I believe that Martin Lipton’s recent speech in Miami was unfortunate in many ways. It appears to me that his remarks were an attempt to protect directors from organized attempts to hold them (or their D&O insurers) responsible even in those rare occasions when directors can be found to have engaged in egregious failure to execute their oversight duties. His hyperbole is particularly inappropriate given the prominence of his position and his vast experience. A more focused approach would have been far more interesting and useful.

I wish to comment in particular on his statement concerning “shareholder litigation” in his speech in Miami:

Although the number of cases brought each year seems to have leveled off after dramatic increases in the post-Enron period, shareholder litigation against directors has grown to be a big business and a type of extortion. While courts, commentators and legislators have long recognized the potential for abusive shareholder class actions, reforms aimed at reducing that potential have not had their intended effect. The recent Hubbard Committee report calls for further efforts to curb this type of litigation. Shareholder litigation continues to be hugely profitable for plaintiffs’ firms, without conferring any real benefits on shareholders generally.

The statement that “reforms aimed at reducing [the potential for abusive shareholder class actions] have not had their intended effect” is patently incorrect. Federal courts have aggressively enforced the requirements of Securities Exchange Act Section 21D(b)(1) and (2) (enacted as part of the Securities Litigation Reform Act of 1995) that plaintiffs in securities class actions plead extensive facts to justify their allegations that the defendants made material misrepresentations or omissions with scienter.

The recent Eleventh Circuit decision, Garfield v. NDC Health Corp., 466 F.3d 1255 (11th Cir. 2006), is a good example. There, the court affirmed the dismissal of a putative class action complaint alleging “channel stuffing” because of failure to comply with the specificity requirements of the PSLRA. The complaint alleged that “NDC understated expenses in violation of GAAP in three ways: ‘(1) it began to capitalize costs well before its development projects reached “technological feasibility;” (2) it amortized costs over periods much greater than the economic life of its software assets; and (3) it applied an excessive burden factor to its capitalized costs, thereby expensing less than necessary in the present term.” The Eleventh Circuit affirmed the dismissal, finding that the plaintiff’s “allegations regarding amortization and capitalization are vague and difficult to evaluate. For example, the Second Amended Complaint does not specify when the improper accounting occurred. It also fails to allege how and what products were improperly capitalized or amortized.” With respect to scienter, the court held that “it is possible to surmise that the Individual Defendants might have been aware of improper revenue recognition in the VAR channel and also knew that they needed to increase actual sales rather than ‘promot[e] discount buying[,]”that conclusion is based on multiple inferences and drawn from somewhat baffling language. [Plaintiff] failed to allege what was actually discussed at the meeting. Accordingly, the allegation regarding the meeting of March 1, 2004, does not give rise to a strong inference of scienter.” Finally, the court held that a certification of financial statements filed with the SEC in accordance with Sarbanes-Oxley is not per se indicative of scienter.

The Garfield decision has been aggressively followed in the district courts in the Eleventh Circuit. The October 2006 decision in Spectrum and the February 2007 decisions in Coca-Cola are good examples. It is only a matter of time before this important decision is cited in other circuits. And, of course, the law is not significant different in the other circuits.

Moreover, the Supreme Court has granted certiorari in a Seventh Circuit case in which the issue before the Court will be whether, in determining whether sufficient facts have been alleged to give rise to the required “strong inference” of scienter, courts are to weigh competing inferences from the allegations. The Sixth Circuit, for example, ruled six years ago that “plaintiffs are entitled only to the most plausible of competing inferences.”

Add to the 10b-5 case law the Delaware Supreme Court’s decision last year in Disney. I quote Professor Ribstein’s description of that decision: “It follows that the only way a board is going to be held liable for breach of fiduciary duty when it it isn’t self-dealing is to (1) really not have any idea what it is doing; and (2) not have a 102(b)(7) clause in the charter; or (3) have such a clause but proceed in conscious disregard of the board’s responsibility, which would be truly puzzling in the absence of self-dealing. In other words, the board will be liable for non-self-dealing conduct on a cold day in August in Miami under a blue moon.” It will be most interesting to see how the Delaware Supreme Court handles the recent decisions of Chancellor Chandler in the options backdating cases.

In short, the reforms are working. Any suggestion that they are not working would appear to be asking for blanket immunity for director decisions, no matter how egregious.