Expert Commentary

D&O Litigation Trends in 2006

For the past 2 years, we have suggested that corporate officials were facing greater exposure to liability. In 2005 little occurred to indicate that the potential exposure faced by directors and officers is decreasing.

Professional, D&O, and Fiduciary Liability
June 2006

Four lawsuits joined the list of top 10 settlements in 2005. Median and mean settlement values continued to rise. More securities lawsuits went to trial in 2005 than in the past 10 years combined. Several senior executives of former Fortune 100 companies have been tried or face trials in 2006. Regulators continue to aggressively pursue perceived stock manipulators and recently have started to target outside directors. Suits involving foreign corporations have been an increasing target of shareholder litigation.

There are some signs that this trend may be abating. Perhaps due to less volatility in the stock market, the impact of Sarbanes-Oxley (SOx), and the efforts of regulators, the frequency with which securities class action suits were commenced decreased in 2005.1 Moreover, the market capitalization and disclosure dollar losses associated with those suits was lower than at any point prior to 2000. However, whether the decrease in securities claims filed reflects a trend downward or is merely an aberration from prior years remains to be seen.

Below we discuss the trends in securities litigation against directors and officers in 2005 and entering 2006.

The Size of Securities Claim Settlements Continues To Grow

In 2005 the average settlement of a securities class action was greater than in 2004, continuing the trend from prior years. The average settlement in 2005 was $28.5 million, up from $27.8 million in 2004. The median settlement also increased from 2004 to 2005, going from $6.3 million to $7.5 million in 2005—according to Cornerstone, the largest such single-year increase in history. Thus, the average settlement amount increased in smaller, as well as larger cases.

Two of the settlements in 2005 were the largest securities settlements in history: in Enron, $7.165 billion was paid to resolve shareholder and bond claims and, in WorldCom, $6.156 billion was paid to settle. The Enron and WorldCom settlements effectively doubled the largest prior settlement. Moreover, 2005 saw the addition of four new settlements in the "top five" list of largest settlements. In addition to Enron and WorldCom, AOL Time Warner settled class action securities litigation for $2.5 billion, and Royal Ahold agreed to pay $1.091 billion to settle securities litigation.

The settlement size of post-Private Securities Litigation Reform Act (PSLRA) class action lawsuits continues to be driven, at least in part, by the size of the market capitalization loss. Another factor is the involvement and leadership of institutional investors as plaintiffs. NERA identifies several other factors, the presence of which drives valuations up: the depth of the defendants' pockets or ability to pay, whether there are codefendant third parties (typically accountants), Section 11 claims, and restatements or other accounting irregularities.2 Since the advent of the PSLRA, the presence of institutional investors acting as lead plaintiff has resulted in significantly larger settlements.3

Rank Issuer Approximated Value of Settlement
1 Enron $7.16 Billion
2 WorldCom $6.16 Billion
3 Cendant $3.53 Billion
4 AOL Time Warner $2.5 Billion
5 Royal Ahold $1.1 Billion

Increasing Civil Trial Activity

The frequency with which plaintiffs have taken federal securities class action cases to trial has markedly increased. The general rule in securities litigation has been that such cases typically are dismissed or settled before trial. According to the Stanford Class Action Securities litigation database, of the 2,284 issuers sued in securities litigation from the effective date of the PSLRA in 1996 until mid-July 2005, over 1,300 have settled. In that same period, only eight securities class actions based on post-PSLRA conduct have gone to trial (in whole or in part). However, in what appears to be a trend toward litigating securities class action suits through trial, six cases have been tried since October 2004 (including one in June and July).4

We intend to track the results as this trend develops. Below is our first scorecard on the results of the post-PSLRA cases which have been taken to trial. Only two have yielded a defense verdict.

Table 1

results of the post-PSLRA cases which have been taken to trial

SEC Enforcement and the Impact of Cooperation

The SEC has continued to step up its prosecution of securities violations and accounting fraud. In fiscal year 2005 (ending September 30, 2005), the SEC filed 974 enforcement actions (up from 679 in 2004).5 In 2002 the Securities and Exchange Commission (SEC) announced its intention to pursue director and officer bars based on individual malfeasance. The number of officer and director bars sought by the SEC has grown from 51 in 2001 to 126 in 2002, totaling over 300 in the past 2 fiscal years, 2003 and 2004.6 SOx enhances the threat of a director or officer bar, permitting the SEC to pursue bar in an administrative proceeding (no longer exclusively within the federal courts) and reducing the standard to support the bar from "substantial unfitness" to mere "unfitness."

The SEC has not been reticent about seeking civil penalties, which the SEC may waive or enhance depending on the target's cooperation with the SEC's investigation. A company that cooperates may avoid millions of dollars in civil penalties and save its executives from a lengthy bar. The SEC reportedly rewarded Royal Ahold's cooperation by not seeking a penalty against the company when the company waived the attorney-client privilege and produced documents to the SEC arguably protected by the attorney work-product doctrine.7

Regulators Increasingly Target Outside Directors

In the wake of the massive accounting scandals at Enron and WorldCom, the SEC announced that it would pursue enforcement actions against outside directors who ignore corporate wrongdoing. The SEC's proclamation represents a fundamental shift in the SEC's enforcement policies with respect to outside directors. An SEC enforcement action against a former outside board member at Chancellor Corporation exemplifies the SEC's new stance. In Chancellor, the SEC alleged that the company improperly booked $19 million in revenue and improperly wrote off $1.4 million in related-party payments. The SEC further alleged that the company fired its auditing firm that disagreed with its accounting practices and replaced the auditors with an auditor who was willing to sign off on the company's accounting. With respect to the company's outside director, Rudolph Peselman, the SEC alleged that Peselman knew that the auditors had been replaced because of their disagreement with the company's accounting practices and that the company had written off $1.4 million in related-party payments. In spite of this knowledge, Peselman approved the company's financial statements, "completely neglect[ing] his duties as a director and an audit committee member," according to the SEC.8 Based on his oversight, the SEC sought to bar Peselman from serving as an officer or director. In 2005 Peselman and the SEC reached a settlement whereby Peselman agreed to a permanent bar from serving as an officer or director.

Heralding the change in the SEC's enforcement policies with respect to outside directors, former SEC enforcement chief Stephen Cutler deemed the Chancellor case the "first salvo in this area." Cutler explained that, "[t]his case signifies the commission's willingness to pursue cases against outside directors who were reckless in their oversight of management and asleep at the switch."9 More recently, Alan Beller, former director of SEC's Division of Corporate Finance, confirmed that a number of SEC ongoing investigations involve outside directors.10

SEC actions against outside directors for so-called oversight failures are civil in nature. Criminal liability against an outside director generally requires that the director willfully or knowingly violated the securities statutes at issue. Accordingly, it is not surprising that in oversight cases there have been no criminal prosecutions against an outside director to date.11

Conversely, criminal sanctions have been imposed against outside directors for insider trading and self-dealing. When an outside director is found to have engaged in insider trading, out-of-pocket payments are not uncommon. In such cases, the SEC may seek disgorgement of trading profits, civil penalties, and an officer and director bar. Similarly, in cases involving self-dealing, the SEC may seek disgorgement of the gains and possibly a civil penalty as well.

Increasing Activity Involving Foreign Corporations

The last several years have seen a substantial increase in the number of SEC enforcement actions and securities class action lawsuits against foreign filers. According to PriceWaterhouseCoopers 2004 Foreign Securities Litigation Study, a record 29 foreign issuers on U.S. exchanges were sued in private U.S. securities class action lawsuits in 2004. In addition, total foreign settlements in 2004 totaled $522,450,000, an increase of almost 6 percent from the 2003 total settlements of $494,600,000.12 Since the enactment of SOx, the number of SEC enforcement actions against foreign registrants and entities has continued to increase. In 2002 there were three enforcement actions against foreign registrants or entities as reported in the SEC Litigation Series Releases.13 In 2003 and 2004, the number of enforcement actions increased to seven. In 2005 there were a record 15 SEC enforcement actions against foreign registrants or entities. There was a modest decrease in the number of securities class action lawsuits filed against foreign issuers in 2005, from 29 suits in 2004 to 25 suits in 2005.

While several foreign jurisdictions have enacted legislation allowing litigation styled on U.S. securities class actions in recent years,14 the United States remains at the center of securities class action litigation. For the most part, it appears that the English Rule in many countries that shifts the winner's fees to the loser, together with limitations on contingent fee arrangements, has so far limited the interest of the plaintiffs' bar in such countries to pursue securities class action litigation. In addition, several U.S. court decisions in recent years have opened the doors to U.S. courts (and class recoveries) for foreign investors. U.S. courts have provided jurisdiction for the claims of purchasers of American Depository Receipts (ADRs) of foreign companies.

More recently, U.S. courts are permitting class actions against foreign companies to include—within the class—the claims of foreign purchasers of the shares of the foreign company purchased on foreign exchanges.15 A clear consequence of such decisions is to broadly expand the size of the class, and therefore expand the exposure of the issuer and its officer and directors to U.S. litigation costs.

A Decreasing Number of Securities Claims

The year 2005 was the lowest year for securities action filings since 1997. Cornerstone Research tallied 176 "traditional" filings in 2005, down from 213 in 2004.16 As the total number of issuers has not materially changed since 2004, there was also a modest decrease in the number of filings per issuer. Of the total issuers listed on the NYSE, NASDAQ, and Amex, 2.4 percent were named as defendants in traditional securities class actions filed in 2005, down from 2.8 percent in 2004. Of these "traditional" securities class actions, 10 were "mega" filings involving $10 billion or greater disclosure dollar loss and represented 67 percent of the total disclosure dollar loss in 2005. This is a decrease from the 16 mega-filings in 2004 (that represented 77 percent of the total disclosure dollar loss in 2004).


The 2005 data suggests that corporate officers and directors continue to experience significant exposure to liability in both private litigation and government enforcement actions. While there was a decrease in the number of private securities class action suits, it is too soon to surmise whether the data reflects a downward trend or is merely an aberration. The corporate scandals of the last several years have resulted in increased liability for outside directors and officers, from both government regulators and private plaintiffs. Finally, SEC proceedings against foreign corporations have increased significantly, although there was a small decrease in the number of securities class actions against such corporations.

1Securities Class Action Case Filings—2005: A Year in Review (the report identifies class action filings as of December 19, 2005).

2Elaine Buckberg, Todd Foster, and Stephanie Planich, Recent Trends in Securities Class Action: 2003 Update, NERA Economic Consulting (April 23, 2004) (last accessed Feb. 7, 2005).

3Laura E. Simmons and Ellen M. Ryan, Post-Reform Act Securities Lawsuits—Settlements Reported Through December 2003, NERA Cornerstone Research (2004), page 9, Figure 9. (last accessed Feb. 7, 2005).

4See also, July 2005 SCAS Alert, "See You in Court: Examining the Recent Spike in Securities Class Action Trials", Bruce T. Carton; Securities Reform Act Litigation Reporter, "Ten Years After the Reform Act: Trends in Securities Class Action Trials", July 2005, Michael Tu.

5The Sarbanes-Oxley Act: The First Year, House Committee on Financial Services, at 15; William H. Donaldson, Chairman, U.S. Securities and Exchange Commission, Remarks to the Practising Law Institute (November 6, 2003).

6Stephen M. Cutler, Director, Division of Enforcement, U.S. Securities and Exchange Commission, The Themes of Sarbanes-Oxley as Reflected in the Commission's Enforcement Program, (last accessed Jan. 27, 2005).

7Examples include Canada, Germany, Sweden, South Korea, and Australia., "SEC to Target 'Reckless' Directors in Fraud Cases, Cutler Says", August 20, 2003.


10Bernard Black, Brian Cheffins, Michael Klausner, "Outside Director Liability", Stanford Law Review, Feb. 2006.


12PriceWaterhouseCoopers 2004 Foreign Securities Litigation Study, page 6.

13Id. at page 3.

14Examples include Canada, Germany, Sweden, South Korea, and Australia.

15In re Royal Ahold N.V. Sec. and ERISA Litig., 351 F. Supp. 2d 334 (D. Md. 2004) and In re Vivendi Universal SA Sec. Litig., 2004 WL 2375830 (S.D.N.Y. Oct. 22, 2004), but see also In re Bayer AG Securities Litig., 2005 WL 2222273 (S.D.N.Y. Sept. 14, 2005) (where court declined subject matter jurisdiction of claims of foreign purchasers of shares on foreign exchanges).

16Stephen M. Cutler, Director, The Themes of Sarbanes-Oxley as Reflected in the Commission's Enforcement Program, (last accessed Jan. 27, 2005).

David T. Burrowes, a principal with Boundas, Skarzynski, Walsh & Black, LLC, since its inception in 2003, has particular expertise with professional liability claims and insurance policies, particularly directors and officers liability, employment practices liability, and insurance company and brokers' errors and omissions. Mr. Burrowes received his BA degree from UCLA and his JD from Vanderbilt University. He has been admitted to practice in California and in Illinois. His e-mail address is

Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.

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