Options Backdating Settlement Has Important D&O Insurance Implications

In what may be a watershed event for the directors and officers (D&O) insurance industry, the parties to the consolidated federal options backdating-related shareholders’ derivative lawsuit involving Broadcom Corp. have agreed to settle the case for $118 million, to be funded by the firm’s D&O insurance.

The significance of this development is that a large part of the settlement will be paid by the company’s Excess Side A carriers. The Broadcom settlement may represent the first occasion on which Excess Side A carriers have contributed substantially toward a D&O claims settlement outside the insolvency context. This settlement involvement of the Excess Side A insurance could have important implications for carriers and policyholders.

As reflected in Broadcom’s Aug. 28, 2009 filing with the SEC the $118 million settlement, which is subject to court approval, includes $43.3 million that “Broadcom had already recovered in connection with prior reimbursements from its insurers (subject to a reservation of rights that will be released upon settlement approval).”

The stipulation also provides that in connection with the settlement Broadcom will pay plaintiffs’ attorneys’ fees and costs of $11.5 million. The settlement does not include its co-founders, Henry Samuels and Henry T. Nichols, III, against whom the suit will continue.

The settlement’s total value of $118 million would make this the second largest options backdating related derivative lawsuit settlement, exceeded only by the $900 million UnitedHealth Group options backdating derivative settlement, and, indeed, one of the largest derivative settlements of any kind.

But notwithstanding the settlement’s size, the net overall benefit to the corporation on whose behalf the lawsuit nominally was filed is an interesting issue. Not only is $43.3 million of the total settlement amount in the form of previously reimbursed defense expense, and not only is the settlement amount further reduced by the plaintiffs’ attorneys’ fees of $11.5 million, but the roughly $63.2 million remainder from the $118 million total is more than offset by litigation expenses the company has incurred in connection with a variety of litigated matters arising from the options backdating scandal.

Broadcom has “advised the Insurers that it has claims for reimbursement exceeding $130 million in respect of the Broadcom Stock Option Matters, of which approximately $85 million remains outstanding.”

The forthcoming cash settlement payment (after remittance of plaintiffs’ attorneys’ fees) effectively represents only a partial offset of the company’s enormous options backdating related litigation expenses.

In order to make sense of this settlement, it is important to understand the structure of the company’s D&O insurance. The Insurance Agreement accompanying the settlement shows that Broadcom had a total of $200 million of D&O insurance, arranged in various layers, with $100 million of “traditional” D&O insurance, and an additional $100 million of Excess Side A insurance. (Side A insurance provides individual directors and officers insurance protection on claims for which the company is unable to provide indemnification, whether due to corporate insolvency or legal prohibition.)

As part of the settlement, and in exchange for relinquishing potential coverage defenses, the carriers each agreed to contribute amounts less than their full policy limits. For their part, the Excess Side A insurers will contribute a total of $40 million, with each successive Excess Side A carrier contributing correspondingly smaller amounts.

The derivative lawsuit’s claim against the individual defendants for the harm to the corporation caused by the backdating includes claims on the corporation’s behalf for the enormous litigation expense the company incurred due to the alleged misconduct. The settlement of the claims in the derivative lawsuit against the individual defendants to recoup the harm to the corporation is not indemnifiable, triggering a potential payment obligation for the Excess Side A carriers.

If there had been no derivative lawsuit and the company had, say, tried to recoup its defense expense from the carriers directly in a declaratory judgment action, the Excess Side A carriers would have taken the position that because there was no nonindemnifiable loss, their policies were not implicated. The derivative lawsuit, asserting nonindemnifiable claims against the individual defendants, triggered the Excess Side A policies, which ultimately contributed a total of $40 million toward the settlement.

Whether or not other options backdating claims have hit Excess Side A insurers, the Broadcom options backdating derivative lawsuit settlement certainly did, and the Excess Side A insurers’ $40 million contribution toward the settlement in and of itself makes this settlement noteworthy.

Topics Lawsuits Carriers Claims Excess Surplus