Navigating today’s complex risk environment can be a monumental task. Steve Shappell, Alliant Claims & Legal, spearheads Executive Liability Insights, a monthly review of news, legal developments and information on executive liability, cyber risk, employment practices liability, class action trends and more. 

Table of Contents

SETTLEMENTS IN SECURITIES FRAUD SUITS NOT COVERED LOSS UNDER D&O POLICY

Joy Global Inc. v. Columbia Cas. Co., No. 2:18-CV-02034 (E.D. Wis. Aug. 18, 2021) 

 

This coverage litigation arose after a manufacturer of refinery equipment announced a potential agreement to be acquired. Subsequently, several shareholder lawsuits were filed against the manufacturer and its directors and officers challenging their representations and conduct with respect to the proposed sale and alleging they had issued a false or misleading proxy report.

 

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D&O INSURER MUST ADVANCE DEFENSE COSTS FOR INVESTIGATION OF FALSE CLAIMS ACT VIOLATIONS 

Guaranteed Rate, Inc. v. ACE Am. Ins. Co., No. N20C-04-268 MMJ CCLD (Del. Sup. Ct. Aug. 18, 2021)

 

A mortgage company received a civil investigative demand from the U.S. Attorney’s Office for the Northern District of New York and the U.S. Department of Justice, which alleged False Claims Act violations in relation to the company’s underwriting and issuance of federally-insured mortgage loans. 

 

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DELAWARE JUDGE DECLINES TO DISMISS POLICYHOLDER LAWSUIT ALLEGING D&O INSURER WRONGFULLY DENIED COVERAGE 

CVR Refining, LP v. XL Specialty Ins. Co., No. N21C-01-260 EMD CCLD (Del. Super. Ct. Aug. 11, 2021)

 

The case at hand arose after two sets of investors brought suit in both the Delaware Chancery Court and New York Federal Court claiming a Texas petroleum refining company and two of its executives manipulated the stock price to the energy company’s benefit. 

 

Read More >>

DEMAND FOR ARBITRATION IS A CLAIM UNDER D&O POLICY 

Supima v. Philadelphia Indem. Ins. Co., No. 20-617 (D. Ariz. June 16, 2021) 

 

In the underlying matter, the insured, a nonprofit, received a demand letter from a wholesale company advising it wanted to arbitrate a dispute pursuant to a license agreement it had with the insured. 

 

Read More >>

DIRECTOR DEFENDANTS NOT ‘NECESSARY AND INDISPENSABLE’ PARTIES IN COVERAGE LITIGATION AGAINST D&O INSURER

LRN Corp. v. Markel Ins. Co., et al., No. 20-cv-8431 (S.D.N.Y. Aug. 23, 2021)


In the underlying suit, a minority shareholder filed a complaint against a consulting company and three of its directors alleging the defendants orchestrated a scheme to reduce the outstanding shares and gain control of the company prior to a planned, but unannounced, merger. 

 

Read More >>

SELLING UNREGISTERED SECURITIES CONSTITUTES PROFESSIONAL SERVICES UNDER PROFESSIONAL LIABILITY POLICY

Saoud v. Everest Indem. Ins. Co., No. 19-12389 (E.D. Mich. Jul. 28, 2021)


An insured retirement planning firm that was not licensed to sell securities sold a “memorandum of indebtedness” to several of its clients. The memoranda were an accounts receivable/lending scheme developed by a non-related company that was not registered as a security with the U.S. Securities and Exchange Commission (“SEC”). 

 

Read More >>

HOLD THE LINE ON HOLDER CLAIMS

Hussein v. Razin, et al., No. 30-2013-00679600 (N.J. Super. Ct. Jul. 29, 2021)


In a rare “holder” claim under the California Securities Laws, a jury found a healthcare technology company and its directors and officers not liable for making false and misleading statements, causing the company’s second largest investor to forego selling his shares.

 

Read More >>

SINGLE LAWSUIT CONTAINS MULTIPLE CLAIMS UNDER D&O POLICY

Stem, Inc. v. Scottsdale Ins. Co., 2021 WL 1736823 (N.D. Cal. July 30, 2021)


As discussed in the June 2021 edition of Executive Liability Insights, the U.S. District Court for the Northern District of California determined that two causes of action contained in one lawsuit constituted separate claims, even though a directors and officers liability (“D&O”) policy defined “Claim” as a “civil proceeding” or a “written demand.” 

 

 

Read More >>

PRIVATE EQUITY FIRM AND POST-MERGER ENTITY MUST FACE INVESTOR SUIT

Hedick, et al. v. The Kraft Heinz Co., et al., No. 19-cv-1339 (N.D. Ill. Aug. 11, 2021)


A private equity firm and an American food conglomerate did not succeed in dismissing a securities class action alleging the company made false and misleading statements in violation of Section 10b and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5.

 

 

Read More >>

MUTUAL FUND SERVICE FEES THAT ARE PRODUCT OF ARM’S LENGTH BARGAINING DO NOT BREACH FIDUCIARY DUTY​ 

Obeslo v. Great-West Life & Annuity Ins. Co., No. 20-1310 (10th Cir. Jul. 26, 2021) 


Plaintiff shareholders brought an action against the investment advisor of their employer sponsored retirement plan’s mutual fund, alleging breach of fiduciary duty for charging excessive fees. They claimed that both the advisory and administrative fees charged to the index and bond funds were so disproportionate to the services rendered that they violated the Investment Company Act of 1940 (“ICA”).  

 

 

Read More >>

TECH COMPANY’S UNFAIR COMPETITION SUIT TOSSED WITHOUT LEAVE TO AMEND 

Enigma Software Grp. USA LLC v. Malwarebytes Inc., No. 5:17-cv-02915-EJD (N.D. Cal. Aug. 9, 2021)


A cybersecurity software company’s unfair competition lawsuit against a rival internet security company, previously cited by both a U.S. Supreme Court justice and the Trump Administration’s Department of Justice in the backlash against the so-called “Big Tech liability shield,” was recently tossed without leave to amend by a California court.

 

Read More >>

COVERAGE FOR MEMBER OF INSURED LLC NOT BARRED BY INSURED VS. INSURED EXCLUSION IN D&O POLICY

Starr Indem. & Liab. Co. v. Point Ruston LLC, No. C20-5539RSL (W.D. Wash. Aug. 17, 2021) 


A Washington federal district court recently held that an insurer did not meet its burden of showing that coverage for a lawsuit stemming from alleged mismanagement of entities involved in a commercial development project was barred by the insured vs. insured (“IvI”) exclusion in a directors and officers (“D&O”) liability policy. 

 

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DERIVATIVE CLAIMS EXPOSE TOP EXECUTIVES TO LIABILITY

Directors and officers of corporations have access to funds as well as sensitive and often potentially lucrative information. Utilization of these funds and information to the sole benefit of the executive, aside from risking potential insider trading violations, exposes the company and its executives to, among other things, shareholder derivative actions. 

 

Read More>>

 

 

APPRAISAL ACTION NOT A CLAIM FOR WRONGFUL ACT UNDER D&O POLICY

Jarden, LLC v. ACE Am. Ins. Co., et al., No. N20C-03-112 AML CCLD (Del. Super. Jul. 30, 2021)

 

A consumer products company entered into a merger agreement, and while the majority of the company’s stockholders approved the merger, several filed appraisal petitions in the Delaware Chancery Court. 

 

Read More>>

CYBER CORNER

Click to read the following cases:

 

  1. EMPLOYEES HAVE STANDING TO SUE EMPLOYER AND IT VENDOR OVER DATA BREACH: In re GE/CBPS Data Breach Litig., No. 1:20-cv-02903-KPF (S.D.N.Y Aug. 4, 2021)
  2. SETTLEMENT OF FINTECH PRIVACY SUIT A BOON TO PLAINTIFFS’ BAR: In re: Plaid Inc. Privacy Litig., No. 20-3056 (N.D. Cal. Aug. 5, 2021) 
  3. PROTECTING FORENSIC REPORTS FROM DISCOVERY KEEPS GETTING HARDER: In re Rutter’s Data Breach Sec. Litig., No. 1:20-CV-382 (E.D. Pa. Jul. 22, 2021)
  4. ARE GIFT CARDS AS GOOD AS CASH?: In re WaWa, Inc. Data Sec. Litig., No. 19-6019 (E.D. Pa. Jul. 30, 2021)
     

 

EPL CORNER

Click to read the following cases:

 

  1. Mendoza v. Fonseca McElroy Grinding Co., Inc., Case No. S253574 (Cal. Aug. 16, 2021)
  2. Busker v. Wabtec Corp., Case No. S251135 (Cal. Aug. 16, 2021)
  3. Botta v. PwC, et al., No. 3:18-cv-0261 (N.D. Cal. Jul. 26, 2021)
  4. Hobby Lobby Stores, Inc. v. Sommerville, No. 2-19-0362 (Ill. App. Ct. Aug. 13, 2021)
  5. Carrone v. UnitedHealth Grp., Inc. et al., No. 20-2742 (3rd Cir. Aug. 11, 2021)
  6. Castellanos v. State of California, et al., No. S266551 (Cal. Super. Aug. 20, 2021) 

SEC CORNER

Click to read the following cases:

 

  1. Alliance for Fair Board Recruitment v. SEC, No. 21-60626 (5th Cir. Aug. 10, 2021)
  2. SEC STRESSES TIMELY NOTICE OF CYBER INCIDENTS TO INVESTORS
  3. FURTHER EVIDENCE THAT CYBER RISK IS A BOARD-LEVEL ISSUE
  4. SEC’S EMPHASIS ON CONTINGENT LIABILITIES ENDURES  
  5. AUGUST 2021 NOTEWORTHY ENFORCEMENT ACTIONS FILED

SHAREHOLDER CORNER

2021 SECURITIES CLASS ACTION FILINGS UPDATE

SETTLEMENTS IN SECURITIES FRAUD SUITS NOT COVERED LOSS UNDER D&O POLICY

Joy Global Inc. v. Columbia Cas. Co., No. 2:18-CV-02034 (E.D. Wis. Aug. 18, 2021) 

This coverage litigation arose after a manufacturer of refinery equipment announced a potential agreement to be acquired. 

Subsequently, several shareholder lawsuits were filed against the manufacturer and its directors and officers challenging their representations and conduct with respect to the proposed sale and alleging they had issued a false or misleading proxy report. All but one suit settled prior to the close of the transaction and the remaining complaint was amended post-merger to allege the misrepresentations in the proxy statement were made to induce shareholders to accept the transaction for an inadequate share price consideration. 


The lawsuit eventually settled and the manufacturer sought coverage under its directors and officers liability (“D&O”) policy. The D&O insurer agreed to reimburse defense costs but denied coverage for the settlements, citing carve-out language in the definition of “Loss” that precluded coverage for “any amount of any judgment or settlement of any Inadequate Consideration Claim,” which the policy defined as “that part of any Claim alleging that the price or consideration paid … for the acquisition … of all or substantially all of … an entity is inadequate.”


The manufacturer argued the settlements should be covered because there were allegations pertaining to misrepresentations, in addition to inadequate share price. In rejecting the manufacturer’s arguments, the Eastern District of Wisconsin held there was no reasonable expectation of coverage based on the “clear and unambiguous” language of the policy, noting that “each cause of action within [all of] the [underlying] suits relied on … allegations of inadequate consideration,” and as such, the entirety of each of the underlying suits were “part of [a] Claim alleging … inadequate consideration.” 


The court further refused to apply the recent ruling in Northrup Grumman where a Delaware trial court found similar policy language required that the allegations only pertain to inadequate share price consideration and “nothing else” to fall outside the scope of coverage. The Wisconsin court found the Delaware court’s reasoning in Northrup Grumman to be “unpersuasive,” stating the clear language of the carve-out did not address the requirement that inadequate consideration be the only allegation. The court further observed that Wisconsin law did not license it “to rewrite unambiguous policy language.” 

 

The Takeaway

As this case highlights, careful attention must be paid to the provisions of the definition of “Loss.” It is vital to ensure the language is expansive and does not limit coverage for settlements where that is not the intent.

D&O INSURER MUST ADVANCE DEFENSE COSTS FOR INVESTIGATION OF FALSE CLAIMS ACT VIOLATIONS 

Guaranteed Rate, Inc. v. ACE Am. Ins. Co., No. N20C-04-268 MMJ CCLD (Del. Sup. Ct. Aug. 18, 2021)

A mortgage company received a civil investigative demand from the U.S. Attorney’s Office for the Northern District of New York and the U.S. Department of Justice, which alleged False Claims Act violations in relation to the company’s underwriting and issuance of federally-insured mortgage loans.  

 

The mortgage company promptly tendered the civil investigative demand under its private company management liability policy. Several months later, after the investigation concluded, the mortgage company requested reimbursement from its insurer, but the insurer denied coverage and litigation ensued.

 

The insurer argued the civil investigative demand was not a “Claim” under the policy, and that, in addition to failing to establish that defense costs had fully eroded the retention, the mortgage company should have requested advancement of defense costs prior to the disposition of the investigation. The court disagreed with the insurer’s argument on all counts, first noting the civil investigative demand was a “Claim” under the policy because the alleged violations of the False Claims Act would clearly be a “Wrongful Act.” According to the court, the insurer was required to provide coverage "whenever a complaint against the insured, read as a whole and with all reasonable inferences made in light most favorable to the policy holder, alleges facts that potentially fall within the scope of coverage." Moreover, because the civil investigative demand and related investigation constituted a “Claim,” the duty to advance defense costs under the policy was triggered.

 

The insurer further contended the policy’s professional services exclusion applied to preclude coverage because the underwriting and mortgage origination activities at issue in the civil investigative demand were considered professional services. The professional services exclusion precluded coverage for “Loss on account of any Claim ... alleging, based upon, arising out of, or attributable to any Insured's rendering or failure to render professional services;” however, the term “professional services” was not defined in the policy. Again, the court disagreed with the insurer, finding the broad nature of the professional services exclusion and the policy’s failure to define “professional services” meant “the exclusion must be interpreted narrowly in favor of coverage.” The court reasoned that because the mortgage company “was in the business of underwriting and issuing loans to borrowers,” and “the Wrongful Acts alleged in the underlying investigation involve[d] … federally-insured loans that failed to meet applicable quality-control standards,” which was a duty that was owed to the federal government, compliance with such standards was not a professional service provided directly to borrowers such that the exclusion would apply.

The Takeaway

This case presents a significant win for insureds when it comes to coverage for False Claims Act violations, or any other government investigation costs. As the federal government’s primary tool for combatting fraud, False Claims Act enforcement is not an insignificant exposure for companies, particularly in the wake of the COVID-19 pandemic, and the Delaware Superior Court is only the latest in a growing list of courts to have found “no distinction between the investigation of, or actually alleging, an unlawful act.” Accordingly, many courts consider government subpoenas and similar investigation demands requesting testimony or documents to be “Claims” under standard directors and officers liability (“D&O”) policy language. Despite the positive outcome, this case also serves as a reminder of the importance of narrowly drafted exclusionary language in D&O policies to avoid needlessly eliminating coverage by leaving an exclusion’s application open to interpretation.

DELAWARE JUDGE DECLINES TO DISMISS POLICYHOLDER LAWSUIT ALLEGING D&O INSURER WRONGFULLY DENIED COVERAGE 

CVR Refining, LP v. XL Specialty Ins. Co., No. N21C-01-260 EMD CCLD (Del. Super. Ct. Aug. 11, 2021)

The case at hand arose after two sets of investors brought suit in both the Delaware Chancery Court and New York Federal Court claiming a Texas petroleum refining company and two of its executives manipulated the stock price to the energy company’s benefit. 

 

The suits were tendered to the company’s directors and officers liability (“D&O”) program and the primary insurer issued a coverage letter noting there may be coverage available for the energy company, but there was no coverage for the individual executives named in the lawsuits.

 

The energy company continued to defend itself and eventually a mediation was scheduled in one of the investor suits. Upon learning of the upcoming mediation, and nearly two years after issuing its initial coverage position, the primary D&O insurer notified the energy company that the matter was “probably not covered” as it principally arose out of the contractual relationship between the parties, and thus, the breach of contract exclusion applied. The energy company accused the insurers of bad faith and anticipatory breach of contract and, in a mad dash to the courthouse, the insurers filed suit in Texas state court just three days before to the insureds’ coverage complaint was filed in Delaware.

 

The insurers argued the Delaware action should be dismissed in favor of the “first filed” Texas action, which they asserted involved the same parties and coverage dispute. In spurning this argument, a Delaware Superior Court Judge refused to allow the insurers to control the forum for the coverage dispute solely based on timing. "While the Texas action was filed three days before this civil proceeding,” the judge noted, “merely using a timeline is not how to legally analyze the issue." The judge further found that per Delaware law, cases filed close in time can be considered “contemporaneous” for purposes of determining the appropriate forum, and the first filed suit is not given deference if it is filed in anticipation of a lawsuit by “natural plaintiffs.” The court went on to state that the insureds were natural plaintiffs for purposes of this dispute.

 

The Takeaway

This ruling and many other recent rulings illustrate the importance of having iron-clad policy language lay out, in no uncertain terms, the forum for coverage disputes.

DEMAND FOR ARBITRATION IS A CLAIM UNDER D&O POLICY 

Supima v. Philadelphia Indem. Ins. Co., No. 20-617 (D. Ariz. June 16, 2021) 

In the underlying matter, the insured, a nonprofit, received a demand letter from a wholesale company advising it wanted to arbitrate a dispute pursuant to a license agreement it had with the insured. Over the next several months, the insured and the wholesale company communicated regarding potential arbitrators and other issues.

 

 

Several years later, the insured received a Statement of Claim, which the wholesale company filed with an alternative dispute resolution organization. The insured provided notice of the Statement of Claim to its directors and officers liability (“D&O”) insurer under the policy in effect at the time the insured had received the Statement of Claim. The insurer, however, denied coverage for late notice, arguing the arbitration demand letter, which was received in a prior policy period, was a “Claim,” despite not being reported until the current policy period. Coverage litigation ensued.

 

The D&O policy defined “Claim” to be a “written demand for monetary or non-monetary relief” or a “judicial, civil, administrative, regulatory, or arbitration proceeding.” The policy further provided “In the event that a Claim is made against the Insured ... the Insured shall, as a condition precedent to the obligations of the Underwriter under this Policy, give written notice of such Claim ... as soon as practicable … during this Policy Period … but, not later than 60 days after the expiration date of this Policy.” 

 

The insured argued the initial letter was not a "Claim" because it contained no demands for monetary or nonmonetary relief, the Statement of Claim was a separate “Claim,” and the policy did not require a “Claim” to be first made during the policy period. The court, however, disagreed, finding the demand letter “clearly gave [the insured] notice in a record of [the wholesaler’s] intent to arbitrate in the agreed manner set forth in the Licensing Agreement.” Therefore, the court concluded the arbitration proceeding was initiated at the time the demand letter was received, making the letter a “Claim” under the D&O policy in place at that time. Moreover, the policy’s notice provision was clear and unambiguous, and, according to the court, the insured should have been aware that notice of the arbitration demand letter was required. The court also held the Statement of Claim was not a separate "Claim" and rejected the insured’s argument that the policy did not require the claim be first made during the policy period.

 

The Takeaway

Timely noticing of claims under claims-made-and-reported policies is vital to securing coverage and avoiding litigation. As the court here noted, insurers need not show prejudice when notice is not timely provided under a claims-made policy because “requiring the insurer to show prejudice would constitute an extension of coverage not contemplated in the original policy.”

DIRECTOR DEFENDANTS NOT ‘NECESSARY AND INDISPENSABLE’ PARTIES IN COVERAGE LITIGATION AGAINST D&O INSURER

LRN Corp. v. Markel Ins. Co., et al., No. 20-cv-8431 (S.D.N.Y. Aug. 23, 2021)

In the underlying suit, a minority shareholder filed a complaint against a consulting company and three of its directors alleging the defendants orchestrated a scheme to reduce the outstanding shares and gain control of the company prior to a planned, but unannounced, merger.

The shareholder specifically alleged the defendants completed an improper “self-tender” of shares at an unfair price, materially increasing the value of shares held by the defendants. The company and the director defendants tendered the suit to their directors and officers liability (“D&O”) insurer but the insurer denied coverage, citing the policy’s securities transaction exclusion. Shortly after the underlying suit was filed, the company obtained a dismissal of the case and only the three director defendants remained.

 

The company sought a reversal of the D&O insurer’s denial and coverage litigation ensued, but the company did not include the three directors as plaintiffs in the suit it filed against its insurer. The D&O insurer asked the court to dismiss the suit, arguing that since the company was dismissed as a defendant in the underlying suit, the three directors were necessary and indispensable parties to the dispute because they were the only defendants seeking coverage. 

 

The court disagreed with the insurer, however, and allowed the company to fight the coverage battle without involving the individuals. Regardless of whether the directors were defendants in the case, the court found it could determine whether the securities transaction exclusion applied, and thus, could decide whether the insurer’s denial of coverage was proper. Since the company could obtain complete relief without joining the directors, the directors were not necessary and indispensable to the coverage litigation, the court found, therefore allowing the case to progress to discovery and further litigation as to the merits of the coverage denial.

 

The Takeaway

Directors seek to avoid claims being made against them, but it is inevitable that it will happen once in a while. In such instances, these individuals take comfort when a D&O insurer stands behind them with protection. At times, however, insurers unjustly disclaim their obligations, forcing insureds to fight for coverage. The resulting coverage litigation may be time-consuming and stressful for those involved, so to the extent corporate policyholders can litigate coverage disputes without involving individual defendants, it would be an efficient and desirable outcome.

 

SELLING UNREGISTERED SECURITIES CONSTITUTES PROFESSIONAL SERVICES UNDER PROFESSIONAL LIABILITY POLICY

Saoud v. Everest Indem. Ins. Co., No. 19-12389 (E.D. Mich. Jul. 28, 2021)

An insured retirement planning firm that was not licensed to sell securities sold a “memorandum of indebtedness” to several of its clients. The memoranda were an accounts receivable/lending scheme developed by a non-related company that was not registered as a security with the U.S. Securities and Exchange Commission (“SEC”).

 

The non-related company later went bankrupt and, along with its CEO, was sued by the SEC for, among other things, selling unregistered securities.

 

Several months into selling the memoranda, the retirement planning firm received a cease-and-desist order from the Michigan Department of Licensing and Regulatory Affairs, as well as a subpoena from the SEC and lawsuits from three separate clients alleging the sale of unregistered securities. When the firm tendered the claim to its professional liability insurer, the insurer responded with a letter stating that there may be coverage for the claim, but followed up later that day with an email indicating the opposite. The retirement planning firm wrote several letters to the insurer asking for a response regarding coverage and advising of an upcoming mediation but heard nothing and the suits were eventually settled without participation from the insurer. Coverage litigation ensued when the firm sought reimbursement of defense costs and settlement amounts. 

 

The insurer argued coverage was precluded because the claims did not involve the insured providing “Professional Services” as required by the insuring agreement. The court, however, noted that Michigan does not follow the “8 corners approach” of many other jurisdictions, which dictates “courts deciding whether an insurer has a duty to defend a claim examine only the allegations of the underlying complaint and the insurance policy.” Accordingly, the court was not limited to analyzing merely the allegations in the complaints in order to determine coverage, and allowed the firm to rely on an affidavit from the underlying lawsuits that suggested the discussion about the memoranda occurred during a discussion about retirement services. As retirement services were included in the definition of “Professional Services,” the court found in favor of the firm.

The Takeaway

The definition of “Professional Services” is a crucial element of a professional liability insurance policy. It is essential that the definition clearly encompasses all aspects of an insured’s business activities in order to avoid costly and time-consuming coverage litigation.

HOLD THE LINE ON HOLDER CLAIMS

Hussein v. Razin, et al., No. 30-2013-00679600 (N.J. Super. Ct. Jul. 29, 2021)

In a rare “holder” claim under the California Securities Laws, a jury found a healthcare technology company and its directors and officers not liable for making false and misleading statements, causing the company’s second largest investor to forego selling his shares. 

The investor alleged that despite the company’s positive public statements concerning its earnings projections, the projections were ultimately retracted and the announcement of disappointing financial results caused the company’s stock price to drop and the investor to suffer substantial damages. According to the investor, had he not relied on the allegedly misleading statements, he would not have held his shares, and would instead have sold them and realized a gain.

 

In order to hold the company and its executives liable, the jury had to find they made a false representation and that the investor relied on this representation when he made the decision not to sell his shares. The jury, however, found the company and its executives made neither a false representation nor intentionally failed to disclose facts that made a representation deceptive. Therefore, the question of whether the investor relied on this representation was never presented and the investor’s case was tossed.

 

The Takeaway

“Holder” claims are forbidden by federal securities laws because of their potential for abuse. While there are still some jurisdictions that allow these types of claims under state securities laws, they are few and far between. Plaintiffs in holder cases must allege and plead reliance on misrepresentations and loss causation with specificity, which includes documenting actions that indicate reliance coupled with a speculative calculation of damages.

 

It is a slippery slope to allow this type of conjecture in the law, which is why the 1975 U.S. Supreme Court decision in Blue Chip Stamps v. Manor Drug Stores forbid it. As Hussein demonstrates, it is important for a directors and officers liability policy to provide broad coverage for directors and officers accused of wrongdoing and to ensure the wrongful acts of others do not jeopardize coverage for innocent insureds.

SINGLE LAWSUIT CONTAINS MULTIPLE CLAIMS UNDER D&O POLICY

Stem, Inc. v. Scottsdale Ins. Co., 2021 WL 1736823 (N.D. Cal. July 30, 2021)

As discussed in the June 2021 edition of Executive Liability Insights, the U.S. District Court for the Northern District of California determined that two causes of action contained in one lawsuit constituted separate claims, even though a directors and officers liability (“D&O”) policy defined “Claim” as a “civil proceeding” or a “written demand.” 

 

The court further found the policy’s interrelated wrongful acts, prior and pending litigation, breach of application, and insured vs. insured exclusions all barred coverage for one of the claims.

 

In a subsequent motion, the plaintiff recently argued the D&O insurer had an obligation to reimburse the defense fees and costs for the entire lawsuit, not just the fees and costs associated with the covered claim. The insurer disagreed, arguing allocation of the legal invoices is possible because the invoices show the plaintiff has not paid attorneys’ fees relating to the covered claim. The court disagreed with the insurer, however, finding there was not undeniable evidence of the allocability of specific expenses because the lawsuit is still on-going. The court also found the insurer’s liability was not limited to the losses associated with the defendant whose acts were “interrelated,” and therefore the insurer had the obligation to defend the entire action.

PRIVATE EQUITY FIRM AND POST-MERGER ENTITY MUST FACE
INVESTOR SUIT

Hedick, et al. v. The Kraft Heinz Co., et al., No. 19-cv-1339 (N.D. Ill. Aug. 11, 2021)

A private equity firm and an American food conglomerate did not succeed in dismissing a securities class action alleging the company made false and misleading statements in violation of Section 10b and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5.

 

In the aftermath of a high-profile merger between two consumer goods brands, which was orchestrated by the private equity firm, the post-merger entity was subpoenaed by the U.S. Securities and Exchange Commission (“SEC”) for documents related to its accounting practices. The SEC eventually launched an investigation into the company’s accounting practices, and several months later, the company disclosed the SEC investigation to investors along with the fact that it would be writing down the value of its brands by billions of dollars.

 

Investors filed suit alleging statements the company made concerning post-merger “synergistic” cost cutting practices were false and misleading, damaged the brand/product quality as well as its supply chain, and ultimately resulted in a decline in sales and an impairment to goodwill. The suit also alleged that had the SEC not initiated a probe into the company’s accounting practices, the goodwill impairment would not have been disclosed.

 

The company and the private equity firm argued the investor suit was merely a hindsight attack on a business strategy that failed to pan out, but the court disagreed, noting the suit sufficiently suggested the company's executives knew, or recklessly disregarded, that its public statements were false. The court also noted the actions taken by the private equity firm in furtherance of the merger amounted to control over the company. For example, upon completion of the merger, the firm owned 25% of the outstanding stock and had placed more than half of its partners on the board or into executive positions at the company. These facts taken together were enough to establish that the firm had control of the company’s operations, the court said. Accordingly, in response to the allegation that the private equity firm violated section 20(a) of the Securities Exchange Act of 1934 as “controlling persons,” the court held the issue of control person liability is a “fact-intensive inquiry” and should not be resolved by a dismissal motion.

 

 

 

MUTUAL FUND SERVICE FEES THAT ARE PRODUCT OF ARM’S LENGTH BARGAINING DO NOT BREACH FIDUCIARY DUTY

Obeslo v. Great-West Life & Annuity Ins. Co., No. 20-1310 (10th Cir. Jul. 26, 2021) 

Plaintiff shareholders brought an action against the investment advisor of their employer sponsored retirement plan’s mutual fund, alleging breach of fiduciary duty for charging excessive fees. They claimed that both the advisory and administrative fees charged to the index and bond funds were so disproportionate to the services rendered that they violated the Investment Company Act of 1940 (“ICA”). 

 

Mutual funds are regulated by ICA, which imposes a fiduciary duty on investment advisers with respect to the compensation they receive for providing services to mutual funds. The U.S. Supreme Court has held that, in order for an investment adviser to face liability, “the adviser must charge a fee that is so disproportionately large that it bears no reasonable relationship to the services rendered and could not have been the product of arm's length bargaining.” Factors considered in determining whether fees are the result of an arm’s length bargain include the nature and quality of the services, the profitability of the fund to the adviser, the collateral benefits accruing to the investment adviser due to the fund, economies of scale, comparative fee structures, and the independence and conscientiousness of the board.

 

After taking into consideration the factors above, as well as the persuasive and credible evidence from the investment advisor that their fees were reasonable, the court found the shareholders’ claim failed to establish any damages and, as such, the investment advisor did not breach their fiduciary duties.

The Takeaway

Excessive fee cases against plan fiduciaries are increasing in frequency. Since such cases are often costly to defend and hard to dismiss, coverage through fiduciary liability insurance is essential. 

 

TECH COMPANY’S UNFAIR COMPETITION SUIT TOSSED WITHOUT LEAVE TO AMEND 

Enigma Software Grp. USA LLC v. Malwarebytes Inc., No. 5:17-cv-02915-EJD (N.D. Cal. Aug. 9, 2021)

A cybersecurity software company’s unfair competition lawsuit against a rival internet security company, previously cited by both a U.S. Supreme Court justice and the Trump Administration’s Department of Justice in the backlash against the so-called “Big Tech liability shield,” was recently tossed without leave to amend by a California court. 

 

 

The suit had previously been revived by the Ninth Circuit, where the cybersecurity software company alleged its competitor committed Lanham Act unfair advertising violations when the competitor’s security software began identifying the company’s security products as potentially unwanted on users' computers.

 

Departing from the Ninth Circuit’s focus on section 230 of the Communications Decency Act, which safeguards online companies from liability for content moderation practices and content posted by third parties, but which the Ninth Circuit said does not cover conduct “driven by anticompetitive animus,” the U.S. District Judge found the competitor was in the clear for flagging the software. In turning his analysis to the Lanham Act, the judge found the cybersecurity software company failed to plead that its competitor’s “alleged labels [were] verifiably false rather than subjective opinions.” Lanham Act claims can only go after false and deceptive statements, the judge said, noting the cybersecurity software company’s allegations disregarded that its competitor’s users were ”aware of why it opines that a given software program may be a [potentially unwanted program] based on [its competitor’s] disclosed criteria and can choose to quarantine or unquarantined the detected program.”

 

The Takeaway

The most interesting part of this opinion, and the reason it has been on everyone’s radar, is the U.S. Supreme Court’s refusal to accept the earlier petition by the defendant to overturn the Ninth Circuit’s opinion. It was widely viewed as a missed opportunity to reign in what has been perceived as tech company immunity from anti-trust claims. While, as the court here stated, this may not be the case to provide further guidance, we will continue to monitor the evolving law on this topic.

 

COVERAGE FOR MEMBER OF INSURED LLC NOT BARRED BY INSURED VS. INSURED EXCLUSION IN D&O POLICY

Starr Indem. & Liab. Co. v. Point Ruston LLC, No. C20-5539RSL (W.D. Wash. Aug. 17, 2021) 

A Washington federal district court recently held that an insurer did not meet its burden of showing that coverage for a lawsuit stemming from alleged mismanagement of entities involved in a commercial development project was barred by the insured vs. insured (“IvI”) exclusion in a directors and officers (“D&O”) liability policy.

The principals of the firms involved in the development project were family members who formed several corporations. Through those corporations, the family members invested in an LLC (the “Project LLC”) that was formed for purposes of running the project. The members of the Project LLC consisted of one of the family corporations, as well as another LLC (the “Manager LLC”) formed by the project’s primary developer and manager. When the developer mismanaged the project, the corporations brought suit against the Project LLC, the Manager LLC, and several other entities alleging breach of fiduciary duty and seeking dissolution of the Project LLC.

 

The Manager LLC provided notice of the matter to its D&O insurer, which denied coverage, citing the IvI exclusion. The insurer argued it had no duty to defend or indemnify because the plaintiff family corporation was an insured under the policy and the claim was brought “on behalf of” an insured since the individuals, through its corporate entities, were “Members” of the Manager LLC. The policy defined “Member” as “an owner” of an LLC “who may serve as a Manager.”

 

The court disagreed with the insurer, finding the definition of “Insured” only meant the “Company” and any “Insured Person.” The court noted that while the policy’s definition of “Insured Person” included any “Executive,” the insurer’s interpretation of the definition of “Executive” was incorrect. The policy defined an “Executive” as any “past, present, or future duly elected or appointed director, officer, trustee, governor, management committee Member or Member of the board of managers.” The insurer contended the phrases “management committee” and “board of managers” conflicted with the definition of “Member,” but the court concluded the definition merely clarified which “Members” qualify as “Executives,” and that not all “Members” are “Managers.”

 

Lastly, the court noted that in corporate law, LLCs are treated as separate entities from their members, and “the mere fact that an officer or ‘principle’ of a corporation has the potential to benefit from the business entity’s action does not mean that the entity undertook the action ‘on behalf of’ the individual.” Accordingly, the court found that while the family corporation was a “Member” of the LLC, it was not a “management committee Member” nor a “member of the Board of managers,” and therefore did not qualify as an “Insured Person” under the policy. Applying the same reasoning, the court found the other defendants did not qualify as “Insureds” because the LLCs were not acting “on behalf of” their principles.

 

DERIVATIVE CLAIMS EXPOSE TOP EXECUTIVES TO LIABILITY 

MULTIPLE CASES

Directors and officers of corporations have access to funds as well as sensitive and often potentially lucrative information. Utilization of these funds and information to the sole benefit of the executive, aside from risking potential insider trading violations, exposes the company and its executives to, among other things, shareholder derivative actions. In several recent Delaware cases, executives withheld funds, manipulated the United States Postal Service reseller program, provided false or misleading public statements, and inflated financial and data measurements to inflate advertising, product, and stock prices, resulting in harm to shareholders and investors.

 

  • OptimisCorp v. Atkins
  • Macomb Cnty. Employees’ Ret. Sys. 
  • Twitter, Inc. S’holder Derivative Litig.
OptimisCorp v. Atkins, et al., No. 2020-0183-MTZ (Del. Ch. Jul. 15, 2021)
 

This matter arose after former directors of a physical therapy company won a multimillion dollar award in a derivative action against the company’s former malpractice counsel. Rather than utilizing the award for the benefit of the company, the ex-directors held onto the funds while the company floundered. The company then filed suit against the ex-directors, accusing them of breaching their fiduciary duty while leading the derivative action.


The Delaware Chancery Court held against the ex-directors, finding they put their own interests first by seeking to divide the award among their shareholder allies, even when it became a company asset that was badly needed. Holding the ex-directors to be fiduciaries when pursuing the derivative action against the malpractice counsel, the court found that “as a fiduciary, the representative plaintiff owes to those whose cause he advocates a duty of the finest loyalty … Any stockholder seeking to bring a derivative suit on behalf of the corporation has to act in the best interest of the corporation.” 

Macomb Cnty. Employees’ Ret. Sys. v. McBride, et al., No. 2019-0658 (Del. Ch. 2021)

 

In another showing of executive hubris, a postage retailer was the subject of consolidated derivative actions against its executives who were alleged to have participated in extensive insider trading. Investors alleged the executives organized the business and acquisitions in order to exploit spreads between discount rates charged to postage resellers and those charged to the company and other online shipping and postage companies that receive a commission on their postage volumes. Once the scheme unraveled, a stock price drop of over 58% was triggered and a bevy of investor litigation followed.


Following a mediation, the company recently announced it reached a deal with investors to settle the derivate suits. Under the deal, the defendants’ insurers will pay $30 million in cash to the company for corporate reforms and “general corporate purposes.” 

In re Twitter, Inc. S’holder Derivative Litig., No. 1:18-cv-00062-MN (D. Del.)

 

A well-known social media site also recently settled several consolidated Delaware derivative claims that alleged executives breached their fiduciary duties by inflating user data measurements used to support advertising rates and participating in insider trading, which resulted in the impairment of the social media company’s ability to borrow or raise equity. Ultimately, the then-CEO stepped down but was permitted to keep his equity compensation, the majority of which was not vested when he was misrepresenting the social media company’s results.


“With some reluctance,” a Delaware vice chancellor approved a $38 million settlement of the derivative claims as well as an $8.75 million attorney fee. Noting his initial reluctance to approve the settlement when it was first brought to him several months prior, the vice chancellor said he had been “concerned about the settlement of a derivative action seeking as damages the amounts spent on litigation in the federal securities action."

APPRAISAL ACTION NOT A CLAIM FOR WRONGFUL ACT UNDER
D&O POLICY

Jarden, LLC v. ACE Am. Ins. Co., et al., No. N20C-03-112 AML CCLD (Del. Super. Jul. 30, 2021)

A consumer products company entered into a merger agreement, and while the majority of the company’s stockholders approved the merger, several filed appraisal petitions in the Delaware Chancery Court. 

 

The company noticed the actions under its run-off directors and officers liability (“D&O”) program, seeking coverage for defense fees and the interest awarded in the appraisal proceeding. The insurers denied coverage on the grounds the appraisal action was not a claim because it did not seek a remedy for a wrongful act, and coverage litigation ensued.

 

Siding with the insurers, the court found the appraisal action did not seek compensation for a wrongful act. The court cited to the Delaware Supreme Court holding in In re Solera Insur. Coverage Appeals, which determined that an appraisal proceeding “does not involve any inquiry into claims of wrongdoing.” Instead, the only issue before the appraising court is the value of the dissenting stockholder’s shares on the date of the merger.

 

Moreover, the acts alleged by the dissenting shareholders did not occur until after the merger was finalized, the court concluded, noting the run-off D&O program under which the appraisal actions were noticed only provided coverage for a securities claim for wrongful acts that occurred prior to the merger. "This conclusion is compelled by the simple fact that, without the merger's execution, no appraisal right exists. If the merger had not closed, none of the dissenting stockholders who submitted appraisal demands would have standing to pursue appraisal," the court noted.

 

Cyber Corner

  • GE/CBPS Data Breach Litigation

  • Plaid Inc. Privacy Litigation

  • Rutter’s Data Breach Sec. Litigation

  • WaWa, Inc. Data Sec. Litigation

EMPLOYEES HAVE STANDING TO SUE EMPLOYER AND IT VENDOR OVER DATA BREACH

In re: GE/CBPS Data Breach Litig., No. 1:20-cv-02903-KPF (S.D.N.Y Aug. 4, 2021)

A federal court recently granted partial dismissal in a class action brought by current and former employees of an energy production services company against their employer and its IT vendor over the vendor’s data breach. 

 

Following its discovery that one of its email accounts had been accessed by an unauthorized party, the vendor, which processes employment and beneficiary information for corporate clients, informed the energy company of the breach, which had exposed the personally identifiable information of current and former employees of the company. The vendor and the energy company jointly notified impacted parties, offering two years of credit monitoring without any further compensation. The employees brought suit alleging various forms of negligence and breach of contract, along with violations of New York state law.

 

The defendants moved to dismiss the complaint on various grounds, including that the employees lacked standing to sue. The court denied this part of the defendants’ motion, concluding the employees had stated a “cognizable injury.” In so ruling, the court noted the data breach “was the result of a targeted phishing attack” designed to obtain the employee data in question and class members had experienced phishing emails and scam phone calls, along with “identity theft, fraud, and abuse.” While the data points in question were otherwise publicly available, the court agreed with the employees that having access to this data “all in one place” could make it easier for hackers to commit identity theft.

 

SETTLEMENT OF FINTECH PRIVACY SUIT A BOON TO PLAINTIFFS’ BAR

In re: Plaid Inc. Privacy Litig., No. 20-3056 (N.D. Cal. Aug. 5, 2021)

 

A software company catering to the banking sector will pay $58 million to settle a potential class action in which the plaintiffs alleged it routinely accessed users’ financial information without their informed consent. In the lawsuit, the plaintiffs claimed the company, whose software provides a link between mobile app platforms and user bank accounts, misled users into furnishing their banking login credentials, unwittingly giving the company access to a trove of personal and financial information. The plaintiffs contended this arrangement constituted an invasion of privacy, unjust enrichment, deceit, and violation of various California state laws.

 

In addition to the monetary settlement (up to one-quarter of which is earmarked for attorney fees), the company has agreed to implement several changes to its user interface, which are designed to protect consumer privacy and limit the personally identifiable information that flows from users’ financial institutions to the mobile apps.

 

 

The Takeaway

 

Companies should strive to make their digital user experiences as transparent as possible, stating clearly the types of information to be collected, how it will be used, and how users can request that it be deleted. Additionally, companies should only collect the data points necessary to complete a given transaction.

 

PROTECTING FORENSIC REPORTS FROM DISCOVERY KEEPS GETTING HARDER

In re: Rutter’s Data Breach Sec. Litig., No. 1:20-CV-382 (E.D. Pa. Jul. 22, 2021)

 

A federal court recently permitted a forensics report created in the aftermath of a data breach to be admitted into evidence, the second such ruing in a consumer class action. 

 

In this case, the defendant, a food and gas retailer, retained outside counsel (known as a breach coach) to advise the company on its legal obligations following suspicions its network credentials had been compromised. In turn, the breach coach engaged a cybersecurity firm to investigate the cause and scope of the attack. When the plaintiffs sought a copy of the report, the company asserted the report constituted attorney work product, or was otherwise subject to attorney-client privilege, and should be excluded from evidence.

 

The court disagreed, finding that at the time the investigation began, it was not even clear whether cardholder data had been compromised, so it could not be said that “the primary motivating purpose behind the [forensics] report was not to prepare for the prospect of litigation.” The court also concluded the report was not protected by attorney-client privilege, noting it was furnished directly to the company rather than first going to counsel, and contained no tactical discussion that would aid the breach coach in providing legal assistance. 

 

 

 

ARE GIFT CARDS AS GOOD AS CASH?

In re: WaWa, Inc. Data Sec. Litig., No. 19-6019 (E.D. Pa. Jul. 30, 2021)

 

A Pennsylvania federal judge in a class action suit involving a chain of convenience stores has provisionally certified a class and preliminarily approved a $12 million gift-card-and-cash settlement for customers, subject to a final hearing. The litigation stemmed from a 2019 data breach where hackers accessed the company’s point-of-sale systems and installed malware targeting payment terminals and fuel dispensers. The settlement terms included three tiers of compensation in the form of gift cards, dependent upon the level of damages suffered. Additionally, as part of the settlement, the convenience store chain agreed to strengthen its data security practices as well as its payment processing systems.

 

The Takeaway

 

While the settlement may sound like a positive result, it is important to note that, if the store purchases cyber insurance, it may have a difficult time securing coverage for the gift cards as a form of damages under its policy. Additionally, a settlement in the form of a gift card or coupon may diminish the magnitude of the loss and potentially result in less coverage under the policy when compared to a monetary settlement. 

 

 

EPL Corner

CALIFORNIA SUPREME COURT CLARIFIES APPLICATION OF STATE’S PREVAILING WAGE LAW

In two recent decisions, the California Supreme Court clarified and limited the scope of the state’s “prevailing wage” law, which requires the basic hourly rate paid on publicly-funded construction projects, or "public works" projects, be paid to a majority of workers engaged in a particular craft, classification, or type of work within the locality.

 

  • Mendoza v. Fonseca McElroy Grinding Co., Inc.

  • Busker v. Wabtec Corp

Mendoza v. Fonseca McElroy Grinding Co., Inc., Case No. S253574 (Cal. Aug. 16, 2021)

In this first case, the court addressed whether the prevailing wage must be paid for mobilization work after a group of unionized engineers brought suit against a roadwork construction company for which the engineers operated milling equipment. The milling machines were sometimes stored at a permanent yard or other offsite location, in which case the engineers needed to mobilize the equipment by reporting to the offsite location, loading it onto trailers, and bringing it to the job site.

 

Under California Labor Code section 1772, workers employed in the execution of any contract for public work are deemed to be employed upon public work. The engineers argued they were “deemed to be employed upon public work” because their mobilization work was performed “in the execution” of a public works contract. Noting that the operation of the milling machinery at the public works site undisputedly qualified as “public work,” the court found the engineers failed to contend that mobilization of the machinery was also “public work.” Instead, they “urge[d] an interpretation of section 1772 that would enlarge the scope of the prevailing wage law to encompass activities that the Legislature has not otherwise defined as public work,” the court noted, further finding  “Section 1772 was not intended to define or expand the categories of work covered by the prevailing wage law.”

 

Rejecting the California Department of Industrial Relations’ broad interpretation of the law, the court held section 1772 was enacted merely to clarify that employees of private contractors or subcontractors can be subject to prevailing wage obligations, so long as they perform public work. When evaluating which activities are subject to prevailing wages, the court explained the focus should be on specifically identified activities, such as those listed in Labor Code 1720. The court declined to definitively establish whether off-site activity such as travel time can be subject to prevailing wage obligations.

 

 

Busker v. Wabtec Corp., Case No. S251135 (Cal. Aug. 16, 2021)

 

This case arose after an equipment and services company hired the plaintiff to perform work on rail cars as part of a broader project to prevent train collisions. The plaintiff was not paid a prevailing wage, despite the fact that workers not employed by the equipment services company were paid prevailing wages for their work installing equipment in the railyard itself.


Here, the question before the California Supreme Court was whether publicly funded work performed on rolling stock, such as a train, is a covered “public work.” California Labor Code section 1720(a) defines “public work” to include “construction” and “installation.” According to the court, both terms refer only to work performed on fixed structures, such as buildings, roads, and dams, not work on rolling stock. Moreover, the California Department of Industrial Relations has consistently excluded rolling stock from coverage as “public work.”


Accordingly, the court found the plaintiff's work was not on a “public work” and therefore the prevailing wage law was not applicable. Like in Mendoza, the court also rejected the plaintiff’s reliance on section 1772, which it held does not expand the definition of "public works."

3RD CIRCUIT UPHOLDS VALIDITY OF ARBITRATION AGREEMENT IN DISCRIMINATION SUIT

Carrone v. UnitedHealth Grp., Inc. et al., No. 20-2742 (3rd Cir. Aug. 11, 2021)

 

A former employee at a healthcare and insurance company brought suit alleging her male associates at the company discriminated against female employees, which ultimately resulted in her being fired in retaliation for complaining about such misconduct. 


Upholding a lower court’s ruling, the Third Circuit recently held the former employee must bring her discrimination claims to arbitration. According to the court, the former employee “had two avenues around arbitration. She could have claimed that the arbitration agreement as a whole lacked mutual assent, or she could have directly challenged the delegation provision's validity.” Because the former employee failed to raise either argument before the district court, she “waived the opportunity to assert them on appeal" and must therefore bring her claims to arbitration, the circuit court found.

 

SUPERIOR COURT JUDGE FINDS CALIFORNIA’S PROPOSITION 22 UNCONSTITUTIONAL 

Castellanos v. State of California, et al., No. S266551 (Cal. Super. Aug. 20, 2021) 

 

A group of rideshare drivers, together with a union and its local chapter, recently challenged the constitutionality of California’s Protect App-Based Drivers and Services Act, commonly known as Proposition 22. California passed ballot initiative Proposition 22, which received millions of dollars of backing from rideshare and food delivery companies, to provide an independent contractor exception for app-based drivers.

 

A California Superior Court judge agreed with the rideshare drivers, finding Proposition 22 unconstitutional and unenforceable because it illegally infringed on the California Legislature’s “plenary power” and constitutional authority “to create and enforce a complete system of workers’ compensation.” If a ballot initiative statute can limit the Legislature’s ability to include app-based workers in the compensation system, the Legislature's power is not “plenary,” making Proposition 22 “constitutionally problematic,” the judge noted. Moreover, because employees, unlike independent contractors, are covered by workers’ compensation laws, the appropriate method to restrict the Legislature’s power is not through “initiative statute,” but by Constitutional amendment.

 

 

ADDITIONAL CASES:

 

  • Botta v. PwC

  • Hobby Lobby Stores, Inc. v. Sommerville

  • Carrone v. UnitedHealth Grp

  • Castellanos v. State of California

FORMER EMPLOYEE FAILED TO PROVE WHISTLEBLOWER RETALIATION IN WRONGFUL TERMINATION SUIT

Botta v. PwC, et al., No. 3:18-cv-0261 (N.D. Cal. Jul. 26, 2021)

A former auditor at a multinational professional services firm lost his whistleblower retaliation suit when the U.S. District Court for the Northern District of California ruled he did not qualify for whistleblower protections because he did not prove the firm violated any laws. 


The former auditor submitted a whistleblower disclosure with the U.S. Securities and Exchange Commission (“SEC”) alleging the firm willingly overlooked clients’ accounting mistakes and shortcomings in internal controls in order to retain business. Less than a year later, the firm fired the auditor, who then filed a whistleblower retaliation suit alleging his removal was in response to his disclosure to the SEC. The auditor claimed the firm violated the anti-retaliation provisions of the Sarbanes-Oxley Act and sought reinstatement as well as compensation for back pay, lost earnings, and emotional distress.


According to the court, the best evidence the former auditor presented was the timing of his firing—less than a year after the filing of his ultimately fruitless SEC complaint. "This hint of a connection wasn't bolstered by other evidence, however, and [the firm] offered a different, persuasive side of the story," the judge said, pointing to evidence presented by the firm that the auditor had fabricated an internal control and falsified documentation while auditing a client. Moreover, the judge noted the managing partner of the firm's U.S. audit practice and its outside counsel both testified they did not know the auditor had filed an SEC complaint, or even suspected he had done so, when the decision was made to fire him.

 

COURT RULES RETAILER DISCRIMINATED AGAINST TRANSGENDER EMPLOYEE

Hobby Lobby Stores, Inc. v. Sommerville, No. 2-19-0362 (Ill. App. Ct. Aug. 13, 2021)

 

This case arose after an arts-and-crafts retailer discriminated against a long-term transgender employee by not allowing her to use the women’s bathroom. The Illinois Human Rights Commission determined the retailer violated the Human Rights Act, which prohibits discrimination in the terms and conditions of employment based on sex, sexual orientation, and gender identity, and awarded the employee damages and injunctive relief. 


On appeal, the retailer argued its policy of regulating bathroom access did not violate the Human Rights Act because it was based on an individual’s “sex,” which it claimed is an immutable condition determined by a person’s reproductive organs. Furthermore, the retailer contended that because the employee had not yet undergone transition surgery, her reproductive organs were not female. 


The court disagreed, noting the word “sex” is defined in the Human Rights Act as “the status of being male or female” and, importantly, “at law, a ‘status’ is something that may be subject to change.” Additionally, the court noted the terms “sex” and “sexual orientation” are not synonymous, and gender identity is just one facet of a person’s sexual orientation as well as a basis for determining a person’s legal sex. The court also stressed the fact that the employee had undergone years of treatments and expense to transition, and her official government documentation recognized her as female. Moreover, the court highlighted that the retailer had changed both its personnel and benefits records to reflect the employee’s sex as female, yet still denied her access to the women’s bathroom. Accordingly, the court held the Illinois Human Rights Commission properly found the retailer’s acts constituted differential treatment from its other female employees and customers, which amounted to unlawful discrimination. 

 

 

3RD CIRCUIT UPHOLDS VALIDITY OF ARBITRATION AGREEMENT IN DISCRIMINATION SUIT

Carrone v. UnitedHealth Grp., Inc. et al., No. 20-2742 (3rd Cir. Aug. 11, 2021)

 

A former employee at a healthcare and insurance company brought suit alleging her male associates at the company discriminated against female employees, which ultimately resulted in her being fired in retaliation for complaining about such misconduct. 


Upholding a lower court’s ruling, the Third Circuit recently held the former employee must bring her discrimination claims to arbitration. According to the court, the former employee “had two avenues around arbitration. She could have claimed that the arbitration agreement as a whole lacked mutual assent, or she could have directly challenged the delegation provision's validity.” Because the former employee failed to raise either argument before the district court, she “waived the opportunity to assert them on appeal" and must therefore bring her claims to arbitration, the circuit court found.

 

SUPERIOR COURT JUDGE FINDS CALIFORNIA’S PROPOSITION 22 UNCONSTITUTIONAL

Castellanos v. State of California, et al., No. S266551 (Cal. Super. Aug. 20, 2021) 

 

A group of rideshare drivers, together with a union and its local chapter, recently challenged the constitutionality of California’s Protect App-Based Drivers and Services Act, commonly known as Proposition 22. California passed ballot initiative Proposition 22, which received millions of dollars of backing from rideshare and food delivery companies, to provide an independent contractor exception for app-based drivers.


A California Superior Court judge agreed with the rideshare drivers, finding Proposition 22 unconstitutional and unenforceable because it illegally infringed on the California Legislature’s “plenary power” and constitutional authority “to create and enforce a complete system of workers’ compensation.” If a ballot initiative statute can limit the Legislature’s ability to include app-based workers in the compensation system, the Legislature's power is not “plenary,” making Proposition 22 “constitutionally problematic,” the judge noted. Moreover, because employees, unlike independent contractors, are covered by workers’ compensation laws, the appropriate method to restrict the Legislature’s power is not through “initiative statute,” but by Constitutional amendment.

SEC Corner

  • Diversity Mandate Challenged

  • Cyber Incidents

  • Cyber Risk is a Board-Level Issue
  • Contingent Liabilities

SEC ORDER APPROVING NASDAQ BOARD DIVERSITY MANDATE CHALLENGED

Alliance for Fair Board Recruitment v. SEC, No. 21-60626 (5th Cir. Aug. 10, 2021)

In a divided vote, the U.S. Securities and Exchange Commission (“SEC”) approved two board diversity proposals filed by the Nasdaq stock exchange. Pursuant to the new regulations, Nasdaq-listed companies must annually disclose statistical information about their boards’ voluntary self-identified gender and racial characteristics and include on their boards a certain number of diverse directors (or explain their failure to do so).

 

Recently, a Texas nonprofit directors’ organization filed a petition with the Fifth Circuit Court of Appeals seeking immediate appellate court review of the SEC’s order approving the Nasdaq’s “discriminate-or-explain” rule. This same nonprofit organization previously filed a challenge to California’s board diversity laws.

 

In their supporting brief and follow-up press release, the directors’ group argued the SEC exceeded its authority in approving the Nasdaq proposals and that such proposals are unfair. The group’s contentions pertain to violations of civil rights, freedom of speech, and discrimination. Specifically, the group argues the SEC’s order “will compel many of our nation’s largest publicly traded corporations to illegally discriminate on the basis of gender, race, and sexual orientation” against potentially qualified candidates. As such, corporate members may actually be harmed by the “virtue signaling rule” because they are now forced to compete in an uneven playing field due to race, gender, and sexual orientation quotas. Further commentary on this topic includes a Harvard study challenging the presumption that corporations with diverse boards produce better financial results.

 

The Takeaway

 

Board diversity remains a hot topic. This most recent case is in the very early stages and the SEC has not yet filed their response. Ultimately, it may take months before a decision is made as to the legality of the Nasdaq regulations. In the interim, cases in California and Washington D.C. brought for, and against, board diversity mandates and disclosures will continue to progress through the judicial process. It is critical for corporations to monitor these developments and position themselves accordingly for any direct challenges made to their compliance or non-compliance with applicable diversity regulations.


SEC STRESSES TIMELY NOTICE OF CYBER INCIDENTS TO INVESTORS

 

A London-based textbook publisher recently agreed to pay a penalty to the U.S. Securities and Exchange Commission (“SEC”) to resolve claims that it misled investors about a cyberattack in which millions of student and school administrator records were stolen. Through software developed by a third party vendor, the publisher offers a service to thousands of schools and universities that allows for entry and tracking of students’ academic performance.

 

The software developer notified the publisher of an unpatched vulnerability, but did not implement the patch until over six month later when it learned of a cyber-attack that exploited the vulnerability on its server. Several months after the attack, the publisher released its semi-annual report referring to a data privacy incident as a hypothetical risk, despite having already experienced a data breach. Days later, the publisher publicly acknowledged the intrusion in response to a media inquiry, announcing it had misstated the nature of the breach, as well as the number of records and the type of data involved. The SEC Order references this initial misstatement, and further notes that the company overstated its data protections. In settling the allegations, the publisher neither admitted nor denied any wrongdoing. 

 

The Takeaway

 

This enforcement action demonstrates the SEC’s ongoing efforts to encourage timely notice of cyber incidents to investors, as well as the importance of having proper processes in place to handle the investor relations aspect of a breach event.

 

FURTHER EVIDENCE THAT CYBER RISK IS A BOARD-LEVEL ISSUE

 

The U.S. Securities and Exchange Commission (“SEC”) recently issued sanctions against eight firms in three separate enforcement actions over lapses in cybersecurity that resulted in disclosure of thousands of customer records. Each firm agreed to settle charges that they violated the so-called “Safeguards Rule” of Regulation S-P, which requires broker-dealers and investment advisers under the SEC’s jurisdiction to adopt written policies and procedures to secure customer data. 

 

A common theme in these proceedings appears to have been the failure to implement multifactor authentication, or “MFA,” as a security control, which requires users to verify their credentials through at least one method besides a matching username and password. The lack of such security measures can lead to an “account takeover,” whereby unauthorized users gain access to email accounts and, with it, confidential data. Additionally, several of these entities allegedly sent breach notifications to customers that were inaccurate or misleading, particularly with respect to the dates the account takeovers were discovered. As part of the settlements, these entities were ordered to cease and desist their violations of the Safeguards Rule, censured for past violations, and required to pay civil penalties.

 

The Takeaway

This is just the most recent example of financial regulators wielding their authority to ensure entities bring their cybersecurity and data privacy practices into compliance with established standards.  Insurance for responding to such proceedings is available, but coverage should be viewed as a backstop, not a first line of defense.

 

SEC’S EMPHASIS ON CONTINGENT LIABILITIES ENDURES 

 

A recent U.S. Securities and Exchange Commission (“SEC”) Enforcement Action highlights a continuing focus on timely disclosure of contingent liabilities. The SEC’s order found that a healthcare company improperly delayed recording or disclosing anticipated losses in pending litigation. The company’s CFO was also charged by the SEC for deciding not to record the loss contingency, along with the company’s controller, who was charged for a separate series of violations involving improper reductions in other expenses.

 

According to the SEC, the healthcare company was a defendant in several class action lawsuits alleging claims under various wage-and-hour labor laws, and on at least two occasions, entered into settlement agreements relating to certain of these suits. In several reporting periods, however, the company did not accrue any loss contingency despite entry into settlement agreements, submission of those agreements for court approval, and grants of preliminary approval by the court. According to the SEC, the healthcare company should have recorded an expense accrual in the period in which it entered into each settlement agreement, but its failure to do so enabled the company to report earnings per share that met analysts’ estimates in each of the relevant periods.

 

The Takeaway

This is the latest in a long list of enforcement actions highlighting how the SEC will view even small errors in financial reporting as material if they make the difference between meeting analysts’ earnings expectations and falling short. This SEC also continues to employ data analytics to seek out potential instances of earnings management and can be expected to continue emphasizing timely disclosure of loss contingencies, particularly involving litigation settlements. 

 

SEC Enforcement Actions, Settlements, and Judgements

AUGUST 2021 NOTEWORTHY ENFORCEMENT ACTIONS FILED*

 Director/Officer

 Role

 Company

 Avtar Singh Dhillon

 Chairman

 Emerald Health Therapeutics, Inc.

 Blessing K. Egbon

 Former CEO

 Exit 7C, Inc.

 Michael J. Conte

 CEO

 Fusion Analytics Investment Partners, LLC 

 Manish Lachwani

 Former CEO

 HeadSpin, Inc.

 Jon Isaac

 CEO

 Live Ventures Incorporated

 Virland A. Johnson

 CFO

 Live Ventures Incorporated

 Joshua Dax Cabrera

 Founder, CEO

 Medsis International, Inc.

 Arthur Hall

 CEO

 Rising Biosciences, Inc.

 Dean Tellone

 President

 Tellone Management Group, Inc.

 Gordon S. Venters

 CEO, President 

 The Movie Studio, Inc.

 Michael V. Shustek

 CEO

 Vestin Mortgage LLC

AUGUST 2021 NOTEWORTHY SETTLEMENTS AND JUDGEMENTS*

Amount

Director/Officer

Role

Company

$3,313,346.00 

Steven Fitzgerald Brown 

CEO, President 

Alpha Trade

$146,481.00

Rush F. Harding IIIFormer CEOCrews & Associates, Inc. 
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*Source: U.S. Securities and Exchange Commission

Shareholder Corner

2021 SECURITIES CLASS ACTION FILINGS UPDATE

 

In the first half of 2021, plaintiffs filed 112 new securities class action lawsuits in federal and state courts, 25% less than in the second half of 2020, making it the lowest number of filings since the first half of 2015, according to the Cornerstone Research and the Stanford Law School Securities Class Action Clearinghouse report, Securities Class Action Filings—2021 Midyear Assessment. This decline was driven in large part by filings related to mergers and acquisitions, which accounted for only 12 of the 112 filings, a 66% decrease compared to the second half of 2020. One trend that continued from 2020 was the decline in federal and state court class actions alleging claims under the Securities Act of 1933.

 

The first half of 2021 also saw COVID-19 filings begin to slow, with 60% of the pandemic-related filings occurring in January and February and only 10% in May or June. Of the 10 COVID-19 filings, 5 related to treatments or vaccines that failed to make it to market.

 

Despite the decline in total filings, federal filings related to special purpose acquisition companies (“SPACs”) doubled in the first half of 2021 compared to all of 2020. Of the 14 SPAC filings in the first half of 2021, more than half alleged the potential targets defrauded investors by misrepresenting their product’s viability. Filings against SPAC-related entities also saw a significant increase in the first half of 2021.

 

The Energy sector was a big target for plaintiffs in the first half of 2021, with the number of filings doubling from the second half of 2020. Despite this increase, Consumer Non-Cyclical continued to be the most common sector targeted, with 31 filings, of which 13 were in the Biotechnology subsector.

 

 

AUGUST 2021 SECURITIES CLASS ACTION FILINGS*

Company
Sector
Zymergen Inc.
Basic Materials
Generac Holdings Inc.
Capital Goods
View, Inc.ˆ
Capital Goods
 Contango Oil & Gas Company 
Energy
Dfinity USA Research, LLC
Financial
PayPal Holdings, Inc.
Financial

 SelectQuote, Inc.

Financial
Annovis Bio, Inc.
Healthcare
ATI Physical Therapy, Inc.ˆ
Healthcare
Cassava Sciences, Inc.
Healthcare
Iterum Therapeutics plc
Healthcare
Koninklijke Philips N.V.
Healthcare
Sesen Bio, Inc.
Healthcare
Spectrum Pharmaceuticals, Inc.
Healthcare
Activision Blizzard, Inc.
Services
Bowl America, Inc.
Services
HyreCar Inc.

Services

Live Ventures Incorporated
Services
Katapult Holdings, Inc.ˆ
Technology
Yalla Group Limited
Technology

^denotes SPAC-related


*Source: Stanford Law School Securities Class Action Clearinghouse

ABOUT ALLIANT INSURANCE SERVICES

Alliant Insurance Services is the nation’s leading specialty broker. In the face of increasing complexity, our approach is simple: hire the best people and invest extensively in the industries and clients we serve. We operate through national platforms to all specialties. We draw upon our resources from across the country, regardless of where the resource is located.

Contributors

Steve Shappell, Esq.
Executive Vice President
Claims & Legal
Steve.shappell@alliant.com
303-885-8228




Abbe Darr, Esq.
Claims Attorney
abbe.darr@alliant.com


David Finz, Esq.
Claims Attorney
david.finz@alliant.com


Erica Ahern
Claims Advocate
erica.ahern@alliant.com


Jacqueline Noster, Esq.
Claims Attorney
jacqueline.noster@alliant.com


Jacqueline Vinar, Esq.
Claims Attorney
jacqueline.vinar@alliant.com


Jaimi Berliner, Esq.
Claims Attorney
jaimi.berliner@alliant.com


Katherine Puthota
Claims Advocate
katherine.puthota@alliant.com


Matia Marks, Esq.
Claims Attorney
matia.marks@alliant.com


Meaghan Fisher
Senior Claims Advocate
meaghan.fisher@alliant.com


Megan Padgett
Senior Claims Advocate
megan.padgett@alliant.com


Robert Aratingi
Senior Claims Advocate
robert.aratingi@alliant.com


Robert Hershkowitz, Esq.
Claims Attorney
robert.hershkowitz@alliant.com


Steve Levine, Esq.
Claims Attorney
slevine@alliant.com


Vanessa Gonzalez
Senior Claims Advocate
vanessa.gonzalez@alliant.com