An Awakened Washington Promises More Stress for Directors & Officers

By | May 11, 2009

Corporations and their directors and officers are living in fear. Fear of the next financial scandal, the next stock market plunge, the next lawsuit. Fear of bankruptcy. Fear of angry policymakers inside Washington and angry citizens outside their homes. It’s no wonder that they’re asking about directors and officers liability insurance protection like never before.

“The last year has been interesting because I think the entire business community, and maybe the world in general, has recognized how risk is so vital, and understanding risk is vital to our economy. And at the center of that are directors and officers. Now they’re looking at their coverage in a way that, perhaps, they never have before,” said Mike Smith, president of AIG Executive Liability, who knows a lot about D&O and about today’s headlines.

“I think that in the past time, they relied on lawyers and brokers and maybe carriers to provide them a product, but today they’re asking more questions, to ensure that they have the coverage that’s going be there when they need it,” Smith said.

“A lot of money has been lost and that leads to a heightened awareness of what’s going on,” according to Michael Price, vice president, Hartford Financial Products.

D&O clients and their advisors are, of course, asking a lot of questions about their protection against securities litigation. They are also asking about the D&O risks they could face if their business were to go belly-up. And, increasingly, they are asking what risks they face when the federal government starts snooping around business a lot more as it is widely expected to do.

Washington Risk
D&O experts at the recent Professional Liability Underwriting Society (PLUS) D&O Symposium in New York said they don’t expect Congress to pass any major legislation to change the shareholder rights climate.

“Congress has other priorities,” said John Coffey, partner, New York
law firm Bernstein Litowitz Berger & Grossmann LLP, capturing the consensus.

President Barack Obama could bring about a “subtle shift” in the shareholders’ rights climate with his appointments to federal courts, according to plaintiffs attorney Sherrie R. Savett of Berger & Montague in Philadelphia. But observers don’t expect Obama to lead a revolution in the judiciary.

The D&O risk from Washington is not so much legislative or judicial in nature as it is regulatory. The Securities Exchange Commission (SEC) and other federal regulators are expected to step up their game, as former Vice President Dick Cheney would say, “big time.” All signs point to a far more aggressive regulatory approach and with that, higher costs.

“You can absolutely take to the bank that the SEC will increase its activity dramatically and quickly,” Randall Bodner, partner, Ropes & Gray in Boston, told the PLUS crowd during the “So, What’s Next? Emerging D&O Liability Trends” panel.

Bodner thinks there is “pent-up prosecutorial zeal” in Washington after
the Bush Administration. He doesn’t think it is as much “anti-business” as it is a desire to make up for missing the Madoff, Stanford and other scandals.

“I agree that there is a huge risk of increased SEC enforcement actions, not to mention the Department of Justice bringing their own criminal suits,” Denise Amantea, a partner with the San Francisco insurance agency, Woodruff Sawyer Insurance, told Insurance Journal in an interview after the PLUS panel.

“It’ll come in different areas. For example, the SEC is going through a rough time right now because it has missed the Ponzi schemes that we read about in the papers, like Madoff and Stanford,” Amantea said.

“The new [SEC] commissioner is going to make sure that these Ponzi schemes and any other fraud or corruption that’s bubbling up get caught before it’s an embarrassing predicament for them.”

The SEC acknowledges that it’s a new day in Washington. “The commission’s enforcement program is in a critical transition period. Our new chairman, Mary Schapiro, joined the agency in January and has been taking a series of steps to bolster our enforcement efforts and restore investor confidence to our markets,” SEC Commissioner Elisse B. Walter told the House Committee on Financial Services in early March.

Insurers see it coming. “I believe there will be significant changes in the way government will be involved in business,” said Fred Cooper, executive vice president, AXIS Financial Insurance Solutions in Berkeley Heights, N.J.

Cooper and others are concerned that this enhanced public oversight will mean “significantly” higher costs for D&O insurers.

Amantea thinks that could be the case, too. “There can be millions in attorney fees pile up long before there is even a trigger of coverage,” she said.

According to Bodner, SEC defense costs can be “onerous” and it is difficult for insurers to push back against the government to control them the way they might be able to do in other cases.

An issue worth watching will be whether regulatory penalties, payments and fines will be an offset for insurance payments, according to Dan A. Bailey, an insurance attorney with Bailey Cavalieri LLC in Columbus, Ohio.

What concerns Cooper is whether carriers have accounted for these higher costs. “Carriers are generally willing to offer the coverage but I don’t think they are pricing for it in excess coverage,” he said.

The cost concern could explain why Bailey said he already sees a significant increase in primary carriers negotiating settlements or “cutting deals early” in the game to cut costs. “I would expect this to continue,” Bailey said.

Corrupt Foreign Practices
One particular area of increased SEC activity could come under the Foreign Corrupt Practices Act (FCPA), a 1977 law that prohibits bribes to foreign officials to obtain business.

The SEC has brought 38 FCPA cases since January 2006 compared to just one a year in the late 1990s. A few recent cases have been high profile.

In December, the SEC reached a landmark $350 million settlement with Siemens AG, which it charged with a scheme involving bribes to government officials in Asia, Africa, Europe, the Middle East and the Americas, in violation of the FCPA.

An FCPA deal involving Halliburton/KBR made headlines in February. The SEC charged that a KBR subsidiary bribed Nigerian government officials over a 10-year period in order to obtain construction contracts. KBR and Halliburton agreed to pay $177 million in disgorgement to settle the SEC’s charges and $402 million to settle parallel criminal charges brought by the U.S. Department of Justice. The sanctions represented the largest combined settlement ever paid by U.S. companies since the FCPA’s inception.

“They [SEC] are on a tear,” believes Amantea, referring to a “flurry of activity” on FCPA cases over the past five years.

FBI Interest
A new report by the law firm of Shearman & Sterling LLP (FCPA Digest of Cases and Review Releases Relating to Bribes to Foreign Officials Under the Foreign Corrupt Practices Act of 1977) reports that the interest in FCPA cases extends to the FBI and to non-U.S. enforcement agencies as well.

“The increased risk of investigation or enforcement action has resulted in increased sensitivity to FCPA concerns in M&A transactions, as well as in common commercial transactions and business relationships,” says the report.

Bailey doesn’t think insurers have yet been badly burned by FCPA cases in part because those caught bribing tend not to be directors or officers. However, he does worry about this exposure for any entity doing business internationally.

The Hartford’s Price suggested that FCPA-related activities could be another catalyst for additional class action suits.

Amantea thinks the FCPA exposure shouldn’t be ignored. She recommends that brokers obtain explicit D&O endorsements that exempt FCPA activities from any prohibition against SEC fines and penalties.

“This could be a big exposure, and the exposure that worries me is not so much the employees who are doing the bribing, but the exposure to directors and officers, who are not necessarily putting this as an issue on their radar screen and supervising it,” said Amantea.

“I would, if I were the broker, absolutely vet the policies to make sure there is that explicit coverage,” Amantea added.

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