Trends in Securities Class and Derivative Actions Suggest Proactive Steps for Directors & Officers

Corporate directors and officers may want to consider carefully reviewing mechanisms to protect them from liability in securities class actions and related derivative actions. The good news for directors and officers about these cases has been widely reported in the press — the number of securities class actions filed last year declined. Many attribute this to the 1995 and 1998 amendments to the federal securities laws which, respectively, significantly increased the pleading standards in those actions for plaintiffs (the PLSRA) and prevent an end run around those standards to state court (SLUSA).

Other trends however offer less comfort for directors and officers. While the number declined the cost of settlements increased. For example, in 2006 there were for the first time five settlement over $1 billion, more than twice the average through 2005. That trend seems to be continuing with the recent announcement of a nearly $3 billion settlement in the Tyco litigation.

The average settlement also increases. In 2006 the average settlement in a securities class action was $45 million (excluding the billion dollar cases). This is an all-time high which is more twice the average through 2005 according to Cornerstone Research.

The increasing cost of settling securities class actions follows reports of twelve outside directors paying $24.75 million as part of the Worldcom securities settlement, ten outside directors paying $13 million as part of the Enron securities settlement and outside directors paying another $1.5 million as part of the Enron DOL/ERISA litigation settlement. While some have argued that these are exceptional cases which should not be of concern, it is difficult to ignore the increasing cost of settlement in securities class actions.

Other trends are equally disturbing. Until recently derivative actions — suits by a shareholder in the name of the company and against directors and officers typically charging a breach of fiduciary duty — infrequently followed along with securities class actions. Last year however Cornerstone found that approximately 45% of the securities class actions had a tag along derivative suit, a significant change from prior years.

Settlement trends in derivative suits are also changing. Traditionally those cases settled for a reform of corporate governance procedures and attorney fees. Consider the following settlements in derivative cases:

–Healthsouth settled in February 2006 with a payment of $445 million;

–Tent Healthcare settled in January 2006 with a payment of $215 million

–Weststar Energy settled in April 2005 with a payment of $32.5 million; and

–i2 Technologies settled May 2004 with a payment of $84.5 million.

Consider also the results in the Just For Fee litigation which was recently concluded. That action was brought by a bankruptcy trustee appointed in the chapter proceeding for the bankrupt company. Following guilty pleas by three former executives the trustee brought a breach of fiduciary duty suit against former directors. The case settled with payments totally $41.5 million — a settlement not paid for by the D&O insurance which had been all but depleted by the time suit was filed,

All of this suggests that directors and officers would do well to take proactive steps to protect themselves. They should review with their counsel trends in their duties and obligations in addition to those involving the scope of their liability. In addition, compliance programs should be carefully reviewed along with provisions and arrangements concerning indemnification. D&O policies should also be reviewed, focusing on questions such as the amount and scope of coverage, rescission and severability.