Imagine that you are a lawyer at a rapidly growing public U.S. company. Your company has recently disclosed bad news to the market. Following this disclosure, the price of the company’s stock sinks by 20%. Within a matter of days, multiple shareholders have filed lawsuits alleging that, prior to the disclosure of the bad news, the company and its senior management had made material misstatements in public filings in violation of the federal securities laws. Upon learning of the lawsuits, your CEO calls you into his office and asks—now what?
Getting sued for securities fraud is a major event in the life of a company. Securities fraud actions are typically brought as class actions, thereby magnifying the potential exposure. It is not uncommon for plaintiffs to seek hundreds of millions, or even billions, of dollars worth of damages. Securities fraud actions can result in bad publicity, frayed business relationships, adverse employment decisions, and regulatory and potentially even criminal investigations. The actions can last years and eat up millions of dollars in legal and other fees alone.
The steps that a securities fraud defendant takes at the outset of the matter can have a significant impact on the ultimate resolution of the matter. This article discusses some of the steps that should be carefully assessed and accomplished soon after a securities fraud action is filed. Companies sued for securities fraud would be wise to think through these issues, as well as the other, case-specific issues that arise soon after the filing of a securities fraud complaint.
I. Promptly Notify Insurers
Securities fraud actions are typically covered by insurance. However, it is often imperative under the insurance policy that notice of the lawsuit be provided to the insurer promptly. Accordingly, the company should immediately notify its broker of the filing of any securities fraud class action and have the broker deliver written notice of the claim to the insurer. Depending on the size of the company and the amount of insurance coverage, it is common for companies to have a “tower” of D&O insurance coverage, i.e., a primary policy with one or more layers of excess coverage. The company should make certain that notice is given to all carriers under all applicable policies. If the company is later hit with additional lawsuits or matters, including derivative demands or regulatory inquiries, it should supplement its original notice.
After providing notice, the company will likely have an ongoing obligation to communicate developments in the lawsuit to the insurer. The company should therefore establish a plan for ensuring that these communications are made in regular way. Among other things, the company will want to think through the potential privilege implications of having litigation counsel provide written communications and updates to the insurer.
II. Select Qualified Securities Litigation Counsel
Careful consideration should be given to the attorneys who will defend a securities fraud action. Securities laws are specialized and the best attorneys in this area have been defending securities cases for years, if not decades. There are numerous procedural quirks and complicated legal issues that often arise in securities fraud actions. For example, counsel must think through unique pleading standards, class certification considerations, how damages are calculated, what sorts of bad acts “count” towards pleading and proving that the defendant acted with an intent to defraud, and a host of other issues. An inexperienced lawyer may not be aware of, or fully understand, these critical issues. Moreover, there are added advantages to choosing a lawyer who regularly litigates against, and knows the tactics of, the plaintiffs’ firms who are active in this space. Thus, most companies choose to hire securities litigation specialists to handle securities fraud actions, rather than simply retaining the litigators who happen to work at their day-to-day law firm and handle their more run-of-the-mill litigation. Many insurers maintain lists of approved panel counsel who have significant experience defending securities fraud actions. Not only are these counsel well known to the insurers who will likely be paying for the defense of the matter, but they will be experienced in working through the various issues raised by a complex securities fraud complaint.
When hiring counsel, it is important to resolve who counsel will be representing. Securities fraud actions are often brought against many defendants. For instance, a single complaint may bring claims against the issuer, its CEO, CFO, and board members. Careful consideration should be given to whether all of the defendants should present a “united front” by being represented by a single law firm or whether, because of unique defenses or even potential conflicts of interest, different defendants should be represented separately. If multiple defendants choose to be represented by the same lawyer, it is advisable to spell out what will happen should a conflict later arise.
III. Indemnification of Directors and Officers
Another threshold issue that companies often must address in securities litigation is indemnification requests by past or present officers or directors who have been sued along with the company. It is common for companies to grant in their articles of incorporation and/or bylaws broad rights to indemnification and advancement of expenses. Moreover, individual directors or officers may have separately negotiated indemnification agreements with the company. Thus, when responding to an indemnification demand, the company should carefully analyze these documents, as well as state law governing indemnification.
The advancement of expenses is most likely to be needed when a director or officer retains separate counsel from the company. When advancing expenses, companies typically obtain a written undertaking from the officer or director that requires him to repay all amounts advanced by the company in the event that it is later determined that he is not entitled to be indemnified.
IV. Notify the Company’s Board of Directors
Company management should notify the company’s board of directors that a securities fraud action has been filed. Thereafter, procedures should be put in place for the board to receive periodic updates regarding the litigation. Careful consideration should be given to whether those updates should be privileged and the best ways to maintain the privilege. Depending on the nature of the allegations, the board may have an obligation to undertake its own investigation. In such circumstances, the board will retain independent counsel of its own.
V. Press Release and Other Public Relations Considerations
Companies hit with a securities fraud action often struggle with whether they should issue some sort of press release in response to the announcement of the lawsuit. For instance, the company may want to make clear that the complaint lacks merit and may believe that issuing a press release denying the claims is the best way to spread the word. Moreover, the company may believe that the issuance of a press release will stem the tide of investor inquiries regarding the lawsuit. A company would be well advised to think carefully through these issues before making any public statement. In fact, there are often good reasons not to issue a press release. For instance, a press release that merely denies liability and asserts that the company will defend the case vigorously are typically viewed as mere boilerplate. As such, they do little to change public perceptions. (They can, however, generate questions if, after issuing such a release, the company settles the case quickly.) Moreover, a more detailed press release -- even one that is carefully vetted -- will often do nothing to slow down the securities fraud plaintiffs and, if not fully accurate, may provide ammunition that can be exploited by the plaintiffs throughout the case. Finally, it is unlikely that a press release -- whether of the boilerplate or detailed variety -- will slow down investor inquiries.
A securities fraud action may, of course, relate to bigger issues that warrant discussion in the press. For instance, the litigation may relate to a business problem, such as a product recall, that warrants a public relations response. The company should not jettison its entire public relations strategy merely because a lawsuit has been filed. However, the company should be particularly vigilant to ensure that what it says is accurate. It should also consider involving its litigation counsel in the review of any proposed public relations communications. Be aware, however, that communications involving attorneys are not always privileged. As a result, you should carefully think through the attorney-client privilege issues associated with counsel’s involvement with public relations efforts.
VI. Document Preservation
Defendants have an obligation to ensure that all potentially relevant documents are maintained during the pendency of a securities fraud action. This obligation is imposed as soon as the complaint has been filed and served. Failure to preserve documents can lead to serious litigation consequences, including potential monetary sanctions, adverse inferences, or default judgments. Accordingly, a securities fraud defendant will want to make sure that all documents that are even arguably relevant are preserved as soon as it learns about the complaint.
As used in the law, the obligation to preserve “documents” does not extend only to paper documents. Rather, the obligation applies to all electronic documents, including emails, and any other medium pursuant to which information is stored or communicated. Accordingly, to ensure that all documents are preserved, a securities fraud defendant should do at least two things. First, the defendants or its counsel should send a memo to all individuals within the organization who may have even potentially relevant information. The memo should direct all of these individuals to maintain and not alter the information until further notice. The memo should expressly cover both paper documents and all forms of electronic documents. Second, the company will want to work with its IT personnel to ensure that electronic documents are maintained. This process may require that automatic document deletion technologies are turned off. It may also involve the imaging of hard drives or the taking of other steps to ensure that electronic documents do not get destroyed. The company, working with counsel, should consider the benefits of bringing in an electronic discovery consultant to assist with document preservation effort.
VII. Get Prepared for a Very Long Process
Securities class actions move very slowly. They typically begin with the filing of many different complaints by many different plaintiffs. The plaintiffs who file those complaints will then go through a court process to determine which plaintiff will be the “lead” plaintiff. The court appointed lead plaintiff selects counsel, who will then typically file an amended and consolidated complaint. This will be the sole operative complaint going forward. It can take many months, and sometimes more than a year, for the selection of lead plaintiff and the filing of this amended and consolidated complaint to occur.
After the filing of the amended and consolidated complaint, defendants typically -- though not uniformly -- file a motion to dismiss the case. The securities laws impose a defendant-friendly stay of discovery during the pendency of such a motion to dismiss. The briefing on a motion to dismiss can last for months and it can thereafter take months or even years for the court to rule on the motion. In light of the lead plaintiff and motion to dismiss processes, it usually takes well more than one year before discovery (exchanges of documents and depositions) begins in a securities class action. Discovery itself can last many months or even years. Accordingly, it is not unusual for securities fraud actions to last multiple years.