Facebook Fiasco Disrupting IPO Insurance Market

The Facebook initial public offering (IPO) fallout has started and its effects are being felt in the area of directors and officers insurance coverage for future social media IPOs.

“D&O underwriters will view social media IPOs differently than other IPOs now,” says Will Fahey, senior vice president in charge of large corporate D&O for Zurich in New York. “The next social media company to try and go public will be priced more expensively and that is to be expected.”

Fahey says the allegations over Facebook’s IPO are substantial and valid as they are in line with the Securities Act of 1933. The act, which is often referred to as the “truth in securities law,” requires that “investors receive all pertinent financial or other information concerning securities that are being offered for public sale.” It is meant to “prohibit deceit, misrepresentations, and other fraud in the sale of securities,” according to the Securities Exchange Commission (SEC).

According to the SEC website, “investors who purchase securities and suffer losses have important recovery rights if they can prove that there was incomplete or inaccurate disclosure of important information.”

The current Facebook IPO lawsuits allege that potentially damaging information about Facebook’s financial standing and outlook was not disclosed to all investors prior to the stock going public.

A May 25, 2012, Reuters report said claims against Nasdaq had risen to the $100 million range from Knight Capital, Citadel Securities, UBS AG, and Citi’s Automated Trading Desk, the top four market makers involved in the IPO. Facebook and Morgan Stanley are also being sued by shareholders.

Facebook shares fell 18.4 percent from their $38 IPO price in the first three days of trading, resulting in a more than $2.9 billion drop in value of stock sold in the IPO, Reuters reported.

Fahey says claims started pouring in just two days after Facebook began trading.

“That is the fastest I have ever seen,” he says. “As far as what happens going forward, these are significant claims that fall under the Securities Act of 1933 of strict liability so I would anticipate a meaningful D&O settlement.”

The financial consequences will not stop with those major claims either, especially considering D&O policies are only one-year policies, but claims can be brought by investors for up to three years.

Ann Longmore, executive vice president of FINEX North America, part of the Willis Group, says unless shareholders have opted out, they are a member of the suit against Facebook and don’t have to do anything. Most of the claims that are going to come in have probably been filed or will be soon. “This matter seems to be attracting enough attention that I don’t think anyone will be waiting to bring action,” she says.

One group that could opt out of the shareholder suit, says Longmore, are very large, sophisticated investors. She says that usually occurs for two reasons: they feel the case has no merit or they want to bring their own class action separately.

“We refer to them as ‘opt out’ cases,” says Longmore. “Carriers are very leery today because of opt out cases. Even settling a class action still leaves the possibility of suits brought by opt outs. It is not possible to have global peace with a single shareholder settlement when you have opt outs.”

Fahey speculates that since Facebook is the second largest offering in U.S. history there is likely a D&O insurance program of around $200 million put up by several excess insurers, with HCC Insurance Holdings thought to be the primary insurer, according to a report by InsuranceInsider.com.

HCC did not return requests for comment by Insurance Journal.

Fahey, whose company, Zurich, is not an insurer of Facebook, says it is doubtful that any kind of financial settlement will exceed Facebook’s D&O insurance tower.

Longmore says the way D&O towers are structured now, there would be some upper layers of Side A only, which protects the assets of the individual directors and officers, and that would be one hurdle to blowing through the entire tower.

“Someone like Facebook is very well-capitalized so the philosophy is to buy enough to satisfy your board and then only really buy what you can’t otherwise cover yourself, and that would be the Side A,” she says.

The biggest challenge for Facebook now, says Fahey, is how it will correct the damage to its reputation with the investment community. Going forward, underwriters will use the Facebook IPO debacle as a bellwether for other social media IPOs, he says.

Topics Lawsuits Trends Claims Tech Market