What to Watch Now in the World of D&O

Due to constantly evolving financial and litigation environments, the issues that are most critical in the world of directors’ and officers’ liability insurance vary significantly over time. This overview addresses the most significant concerns of current interest for D&O insurance professionals and their clients.

Corporate Bankruptcies

According to the Administrative Office of the U. S. Courts, the number of business-related bankruptcies increased 63% (to 55,021 from 33,822) during the year ended June 30, 2009. Although the overall economy may be beginning to recover, lots of companies could face bankruptcy risk for some time to come.

Among other problems associated with bankruptcy is the risk of claims against officials at the bankrupt firms. For example, Advisen at the end of 2008 noted that since 1995, roughly 35 percent of the large public companies (assets of over $250 million) that filed for bankruptcy also sustained securities class action lawsuits against their directors and officers. During 2007 and 2008, the percentage increased to 77 percent. The directors and officers of private companies also face a heightened claims exposure when their companies file for bankruptcy.

Bankruptcy associated-claims present a host of complications. One illustration is the July 2009 Visitalk case in which the Ninth Circuit upheld the carriers’ denial of coverage for a lawsuit brought by a company against former directors and officers, as a result of the policies’ insured vs. insured exclusion.

Bank Failures

The number of 2009 year to date failed banks is up to 98 (as of Oct. 2, 2009), and the total number of bank failures since Jan. 1, 2008, is 123. Alarmists have predicted that as many as 1,000 banks could fail by the end of 2010. Whether the number will come anywhere near that level, this is the most significant wave of bank failures since the S&L crisis.

The question remains whether this time around there will be the same level of litigation as during the last failed bank wave. Thus far, the FDIC has initiated relatively little litigation to recoup its losses from the directors and officers of the failed banks. However, during the S&L crisis, they usually did not act until statutes of limitations were about to expire. There could yet be 21st Century edition of failed bank litigation.

Private litigants might also get in the act — for example, investors who lost their entire investment when a bank closed might sue. There has also been some securities class action activity involving failed banks whose shares were publicly traded. Of the 25 banks that failed in 2008, six of them are involved in securities class action litigation, even though only 11 were publicly traded.

Whether failed bank litigation ultimately will emerge, the D&O insurers have responded defensively to bank failures. Many banks face challenging circumstances when renewing their D&O. Some find that if they can obtain coverage at all, it is at greater cost for restricted terms and conditions. The wave of failed banks has already had a big impact in the D&O marketplace.

Derivatives Mega Settlements

The last several years have witnessed unprecedented mega settlements in shareholders’ derivative lawsuits. These include the $900 million UnitedHealth Group options backdating case; the $118 Broadcom backdating settlement; and the $115 AIG settlement.

One consequence is that Excess Side A carriers are being called upon to contribute significantly toward settlement outside of the insolvency context. The recent Broadcom settlement, in which the Excess Side A insurers collectively contributed $40 million toward settlement, represents a milestone development.

Until now, insurers have enjoyed the opportunity to offer Excess Side A insurance in a relatively low loss cost environment, particularly outside the insolvency context. The Broadcom settlement highlights the potential for Excess Side A insurers to sustain significant claims losses on this product, even outside of insolvency. The mega derivative settlements underscore the growing possibility of these kinds of losses.

Congress on Stoneridge

In January 2008, the U.S. Supreme Court in the Stoneridge case followed its prior decision in Central Bank of Denver and held that there is no private right of action for “scheme liability” or aiding and abetting under federal securities laws, ruling that Congress had reserved to the SEC the right to enforce aiding and abetting.

But in July, Sen. Arlen Specter introduced the Liability for Aiding and Abetting Securities Violations Act of 2009, which would overturn Stoneridge to allow private litigation against a person that provides “substantial assistance” in a violation of the securities laws.

The potential defendants could include not just gatekeepers (such as accountants and lawyers) but also other companies whose business transactions with the primary violator are alleged to have aided and abetted the fraud.

Recent events — including the popular need to assign blame for the economic crisis— may increase the likelihood of the bill’s passage. This possibility has significant implications for D&O insurance. In particular, the way in which the term “securities claim” is defined in the D&O policy could become even more important. The Specter bill makes it critically important to review the definition to ensure it is sufficiently broad to encompass aiding and abetting claims.

Hard Market Ahead?

Earlier this year, Advisen took the bold step of predicting that the D&O insurance marketplace is headed toward a “hard market” as early as late 2009 or early 2010. As 2009 progresses, the possibility of a hard market earlier rather than later seems less and less likely. The D&O insurance marketplace for financial companies is definitely harder than for the rest of the marketplace. Nevertheless, the marketplace remains competitive. Pricing declines of recent years have largely ended, but significant pricing increases remain the exception. A generalized harder market is not completely out of the question. The costs of the subprime crisis, together with years of pricing declines, could trigger increases and restrictions. It remains to be seen.

Topics Lawsuits Market