Securities Litigation andD&O Insurance:

Understanding Your Exposure and Minimizing Your Risk

Nina (Nicki) Locker

Steven Guggenheim

Michael Winograd

The “Truth” Is Revealed

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June 2010

July 2010

September 2010

October 2010

mid-October

2010

January 2011

Securities class action

filed

Q3/Q4 2010

guidance

Restatement 2009/missed guidance

release

SEC informalinquiry

Share Price

FY 2009 Form

20-F filed

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The Basics

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• Who are the plaintiffs?– Investors who purchased during the class period and

held through the bad news• What is their basic claim?

– Company made a false statement upon which plaintiffs relied in purchasing or selling the Company’s stock

– Section 11 versus 10b-5 Intent to defraudCircumstantial evidence enough

• Who do plaintiffs typically sue?– Company, CEO,CFO– Directors?

What Plaintiffs Look For

Bad News

+Significant stock drop

+

Insider trading/offering

=

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A Really Bad Week For MyStockDropped.com

• Day 1 – Contrary to company’s revenue recognition policy, major reseller claims no obligation to pay until resale; GC investigates

• Day 2 – Reseller sends GC email supporting its claim

• Day 3 – Sales person admits agreement but claims isolated instance

• Day 4 – Earnings announcement and conference call

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email for really bad week presentation.nrl

A Really Bad Week (cont’d)

• Day 5 – GC’s investigation uncovers evidence suggesting widespread practice and raising questions regarding CFO knowledge

• Day 6 – Audit Committee retains regular outside counsel to conduct investigation

• Day 7 – CEO sells 50,000 shares

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The Aftermath

• Two year restatement of company’s financial statements

• Government commences investigation

• Shareholders file securities class action lawsuit

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What Went Wrong?

• Problem – Disclosures mishandled

• Solution – Best practices for disclosing bad news

– Don’t “spin” news

– Provide updates when necessary

– Stick to historical facts

– Avoid premature explanations

– Designate single spokesperson

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What Went Wrong?

• Problem – No insider trading policies• Solution – Control insider stock sales

– Insider trading policyProhibition against trading on the basis of material,

non-public informationProcedures to communicate policy to directors,

officers and employeesPre-clearanceBlackout periodsCompliance officer

– Proactively closing trading window– 10b5-1 plans

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What Went Wrong?

• Problem – Investigative counsel lacked credibility and objectivity

• Solution – Carefully consider who should conduct investigation

– Inside counsel, regular outside counsel vs. independent counsel

Relationship of counsel to issues under review

Seniority of employees potentially involved

Seriousness and nature of suspected activity

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What Went Wrong?

• Problem – Emails that make a bad situation worse

– Board member to Board member email: “I had concerns about his [the CFO’s] integrity from the outset. But I was overruled. Turns out I was right. ”

• Solution – Educate directors, officers and employees to treat email with caution

– Limit discussion of sensitive topics via email

– Avoid post-mortems

– Understand that email/instant messaging creates a permanent message

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You Got Sued: Now What?

• Call your Board

• Notify your insurance broker/insurance consultant

• Notify your outside counsel/auditors

• Preserve your documents

• Consider communication to employees and customers

• Hurry up and wait

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Selection of Limits: MyStockDropped.Com

Total shares outstanding 35,339,781

Deduction of insider shares (1) (102,485) Potential class member shares 35,237,296 Reduction in share price following a drop of 60% from $25.00 15.00$ Potential SEC class action exposure 528,559,440$

Settlement value at 75th percentile (2) 17,934,864$

Defense Costs (3) 3,302,351$ Example of Policy Limit 22,000,000$

Footnotes:(1) In a Securities Class Action, Directors,Officers and affiliates are generally excluded from the Class.

Data obtained from recent financial reports indicates that 0% of shares are owned directly orbeneficially by MyStockDropped.Com directors, officers and affiliates.

(2) Database indicates that for cases with this potential class action exposure, 75% of the cases settle for 3.4% or less of exposure.

(3) The defense cost amount shown above is an example only. (4) Settlement values and defense costs for shareholder derivative actions are not included in these calculations.

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Directors and Officers InsuranceHot Issues: Dishonesty Exclusion

• Problem: Carrier can deny coverage for “dishonest conduct”

• Solution: Language requiring some kind of “final adjudication”

• Pitfalls: Avoid soft or vague triggers

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Directors and Officers InsuranceHot Issues: Severability

• Problem: An insurer can rescind (revoke) the policy against all insured persons if there are false statements in the insurance application.

• Solution: Language limiting rescission to those who knew of the false statements and forcing the insurer to sue to rescind.

• Pitfalls: Avoid so-called “non-rescindable” endorsements.

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Directors and Officers InsuranceHot Issues: “Exhaustion”

• Problem: Language in excess policy may allow excess insurer to avoid paying under policy if underlying insurer paid less than its full policy limits

• Solution: Language specifically allowing insured to pay reminder of underlying limits where underlying insurer fails to pay

• Pitfalls: Avoid language that requires “admission of liability” by underlying insurer or language which only requires payment by excess carrier under limited circumstances

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Out of Pocket Contributions by Directors and Officers

• Empirical studies show that out-of pocket contributions are still rare

– Officers less than 5% of settlements

– Outside Directors less than 1% of settlements

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Out of Pocket Contributions by Directors and Officers – The Perfect Storm

• Factors

– Bankruptcy

– Inadequate insurance

– Strong merits

Section 11

SEC imposed penalties

Suspicious insider selling

– Wealthy directors

• Enron, Worldcom

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