Facebook Fiasco, ‘Blank Check’ Companies Disrupt IPO Insurance Market

By | June 21, 2012

The Facebook initial public offering (IPO) fallout is just getting started, but its effects are already being felt in the insurance community when it comes to covering directors and officers 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 nature of 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” and is also meant to “prohibit deceit, misrepresentations, and other fraud in the sale of securities,” according to the SEC. (see the entire act here: http://www.sec.gov/about/laws/sa33.pdf)

According to the Securities Exchange Commission’s (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.”

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

A report by Reuters from May 25, 2012 said that claims against Nasdaq are already in 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 Facebook IPO. Facebook and Morgan Stanley are also being sued by shareholders.

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 speculated 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 speculated to be the primary insurer, according to a report by InsuranceInsider.com

[Note: Zurich is not an insurer of Facebook. HCC did not return requests for comment by Insurance Journal.]

However, Fahey 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.

“I think it’s fair to say for Facebook, the offering is not going the way they wanted it to and the subsequent suit has obliterated all the positive press the company received for this IPO,” he says. “They have to get people as excited about the company as they were before the IPO.”

Going forward, underwriters will use the Facebook IPO debacle as a bellwether for other social media IPO’s. But, says Fahey, underwriters, including Zurich, will differentiate future IPOs from those that involve social media companies.

“Underwriters will continue to look at those as attractive new business if they like the company,” he says. “At Zurich, our strategy to writing IPOs is unchanged by what happened with Facebook and we anticipate binding other IPOs in the future.”

Facebook isn’t the only issue, however, that is changing the landscape of the IPO marketplace and making underwriters nervous.

“Underwriters have expressed concern over any merger regardless of the industry they are in,” says Longmore.

Longmore says the American JOBS (Jumpstart our Business) Act has had some unintended consequences in the IPO community, specifically an increase in “blank check company” (or shell companies) IPOs. A blank check company is defined by the SEC as one with no business plan and sometimes no employees, or is created purely for the purpose of merging or acquiring with another company or companies.

The JOBS Act addresses easing the IPO rules and requiring less disclosure to encourage small private companies to go public and create more jobs. What lawmakers didn’t count on was blank check companies taking advantage of the lax regulations. According to a recent article in the Wall Street Journal, more than a dozen blank check companies have filed for an IPO and identified themselves as emerging growth companies since the JOBS Act was passed.

Underwriters are becoming increasingly uncomfortable with insuring these IPOs, says Longmore, and combined with the Facebook issues and tech companies in general, the market is definitely shifting.

“The decreased disclosure without any decrease in potential liability to carriers is not a good combination. Then we had Facebook, which looked fantastic and now has valuation questions being raised as well as a whole host of allegations by a number of parties,” she says. “It is an understatement to say carriers are a little jittery.”

Longmore says depending on the offering, capacity is likely to be restricted, especially if it is a blank check or social media IPO. “Brokers will become even more important because these [accounts] will not be welcome with open arms.”

About Amy O'Connor

O'Connor is the Southeast editor for Insurance Journal and associate editor of MyNewMarkets.com. More from Amy O'Connor

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