Direct General - Big Brother & The Holding Company

December 20, 2007
Corporate Governance Newsletter

The shareholders of Direct General Corp. received welcome news when a federal judge approved the settlement of their class action suit. Led by the Structural Ironworkers Local Union #1 Annuity, Pension and Welfare Funds, shareholders recovered $14.96 million, including $2.96 million recovered from the well-lined pockets of the individual defendants.

Direct General is a financial services holding company known mainly for offering subprime automobile insurance in Florida and the Southeast. Run and largely owned by William Adair and family, Direct General was a classic “pump-and-dump” scheme. During the August 11, 2003 through January 26, 2005 class period, corporate insiders issued a series of false statements to investors regarding the company’s new business and strong loss reserves.

As an insurer, Direct General’s cash reserves were supposed to account for potential liabilities – claims made under insurance policies – and be adjusted every quarter. In August 2003, Direct General was faced with both rising claims and new legislation in Florida, potentially doubling the company’s claims exposure. While other insurers increased their loss reserves, defendants assured investors that the company’s reserves were adequate and that they had properly accounted for the new legislation. Defendants continued the deception for five quarters while engaging in massive insider stock sell-offs. Finally, on January 27, 2005, defendants disclosed the inadequacy of Direct General’s loss reserves, and the company’s stock price plummeted.

Plaintiffs’ attorneys worked with investigators, forensic accountants and industry experts to win significant victories at both the motion to dismiss and class certification stage of the litigation. After digging into Direct General’s financial records and internal correspondence, plaintiffs’ attorneys identified both errors in the company’s calculation of loss reserves and the individual defendants’ motivation to mislead shareholders.

With evidence well in hand, defendants were forced to come to the bargaining table. Borrowing from a common adage, plaintiffs’ attorney Ramzi Abadou remarked that “these books did not cook themselves – the defendants were the chefs.”

Despite serious issues concerning the proper measurement of damages and the specter of dueling insurance and actuarial experts at trial, Structural Ironworkers secured a settlement that is not only highly beneficial to the class, but also ensured that the corporate wrongdoers felt the pain of turning over $2.96 million of their own money. Settlement funds will be distributed once the claims-filing process is complete.

In re Direct General Corp. Sec. Litig., No. 3:05-0077, Order (M.D. Tenn. July 20, 2007).

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