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SVP & Partner, Woodruff Sawyer & Company
- Counsels on corporate governance matters, ways to reduce exposure to shareholder lawsuits and regulatory investigations
- Board of Directors - Realty Income Corporation (NYSE: O)
- Board of Advisors - Rock Center for Corporate Governance, Stanford University
- Lecturer at Stanford University's Directors’ College
- Law Clerk to the Honorable Judge Frank Magill of the United States Court of Appeals for the Eighth Circuit
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Director and Officer Liability and its Mitigation
SVP & Partner, Woodruff Sawyer & Company
- The rising cost of director and officer insurance continues to be a challenge.
- The Council of Insurance Agents and Brokers reported six consecutive quarters of premium increases for the lines of insurance that include D&O coverage as of the end of 2013. Coverage for IPOs are especially challenging.
The good news is that the rate of premium increase seems to be slowing.
On another positive note, insurer profits are good and there is plenty of capacity in the market. As a result, it seems unlikely that the rate environment will worsen. On the other hand, don’t expect aggressive price competition to reappear until the interest rate environment improves and insurers are once again able to make the kind of profit on their investment portfolios that will allow them to forgo increases in premiums.
- D & O coverage continues to expand.
- Opportunities for high-quality coverage are still strong. AIG recently introduced an endorsement that will cover SEC investigative costs incurred by a company (if there is a concurrent and related securities claim). AIG is charging a 30 percent additional premium for the endorsement. Other carriers have followed with a similar offering.
- Litigation against directors and officers remains active.
- The largest source of exposure for directors, officers, and the companies they serve is securities class action suits.
Class action filings in securities cases remained constant in 2013, while the frequency of other types of D&O litigation, such as breach of fiduciary suits and regulatory actions, has risen over time. Still, securities class action suits continue to pose the greatest severity of risk. Understanding your company’s exposure to the risk of securities class action litigation is a critical step to determining what limits of insurance are appropriate for you.
- Policy change at the Securities and Exchange Commission could alter the D&O liability climate.
- The Securities and Exchange Commission has long allowed both individuals and corporations to settle enforcement actions under their "neither admit nor deny" policy. This policy is driven by the belief that if defendants are allowed to settle without admitting any wrongdoing, they are more likely to do so.
But this policy has come under scrutiny and criticism, and SEC Chair Mary Jo White recently announced that her agency will seek to extract admissions of wrongdoing from companies in certain circumstances, especially in circumstances where large numbers of investors have been harmed.
The concern, of course, is whether this pendulum will swing all the way to individual defendants.
If it does, it creates a perilous situation for individuals when it comes to their indemnification agreements and D&O insurance. Most of these contracts are written in a way that causes an individual to lose coverage if he or she admits guilt. As a consequence, most individual defendants – to avoid certain bankruptcy – will be motivated to avoid admitting guilt. This will be true even to the point of allowing the SEC to subject them a lengthy and painful trial that they would have been willing to avoid if they could settle without admitting guilt.
- Merger and acquisition lawsuits are still common, but the tide may be starting to turn.
- It has been well reported that the sale of a public company – no matter what the price – is almost always accompanied by shareholder suits against the selling company's directors and officers.
There are situations in which shareholders are more than justified in bringing suit to stop or fix a transaction. This is particularly the case with deals that involve undisclosed conflicts of interest.
However, it just cannot be the case that nearly every single public company merger and acquisition involving a target company worth more than $100 million is problematic. The rate of M&A suits for smaller deals is close to 60 percent – and the idea that more than half of M&A deals of this size are improper or inadequately described to shareholders is unreasonable.
The allegations in the suits brought to stop M&A deals normally include things like breaches of fiduciary duty and inadequate disclosure. The vast majority of M&A suits are settled for little more than plaintiffs' attorneys' fees, ranging from $400,000 to $1.2 million.
But are plaintiffs' attorneys' fee awards inevitable? Many have said that the situation won't be fixed until the courts become more skeptical of plaintiffs' attorney claims. The courts may be taking note of the argument that fewer frivolous cases will be brought when bringing frivolous cases is no longer a lucrative pursuit. Average plaintiffs' attorneys' fee awards for disclosure-only settlements declined for three consecutive years. And in two recent cases (Frontier Oil/Holly Corp and Transatlantic Holdings/Alleghany), plaintiffs' attorneys were denied fees altogether.
- Worldwide anti-corruption efforts continue to gain momentum.
- U.S. companies doing business abroad have long been concerned about anti-corruption compliance. Certainly the SEC and DOJ's active enforcement of the U.S. Foreign Corrupt Practices Act has motivated U.S. directors and officers to take compliance seriously.
Other countries also have strict anti-corruption/anti-bribery laws. Brazil is the latest country to enter the fray. On August 2, 2013, Brazilian President Dilma Rousseff signed into law new anti-corruption legislation, known popularly as the "Clean Companies Act." The Act, which took effect Jan. 24, 2014, prohibits companies from engaging in bribery and other corrupt practices involving either foreign or domestic government officials. With the signing of the Act, corporations that do business in Brazil need to ensure they have an effective corporate compliance program.
The Act applies to companies – whether exchange-listed or not – doing business in Brazil, including those operating through a local subsidiary. It prohibits the bribery of government officials, and activities like bid-rigging, financing or influencing others to engage in illegal acts. Notably, companies may be liable under the Clean Companies Act if any employee pays a bribe on behalf of the business: Prosecutors need not prove that the company had any "corrupt intent." Finally, any company considering an acquisition that involves Brazilian operations take note: The law holds that successors will be tagged with successor liability to the extent the acquired company had been in violation of the act.
- Cost of D&O insurance for IPO companies is increasing.
- Reflecting carrier losses in the past, the price for D&O insurance for companies going through an IPO is increasing.
About 12 percent of IPO companies are sued within five years of their IPO. The relatively high frequency of suits against IPO companies coupled with ever-increasing defense costs has prompted insurers to develop higher rating classes for IPOs. This loss experience has also reduced the number of insurers that are willing to quote the primary layer for IPOs, further increasing the premiums that the market will bear.
D&O pricing for IPOs has increased at a much faster rate than for the rest of the public company D&O market.
- Corporate governance continues to a critical part of D&O risk management.
- Corporate governance is the fire-sprinkler system for the fire that is D&O litigation. An innovation some companies are pursuing is the insertion of “choice of forum” provisions in their corporate charters or bylaws.
Director and Officer Liability and its Mitigation: Key Trends