion. The agreement was conditioned on approval of twothirds of the outstanding shares, as opposed to the approval of the holders of the majority of the minority interest. A derivative suit claimed that the company substantially overpaid and that the transaction was entirely unfair to the company and its minority shareholders.
The court determined the “entire fairness” doctrine was the appropriate standard of review for the transaction under Delaware law, stating, “[w]here, as here, a controlling stockholder stands on both sides of a transaction, the interested defendants are ‘required to demonstrate their utmost good faith and the most scrupulous inherent fairness of the bargain.’ In other words, the defendants with a conflicting self-interest must demonstrate that the deal was entirely fair to the other stockholders.” Normally, the burden of persuasion under the entire fairness doctrine lies with the defendants, although that burden can shift by showing that the transaction was approved by an effective special committee of independent directors or by an
“informed vote of the majority of the minority shareholders.” The court did not find the special committee to be “well functioning” or effective in this case. However, it also concluded that it made no difference to the analysis, as the transaction was not entirely fair regardless of the party that bore the burden of persuasion. The court found that during the special committee’s evaluation, it became apparent that the value was substantially less than the consideration to be paid by the issuance of stock. Calling the special committee’s work a “non-adroit act of commercial charity,” the court determined that both the price paid and the process was unfair.
The special committee acted with a “controlled mindset” in only evaluating the proposed transaction and focused on finding a way to get the terms to “make sense” with no mandate to explore other options. In other words, the special committee lacked the “leverage to extract benefits for the minority” and had no real bargaining power. Additionally, the court noted one of the members of the special committee had a conflict of interest, and although that director ultimately recused himself from the vote, he did act throughout the evaluation process and his position was not identified as a conflict until the date of the approval vote. Because the court concluded the transaction was not entirely fair, it crafted a remedy by awarding damages in an amount that approximated the difference between the price the special committee would have approved had the transaction been entirely fair and the price actually agreed, $1.263 billion, plus statutory simple interest. In Re S. Peru Copper Corp. Shareholder Derivative Litig., 2011
Del. Ch. LEXIS 160 (Del. Ch. 2011).
The court determined the “entire fairness” doctrine was the appropriate standard of review for the transaction under
Delaware law …
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The court … concluded that, from an objective perspective, the facts, circumstances or situations … could reasonably give rise to a claim.
Prior Knowledge Exclusion Triggered by Reasonable Person Standard
St. Paul Mercury Insurance Company (St. Paul) issued an EPL policy to First Bancshares, Inc.
(First Bancshares) and one of its subsidiaries, First Home Savings Bank (First Home) for the
July 1, 2007 to July 10, 2010 period. The policy provided coverage for claims involving an “Employment Practices Act,” which included claims of wrongful discharge by a former employee. The policy contained a prior knowledge exclusion that precluded coverage for “any claim arising from any such fact, circumstance or situation to the extent the claim is against an Insured who knew of such fact, circumstance or situation prior to the issuance of the proposed policy.” On April 12, 2007, First Home terminated Vicky Dooms. On April
29, 2007, she filed an application for unemployment benefits with the Missouri Division of Employment Security (Division). Dooms’ claim was rejected in response to her initial application and she filed an appeal on May 21, 2007, which was again rejected. On October
14, 2009, Dooms then filed a wrongful discharge lawsuit. First Bancshares tendered the suit and St. Paul denied coverage based on the prior knowledge exclusion. Coverage litigation ensued and St. Paul argued that the proceedings before the Division satisfied the prior knowledge exclusion, which consisted of two elements: 1) whether First Bancshares knew of facts, circumstances or situations which could reasonably give rise to a claim; and 2) whether Dooms’ suit arose from facts, circumstances or situations known to First
Bancshares. St. Paul contended that the proceedings before the Division constituted prior knowledge because in Dooms’ application for unemployment benefits, she claimed she was retaliated against for being a “whistleblower” when she accused two officers of engaging in unethical conduct. First Bancshares did not dispute that Dooms’ lawsuit arose from facts, circumstances or situations encompassing the proceedings before the Division, and did not dispute that they were aware of the proceedings. The issue focused on whether the Division proceedings encompassed facts, circumstances or situations that could have reasonably given rise to the claim. First Bancshares claimed the Division proceedings did not meet the requirements of the prior knowledge provision because: 1) the proceedings were resolved in their favor; and 2) Dooms never made a threat of a lawsuit after the proceedings concluded and before suit was filed. St. Paul countered that a “reasonable person” standard should control the determination of whether the proceedings before the Division satisfied the prior knowledge exclusion requirements. The court agreed and concluded that, from an objective perspective, the facts, circumstances or situations surrounding the Doom proceedings in the Division could reasonably give rise to a claim. Although the proceedings before the
Division ended in a determination in First Bancshares’ favor, the basis for the proceedings was Dooms’ termination. Throughout the proceedings, Dooms claimed she was terminated in retaliation, which was the same basis for her state court action. Moreover, even though there was no evidence suggesting that Dooms directly threatened First Bancshares with a lawsuit, the record demonstrated that the facts, circumstances or situations surrounding the Division proceedings would have led a reasonable person to anticipate a claim.
Accordingly, the court ruled in favor of St. Paul based on its prior knowledge exclusion. First
Bancshares, Inc. v. St. Paul Mercury Ins. Co., 2011 U.S. Dist. LEXIS 105405 (W.D. Mo. 2011).
76 Aon Financial Services Group Legal & Claims Practice

SEC Filings
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SEC Settlements
• The SEC filed fraud charges against StratoComm
Corporation, Roger D. Shearer, CEO, and Craig
Danzig, former director of investor relations. The SEC is seeking disgorgement, prejudgment interest, penalties, and an order barring Shearer from serving as an officer or director of a public company.
• The SEC filed fraud charges against Christopher Sells, former VP of Commercial Operations, and Timothy
Murawski, former VP of Sales of Hansen Medical,
Inc.
The SEC is seeking penalties against both Sells and Murawski, and an order barring Sells from serving as an officer or director of a public company.
• The SEC filed fraud charges against Thomas Wu, former CEO, Ebrahim Shabudin, former COO, and
Thomas Yu, a senior officer, of United Commercial
Bank.
The SEC is seeking penalties and an order barring Wu, Shabudin and Yu from acting as officers or directors of a public company.
• The SEC filed fraud charges against InfrAegis, Inc.
(InfrAegis) and its chairman, CEO, and president,
Gregory Webb. The SEC is seeking disgorgement and prejudgment interest against InfrAegis and
Webb, and a penalty against Webb.
• The SEC settled fraud charges involving fraudulent stock options backdating against Gregory L. Reyes, former CEO of Brocade Communications Systems,
Inc. Reyes was ordered to pay disgorgement of
$150,000, prejudgment interest of $145,220, and a penalty of $550,000. Additionally, Reyes was barred from serving as an officer or director of a public company for 10 years.
• The SEC settled fraud charges against Craig On, former CFO of United Commercial Bank.
On was ordered to pay a penalty of $150,000.
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* Source: http://www.sec.gov/litigation.shtml
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General News
SEC Issues First Annual Report on the Dodd-Frank Whistleblower Program
As reported in the May 2011 Month in Review, the Securities and Exchange Commission (SEC) adopted new rules that allow corporate whistleblowers to collect between 10 and 30 percent of imposed penalties when they report violations of securities laws, even if they bypass their employers and report the wrongdoing directly to the SEC. Although the rules just went into effect in August of 2011, the SEC already issued its first annual report describing the whistleblower award program. The SEC reports that it received 334 whistleblower tips from
37 different states and 11 foreign countries, primarily China and the United Kingdom. Market manipulation, corporate disclosures, financial statements, and offering fraud were among the most common complaint categories. Unsurprisingly, given the infancy of the program, no whistleblower awards were paid through September 30, 2011. Upon its enactment, there was an initial concern about the possible inadequacy of funds to reward whistleblowers; however, the SEC’s report indicates that the whistleblower awards’ fund is fully funded with over $452 million. With such a bountiful fund, whistleblower submissions are expected to rise. Presumably, when the SEC produces its annual report at the end of 2012, there will be significantly more information, and a considerable number of whistleblower awards will likely have been paid. Consequently, the SEC’s analysis in its 2012 report should be much more informative and provide greater insight into the effectiveness and efficiency of the program.
ISS Policy Updates for 2012
On November 17, 2011, Institutional Shareholder Services (ISS), the prominent proxy advisory firm, released 2012 updates to its U.S. proxy voting guidelines, including revisions to its payfor-performance policy and methodology. ISS has also adopted a new approach to analyzing executive compensation that it claims will provide a more “robust view” of the relationship between executive pay and company performance over a “sustained time horizon.” This approach will utilize two analytical tools: 1) “Peer group alignment,” which is the degree of alignment between the company’s Total Shareholder Return (TSR) and CEO pay over a one-year and three-year period, as compared to a group of peer companies. It also will consider the multiple of the CEO’s total pay compared to the median among peer group companies; and 2) “Absolute Alignment,” which is a comparison of the trend in CEO pay and the trend in TSR over the prior five fiscal years for the company in question. ISS indicates that it will consider additional factors if it determines that a particular company has problematic levels of alignment. Concerning how the board responds to say-on-pay votes, ISS will make recommendations on a case-by-case basis concerning individual compensation committee members up for re-election, and management say-on-pay proposals if the company’s previous say-on-pay proposal received less than 70 percent support of all votes cast. ISS’ case-by-case determinations will take into account, among other factors, the actual level of support (with less than 50 percent calling for “the highest degree of responsiveness”), the company’s response in terms of changes to compensation packages, disclosure of engagement efforts with major institutional investors on the issues that contributed to low levels of support, and other recent compensation actions taken by the company. Regarding the board’s response to frequency of advisory vote on pay results, under the new policy, if a majority of votes are cast expressing a preference for a certain frequency of advisory vote on pay, but the board does not implement that preference, then ISS would recommend voting against or withholding from voting for the entire board. If a majority of shareholders does not back any single frequency option, and the board adopts the option that receives plurality support, then ISS will determine its recommendation on a case-by-case basis. As for proxy access proposals, ISS will approach proxy access shareholder proposals on a case-
With such a bountiful fund, whistleblower submissions are expected to rise.
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… the regulation will require an employer to demonstrate a
“legitimate business purpose” for a disputed employment practice and prove that it “reasonably achieves that purpose.” by-case basis, whether sponsored by the company or by a shareholder. In determining a voting recommendation, ISS states that it will consider a number of factors, including proposed ownership thresholds that would apply to shareholders who wish to submit board nominees under the proposed proxy access framework, the maximum proportion of directors that shareholders may nominate each year, and the method for handling nominations from multiple shareholder groups. Finally, on the topic of political spending proposals, ISS will generally recommend a vote for political spending proposals, having previously made recommendations on a case-by-case basis. The change in policy is based primarily on ISS’ perception that institutional investors have become more interested in the issue. ISS’ 2012 policies may be viewed in full at http://www.issgovernance.com/policy.
EEOC Approves New Age Discrimination Regulation
A divided Equal Employment Opportunity Commission (EEOC) approved a draft final regulation to limit employer defenses in age discrimination cases. The regulation will eliminate “business necessity” from the “reasonable factors other than age” defense available to employers under the Age Discrimination in Employment Act (ADEA), making it easier for older workers to pursue disparate impact lawsuits. If approved by the White House
Office of Management and Budget, the regulation will require an employer to demonstrate a “legitimate business purpose” for a disputed employment practice and prove that it
“reasonably achieves that purpose.” Applying a tort law standard, the EEOC will now review an employer’s entire decision-making process, not just one factor, to ensure consistency with the Supreme Court’s opinions in Smith v. City of Jackson and Meacham v. Knolls Atomic Power
Laboratory, in which the Supreme Court ruled the business necessity defense under Title VII of the 1964 Civil Rights Act should have no place in ADEA disparate impact cases. Accordingly, the firm of Paul, Hastings, Janofsky & Weaver suggests employers consider the following before implementing a business practice with a possible adverse effect on older employees or applicants: “1) Are the practice at issue and its method of implementation common in other similar businesses; 2) Is the practice closely related to the employer’s stated business goal;
3) What steps has the employer taken to control application of the allegedly discriminatory criterion; 4) Has the employer assessed the potential for an adverse impact on older employees and applicants (first in a privileged study, and later in an analysis that can be used in possible defense of the action); 5) How many older workers would be impacted by the practice, and how severely would they be impacted; 6) What steps have been taken to mitigate the severity of the harm to impacted workers; 7) Have managers and supervisors been trained on the implementation of the practice; and 8) If other alternatives to the practice are available, what rationale does the employer have for selecting the practice in question?” Employers should continue to carefully review and monitor compensation and selection practices, and if these proposed rules are approved, be prepared to vigorously defend their business practices.
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Cases of Interest
Mere Allegations Do Not Trigger Exclusion
This coverage action involved whether allegations of bad faith triggered the illegal profit/ payment exclusion in a D&O policy issued by Progressive Casualty Insurance Company
(Progressive) to Umpqua Bank (Umpqua). The exclusion barred coverage for “Loss … arising out of or in any way involving … conflicts of interest, engaging in self dealing, or acting in bad faith.” The court held that in order for the exclusion to apply, Progressive must actually prove that Umpqua was “acting in bad faith.” First, the word “alleged” was not included within the text of the illegal profit/payment exclusion. Further, Progressive expressly stated that its other policy exclusions were triggered by allegations. Finally, at a minimum, the relevant exclusionary language was ambiguous, and therefore, must be construed against Progressive.
Here, since the underlying case settled without an allocation of fault, Umpqua was entitled to coverage. Umpqua Bank v. Progressive Cas. Ins. Co., 2011 U.S. Dist. LEXIS 132127 (D. Or. 2011).
The Identity of a Confidential Informant Must be Disclosed in a Securities Class Action
In this securities class action, the Plumbers and Pipefitters Local Union No. 630 Pension-
Annuity Trust Fund (lead plaintiff) identified 11 former Arbitron, Inc. employees in the complaint as “Confidential Informants.” Arbitron asked the court to make the lead plaintiff reveal the confidential informants’ identities and produce documents given to its counsel.
The lead plaintiff took issue with Arbitron’s request for disclosure of the informants’ identities on several grounds. First, the lead plaintiff contended disclosure was unnecessary because it provided Arbitron with an 83-person list of current or former officers or employees likely to have discoverable information. Second, lead plaintiff claimed any disclosure would breach the attorney work product doctrine and reveal counsel’s mental impressions. Lastly, the lead plaintiff asserted the informants were concerned they would suffer retaliation in their current or future employment if their identities were disclosed. The court initially noted that the complaint’s securities fraud allegations “are supported by the first-hand knowledge’” of the informants. As a result, the court concluded Rule 26 “clearly requires that the names of the 11 informants be produced (unless they are held to be privileged).” The court quickly decided that the informants were not entitled to work product protection because their identities were “not a reliable indicator of counsel’s actual thought process,” given there were many other reasons that counsel may have chosen to describe or not describe certain witnesses in the complaint. The court illustrated that it would create a significant burden to require Arbitron to “engage in a costly process of elimination in which it would take numerous depositions simply to smoke out which of the 83 disclosed names are the 11 [confidential informants].” Simply put, the court believed the informants’ names “will almost certainly eventually become known during this litigation,” because each current or former employee will have to state if he or she made statements to plaintiff’s counsel in the manner attributed to a particular informant. Therefore, the court stated, “Denying the instant motion would thus not permanently keep the 11 [informants’] identities under wraps. Instead, it would merely elongate the deposition discovery process, imposing costs and burdens on all parties.” Finally, the court determined there was “no reliable, non-conclusory basis to find that any of the [confidential informants] … faces a risk of retaliation sufficient to justify nondisclosure of his or her name to the defense.” Accordingly, the court held that Arbitron is entitled to discover the identities of confidential informants; however, the court permitted the lead plaintiff a short period of time to offer further support that the disclosure of a particular informant’s name would result in retaliation. Plumbers and Pipefitters Local Union No.
630 Pension-Annuity Trust Fund v. Arbitron, Inc., 2011 U.S. Dist. LEXIS 131091 (S.D.N.Y. 2011).
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“Denying the instant motion would … merely elongate the deposition discovery process, imposing costs and burdens on all parties.”
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… the term ”litigation” commonly refers to a lawsuit or other legal action, which does not commence “until a legal action is initiated by the filing of a complaint or a similar document in a court of law.”
Court Finds for Board Pursuant to Business Judgment Rule
Without making a demand upon the board, certain shareholders of Goldman Sachs (Goldman) filed a lawsuit alleging that the board of directors breached their fiduciary duties by:
1) approving Goldman’s compensation structure, and 2) by failing to adequately monitor
Goldman’s operations. The court found that the facts alleged by the plaintiffs, if true, “support only a conclusion that the directors made poor business decisions,” and therefore, the plaintiffs were not excused from making a demand upon the company. First, the plaintiffs failed to establish that a majority of the directors were interested or lacked independence since there was no evidence of how the directors were influenced in their decision-making processes. Additionally, the court found that Goldman’s compensation scheme was not approved in bad faith or on an uninformed basis, but instead was “the product of a valid exercise of business judgment.” The court reasoned that compensation is a core function of a board, and the business judgment rule only requires the board to reasonably inform itself.
Regarding the plaintiffs’ claim that the board failed to properly monitor the company, the court found that the “unethical” conduct alleged by the plaintiffs involved risky, but legal, business decisions that were within the board’s discretion. Because reputational risk exists in any business decision, these decisions could not be considered “red flags” that put the board on notice of unlawful conduct. “Good faith, not a good result, is what is required of the board.” In re Goldman Sachs Group, Inc. S’holder Litig., 2011 Del. Ch. LEXIS 151 (Del. Ch. 2011).
Attorney Letters Advising of Client’s Employment Issues Not Considered a Claim
SNL Financial (SNL), procured two successive employment practices polices from Philadelphia
Indemnity Ins. Co. (Philadelphia). During the first policy period, in January 2008, SNL received a letter from an attorney retained by a former employee indicating that he was consulted about certain discriminatory conduct in connection with the employee’s termination. The attorney asked to discuss the issues, but did not make a demand or threaten litigation. Several months later, after attorneys for both parties engaged in discussions concerning the matter, SNL’s counsel learned that the employee’s attorney had prepared a draft complaint. The claimant’s counsel did not share the complaint and did not file or serve it. Near the end of the first policy period, a “friend” of SNL’s counsel (also an attorney) was permitted to view an unsigned version, but not make notes or copy it. When the policy renewed, SNL stated in its application that it had not been involved in any litigation in the prior twelve months. Shortly thereafter, during the second policy period, the employee filed a lawsuit against SNL, which was promptly given to Philadelphia. The policy’s definition of “Claim” included a “written demand for monetary or non-monetary relief.” Philadelphia disclaimed coverage, asserting that the attorney letters constituted a claim which was not made during first policy period and was late under the second policy period. Alternatively, Philadelphia asserted that the draft complaint was a claim, and notice was late on the same basis. After SNL filed this coverage action, Philadelphia sought to rescind the policy based on SNL’s statement in the application that it had not been involved in litigation in the prior 12 months. The court disagreed with
Philadelphia’s arguments, finding that the attorney letters did not include any demand. Rather, the letters stated a desire for a discussion in hopes of arriving at an amicable resolution. Further, the court stated that the draft complaint was expressly not provided to SNL, which “disavowed any suggestion that the unsigned draft complaint was intended as a ‘written demand for monetary or non-monetary relief.’” Thus, the claim was not made within the first policy period and notice was timely under the second policy period. The court easily dispensed with
Philadelphia’s rescission argument because the term ”litigation” commonly refers to a lawsuit or other legal action, which does not commence “until a legal action is initiated by the filing of a complaint or a similar document in a court of law.” Thus, there was no litigation prior to policy inception and no misrepresentation in SNL’s application. SNL Fin., LC v. Philadelphia Indem.
Ins. Co., 2011 U.S. App. LEXIS 23529 (4 th Cir. 2011).
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Second Circuit Adopts “Moench” Presumption in Tandem ERISA Putative Class Actions
Recently, the U.S. Court of Appeals for the Second Circuit joined several other federal circuits in adopting the “Moench” presumption of prudence (named after a Third Circuit decision) when it dismissed two ERISA putative class actions alleging that fiduciaries breached their duties to plan participants by imprudently continuing to offer company stock as an investment option. In the first matter, the sponsor offered two retirement plans that required shares of common stock be included as an investment option in the plan. In the second matter, the sponsor also offered two retirement plans that invested primarily in qualifying employer stock. During the class periods, the plan participants alleged that share prices fell due to inflated ratings for financial products linked to the subprime mortgage market. In both cases, plan participants emphasized two primary arguments. First, they alleged breach of duty of prudence and loyalty because the plan fiduciaries refused to divest the plans of company stock. Second, they alleged that plan fiduciaries breached their duties by failing to make accurate information available to plan participants. On the first claim, the Second Circuit concluded that the plan fiduciaries were entitled to the Moench presumption of prudence.
The Second Circuit highlighted that the Moench presumption “provides the best accommodation between the competing ERISA values of protecting retirement assets and encouraging investment in employer stock.” The Second Circuit found that plan fiduciaries should override plan terms requiring or strongly favoring investment in employer stock only when “owing to circumstances not known to the [plan] settlor and not anticipated by him,” maintaining the investment in company stock “would defeat or substantially impair the accomplishment of the purposes of the [plan].” The Second Circuit focused on the longterm horizon of retirement savings and highlighted that it goes against the grain if fiduciaries were to divest from employer stock at the sign of any impending price decline. Instead, “only circumstances placing the employer in a ‘dire situation’ that was objectively unforeseeable by the settlor could require fiduciaries to override plan terms.” Importantly, the Second Circuit noted that even though proof of the employer’s impending collapse may not be required to establish liability, “mere stock fluctuations, even those that trend downhill significantly, are insufficient to establish the requisite imprudence to rebut the Moench presumption.”
The Second Circuit stressed that a fiduciary’s actions should not be judged in hindsight; instead it should have a temporal reference to the timing of each investment decision. On the second claim, the Second Circuit held that the plan fiduciaries did not have a duty to provide participants with nonpublic information concerning the company stock’s expected performance and that the plan participants did not adequately allege that the fiduciaries in their official capacities made any knowing misstatements about the company stock. In re
Citigroup ERISA Litig., 2011 U.S. App. LEXIS 21464 (2d Cir. 2011) and Gearren v. The McGraw Hill
Cos., Inc., 2011 U.S. App. LEXIS 21115 (2d Cir. 2011).
Defense Fees Reduced Pursuant To Policy Provisions
Lance-Kashian & Company (Lance-Kashian) sought coverage from its carrier, Endurance, for the entire amount of defense fees and costs incurred in defending a suit filed against it and
RPP III. RPP III was not an insured under the Endurance policy. Endurance issued a duty to defend policy and sought to reduce the defense fees and costs based on lack of consent, reasonableness of rates, and allocation. Endurance argued that it agreed to not assert its policy right to select counsel in exchange for allocating defense costs and paying reduced rates.
The court agreed with Endurance. Because Endurance’s coverage letter consented to only two of the three defense firms, Endurance was not required to pay the fees of the third firm.
The court also found that the rates proposed by Endurance were reasonable. Pursuant to the policy, Endurance’s determination “as to reasonableness” of defense costs “shall be conclusive” on the insureds. The court reasoned that Lance-Kashian failed to show that Endurance was legally precluded to set the rates it would pay or that the rates were objectively unreasonable,
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especially considering that one defense firm accepted the proposed rates. On allocation,
Lance-Kashian argued that Endurance must pay all defense costs “reasonably related” to its defense and could not allocate costs between it and RPP III, except for defense costs solely attributable to the defense of RPP III. The court rejected Lance-Kashian’s argument because the “reasonably related” rule did not apply when there is an allocation provision in the policy. Instead, Endurance’s allocation provision required an allocation between insured and uninsured loss, and the parties were to use their best efforts to reach an allocation agreement.
The court concluded that Endurance used its best efforts, and that Lance-Kashian had not, instead focusing on settling the case. Therefore, the court upheld Endurance’s one-third allocation to covered defense fees and costs. Endurance Am. Specialty Co. v. Lance-Kashian & Co.,
2011 U.S. Dist. LEXIS 129330 (E.D. Cal. 2011).
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SEC Filings
• The SEC filed fraud charges against Solaris
Management, LLC (Solaris Management), investment adviser to the Solaris Opportunity
Fund, LP (Solaris Fund), and its owner Patrick G.
Rooney for the fraudulent misuse of Solaris Fund’s assets. The SEC is seeking disgorgement, prejudgment interest, and civil penalties against
Solaris Management and Rooney, in addition to a permanent officer and director bar against Rooney.
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SEC Settlements
• Final judgments were entered against Frank C. Calmes and Lynn D. Rowntree, former principals at First
Equity Corporation (First Equity), and Manny J.
Shulman, CEO of Younger America.
Calmes was ordered to pay disgorgement of $1,886,918, prejudgment interest of $468,441, and a penalty of
$5,000. Rowntree was ordered to pay disgorgement of $693,948, prejudgment interest of $157,411, and a penalty of $5,000. Shulman was ordered to pay disgorgement of $273,152, prejudgment interest of
$95,633, and a penalty of $5,000. Additionally,
Calmes and Shulman were permanently barred from acting as officers or directors of a public company.
• The SEC settled fraud charges against three former outside directors who comprised the Audit and
Compensation Committee of DHB Industries, Inc. n/k/a Point Blank Solutions, Inc.
Cary Chasin was ordered to pay disgorgement of $100,000, prejudgment interest of $5,723 and a penalty of
$100,000. Jerome Krantz was ordered to pay disgorgement of $375,000, prejudgment interest of
$21,464, and a penalty of $100,000. Gary Nadelman was ordered to pay disgorgement of $820,000, prejudgment interest of $46,935, and a penalty of $100,000. Additionally, Chasin, Krantz and
Nadelman were permanently barred from acting as officers or directors of a public company.
• The SEC settled fraud charges against Atlantis
Technology Group and its CEO, Christopher M.
Dubeau. Dubeau was ordered to pay disgorgement of $312,000, prejudgment interest of $12,947, and a penalty of $100,000. Additionally, Dubeau was permanently barred from serving as an officer or director of a public company.
• The SEC settled fraud charges against William F.
Burbank, IV, former CEO and president of China
Voice Holding Corp.
Burbank was ordered to pay disgorgement of $60,333, prejudgment interest and a penalty of $60,000, and was barred from acting as an officer or director of a public company for 10 years.
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* Source: http://www.sec.gov/litigation.shtml
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General News
Annual Director Compensation and Board Practices Report Released
The 2011 U.S. Director Compensation and Board Practices Report, a benchmarking tool containing over 120 corporate governance data points, analyzes board structure and director compensation information for a sample of 334 public companies registered with the Securities and Exchange Commission (SEC). The report, which was jointly released by The Conference
Board, NASDAQ OMX, and NYSE Euronext, summarizes participants’ responses concerning corporate practices existing at the time of the survey collection or based on disclosure provided to shareholders in proxy statements and other 2010 SEC filings. Available data points include board/committee composition and leadership, director election practices, anti-takeover practices, director compensation practices, risk oversight practices, CEO succession and succession planning practices, board-shareholder engagement practices, policies on director performance assessment, and policies on director retirement. Notably, the report highlights the percentage of companies with a non-CEO chair, which “varies from a low 43 percent in financial services industries to 50 percent in nonfinancial industries,”
while nearly all lead directors “meet widely appointed independence standards such as those set by national securities exchanges.” Additionally, the report draws attention to pressure exerted by shareholder and proxy advisor groups to drive the “recent trend toward the repeal of existing poison pills designed with the sole intent of entrenching management,” and consequently, “more than 80 percent of surveyed companies across industries and virtually all financial companies in the largest size group reported not having a poison pill in place.”
Concerning say-on-pay frequency, the report illustrates that “82 percent of manufacturing companies, 81 percent of those in nonfinancial services, and 76 percent of those in financial services are currently holding annual say-on-pay voting … while [t]en percent of companies in the financial services industry and 47 percent of manufacturing and nonfinancial services companies in the smallest size group ($100 million or less in annual revenue) avail themselves of the temporary exemption from the advisory vote granted by the SEC rules to smaller issuers.” Finally, the report claims that “[v]irtually no companies across industries and size groups assign CEO succession planning oversight responsibilities to a dedicated standalone committee of the board.” Rather, “these functions are performed either by the full board … or through delegation to the compensation committee or the nominating/corporate governance committee.” We have highlighted only a few major findings from the study; however, the full report is available at http://www.conference-board.org/publications/publicationdetail.
cfm?publicationid=2040.
Federal Courts Challenge SEC Proposed Settlements
In SEC v. Citigroup Global Mkts., Inc., the United States District Court for the Southern District of New York recently rejected a consent judgment between the SEC and Citigroup Global
Markets, Inc. (Citigroup) on the basis that the judgment failed to provide evidence that the relief against Citigroup was fair, reasonable, and in the public interest. Citigroup consented to the entry of judgment without “admitting or denying the allegations of the complaint.” The terms of the agreement required Citigroup to disgorge $160 million in profits, plus $30 million in interest, and pay a civil penalty in the amount of $95 million. The court based its decision on the fact that it had not been provided with any proven or admitted facts upon which to determine whether the consent judgment was in the public interest. Subsequently, in a letter from a judge for the United States District Court for the Eastern District of Wisconsin to the
SEC in a separate matter, SEC v. Koss Corp., et al., the Citigroup decision was cited and a request was made for the SEC to provide facts establishing the proposed settlement was fair and reasonable. As a result, the SEC appears to have changed its policy, and will now require an
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… the authors endeavored to determine if they could correlate market reaction to the appointment of female directors.
admission of guilt for civil charges when there has already been an admission or conviction of criminal violations. For cases where there is no parallel criminal case, such as in SEC v. Citigroup, we will continue to monitor whether other federal courts adopt the additional requirements discussed herein for such SEC settlements. For instance, will a court which follows the Citigroup reasoning require an admission from the defendant, or will it be satisfied with something less provided by the SEC and defendant? The SEC and Citigroup have both appealed the court’s rejection of the consent judgment.
Study Finds Positive Market Reaction Following Appointment of Female Directors
A recent paper authored by Renee Adams, Professor of Finance at the University of South
Wales; Stephen Gray, Professor of Finance at the University of Queensland; and John
Nowland with the Department of Accountancy at the City University of Hong Kong, focused on examining market perception following the appointment of female directors in public companies revealed positive and significant market reaction. The paper entitled Does
Gender Matter in the Boardroom? Evidence from the Market Reaction to Mandatory New Director
Announcements, followed a study conducted in Australia where director announcements are mandated immediately following appointment, and encouraging results were noted. With the growing trend of initiatives throughout the world to promote boardroom diversity, the authors endeavored to determine if they could correlate market reaction to the appointment of female directors. However, given the breadth of information provided to shareholders in annual reports and/or proxy statements in the U.S., along with timing thereof, too many variables existed in analyzing the U.S. market. In Australia, on the other hand, they noted an average bump in stock price of two percent following announcement of female directors.
Positive market reaction was most noticeable in firms with majority independent boards, small companies and large corporations with high market-to-book ratios.
Cases of Interest
FDIC Has No Standing to Intervene in Directors and Officers Coverage Litigation Action
Several years ago, the Office of Thrift Supervision seized IndyMac Bank, F.S.B. (IndyMac) and appointed the Federal Deposit Insurance Corporation (FDIC) as receiver to manage IndyMac’s assets. Thereafter, IndyMac Bancorp, the holding company for IndyMac, of which IndyMac was its only asset, filed for bankruptcy. Not surprisingly, the former IndyMac and IndyMac
Bancorp officers and directors have been sued in several different courts for various violations of corporate fiduciary duties and securities laws. Prior to its fall, IndyMac and IndyMac Bancorp obtained D&O insurance spread over two different policy periods, 2007-2008 (Tower 1) and
2008-2009 (Tower 2). Within each policy period, there were eight different $10 million layers.
The first four carriers in each tower provided Side A, B, and C coverage, while the second four carriers in each tower provided only Side A coverage for the directors and officers. The
Tower 2 policies contained a clause specifically exempting certain types of litigation from coverage. In this coverage litigation, the Tower 2 Side A insurers asked the court to declare that they were not responsible for providing coverage for the IndyMac directors and officers on certain underlying actions, including litigation brought by the FDIC, because they already sought coverage for the underlying actions under Tower 1. The IndyMac directors and officers responded by filing counterclaims against the Side A, B, and C insurers from Tower 2. The
FDIC sought to intervene in the coverage action to protect its purported interest in obtaining a declaration that the underlying matters, in which it was a claimant, were covered. Initially, the court analyzed if the FDIC was entitled to intervene as a matter of right and highlighted that a “proposed intervenor must have an actual interest protected by law and that interest must be related to the subject matter of the present suit.” The FDIC argued it had an interest
88 Aon Financial Services Group Legal & Claims Practice

in making sure that the insurance coverage issues were properly resolved so that it might be able to recover any eventual judgment out of the insurance proceeds. The court rejected these arguments and concluded the FDIC failed to identify any legally protected interest because the underlying actions were still ongoing. Moreover, “[t]he FDIC has not obtained a judgment against the [IndyMac directors and officers] and may never do so. It has no judgment that it seeks to be able to enforce, but rather the hope of an eventual judgment.” Consequently, the court determined that the underlying claims and the coverage action were not related for purposes of mandatory intervention. The court then examined if the FDIC could permissively intervene in the coverage litigation and noted that “the proposed intervenor must have an independent grounds for jurisdiction and present common questions or law or fact to the main action.” The court quickly found that the FDIC’s motion to intervene did not meet this test either. The court reiterated that because the FDIC had not obtained a judgment against the insured persons, there was no interest to protect. Simply put, the court concluded “the FDIC’s claims are not yet ripe for adjudication and that it would not have standing as a permissive intervenor.” XL Specialty Ins. Co. v. Perry (In re IndyMac Bancorp, Inc.), 2011 U.S. Dist. LEXIS 145585
(C.D. Cal. 2011).
Court Denies Coverage for Defense Expenses Where the Relief Sought
Was Not Covered by the Policy
An insured individual, Todd Duckson (Duckson), was employed at a law firm that purchased a claims-made lawyers’ professional liability insurance policy. The individual performed legal services on behalf of an investment fund (the Fund). The SEC filed suit against the Fund and
Duckson, among others, alleging that Duckson, acting as outside counsel to the Fund, made materially false and/or misleading statements about the Fund orally and in writing and in the course of his representation, Duckson assisted in the preparation of two private placement memoranda, both of which were materially misleading. In the coverage litigation that subsequently ensued, the insurers sought a declaratory judgment that there was no duty to defend or indemnify Duckson because the SEC action did not seek damages covered by the policy. Duckson sought a declaratory judgment that he was entitled to coverage for defense of the SEC action and that insurers owed him indemnity coverage for his “claim expenses” in addition to potential damages. The parties disputed the scope of coverage of the policy.
Three coverage obligations were at issue: 1) whether the insurers had a duty to defend
Duckson; 2) whether the insurers were obligated to pay his “claim expenses,” even if not required to defend him; and 3) whether the insurers were obligated to indemnify Duckson in the event of a judgment against him in the SEC litigation. The question concerning the insurers’ duty to defend focused on whether the relief sought by the SEC fell within the policy’s definition of “damages.” If it did not, there was no duty to defend. The SEC sought:
1) a declaratory judgment; 2) injunctive relief; 3) disgorgement of ill-gotten gains; 4) civil penalties; and 5) officer-director bars. The court concluded that none of the relief sought by the SEC constituted “damages” under the policy and, therefore, the duty to defend was not triggered. On the critical issue of coverage for “claim expenses,” the insured argued that the “coverage” paragraph obligated the insurers to pay all of his “claim expenses,” which would include his SEC action defense costs. Duckson argued that even where the underlying claim is outside the policy’s coverage, the insurers have a separate obligation to pay for the entire defense by reason of the “claim expenses” provision of the policy. The court, while recognizing that this policy was a combination of a duty to defend and a duty to pay claim expense policy, rejected this argument and concluded “that no ‘claim expenses’ are recoverable because the SEC action as currently filed is not covered by the Policy.” Finally, the court concluded that the issue of indemnification did not need to be resolved at this stage, but based upon the current allegations, as stated above, no indemnification coverage would exist. Continental Cas. Co., et al. v. Duckson, 2011 U.S. Dist. LEXIS 131566 (E.D. Ill. 2011).
The court concluded that none of the relief sought by the SEC constituted “damages” under the policy ...
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The court also concluded that the Trust could not use a theory of estoppel to expand coverage beyond the terms of the policy.
Disgorgement Payment Not Covered under Professional Liability Policy
JPMorgan Securities Inc. (JPMorgan), as successor to Bear Stearns, sought coverage under professional liability policies for a $160 million disgorgement payment and $90 million in civil penalties paid pursuant to a formal offer of settlement with the SEC. JPMorgan asserted that the disgorgement payment, despite its label, constituted compensatory damages and, therefore, was covered under the professional liability policies. The court found in favor of the insurance carriers. The court reasoned that under New York law, “disgorgement of illgotten gains or restitutionary damages does not constitute an insurable loss.” Here, the only reasonable interpretation of the SEC order was that Bear Stearns knowingly and intentionally facilitated illegal late trading, and the order required disgorgement of funds gained through that illegal activity. The court also rejected JPMorgan’s argument that because the SEC did not itemize the $190 million figure, the disgorgement payment was in fact compensatory. The SEC is not required in a disgorgement calculation “to trace every dollar of proceeds” or “identify misappropriated monies which have been comingled.” Finally, the fact that the $250 million sanction was placed in a fund to be distributed to harmed investors was of no consequence since most SEC cases involving an economic settlement include a provision providing distribution to wronged investors. JPMorgan Sec. Inc. v. Vigilant Ins. Co., 2011 N.Y. App. Div.
LEXIS 8829 (N.Y. App. Div. 2011).
$56 Million Stipulated Judgment Is Not “Loss” Because Former Officer Was
“Absolved from Payment” in a Limited Assignment of Rights Agreement
In this coverage litigation, Interstate Bakeries, Inc. (Interstate) filed for Chapter 11 bankruptcy protection. In its plan for reorganization, U.S. Bank National Association, as trustee for a creditors’ litigation trust (Trust), obtained an assignment of rights containing certain conditions, including an agreement that the Trust could only pursue Interstate’s D&O insurance carriers to satisfy any judgment against its former officers and directors. The Trust then sued Paul Yarrick, a former Interstate officer, who tendered the claim to the primary D&O carrier, Federal Insurance Company (Federal), and several excess insurers. Federal denied the claim for several reasons and advised the Trust that the assignment triggered a carve out to the definition of “Loss” for “any amount not indemnified by the Insured Organization for which the Insured Person is absolved from payment by reason of any covenant, agreement, or court order.” Ultimately, Yarrick and the Trust agreed to a $56 million stipulated judgment and
Yarrick assigned his rights to insurance coverage to the Trust, which in turn filed suit against the D&O insurance tower. The trial court determined there was no coverage and the Trust appealed. On appeal, the Trust “urg[ed] [the Eighth Circuit] to find that the policy language,
‘absolved from payment,’ [was] inapplicable.” The Trust argued that Yarrick was not “absolved” because “he will effectively suffer” other “adverse consequences,” such as a “stigma” from the judgment or “could enjoy less insurance coverage in any future action that may arise.”
The Eighth Circuit rejected the Trust’s argument and made clear that the policy language focused on being absolved from “payment,” and found that the Trust’s sole focus on the term
“absolved” was an “impermissible and unnatural parsing of the policy language.” The court also concluded that the Trust could not use a theory of estoppel to expand coverage beyond the terms of the policy. Accordingly, the Eight Circuit affirmed the trial court’s decision in favor of Federal because the stipulated $56 million judgment and covenant not to execute against any asset other than insurance was not “Loss” under the policy because Yarrick had been
“absolved from payment” for the judgment. U.S. Bank Nat’l Ass’n v. Fed. Ins. Co., 2011 U.S. App.
LEXIS 24623 (8 th Cir. 2011).
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SEC Filings
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SEC Settlements
• The SEC filed fraud charges against Nancy Shao Wen
Chu, CFO of Soyo Group, Inc.
The SEC is seeking disgorgement, prejudgment interest, penalties, and an officer and director bar.
• The SEC filed fraud charges against ZipGlobal
Holdings, Inc.
and Michael Lee, CEO and President;
MicroHoldings US, Inc.
and James Wheeler, CEO; and Paul Desjourdy, former President, CEO, CFO, and General Counsel of Symbollon
Pharmaceuticals, Inc.
The SEC is seeking disgorgement, prejudgment interest, penalties, and officer and director bars.
• The SEC filed market manipulation charges against
Giuseppe Pino Baldassarre, former CEO of Dolphin
Digital Media, Inc.
The SEC is seeking disgorgement, prejudgment interest, penalties, and an officer and director bar.
• The SEC filed fraud charges against Stiefel
Laboratories, Inc.
and Charles Stiefel, former chairman and CEO. The SEC is seeking disgorgement, prejudgment interest, penalties, and an officer and director bar.
• The SEC filed fraud charges against Belmont
Partners, LLC and its owner, Joseph Meuse, and
Alternative Green Technologies, Inc. (AGTI), and its CEO, Mitchell Segal. The SEC is seeking disgorgement against all defendants, a penalty against AGTI, and officer and director bars against
Meuse and Segal.
• The SEC filed fraud charges against Fannie Mae and three former executives, Daniel Mudd, former CEO;
Enrico Dallavecchia, former CRO; and Thomas Lund, former EVP of the Single Family mortgage credit book of business. The SEC is seeking disgorgement, pre-judgment interest, penalties, and officer and director bars.
• The SEC filed fraud charges against Freddie Mac and three former executives, Richard F. Syron, former chairman and CEO; Patricia Cook, former Chief
Business Officer and EVP of Investments and Capital; and Donald Bisenius, former SVP for Single Family
Guarantee. The SEC is seeking disgorgement, prejudgment interest, penalties, and officer and director bars.
• The SEC filed charges of bribery and violations of the
FCPA against three former executives of Magyar
Telekom; Elek Straub, former chair-man and CEO;
Andras Balogh, former Director of Central Strategic
Organization; and Tamas Morvai, former Director of
Business Development and Acquisitions. The SEC is seeking disgorgement and penalties.
• Final judgments were entered against Integrity
Financial AZ, LLC (IFAZ), Steven R. Long and Stanley
M. Paulic, founders of IFAZ. Long was ordered to pay disgorgement of $1,481,736, prejudgment interest of
$97,723, and a penalty of $1,465,306. Paulic was ordered to pay disgorgement of $586,225, prejudgment interest of $38,663, and a penalty of
$586,225. IFAZ was ordered to pay disgorgement of
$5,598,717, prejudgment interest of $429,403, and a penalty of $650,000.
• The SEC settled fraud charges against Wachovia
Bank N.A.
(Wachovia). Wachovia was ordered to pay disgorgement of $13,802,984, prejudgment interest of $7,276, and a penalty of $25,000,000.
• A final judgment was entered against Mark P. Kaiser, former EVP of Purchasing and Chief Marketing Officer of U.S. Foodservice, Inc.
Kaiser was ordered to pay disgorgement of $352,329, and was barred from acting as an officer or director of a public company.
• The SEC settled fraud charges against three former executives of Rudy Nutrition, Inc.
Daniel
“Rudy” Ruettiger, CEO, was ordered to pay disgorgement of $185,750, prejudgment interest of $11,366, and a penalty of $185,750. Rocco
“Rocky” Brandonisio, President, was ordered to pay a penalty of $50,000. Kevin S. Kaplan, CFO, was ordered to pay a penalty of $25,000, and was barred from acting as an officer or director of a public company for five years. Additionally,
Ruettiger and Brandonisio were barred from acting as officers or directors of a public company.
• A final judgment was entered against Alfred S. Teo, Sr. and a trust controlled by Teo, MAAA Trust (the
Trust).
Teo and the Trust were ordered to pay disgorgement of $17,422,054, pre-judgment interest of $14,649,035, and a penalty of $17,422,054.
Additionally, Teo was barred from serving as an officer or director of a public company.
• The SEC settled fraud charges against GE Funding
Capital Market Services (GE).
GE was ordered to pay disgorgement of $10,625,775, prejudgment interest of $3,775,987, and a penalty of $10,500,000.
• The SEC settled charges of bribery and violations of the FCPA against Magyar Telekom and its parent company, Deutsche Telekom AG.
Magyar Telekom was ordered to pay disgorgement and prejudgment interest of $31,200,000, and a criminal penalty of
$59,600,000. Deutsche Telekom AG was ordered to pay a penalty of $4,360,000.
* Source: http://securities.stanford.edu/
2011 Year in Review Legal News and Developments in Executive Liability 91
Jul
Aug
May
Jun
Mar
Apr
Jan
Feb
Sep
Oct
Nov
Dec

Jul
Aug
May
Jun
Mar
Apr
Jan
Feb
Nov
Dec
Sep
Oct
92 Aon Financial Services Group Legal & Claims Practice

Cases of Interest
Case Cited
Abercrombie & Fitch Co. v. Fed. Ins. Co.
America Service Group, Inc. v. Zurich Am. Ins. Co.
Brecek & Young Advisors, Inc. v. Lloyds of London Syndicate 2003
Month
April
May
October
Bruckmann, Rosser, Sherrill & Co., L.P., et al., v. Marsh USA, Inc., et al.
Bryan Bros., Inc. v. Cont’l Cas. Co.
Business Roundtable v. SEC
Chubb Custom Ins. Co. v. Grange Mut. Cas. Co.
Citigroup, Inc. v. Fed. Ins. Co.
June
March
“Tie-In” of Limits of Liability Language in Private Equity Policy and Portfolio
D&O Policies Enforceable
Prior Knowledge Provision Is an Unambiguous Condition Precedent to Coverage to Which the Innocent Insured Provision Is Inapplicable
Shareholder-Nominated Proxy Rule Vacated by the District of Columbia Circuit July
September Use of a Computer Software Program Constitutes Insurance Services under E&O
Policy
August Excess Insurers’ Payment Obligations Not Triggered if an Insured Accepts a
Compromise Payment from Primary Carrier for Less than Full Primary Limit
City of Roseville Employees’ Retirement Sys. v. Horizon Lines, Inc., et al.
August
Continental Cas. Co., et al. v. Duckson December
Court Rejects Collective Knowledge to Plead “Scienter” Under PSLRA
Court Denies Coverage for Defense Expenses Where Relief Sought Was Not
Covered by the Policy
Cracker Barrel Old Country Store, Inc. v. Cincinnati Ins. Co.
Endurance Am. Specialty Co. v. Lance-Kashian & Co.
Erica P. John Fund, Inc. v. Halliburton Co.
Exec. Risk Indem., Inc. v. Charleston Area Medical Center, Inc.
Fed. Ins. Co. v. Firemen’s Ins. Co.
Fed. Ins. Co. v. Int’l Bus. Machs. Corp.
Article Title
Bad Faith Does Not Encompass Reasonable Dispute over Policy Interpretation
Insured Sues Excess Carrier for Alleged Violations of a Consumer Protection Law
Court Denies Waiver Argument of Insureds and Rejects Insurer’s Attempt to
Interrelate E&O Claim to Prior Claim
October EEOC Lawsuit Does Not Constitute an EPL Claim
November Defense Fees Reduced Pursuant To Policy Provisions
May U.S. Supreme Court Rules that Proof of Loss Causation Is Not Required to Obtain
Class Certification of a Federal Shareholder Class Action Fraud Suit
May Punitive Damage Award Does Not Trigger Fraud and Dishonesty Exclusion in
D&O Policy
February “Other Insurance” Clause in D&O Policy Allows Contribution from CGL Carrier
Fed. Ins. Co. v. SafeNet, Inc.
Fed. Ins. Co. v. The Estate of Irving Gould, et al.
Feldman v. Illinois Union Ins. Co.
First Bancshares, Inc. v. St. Paul Mercury Ins. Co.
Flagship Credit Corp. v. Indian Harbor Ins. Co.
Gateway, Inc. v. Gulf Ins. Co.(acquired by Travelers)
Genesis Ins. Co. v. Magma Design Automation Inc.
January No Coverage for ERISA Complaint that Alleges Settlor Liability Rather than a
Breach of Fiduciary Duty
September D&O Policy Rescinded Following CFO’s Guilty Plea
September Excess D&O Insurers Not Required to Drop Down or Otherwise Pay Due to
Insolvency of Underlying Insurer
September D&O Policy’s “Interrelated Wrongful Acts” Precludes Coverage for Amended
Pleading with New Facts, Parties, and Liability Theories
October
April
Prior Knowledge Exclusion Triggered by Reasonable Person Standard
“Loss” Does Not Include Statutory Civil Damages Because They Are Akin to a
“Penalty”
August
April
Coverage Available for Employees Subpoenaed but Not Named in SEC Lawsuit
The Phrase “Full Reservation of Rights” Is Sufficient for Insurer to Seek
Reimbursement of Settlement Payments from the Insured and Excess Carrier
Greenman-Pedersen, Inc. v. Travelers Cas. & Sur. Co. of Am.
Hollis Park Manor Nursing Home v. Landmark Am. Ins. Co.
In re Citigroup ERISA Litig.
In re DVI Sec. Litig.
In re Goldman Sachs Group, Inc. S’holder Litig.
In Re S. Peru Copper Corp. Shareholder Derivative Litig.
In re: Beach First National Bancshares, Inc.
JPMorgan Chase & Co. v. Indian Harbor Ins. Co.
August
July
IvI Exclusion Carve-Out Inapplicable
“Derivative” Exception to Professional Services Exclusion in D&O Policy Not
Applicable
November Second Circuit Adopts “Moench” Presumption in Tandem ERISA Putative Class
Actions
March
November Court Finds for Board Pursuant to Business Judgment Rule
October Acquisition of Subsidiary Owned by the Acquiror’s Controlling Shareholder Does
Not Satisfy the Entire Fairness Review
May
Third Circuit Clarifies the “Fraud-On-The-Market” Presumption to “Scheme
Liability” Claims Against Secondary Actors Under Section 10(b) of the Securities
Exchange Act
June
D&O Policy Providing Corporate Indemnity and Corporate Liability Coverage Is an Asset of the Estate of Debtor in Adversary Proceeding Brought by Trustee
Excess Policy Provisions Requiring Each Underlying Carrier to Admit Liability and Pay Full Amount of Liability Enforced to Deny Coverage
2011 Year in Review Legal News and Developments in Executive Liability 93

94
Case Cited
JPMorgan Securities Inc. v. Vigilant Ins. Co.
King v. VeriFone Holdings, Inc.
La. Mun. Police Emples Ret. Sys. v. Morgan Stanley & Co.
Lee Bentley Farkas v. Nat’l Union Fire Ins. Co. of Pittsburgh, PA
MBIA Inc., v. Fed. Ins. Co.
MLSMK Inv. Co. v. JPMorgan Chase & Co.
Mut. Real Estate Holdings, LLC v. Houston Cas. Co.
Office Depot, Inc. v. Nat’l Union Fire Ins. Co. of Pittsburgh, PA
Plumbers and Pipefitters Local Union No. 630 Pension-Annuity Trust
Fund v. Arbitron, Inc.
Shapiro v. Kennedy
Sherwood Brands, Inc. et al. v. Great Am. Ins. Co.
SNL Fin., LC v. Philadelphia Indem. Ins. Co.
The Booth Family Trust v. Jeffries
The Goodyear Tire & Rubber Co. v. Fed. Ins. Co.
The Mills, Ltd. P’ship v. Liberty Mut. Ins. Co.
The Unencumbered Assets, Trust, v. Great Am. Ins. Co., et al.
Tyco Int’l, Ltd. v. Kozlowski
U.S. Bank Nat’l Ass’n v. Fed. Ins. Co.
Umpqua Bank v. Progressive Cas. Ins. Co.
Westport Ins. Corp. v. Markham Group, Inc.
Wintermute v. Kan. Bankers Sur. Co.
XL Specialty Ins. Co. v. Perry (In re IndyMac Bancorp, Inc.)
XL Specialty Ins. Co., et al. v. Loral Space & Communication, Inc.
Yessenow v. Exec. Risk Indem., Inc.
Month Article Title
December Disgorgement Payment Not Covered under Professional Liability Policy
March Stockholder-Plaintiff May File a Delaware Section 220 Request to Inspect Books and Records Even If a Derivative Lawsuit Is Filed First
March Delaware Section 220(b) Books and Records Request Is Proper If It Reasonably
Relates to a Stockholder
July
June
D&O Policy’s “In Fact” Exclusion Does Not Require Exhaustion of Appellate
Remedies
Investigative and Special Litigation Committee Expenses Covered under D&O
Policy
PSLRA Bars All RICO Claims Premised Upon Acts of Securities Fraud July
October
October
No Coverage for Claim Made Prior to Policy Period
Defense Costs Responding to SEC Investigation Not Covered Under D&O Policy
November The Identity of a Confidential Informant Must be Disclosed in a Securities Class
Action
August
February
Derivative Action Dismissed for Failure to Allege Demand Futility with
Particularity
Maryland Court Rules Notice Prejudice Statute Applicable to Claims Made and
Reported D&O Policy
November Attorney Letters Advising of Client’s Employment Issues Not Considered a Claim
April One SLC Member’s Recusal Taints the Recommendation to Dismiss and Proves the SLC Was Not an Independent Committee
October Failure to Exhaust Primary D&O Policy Bars Coverage under Excess Policy
February “Shaved” Underlying Layers of D&O Policies Are Exhausted and Trigger Excess
Carrier’s Coverage
September Dishonesty Exclusion and Rescission Used to Deny Coverage under D&O
Insurance Policy
January Court Applies NY Internal Affairs Doctrine Despite Entity Being Incorporated in
Bermuda
December $56 Million Stipulated Judgment is Not “Loss” Because Former Officer Was
“Absolved from Payment” in a Limited Assignment of Rights Agreement
November Mere Allegations Do Not Trigger Exclusion
January Prior Knowledge Exclusion in E&O Policy, Which Includes the Policy Term
“Might,” Is Unambiguous
January Criminal Claim Need Not Allege “Loss” to Trigger Defense Coverage; Personal
Profit and Dishonesty Exclusions Necessitate Fact Adjudication
December FDIC Has No Standing to Intervene in Directors and Officers Coverage Litigation
Action
February
June
Plaintiffs’ Attorney Fees Award in Derivative Suit Covered by D&O Policy, but
Definition of Securities Claims Bars Coverage for Fee Award in Claim Alleging
Only Breach of Fiduciary Duties
Suit by Trustee in Bankruptcy Does Not Trigger Bankruptcy Exclusion or IvI
Exclusion
Aon Financial Services Group Legal & Claims Practice

Shareholder Class Action Filings
Filing
1 st Centennial Bancorp
Acxiom Corp.
Advanced Battery Technologies, Inc.
Aegean Marine Petroleum Network, Inc.
Aeropostale, Inc.
Agfeed Industries, Inc.
Agnico-Eagle Mines Limited
American Superconductor Corporation
A-Power Energy Generation Systems, Ltd.
Apple Reit Nine, Inc.
Apple Reit Nine, Inc./Apple REIT Ten, Inc.
Artificial Life, Inc.
Avon Products, Inc.
Bank of America Corporation
Bank of America Corporation
Best Buy Co., Inc.
BioMimetric Therapeutics, Inc.
Blue Coat Systems, Inc.
Boutique Hotel Development Company, LLC
Broadwind Energy, Inc.
Carlyle Capital Corp.
Central European Distribution Corp.
China Agritech, Inc.
China Automotive Systems, Inc.
China Century Dragon Media, Inc.
China Electric Motor, Inc.
China Integrated Energy, Inc.
China Intelligent Lighting and Electronics, Inc.
China MediaExpress Holdings, Inc.
China Medical Technologies, Inc.
China Medicine Corporation
China Valves Technology, Inc.
Ciber, Inc.
Cisco Systems, Inc.
CNinsure, Inc.
Coinstar, Inc.
Community Health Systems, Inc.
Computer Sciences Corp.
Cooper Companies, Inc.
Deer Consumer Products, Inc.
Dendreon Corporation
Deutsche Bank AG
Diamond Foods, Inc.
DryShips, Inc.
Duoyuan Printing, Inc.
March
April
February
December
July
February
October
March
October
January
May
June
November
April
August
June
November
November
April
July
February
September
February
July
August
May
February
June
October
February
October
April
April
Month
April
April
April
February
October
October
November
April
July
November
June
April
Sector
Financial
Technology
Technology
Energy
Services
Consumer Non-Cyclical
Basic Materials
Technology
Capital Goods
Services
Financial
Technology
Consumer Non-Cyclical
Financial
Financial
Services
Healthcare
Technology
Services
Capital Goods
Financial
Consumer Non-Cyclical
Basic Materials
Consumer Cyclical
Services
Consumer
Energy
Non-Cyclical
Services
Healthcare
Healthcare
Basic Materials
Technology
Technology
Financial
Services
Healthcare
Technology
Healthcare
Consumer Cyclical
Healthcare
Financial
Consumer Non-Cyclical
Transportation
Consumer Non-Cyclical
C.D. California
C.D. California
S.D. New York
S.D. New York
C.D. California
S.D. New York
D. Colorado
N.D. California
S.D. New York
W.D. Washington
M.D. Tennessee
E.D. Virginia
N.D. California
C.D. California
W.D. Washington
S.D. New York
N.D. California
E.D. Missouri
D. Wyoming
Jurisdiction
C.D. California
E.D. Arkansas
S.D. New York
S.D. New York
S.D. New York
M.D. Tennessee
S.D. New York
D. Massachusetts
C.D. California
S.D. New York
E.D. New York
C.D. California
S.D. New York
S.D. New York
S.D. New York
D. Minnesota
M.D. Tennessee
N.D. California
W.D. Missouri
N.D. Illinois
D. District Columbia
D. New Jersey
C.D. California
S.D. New York
C.D. California
C.D. California
2011 Year in Review Legal News and Developments in Executive Liability 95

96
Filing
Ebix, Inc.
Elan Corporation, PLC
Ener1, Inc.
Equinix, Inc.
Fairfax Financial Holdings, Ltd.
Finisar Corporation
Focus Media Holding Limited
FriendFinder Networks, Inc.
FrontPoint Partners, LLC
Fushi Copperweld, Inc.
FXCM, Incorporated
Gentiva Health Services, Inc.
Gerova Financial Group, Ltd.
GLG Life Tech Corporation
GMX Resources, Inc.
Green Mountain Coffee Roasters, Inc.
Guaranty Financial Group, Inc.
Gulf Resources, Inc.
HCA Holdings, Inc.
Hewlett Packard Co.
Hospira, Inc.
Human Genome Sciences, Inc.
Impac Mortgage Holdings, Inc.
Imperial Holdings, LLC
Imperial Sugar Company
Intralinks Holdings, Inc.
Itron, Inc.
JBI, Inc.
Jiangbo Pharmaceuticals, Inc.
JinkoSolar Holdings Co. Ltd.
Juniper Networks, Inc.
Keyuan Petrochemicals, Inc.
Kid Brands, Inc.
K-V Pharmaceutical Company
L&L Energy, Inc.
Life Partners Holdings, Inc.
Lloyds Banking Group, PLC
Logitech International, S.A.
Longtop Financial Technologies Limited
Magnum D’Or Resources, Inc.
Mannkind Corp.
Mantria Corporation/Speed of Wealth
Medifast, Inc.
MF Global Holdings, Ltd.
Miller Energy Resources, Inc.
February
July
July
October
August
November
March
October
August
February
November
May
May
July
January
November
March
November
August
May
December
May
November
November
April
October
September
November
November
May
September
September
December
Month
July
February
August
March
July
March
December
November
January
May
March
September
Technology
Consumer Cyclical
Healthcare
Technology
Technology
Basic Materials
Consumer Cyclical
Healthcare
Energy
Financial
Financial
Technology
Technology
Services
Healthcare
Services
Healthcare
Financial
Energy
Sector
Technology
Healthcare
Technology
Technology
Financial
Technology
Services
Technology
Financial
Basic Materials
Financial
Healthcare
Financial
Basic Materials
Energy
Consumer Goods
Financial
Basic Materials
Healthcare
Technology
Healthcare
Healthcare
Services
Financial
Consumer Non-Cyclical
Technology
E.D. Washington
D. Nevada
S.D. Florida
S.D. New York
N.D. California
C.D. California
D. New Jersey
E.D. Missouri
W.D. Washington
W.D. Texas
S.D. New York
S.D. New York
C.D. California
S.D. Florida
C.D. California
D. Colorado
D. Maryland
S.D. New York
E.D. Tennessee
Jurisdiction
N.D. Georgia
S.D. New York
S.D. New York
N.D. California
S.D. New York
N.D. California
S.D. New York
S.D. Florida
D. Connecticut
S.D. New York
S.D. New York
E.D. New York
E.D. New York
S.D. New York
W.D. Oklahoma
D. Vermont
N.D. Texas
C.D. California
M.D. Tennessee
C.D. California
S.D. Illinois
D. Maryland
C.D. California
S.D. Florida
S.D. Texas
S.D. New York
Aon Financial Services Group Legal & Claims Practice

Filing
Mindray Medical International, Ltd.
Motricity, Inc.
National Title Co.
News Corporation
NIVS Intellimedia Tech. Group, Inc.
Oclaro, Inc.
Office Depot, Inc.
Oilsands Quest, Inc.
Olympus Corporation
Omnicare, Inc.
OmniVision Technologies, Inc.
Pacific Biosciences of California, Inc.
Pain Therapeutics, Inc.
Penson Worldwide, Inc.
Primo Water Corporation
Puda Coal, Inc.
Radient Pharmaceuticals Corp.
Raser Technologies, Inc.
Research in Motion Limited
Rosetta Stone, Inc.
Royal Caribbean Cruises, ltd.
Satcon Technology Corporation
SchengdaTech, Inc.
Sequans Communications, S.A.
Sigma Designs, Inc.
Sino Clean Energy, Inc.
SinoTech Energy Limited
SkyPeople Fruit Juice, Inc.
Smart Technologies, Inc.
Smith Micro Software, Inc.
Stereotaxis, Inc.
Subaye, Inc.
Suffolk Bancorp
Superior BanCorp
Tekelec
Temple-Inland, Inc.
The Bank of New York Mellon Corporation
The Great Atlantic & Pacific Tea Company, Inc.
The Princeton Review, Inc.
The Royal Bank of Scotland Group PLC
The Talbots, Inc.
The Timberland Company
Tongxin International, Ltd.
Travelzoo, Inc.
United Western Bancorp, Inc.
2011 Year in Review Legal News and Developments in Executive Liability
August
April
October
June
October
April
October
March
January
November
December
September
July
January
February
June
January
August
March
December
August
December
April
March
November
May
March
August
July
March
September
December
May
Month
July
August
May
July
March
May
April
February
November
August
October
November
Healthcare
Financial
Capital Goods
Energy
Healthcare
Technology
Technology
Services
Services
Technology
Basic Materials
Technology
Technology
Basic Materials
Sector
Healthcare
Technology
Financial
Services
Technology
Technology
Services
Energy
Consumer Cyclical
Healthcare
Technology
Healthcare
Energy
Consumer Goods
Technology
Technology
Healthcare
Services
Financial
Financial
Technology
Basic Materials
Financial
Consumer Non-Cyclical
Services
Financial
Services
Consumer Cyclical
Financial
Technology
Financial
S.D. New York
S.D. New York
N.D. California
C.D. California
E.D. Missouri
S.D. New York
E.D. New York
N.D. Alabama
E.D. North Carolina
N.D. Texas
S.D. New York
D. New Jersey
D. Massachusetts
S.D. New York
D. Massachusetts
D. New Hampshire
E.D. New York
S.D. New York
D. Colorado
Jurisdiction
S.D. New York
W.D. Washington
C.D. California
S.D. New York
C.D. California
N.D. California
S.D. Florida
S.D. New York
E.D. Pennsylvania
E.D. Kentucky
N.D. California
N.D. California
W.D. Texas
N.D. Texas
M.D. North Carolina
C.D. California
C.D. California
D. Delaware
S.D. New York
E.D. Virginia
S.D. Florida
D. Massachusetts
S.D. New York
S.D. New York
S.D. New York
C.D. California
97

Filing
Universal Travel Group, Inc.
Urban Outfitters, Inc.
Veolia Environment S.A.
Vestas Wind Systems A/S
Weatherford International Ltd.
WebMD Health Group Corp.
Wilshire Bancorp, Inc.
WMS Industries, Inc.
Wonder Auto Technology, Inc.
Yahoo, Inc.
Yongye International, Inc.
YRC Worldwide, Inc.
Yuhe International, Inc.
Zoo Entertainment, Inc.
ZST Digital Networks, Inc.
Sector
Services
Services
Services
N/A
Energy
Technology
Financial
Services
Consumer Non-Cyclical
Technology
Basic Materials
Transportation
Consumer Non-Cyclical
Technology
Technology
Month
April
March
December
March
March
August
March
May
May
June
May
February
June
July
April
Jurisdiction
D. New Jersey
E.D. Pennsylvania
S.D. New York
D. Colorado
C.D. California
S.D. New York
C.D. California
N.D. Illinois
S.D. New York
N.D. California
S.D. New York
D. Kansas
S.D. Florida
S.D. Ohio
C.D. California
Please note, this table represents 2011 SCA filings FSG tracked in the 2011 Month in Review publications.
98 Aon Financial Services Group Legal & Claims Practice

Shareholder Class Action Settlements
Case
Accuray, Inc.
Acura Pharmaceuticals, Inc.
Addus Homecare Corp.
Advanced Technologies Group/
Oxford Global Network/Luxury Lounge
Sector
Healthcare
Healthcare
Healthcare
Technology
Akeena Solar, Inc.
Alstom S.A.
Ambac Financial Group, Inc.
Utilities
Conglomerates
Financial
Ambassadors Group, Inc.
Services
American Capital Corp./Royal Palm Capital Group, Inc. Financial
American Capital Corp./Royal Palm Capital Group, Inc. Financial
American International Group, Inc.
Apollo Group, Inc.
ArthroCare Corporation
Atricure Inc.
BankUnited Financial Corp.
Beckman Coulter, Inc.
Bernard L. Madoff Investment Securities – Tremont
Funds/Rye Funds
Financial
Services
Healthcare
Healthcare
Financial
Technology
Financial
Bernard L. Madoff Investment Securities, LLC
Cadence Design Systems, Inc.
CardioNet, Inc.
Colonial BankGroup, Inc.
Corus Bankshares, Inc.
Credit Suisse Group [ADR]
DG FastChannel, Inc.
DVI, Inc.
E*Trade Financial Corp.
First Trust Portfolios L.P.
FleetBoston Financial Corp.
Franklin Templeton Funds
Fuwei Films (Holdings) Co., Ltd.
Giant Interactive Group, Inc.
GT Solar International, Inc. [IPO]
Harmony Goldmining Co. Ltd.
Harris Stratex Networks, Inc.
Image Innovations Holdings, Inc.
Industrial Enterprises of America, Inc.
Infineon Technologies AG
InterVoice-Brite, Inc.
JA Solar Holdings Co. Ltd.
Koss Corporation
Lancer Partners, L.P.
Lehman Brothers Holdings, Inc.
Levitt Corp.
Financial
Technology
Healthcare
Financial
Financial
Financial
Services
Financial
Financial
Financial
Financial
Financial
Basic Materials
Technology
Technology
Basic Materials
Technology
Services
Energy
Technology
Technology
Technology
Consumer Goods
Consumer Goods
Financial
Capital Goods
Month
April
November
April
June
September
May
August
April
April
May
October
December
November
January
June
September
April
January
August
March
August
May
June
February
June
July
February
October
August
December
July
June
February
December
August
May
March
July
March
December
April
September
July
Amount
$13,500,000
$1,500,000
$3,000,000
$19,258,036
$4,770,000
$6,950,000
$33,000,000
$7,500,000
$12,500 [Partial]
$14,000 [Partial]
$725,000,000 [Partial]
$145,000,000
$74,000,000
$2,000,000
$3,000,000
$5,000,000
$100,000,000
$2,150,000
$13,000,000
$10,500,000
$9,000,000
$8,900,000
$575,000
$3,400,000
$6,200,000
$4,750,000
$4,500,000
$1,000,000
$5,000,000
$507,000,000
$1,950,000
$62,500,000 [Partial]
$40,000,000
$7,250,000
$10,500,000
$10,000,000
$70,000,000
$2,000,000
$4,000,000
$79,000,000
$5,150,000
$5,500,000
$4,437,368
Jurisdiction
N.D. California
N.D. Illinois
N.D. Illinois
SEC
N.D. California
S.D. New York
S.D. New York
E.D. Washington
Nebraska
Nebraska
S.D. New York
Arizona
S.D. Florida
S.D. Ohio
S.D. Florida
C.D. California
S.D. New York
S.D. New York
N.D. California
S.D. California
M.D. Alabama
N.D. Illinois
S.D. New York
S.D. New York
E.D. Pennsylvania
S.D. New York
N.D. Illinois
New Jersey
Maryland
S.D. New York
S.D. New York
New Hampshire
S.D. New York
S.D. New York
S.D. New York
S.D. New York
N.D. California
N.D. Texas
S.D. New York
E.D. Wisconsin
S.D. Florida
S.D. New York
S.D. Florida
2011 Year in Review Legal News and Developments in Executive Liability 99

100
Case
MBIA, Inc.
Medicis Pharmaceutical Corp.
Merit Securities Corp.
Merrill Lynch Mortgage Investors, Inc.
MF Global, Ltd.
Motorola, Inc.
National City Corp.
Navistar International Corp.
NetBank, Inc.
NexCen Brands, Inc.
Noah Education Holdings, Ltd. [IPO]
Nortel Networks Corp. [SEC]
Nuvelo, Inc.
Oppenheimer Champion Income Fund
Sector
Financial
Healthcare
Services
Financial
Financial
Technology
Financial
Consumer Cyclical
Financial
Financial
Services
Technology
Healthcare
Financial
Amount
$68,000,000
$18,000,000
$7,500,000
$315,000,000
$90,000,000
$3,150,000
$168,000,000
$13,000,000
$12,500,000
$4,000,000
$1,750,000
$35,500,000
$8,916,667
$52,500,000
Oppenheimer Core Bond Fund
Oracle E Fund/Oracle J Fund [SEC]
Panera Bread Co.
PCS Edventures!.com, Inc.
Pilgrim’s Pride Corporation
Popular, Inc.
Financial
Financial
Services
$47,500,000
$242,500
$5,750,000
Services $665,000
Consumer Non-Cyclical $1,500,000
Financial $37,500,000
Provident Entities/Medical Capital Notes
Prudential Financial, Inc.
Rentech, Inc.
Financial
Financial
Basic Materials
$80,000,000 [Partial]
$16,500,000
$1,800,000
Rydex Inverse Government Long Bond Strategy Fund Financial
Sadia S.A.
Consumer Non-Cyclical
$5,500,000
$27,000,000
Satyam Computer Services, Ltd.
Services $125,000,000
Satyam Computer Services, Ltd.
Schwab Funds [SEC]
SearchMedia Holdings Ltd.
SemGroup Energy Partners, L.P.
Semtech Corp.
Signalife, Inc.
Superior Offshore Int’l, Inc.
Telenav, Inc.
Tellabs, Inc.
Tyco International Ltd. [SEC]
United Rentals, Inc. [SEC]
Value Line Funds [SEC]
Wachovia Corp. [2008]
Wachovia Preferred Securities and Bond/Notes
Wamex Holdings, Inc. et al. [SEC]
Washington Mutual, Inc.
Washington Mutual, Inc.
Wells Fargo Mortgage Backed Securities
Wells Fargo Securities [SEC]
Xybernaut Corporation
Zynex, Inc.
Services
Financial
Financial
Basic Materials
Technology
Healthcare
Energy
Services
Technology
Conglomerates
Services
Financial
Financial
Financial
Various
Financial
Financial
Financial
Financial
Technology
Healthcare
$25,500,000 [Partial]
$118,944,996
$2,750,000 [Partial]
$28,000,000
$20,000,000
$4,000,000
$1,900,000
$3,800,000
$7,375,000
$50,000,001
$14,000,000
$43,705,765
$75,000,000
$627,000,000
$14,256,179
$208,500,000
$41,500,000
$125,000,000
$7,400,000
$4,500,000
$2,500,000
November
August
July
June
October
July
April
May
November
May
July
November
May
April
April
January
July
May
January
February
February
May
January
February
September
November
January
May
August
March
November
September
February
Month
October
December
October
November
January
July
August
February
August
August
March
November
April
May
S.D. New York
N.D. California
S.D. Florida
N.D. Oklahoma
C.D. California
South Carolina
S.D. Texas
N.D. California
N.D. Illinois
S.D. New York
Connecticut
SEC
S.D. New York
S.D. New York
S.D. New York
W.D. Washington
S.D. New York
N.D. California
SEC
E.D. New York
Colorado
Jurisdiction
S.D. New York
Arizona
S.D. New York
S.D. New York
S.D. New York
N.D. Illinois
N.D. Ohio
N.D. Illinois
N.D. GA
S.D. New York
S.D. New York
S.D. New York
N.D. California
Colorado
Colorado
E.D. New York
E.D. Missouri
Idaho
E.D. Texas
Puerto Rico
N.D. Texas
New Jersey
C.D. California
N.D. California
S.D. New York
S.D. New York
Aon Financial Services Group Legal & Claims Practice

Aon
200 E. Randolph St.
Chicago, IL 60601 www.aon.com
For further information please contact
Aon Financial Services Group Legal & Claims Practice:
Steve Shappell, Esq
Managing Director p: 303.639.4110 e: steve.shappell@aon.com
Published by Aon Services Corporation
Copyright Aon 2012
This document has been prepared by Aon. Further distribution or duplication is not permitted without the express written permission.
#7990: K0066-79629 1/2012