Every year just after Labor Day, I take a step back and survey the most important current trends and developments in the world of Directors’ and Officers’ liability and D&O insurance. This year’s survey is set out below. Once again, there are a host of things worth watching in the world of D&O.
Will Federal Court Securities Litigation Filing Activity Continue at its Recent Historically Elevated Levels?
In its most recent annual securities class action litigation report, Cornerstone Research noted that the approximately four percent of publicly traded companies were hit with a securities class action lawsuit in 2015. This figure represents the highest annual securities litigation filing rate during the modern era of securities litigation. By way of comparison, the annual average litigation rate during the 1997-2014 period was only 2.9%. The significance of the elevated litigation rate is, according to the report, that in 2015 the likelihood that a U.S.-listed company would get hit with a securities class action lawsuit was at its highest level since the U.S. securities laws were substantially revised in 1995.
The elevated litigation pace in 2015 has continued into the current year. Cornerstone Research stated in its mid-year 2016 securities litigation report (here) that the pace of litigation so far this year has been even greater than last year’s record rate. According to the report, if the pace of filings in the year’s first six months were to continue for the remainder of the year, the litigation rate for the year would be five percent – well ahead of last year’s record rate and far above the annual historical filing rates.
The increased federal court securities litigation activity is a reflection of a number of factors, including, in particular, the shift of merger objection litigation from Delaware state courts to other courts (about which see more below); the increase of IPO-related litigation activity; the elevated level of litigation involving non-U.S. companies whose securities trade on U.S. exchanges; and heightened levels of litigation involving companies in the life sciences and high technology sectors.
Whether these elevated levels of litigation activity will continue of course remains to be seen. However, to the extent this level of federal court securities litigation activity continues, it eventually will affect D&O insurer’s underwriting and pricing, particularly for carriers active in the underwriting primary D&O insurance. Companies in the sectors that are experiencing the highest level of litigation activity are likeliest to see these changes first.
Will Collective Investor Litigation Outside the U.S. Continue to Grow?
For many years, securities class action litigation activity was essentially a U.S.-based phenomenon. In more recent years, significant securities litigation activity has developed in a number of countries, including, in particular, Australia and Canada. Even more recently, collective investor actions have spread to a number of other countries as well. While these actions seeking investor redress are very different from the U.S.-style class action litigation, they nevertheless represent a very significant development, one that appears likely to continue to evolve and grow.
These changes are coming about for a number of reasons, particularly the advent of a number of very high-profile corporate scandals; local legal reforms providing new procedural mechanisms; and the rise of third-party litigation funding.
The most significant development in this global rise of collective investor actions is the March 2016 settlement of Fortis investor claims for €1.204 Billion under the Dutch collective settlement procedures. This significant settlement represents a watershed event in the development of European collective investor actions. Not surprisingly in light of the magnitude of several recent corporate scandals, several groups of aggrieved investors have initiated action under the Dutch collective settlement act to recover investment losses.
A wave of corporate scandals has accelerated this phenomenon. Investor outrage over scandals involving, for example, Petrobras, Toshiba, Tesco, Volkswagen, and other companies has led to a number of collective investor actions outside the U.S. Investors, in initiatives organized by third-party litigation funding firms and often led by U.S.-based plaintiffs’ laws firms, have filed claims in a number of jurisdictions, often including actions in the Netherlands, in an effort to seek collective redress.
Recent legal reforms in a number of countries suggest that these developments are likely to continue. India and Thailand, among others, have recently enacted reforms allowing class action litigation in those countries. Proposed class action procedures are under review in Hong Kong as well. Although the procedures adopted in other countries differ in significant ways from the U.S-style class action procedures, the fact is that an increasing number of countries are adopting measures allowing for collective action.
The likelihood is that we will continue to see growth in the development of collective investor actions outside the U.S., as the combination of corporate scandals, third-party litigation funding and legislative reform continue to drive these procedures.
To What Extent Will Litigation Funding Drive Litigation?
As noted in the previous section, litigation funding is a potent and growing force on the global claims environment. Litigation funding is well established in Canada and Australia and its becoming increasingly important in the U.S. and elsewhere. The large litigation financing firms have substantial assets out of which to invest; according to the Wall Street Journal (here), Burford Capital LLC has already invested $800 million in the U.S. and abroad; Gerchen Keller has deployed $700 million of the $1.4 billion it has raised.
The leading funding firms have moved away from single-lawsuit funding arrangements, toward investment in portfolios of lawsuits. For example, Burford Capital, which at its founding invested 100% of its funds in individual cases, in 2015 invested just 13% in individual cases. These changes have allowed the firms “to deploy money faster and creased more consistent returns” for investors. The results are impressive; according to the Journal article, Burford Capital’s internal rate of return is 28%. The fact that these returns are uncorrelated with more conventional marketplace investments has drawn investment from pension funds and university endowments, among others.
The ability of these firms to generate these kinds of returns has attracted competition. As the Wall Street Journal noted in its August 5, 2016 article, “Litigation Funding Goes Mainstream” (here), litigation funding startups and investment platforms have attracted thousands of investors looking for high returns that are not correlated with ordinary investment market risks. Many of these new startups are targeting lawsuits smaller than the types of lawsuit in which the more established funding firms are focused.
As the litigation funding industry has grown and become higher profile, it has also attracted increased scrutiny. Several developments, including the high-profile Hulk Hogan lawsuit against Gawker that was financed by a third party, have led to calls for regulation of the third-party litigation funding industry. But while the litigation funding industry may attract some controversy, it is clearly growing and is having an increasingly important impact on the litigation environment and on claim activity in general.
What’s Next for Cybersecurity-Related D&O Litigation?
For many years, commentators have been predicting that cybersecurity-related incidents would drive a new wave of D&O litigation, as the plaintiffs’ lawyers targeted senior officials at companies that experienced a data breach. And for a time, that seemed to be happening. In 2014, plaintiffs’ lawyers filed shareholder derivative lawsuits against Wyndham Worldwide and Target Corporation. In 2015, plaintiffs filed a derivative suit against Home Depot as well.
But just as momentum seemed to be picking up for this type of litigation, the dynamic seemed to shift the other way. In October 2014, the Wyndham Worldwide derivative litigation was dismissed. And then on July 7, 2016, in the latest of these cases to hit the skids, District of Minnesota Judge Paul Magnuson, in reliance on the report of the special litigation committee appointed to investigate the claims and in the absence of opposition from the plaintiff, granted the motions of the special litigation committee and of the defendants and dismissed the consolidated cybersecurity-related derivative litigation that had been filed against Target Corporation’s board.
The poor track record in these kinds of cases has not been lost on prospective claimants and their attorneys. Though there have been numerous high profile data breaches in the interim (Anthem, Sony Entertainment , etc.), there really has only been one significant cybersecurity derivative lawsuit filed since the Target Corp. lawsuits were filed in early 2014; the exception is the derivative suit filed against Home Depot in September 2015. Otherwise, there has not exactly been a flood of this kind of litigation, and based on the results so far, the relative dearth of litigation seems understandable.
There are a couple of things to keep in mind before concluding that we can stop worrying about the possibility of this type of litigation. The first is that derivative lawsuits generally are tough cases to pursue, owing to the numerous procedural hurdles involved. As the Target case shows, it is hard for derivative plaintiffs simply to establish their right to proceed with their claims. The other thing is that the processes of the Wyndham board and the internal processes of Target Corp. each withstood scrutiny; in each case, the record allowed the companies to argue the derivative lawsuit should not be permitted to proceed. Even in a world where cybersecurity has become a watchword, not every company will fare as well under scrutiny. Even if these early cases have been dismissed, their undoubtedly will be future cases involving lax processes or inattentive or conflicted boards, where it will be harder for the defendants to oppose a plaintiff shareholder’s right to proceed with a cybersecurity-related derivative claim.
So, cybersecurity-related D&O litigation has not been all that great for the plaintiffs, so far. However, it is far too early to declare that this type of litigation is off the table. There undoubtedly will be a case somewhere down the line where the facts do not support an early dismissal. The plaintiffs’ lawyers are still working on how they are going to make money from this type of litigation. I suspect that when a case with worse facts shows up, the plaintiffs’ lawyers will know what to do. But while I am sure there will be significant case somewhere down the road, what is uncertain is when that will happen and whether or not this type of litigation will indeed become a substantial phenomenon.
Has the Merger Objection Litigation Curse Been Lifted?
One of the more noteworthy phenomena on the litigation scene in recent years has been the rise of merger objection lawsuits. We had reached the point that nearly every merger attracted at least one lawsuit challenging the transaction. Many of these lawsuits settled quickly based on the defendants’ agreement to make additional transaction-related disclosures and to pay the plaintiffs’ attorneys’ fees. However, in a series of rulings culminating in the January 2016 ruling in the Trulia case, the Delaware Court of Chancery has shown its disapproval of the disclosure-only settlement model.
One immediate practical consequence of the Chancery Court’s rejection of the disclosure-only settlements has been that fewer merger objection lawsuits are being filed, particularly in Delaware. As detailed in an August 2, 2016 report from Cornerstone Research entitled “Shareholder Litigation Involving Acquisition of Public Companies: Review of 2015 and 1H 2016 M&A Litigation” (here), the percentage of merger transactions attracting litigation began to fall to the lowest levels in years during the second half of 2015, and the litigation dropped even further in the first half of 2016. The filing patterns in late 2015 and so far in 2016 also suggest that as a result of the Trulia decision, plaintiffs are seeking to file fewer lawsuits in Delaware. Plaintiffs filed in Delaware for 61 percent of the litigated deals over the first three quarters of 2015 but only 26 percent of litigated deals in 4Q2015 and 1H2016.
The drop off in merger objection lawsuits outside of Delaware has been less dramatic. In other words, the plaintiffs’ lawyers still active in pursuing this type of litigation increasingly are filing their merger objection lawsuits outside of Delaware. With these kinds of cases now relatively more likely to be heard outside Delaware, the question of whether or not judges in other jurisdictions will follow the lead of Delaware’s courts in rejecting disclosure-only settlements takes on relatively greater importance. There had been some reason to be concerned that judges in other jurisdictions were not inclined follow Delaware’s lead and might continue to approve disclosure-only settlements of these kinds of cases.
However, on August 10, 2016, in a lawsuit involving Walgreen’s acquisition of Alliance Boots, the Seventh Circuit, in a blistering opinion written by Judge Richard Posner, affirmatively adopted the Delaware Chancery Court’s position on disclosure-only settlements. Saying that these kinds of lawsuits are “a racket” and characterizing the additional disclosure that was the basis of the settlement as “worthless,” the appellate court reversed the district court’s approval of the settlement.
The strongly-worded opinion by a respected jurist on a federal appellate court could well represent the death-knell for these kinds of lawsuits. With the ability to extract a quick settlement seriously in doubt, plaintiffs’ lawyers may well hesitate to file these kinds of lawsuits in the future. Of course, there will still be M&A-related lawsuits, particularly when there are allegations of conflicts of interest, but the routine filing of a lawsuit every single time a merger is announced may be a thing of the past. It will be worth watching what the year-end lawsuit filing figures show.
What Impact Will Brexit and the Upcoming U.S. Presidential Election Have on the D&O Marketplace?
For many purposes, it can often seem that the world of D&O is its own universe, with its own unique issues and challenges and operating according to its own rules. Of course, this has never been true, as the D&O insurance marketplace has always been subject to larger factors, such as the relative supply of insurance capital. Two particular pending developments in the larger world potentially could affect the world of D&O. The outcome of the recent U.K. vote in favor of Brexit could have a significant impact on the insurance marketplace, and by extension the world of D&O. There could be significant consequences from the upcoming U.S. Presidential election as well.
Though the Brexit vote itself roiled the financial marketplace and sent the British Pound plunging, the fact is that at this point no one really yet knows what it means. Not only has the U.K. government not yet formally exercised its rights under applicable treaties to withdraw from the E.U., but the government has not yet even stated what its position with respect to withdrawal will be. A vast number of issues will have to be sorted out as the U.K. withdraws from the E.U., the most important of which is whether or not U.K. businesses and financial firms will continue to have access to the so-called “single market” within the E.U. An equally important issue is whether or not there will continue to be free movement of persons to and from the E.U.
Both the access to the single market and the free movement of people have been important to the growth of the financial services industry in London, including the insurance industry. Access to the single market has allowed London to establish itself as a sort of a global headquarters for doing business throughout Europe. The free movement of persons has allowed the London financial businesses to attract the top talent from around the continent. While it remains to be seen how the whole process plays out, if the consequences of Brexit include the loss of access to the single market or restriction of the free flow of people, the financial services industry could be affected. During what is likely to be a long period of negotiations, there likely will be fewer new business initiatives in the London insurance marketplace and hiring will likely be stayed. Europeans working in London may well start to leave, in anticipation of what is yet to come.
London will always be an important part of the global insurance marketplace. The London insurance marketplace will remain the only place where certain kinds of business can get done. But the business dynamic in London seems likely to change. What it will all mean is at best uncertain.
The upcoming U.S. Presidential election presents its own set of potential challenges. Obviously, the outcome of the election could substantially affect a wide variety of important issues. Among other things, the winner of the upcoming election will have the ability to shape the U.S. Supreme Court in ways that could affect the country’s jurisprudence for a generation. The next President will not only have the ability to fill the seat vacated by the death of Justice Scalia, but may also have the occasion to name a number of additional justices as well. As many as three of the current justices are already are or are about to turn eighty. (Justice Ginsberg is 83; Justice Kennedy is 80; Justice Breyer is 78.) It is possible that the next President could appoint as many as four new Supreme Court justices.
Moreover, there are a host of vacancies in the lower courts as well. There are 72 vacancies at the district court level, and another 11 vacancies at the circuit court level. The next President could dramatically affect the make-up of the federal judiciary. The next President’s power also include a number of other appointments that could shape the legal environment, including, for example, the Attorney General and (as seems likely) the chair of the SEC.
The consequences from both the forthcoming Brexit negotiations and the upcoming U.S. Presidential election will be enormous. The outcome of these processes will affect the political, economic and legal worlds in many ways. The world of D&O could be substantially affected as well.