Security Class Action Lawsuits

Transcription

1 Special Report Security Class Action Lawsuits Over the last 18 months more than 75 security class action lawsuits were settled on behalf of investors. The value of the settlements and awards was in excess of $4.3 Billion. That equates to more than $56 Million per case. (The $4.3 Billion does not include the $2.65 Billion settlement in the Citigroup/Worldcom case). 76% of the class action lawsuits were based on allegations that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 by making a series of materially false and misleading statements and/or omissions. That as a result of these materially false and misleading statements and/or omissions the price at which the securities were traded in the public market was artificially inflated. 20% of the class action lawsuits are based on materially false and misleading statements and omissions or failing to follow the terms outlined in a Prospectus and/or Prospectus Supplements. 27% of the class action lawsuits named officers and directors as defendants (some by name, others by position). 32 additional security class action lawsuits were pending at the time of writing this report. At a minimum, 7 legal firms are actively pursuing security class action lawsuits. These firms are expending hundreds of thousands of dollars searching through company press releases, financial reports and prospectuses looking for potential areas of wrong doing. If and when they believe they have identified a company that has violated a section of the securities act they advertise for lead plaintiffs. In other words, these law firms do not wait for someone to come to them with a potential class action case, they create the potential class action case and then look for lead plaintiffs. In my opinion this is the new breed of ambulance chaser and it is substantially more lucrative than medical claims. Although the vast majority of companies carry insurance to protect against these types of potential liabilities, including protection for their officers and directors, there is no insurance reimbursement that covers the time spent by staff, officers and directors responding to the allegations, time spent in discovery, and the fact that lawsuits are a major disruption to a company s ability to focus on doing business. Many of the aforementioned lawsuits were in the system for more than 3 years. That s 3 years of continuous disruption. - 1

2 Directors could be facing a much greater degree of personal liability. The following memorandum is reprinted by permission of Weil, Gotshal & Manges LLP. Sarbanes-Oxley Materials Director Liability Warnings From Delaware January 2003 INTRODUCTION AND SUMMARY In recent days, The Wall Street Journal and Fortune have published provocatively titled articles Delaware Justice Warns Boards of Liability for Executive Pay and Over-paid CEOs? Try Suing the Paymasters: Delaware judge, in warning signal to boards, opens door to courtroom remedy reporting recent comments by E. Norman Veasey, the Chief Justice of the Delaware Supreme Court, in a round-table discussion that appears in the January 2003 issue of the Harvard Business Review. Chief Justice Veasey s observations, together with recent actions by the Delaware Supreme Court, signal that court s and almost certainly other courts heightened sensitivity and focus upon corporate governance issues and the increased exposure to liability directors face in the post-enron and post-sarbanes-oxley Act of 2002 world. Chief Justice Veasey s observations, together with recent decisions and articles by other Delaware judges, suggest a perceptible shift in the rigor with which the courts will review director conduct. Although it is too early to predict the precise doctrinal contours that will be applied by the courts, now is the time for directors and their advisors to review and, where appropriate, strengthen and follow their procedures to meet the evolving demands and heightened judicial scrutiny that is sure to come. Now, more than ever, it is critical for directors to establish and follow procedures designed to assure independent, informed decision-making. As discussed in more detail below, We urge directors to take heed of what Chief Justice Veasey calls a new set of expectations for directors... that is changing how the courts look at these issues. These new expectations suggest heightened judicial scrutiny of director con-duct and may lead to new limitations on the protection provided to directors by the business judgment rule. In Chief Justice Veasey s words, directors who are supposed to be independent should have the guts to be a pain in the neck and act independently. - 2

3 Again in Chief Justice Veasey s words: corporations should genuinely and in good faith have good corporate practices in place, and independent directors should have the guts to make sure those practices are followed, without being adversarial. DISCUSSION Chief Justice Veasey observes in the Harvard Business Review that the changes in corporate governance that we re seeing through the voluntary best practices codes, for example, or through the New York Stock Exchange listing requirements have created a new set of expectations for directors and states that that is changing how the courts look at these issues. What s Wrong with Executive Compensation? A roundtable moderated by Charles Elson, Harv. Bus. Rev., Jan. 2003, at 68, 76. Courts including the Delaware Supreme Court long have held that in making business decisions, directors must consider all material information reasonably available. See, e.g., Brehm v. Eisner, 746 A.2d 244, 259 (Del. 2000); Smith v. Van Gorkom, 488 A.2d 858, (Del. 1985); Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984). The new set of expectations for directors created by best practices codes, Sarbanes-Oxley and new listing requirements as well as common knowledge of the Enron and WorldCom experiences (to name just two) may well play a role in a court s assessment with respect to whether material information that directors did not obtain nevertheless was reasonably available to directors. The new set of expectations for directors may also create the backdrop for claims that directors who do not act in accordance with the new set of expectations have not acted in good faith. Such a finding would be particularly significant in light of charter provisions adopted by shareholders of most corporations pursuant to statutes modeled upon Section 102(b)(7) of the Delaware General Corporation Law, which permit shareholders to protect directors from liability for money damages for breaches of the duty of care but not acts or omissions not in good faith. The meaning and possibly new meanings of good faith in light of the new set of expectations for directors likely will play an important role in litigation regarding the conduct of outside directors. As Delaware Vice Chancellor Leo E. Strine, Jr. recently observed, corporate failures such as Enron generate increased pressure on courts to examine carefully the plausibility of director claims that they were able to devote sufficient time to their duties to have carried them out in good faith. Derivative Impact? Some Early Reflections on the Corporation Law Implications of the Enron Debacle, 57 Bus. Law. 1371, 1385 (2002). Vice Chancellor Strine notes that one can envision plaintiffs lawyers who will try to take apart a board of directors based on the simple argument that the board simply could not have carried out its duties in the time devoted to them. Id. at By way of example only, plaintiffs pursuing arguments such as these may ask courts to decide questions such as: could directors have had a good faith belief that they devoted enough board and/or committee time to oversight in light of the size and scope of the corporation s activities and with hindsight what went wrong? - 3

4 could directors have had a good faith belief that an audit committee of a multi-billion dollar multi-national corporation that meets for an hour or two quarterly (and possibly with some members participating by phone) devoted enough time and attention to oversight? could directors have had a good faith belief that a chief executive officer would have left the corporation or not performed up to his or her potential if he or she were offered less money than the millions or tens of millions of dollars the compensation committee agreed to pay? and could directors who have full time jobs and/or serve on multiple boards (and/or multiple audit committees) have had a good faith belief that their multiple obligations provided them enough time to exercise sufficient oversight over the affairs of each corporation they serve? Chief Justice Veasey comments to the Harvard Business Review also urge that compensation committees should have their own advisers and lawyers. Harv. Bus. Rev. at 76. This statement raises numerous questions relating to both compensation and other matters: To what extent can compensation committees rely upon the corporation s advisors and lawyers? To what extent can other committees such as audit committees, which under the Sarbanes-Oxley Act have authority to engage independent counsel and other advisors, as it determines necessary to carry out its duties rely upon the corporation s advisors and lawyers? Should the board as a whole have its own advisors and lawyers? Can the board and/or more than one committee utilize the same advisors and counsel? To what extent will a compensation or audit committee determination not to retain their own advisors and lawyers based upon cost considerations and/or their confidence in the board s advisors face allegations that the failure to do so reflected some-thing less than good faith? Are all committees obligated to at least consider whether they need their own advisor and counsel? If so, can reliance upon the company s advisors and counsel on that subject possibly be deemed to reflect something less than good faith? Chief Justice Veasey s comments to the Harvard Business Review also urge directors to demonstrate their independence, hold executive sessions, and follow governance procedures sincerely and effectively in order to guard against anything that might happen to them in court. Harv. Bus. Rev. at 76. In Chief Justice Veasey s words, directors who are supposed to be independent should have the guts to be a pain in the neck and act independently. Id. The implications of this statement obviously are substantial. Finally, we note that from June 2002 through today, the Delaware Supreme Court has issued written decisions in five cases involving the performance by directors of their fiduciary duties. In every one of these five decisions, the Supreme Court held for the shareholders and against directors (and reversed Court of Chancery decisions that had rejected the shareholder claims). See Telxon Corp. v. Meyerson, 802 A.2d 257 (Del. June 7, 2002) (reversing grant of sum-mary judgment); Saito v. McKesson HBOC, Inc., 806 A.2d 113 (Del. June 11, 2002) (reversing - 4

5 decision limiting access to corporate books and records by shareholder investigating alleged wrongdoing); Levco Alternative Fund Ltd. v. Reader s Digest Ass n, Inc., 2002 WL (Del. Aug. 13, 2002) (reversing denial of motion for preliminary injunction); OmniCare, Inc. v. NCS Healthcare, Inc., 2002 WL (Del. Dec. 10, 2002) (reversing denial of preliminary injunction); MM Cos. v. Liquid Audio, Inc., No. 606, 2002 (Del. Jan. 7, 2003) (reversing final judgment dismissing challenge to board decision to adopt defensive measures that changed the size and composition of the board during a proxy contest). And, in a sixth case, involving a limited partnership agreement creating fiduciary duties substantially mirroring traditional fiduciary duties that apply in the corporation law, the Supreme Court affirmed the Court of Chancery s finding that a general partner breached its fiduciary duty to limited partners and affirmed the Court of Chancery s finding that rescission was not required, but held that the Court of Chancery erred by failing to fashion a remedy that is an appropriate substitute for rescission under the circumstances of the case. See Gotham Partners, L.P. v. Hallwood Realty Partners, L.P., 2002 WL (Del. Aug. 29, 2002). No one, obviously, should reach broad conclusions based upon a small population of cases arising in disparate factual and procedural contexts. This unusual string of Supreme Court decisions siding with shareholders, however, certainly suggests a heightened sensitivity by the Delaware Supreme Court to shareholder claims and certainly should stand as a warning to directors and their counsel. The bottom line lesson from Chief Justice Veasey: corporations should genuinely and in good faith have good corporate practices in place, and independent directors should have the guts to make sure those practices are followed, without being adversarial. Harv. Bus. Rev. at 77. Following this advice will offer a strong defense to the heightened threat of shareholder litigation. As always, please feel free to contact your Weil Gotshal contact for further information or advice on these corporate governance developments End Of Memorandum

6 What can directors do to assist their respective companies in avoiding lawsuits? 1. I recommend that a director s committee be set up to approve all information disseminated to the public. This includes yearend financial reports, quarterly financial reports and any and all press releases that are not oriented towards products or services. This committee should also be responsible to ensure that all material information is disseminated to the public. In many cases, it is not what was disclosed, it is what was not disclosed that gets a company into trouble. 2. Individuals should limit the number of boards that they sit on and for those boards that they choose to be a member of, limit the number of special committees that they serve on. 3. Minutes of board meetings should be well documented. Time and place, Who was present and who was not, Venue telephone, in person, All voting should indicate who the dissenting voters, if any, were, Questions to management and their answers should be documented in detail. Every board meeting should have an agenda item called disclosure. Whereby the board asks management specifically if there are any items that should be made public. One of the major problems with the dissemination of material information is of course the timing. As board meetings generally do not take place more often than every quarter a method to ensure that material information is disseminated immediately must be implemented. It is highly unusual, if management is doing its job that directors would not be aware of material items taking place within a company that should be disseminated to the public. Committees should make formal reports to the other directors, which become part of the minutes, at every board meeting. It would be advantageous if reports were distributed with the agenda to allow directors sufficient time to absorb the information contained within the reports. Compensation committees must detail and record all parts of remuneration packages given to senior management and ensure that they are placed in the minutes of board meetings. The minutes of the previous board meeting should be approved at the next board meeting, but it should be sent to directors within 3 days from the time the meeting took place. Speed is important, if it takes to long for minutes of a previous meeting to arrive Directors cannot be expected to remember and comment on what was said. Directors should scrutinize the minutes to make sure that they are accurate, not only in what they do say, but what may have been inadvertently left out. - 6

7 The agenda for a board meeting should be sent out in advance and should allow directors enough time to add items. A pre board meeting package should be sent to directors allowing them sufficient time and information so that they can be fully prepared to discuss agenda items. Management should not spring important items to be dealt with at board meetings and then require immediate decisions by directors. 5. There are numerous items that directors should make themselves aware of to ensure that their corporations are not subject to lawsuits. Directors should ensure that the company has and follows guidelines for equal pay and promotion opportunities across sectors of age, religion, sex, marital status, sexual orientation and race. Directors should be aware of local, state and federal regulations pertaining to handicapped access. Directors should be aware of local, state and federal regulations pertaining to environmental and biological hazard and disposal concerns. Directors should be aware of how the company sets its prices. Directors should be aware of any and all predatory sales and marketing practices. Directors should scrutinize any and all loans or special benefits given to employees, especially senior management. Directors should make themselves aware of their fiduciary responsibilities with respect to takeovers and mergers. In that regard they may wish to read a document by Arthur Fleisher, Jr. and Alexander R. Sussman titled Directors Fiduciary Duties In Takeovers And Mergers. The document can be found at Note: All statements made in this report are general in nature, not legal advice and not warranted or guaranteed. Readers are cautioned not to rely on this information. Because laws change over time and in different jurisdictions, it is imperative that you consult an attorney in your area regarding legal matters. - 7