Business Litigation: A Look Into 2011

A lagging economy, stricter regulatory environment, and a sweeping financial reform bill had significant bearings on a wide range of corporate governance matters in 2010. Expect that to continue in 2011.

On a macro level, legal experts say, securities litigation that arose out of the credit crisis is on the decline, as well as so-called “stock drop” cases, stemming from the filing of financial restatements. Taking their place, however, are several new categories of securities litigation, many of which target the financial services industry.

Steven Scholes, a partner in the law firm of McDermott Will & Emery, says one particular area generating a “tremendous amount of activity” is the growing firestorm of lawsuits filed against banks by institutional investors. “That is really just now starting to work its way through the system,” he says.

In general, such lawsuits filed by Federal Home Loan Banks (a group of banks that lend money to other banks that offer mortgages) and other mortgage investors across the country allege that commercial banks misstated or failed to disclose important information regarding mortgage-related securities. Among the big-name institutions currently facing multiple lawsuits are Citigroup, Wells Fargo, Bank of America, JP Morgan, and many more.

At the same time, the Federal Deposit Insurance Corp. reportedly is conducting 50 civil and criminal proceedings against executives, employees, and officers of failed banks. Those proceedings may be a signal of more to come, given that the FDIC's latest quarterly report on the banking industry rated 860 banks as “problem institutions.” (And they are not to be confused with the 149 banks that failed through early December of 2010, the highest number since 1992.)

Another new type of litigation has emerged as well, pushing the boundaries of insider trading. If successful—and nobody yet knows whether it is—it could create legal obstacles for some institutional investors bringing claims. Scholes cites a recent lawsuit brought by discount retail chain, Big Lots, against a Florida-based research firm, Retail Intelligence Group. The lawsuit accuses RIG of violating trade-secret laws after it duped 72 Big Lots store managers into revealing a variety of proprietary information—inventory, quarterly sales performance statistics, payroll, and more—and then sold the information to investors.

The lawsuit, Scholes says, mirrors similar insider-trading investigations by the government about whether the information that analysts and consultants provide to hedge funds and other investors about a company's supply chain (known as “channel checking” in the business) constitutes insider information. From a securities standpoint, “this is going to be a very interesting series of investigations and lawsuits as to how this all plays out,” he says.

Dodd-Frank Implications

Claims against companies for securities fraud will also probably get a big boost from the new whistleblower protections in the Dodd-Frank Act. The law will reward tipsters with bounties of as much as 30 percent of any settlements that ultimately stem from their alerts to regulators. “Dodd-frank has encouraged—and will encourage—the filing of whistleblower claims,” says Layne Kruse, a partner with the law firm Fulbright and Jaworski. “That is going to create a major issue.”

“Dodd-Frank has encouraged—and will encourage—the filing of whistleblower claims. That is going to create a major issue.”

—Layne Kruse,

Partner,

Fulbright and Jaworski

The Securities and Exchange Commission proposed whistleblower regulations in November and is scheduled to adopt them sometime this spring.

Expect major changes to director and officer obligations as well. William Chandler, chancellor of the Delaware Chancery Court, said during a recent Webcast that the federal government “inevitably” will issue additional compliance requirements relating to directors' obligations for monitoring and supervising a company's risks—whether that's in respect to audit, financial, and accounting responsibilities of boards, obligations for compensation committees, or the mandate that companies create risk committees, he said.

“What that ultimately yields is litigation, typically derivative [shareholder] litigation,” Chandler said.

Norman Veasey, a former chief justice of the Delaware Supreme Court and currently a partner at Weil, Gotshal & Manges, said during the same Webcast that federal legislation will not change the standard of Delaware law, which has long been the standard for internal governance of a corporation. “That's unchanged by Dodd-Frank,” he said.

Chandler said Delaware law will still reign supreme in cases challenging director liability. A long-standing principle of Delaware law is that directors have a duty of care to determine the scope and design of internal compliance programs. But the threshold for finding a director personally liable and for breaching his duty of oversight and monitoring has always been very high, and that's unchanged by Dodd-Frank. “We've put our stake down,” Chandler said. “That's our standard.”

Another potential area of litigation indirectly stemming from Dodd-Frank revolves around the mandate that the SEC study the question of whether to allow private plaintiffs the right to bring actions involving overseas securities frauds. Depending on which way the SEC finds, “that obviously could increase litigation,” Scholes says.

The issue stems from a U.S. Supreme Court decision handed down in June, Morrison v. National Australia Bank. The case sharply curbed the extraterritorial scope of Section 10(b) of the Exchange Act, barring so-called “F-cubed” securities fraud actions—that is, lawsuits filed in U.S. courts by foreign investors against foreign companies that trade on foreign exchanges. Essentially, the Supreme Court said that such cases have no business being heard in the United States; Congress then told the SEC to consider loosening Section 10(b) so they could.

“Going forward, the scope of Morrison will be quite important,” says Eugene Goldman, a partner in the law firm of McDermott Will & Emery. Richard Spinogatti, senior counsel at the law firm Proskauer Rose, notes that “a variety of consequences have flowed from Morrison's holding” already, including the dismissal of many Section 10(b) claims based on securities transactions that occurred outside the United States.

Supreme Court

Bessette

In addition to legislative and enforcement actions, 2011 is shaping up to be “quite a banner year for securities litigation out of the Supreme Court,” says Paul Bessette, co-chair of the securities litigation practice group at law firm Greenberg Traurig. Many of the cases the court has agreed to hear this term so far relate to business or corporation law somehow. Among the more significant are:

Matrixx Initiatives vs. James Siracusano. This case will attempt to answer the question of how much information companies are expected to disclose to the public, even if certain information doesn't appear significant at first glance.

AT&T v. Concepcion. The question here is whether the Federal Arbitration Act precludes companies from enforcing class-action lawsuit bans when they are embedded in arbitration agreements.

FCC v. AT&T. This case will tackle the controversial question of whether corporations have the same privacy rights as individuals.

Janus Capital Group v. First Derivative Traders. This case examines the question of whether a service provider can be held primarily liable in a private securities fraud suit for aiding and participating in another company's misstatements.

Kasten v. Saint-Gobain Performance Plastics Corp. At issue is whether employees who raise verbal complaints about labor practices are protected under the Fair Labor Standards Act.

Goodyear Tires v. Brown; and J. McIntyre Machinery v. Nicastro. These two cases are separate, but both tackle the murky issue of when foreign companies can be sued in U.S. courts—a topic the Supreme Court last addressed more than two decades ago.

All told, with regulators and legislators threatening more and more enforcement actions and the Supreme Court undertaking a handful of business cases, 2011 promises to be an eventful year in the world of corporate litigation.