Nine Cases to Shape the 2010 Legal Landscape

2009 was a notable year for securities litigation and regulatory enforcement, as the first consequences of the financial crisis had their days in court. Expect more to come in 2010.

The year started with a stern ruling from the Delaware Chancery Court that, no, shareholders at Citigroup could not sue the company’s leaders solely because directors made some pretty dumb decisions in years leading up to the mortgage meltdown. It ended with the Securities and Exchange Commission busting the powerful Galleon Group hedge fund, charging high-profile CEO Raj Rajaratnam with insider trading.

And those are just the legal proceedings that have already taken place. Many others only began in 2009 and will have far-reaching consequences as they come to fruition in 2010. Below is Compliance Week’s list of the most important litigation last year and what’s likely to happen next.

Decisions Made

In Re Citigroup Shareholder Derivative Litigation (Delaware Chancery Court; Feb. 24, 2009). In this case, unhappy investors sued current and former directors of Citigroup for failing to monitor, manage, and disclose Citigroup’s risks in the sub-prime lending market. Well, they failed. The court refused to second-guess the soundness of Citi’s decisions—no matter how bad those decisions were. In a 58-page ruling that provided some of the Chancery Court’s most expansive comments ever on the business judgment rule, the court held that oversight duties under Delaware law “are not designed to subject directors, even expert directors, to personal liability for failure to predict the future and to properly evaluate business risk.”

Ashcroft v. Iqbal (U.S. Supreme Court; May 18, 2009). Iqbal could sharply raise the standard of what plaintiffs must demonstrate to pursue a case in court. Essentially, the High Court said plaintiffs must offer more than “threadbare recitals of a cause of action’s elements supported by mere conclusory statements” for a judge to allow their case to proceed. Threadbare recitals, however, are the coin of the realm in lawsuits against corporations. The Iqbal decision could affect the pleading standards of all federal lawsuits: anti-trust, shareholder litigation, whistleblower complaints, discrimination claims, and more.

Van Asdale v. International Game Technology (Ninth Circuit Court of Appeals, Aug. 13, 2009). This was the Calfornia-based Ninth Circuit’s first attempt to define the requirements for a whistleblower-retaliation complaint under Sarbanes-Oxley. The court ruled that two former in-house corporate lawyers, who claimed to be fired for raising alarms about possible fraud, could indeed sue International Game for wrongful termination under SOX. The court said the pair only needed to demonstrate that they reasonably believed fraud had occurred at their company—not that fraud actually did occur. With that ruling, the Ninth Circuit put itself squarely in opposition to other appeals courts, such as the Virginia-based Fourth Circuit.

Actions Taken

SEC v. Bank of America (U.S. District Court for the Southern District of New York; Filed Aug. 3, 2009). In an enforcement action against the Bank of America, the Securities and Exchange Commission alleges that BofA executives misled shareholders about $5.8 billion in bonuses to be paid to Merrill Lynch executives ahead of a shareholder vote on their proposed merger. The SEC and the bank had agreed to a $33 million settlement over the matter—but in a rare and shocking move, federal district court judge Jed Rakoff rejected the deal. A settlement with the bank itself, rather than the executives in question, was effectively a “proposal to have the victims of the violation pay an additional penalty for their own victimization,” Rakoff said. The case was a shot across the bow to regulators and corporations alike, that judges might not go along with quick-hit settlements seeking to put the financial crisis in the past. It is now scheduled for a jury trial in March of 2010.

Cohen

U.S. v. Rajaratnam (U.S. District Court for the Southern District of New York; Filed Nov. 5, 2009). The SEC made headlines with mass arrests of more than a dozen people, alleging an insider-trading ring that netted more than $20 million in illicit profits. So far, 14 people have been charged for their involvement in the ring, and the SEC has warned that more arrests might be coming. Larry Cohen, head of the corporate practice at the Gibbons law firm, says the Galleon busts are a lesson for all fund managers and corporate leaders to have written procedures in place to combat insider trading. “Even if the complaint is dismissed on a technicality, many fund managers are undoubtedly examining their compliance procedures and are taking greater steps to prevent insider trading violations,” he says.

Proceedings Started

Hertz v. Friend (U.S. Supreme Court; Filed March 2, 2009). The U.S. Supreme Court, for the first time, will consider what constitutes a company’s “principal place of business.” The case involves employees of auto rental giant Hertz who claim that the company violated California’s wage-and-hour laws. Hertz is incorporated in Delaware, has its headquarters in New Jersey, and does its biggest volume of business in California. Some argue that a company’s “principal place of business” is where the company’s headquarters exist; others apply a variety of other tests such as where the majority of the company’s operations occur. Experts say the case could determine the battlefields where class actions and other litigation involving multi-state corporations will be fought.

Merck & Co. v. Reynolds (U.S. Supreme Court; Certiorari granted May 26, 2009). This case tackles the murky issue of when the statute of limitations of a federal securities fraud claim is triggered—an issue the court last addressed nearly 20 years ago. The dispute stems from allegations that pharmaceutical giant Merck misled shareholders by downplaying the heart-attack risks linked to its painkiller Vioxx. A federal judge dismissed the case after finding that the lawsuit, which had been filed in 2003, fell outside the two-year statute of limitations. The judge said that the plaintiffs should have known about the alleged fraud in 2001, when a report containing damaging data about Merck was released. Plaintiffs appealed, and here we are.

Conrad

Jones v. Harris Associates (U.S. Supreme Court; Filed Nov. 3, 2008). In this case, certain mutual fund shareholders sued the fund’s investment adviser, Harris Associates, alleging that the investment adviser charged excessive management fees for its services. At issue is what role the courts should play in regulating the compensation paid to investment advisers for mutual funds. “If the Court lowers the standard for litigation challenging management fees, it will open the floodgates to meritless lawsuits,” Robin Conrad, a spokesman for the U.S. Chamber of Commerce, wrote in a friend-of-the-court brief. “It shouldn’t be up to the trial bar to decide how much mutual funds pay their investment advisers.”

Free Enterprise Fund v. PCAOB (U.S. Supreme Court; argued on Dec. 7, 2009). Fittingly, 2009 ended with what may well be the most important litigation of the post-Sarbanes-Oxley era: a lawsuit claiming that the Public Company Accounting Oversight Board (and by extension, SOX itself) is unconstitutional. Conservative critics of the law teamed up with a small Nevada accounting firm, alleging that the PCAOB violates separation-of-power principles because its board members aren’t nominated by the president and approved by Congress.

Sloan

If the High Court finds the PCAOB unconstitutional—and many people have dismissed this lawsuit as frivolous for years, only to be proven wrong again and again—that could signal “a new wave of litigation about the scope and admissibility about the powers of independent regulatory agencies,” says Cliff Sloan, partner at law firm Skadden, Arps. The other implication, he adds, is that it would raise a host of questions about the scope of accounting firm oversight: “Who does those functions? Would there be legislation?”