It may come as little surprise that litigation has emerged in the wake of the tragic Grenfell Tower fire in London last month. Some may find it surprising, however, that among the lawsuits arising from the London building fire is a securities class action suit filed in the United States. The lawsuit is just the latest example of the follow-on securities suit, a phenomenon that, as discussed below, is one of several factors that helps explain the current elevated pace of securities class action lawsuit filings in the U.S.
The recently filed securities suit involves Arconic, Inc. Arconic is metals manufacturing and engineering firm that was formed in late 2016 when it split from Alcoa. Among other things, Arconic manufactures building materials, including Reynobond PE, a lightweight building cladding material that consists of two sheets of aluminum sandwiching a polyethylene. The Grenville Towers building used Reynobond PE for its exterior cladding.
Following the fire, the building’s use of the cladding material was the subject of significant media scrutiny, including a June 24, 2017 New York Times article entitled “Why Grenfell Tower Burned: Regulators Put Cost Before Safety” (here). In its June 26, 2017 press release the company announced that it would discontinue sales of the building cladding product and acknowledged that it had supplied the Reynobond PE product to a fabricator that had in turn supplied it to the façade installer that worked on the Grenfell Tower building.
On July 13, 2017, an Arconic shareholder filed a securities class action lawsuit in the Southern District of New York against Arconic, its CEO, and its CFO. A copy of the complaint can be found here. Among other things, the complaint alleges that “(i) Arconic knowingly supplied its highly flammable Reynobond PE (polyethylene) cladding panels for use in construction; (ii) the foregoing conduct significantly increased the risk of property damage, injury and/or death in buildings constructed with Arconic’s Reynobond PE panels; and (iii) as a result of the foregoing, Arconic’s public statements were material false and misleading at all relevant times.” The complaint also quotes at length from the Times article to which I linked above, in which the newspaper reported that the building cladding materials were marketed in Britain without product warnings the company included in its sales pitch elsewhere.
The new securities class action lawsuit has only just been filed; it remains to be seen whether it will prove to be meritorious. While the suit’s future course is uncertain, the case does represent an example of the way in which an incident or event can be transformed into a securities suit. This type of lawsuit arises often enough to be characterized as prevalent. The triggering event can be a man-made or natural disaster or even an adverse legal development, such as the filing of a regulatory investigation or enforcement action.
These kinds of lawsuits are nothing new; follow-on lawsuits have been a feature of the litigation landscape for years. To cite just one example from past years, a follow-on securities suit was filed against BP in the wake of the Deepwater Horizon disaster. Regular readers will recall that I have frequently noted the phenomenon of the filing of civil lawsuits following companies’ announcement of the onset of a bribery investigation or enforcement action.
There have been a number of these kinds of follow-on suits filed this year. For example, in May 2017, Anadarko Petroleum was hit with a securities suit after the company closed down more than 3,000 of its vertical wells following an explosion at a home in Colorado that killed one person and injured others. The company’s April 26, 2017 statement when it closed down wells can be found here. The complaint in the securities suit, filed on May 3, 2017 in the Southern District of Texas, can be found here.
There have also been a number of suits following on regulatory investigations as well. For example, in February 2017, as discussed here, USANA Health Sciences was hit with a securities suit after the company announced that it had self-reported possible anti-bribery violations in the company’s Chinese operations. Along the same lines, in March 2017, Caterpillar was named in a securities class action lawsuit following media reports that government investigative agencies had raided the company’s corporate headquarters in connection with an investigation of the company’s tax strategy involving overseas units, as discussed here. In April 2017, BofI Holding was named in a securities suit after media reports that the organization was under investigation for possible involvement in money laundering, as discussed here.
There have been others of these follow-on cases filed this year as well; indeed, one of the factors in the heightened level of securities class action filings activity this year is the prevalence of these kinds of lawsuit filings. These kinds of cases represent a significant part of the securities suit filing activity this year that does not involve merger objection suits.
The possibility of these kinds of cases arising is of course a problem for the companies involved, but it is also a problem for the companies’ D&O insurers. The risk exposure that these kinds of claims represent is not necessarily susceptible to underwriting; it is hard to reduce the possibility that a company might experience this type of incident- or event-based claim to objective underwriting criteria that would permit risk segmentation and aid risk selection.
For underwriters seeking to avoid losses associated with these kinds of claims, the best approach may be to target only higher attachment point excess placements; the idea behind this approach is that these kinds of claims arguably are more conjectural (from the standpoint of the claimants) than, say, suits involving allegations of financial fraud and insider trading. A higher attachment point approach as a way to reduce exposure to these kinds of claims would reflect an assumption that these kinds of claims represent less of a severity risk than securities suits proceeding on other bases.
Carriers active in writing primary D&O have to accept that they are exposed to these kinds of risk. The absence of objective underwriting criteria to allow underwriters to select away from this type of risk means that pricing will have to reflect this element of frequency exposure. The premium to be charged has to reflect the possibility of these kinds of claims. Which of course begs the question whether in the current claims environment – with securities class action lawsuit filing levels at historically high levels – and in the current competitive pricing environment – where insurance buyers expect to see and usually do see pricing decreases – the pricing charge adequately accounts for this type of risk exposure.
In mulling these issues over, one of the things I thought about are the frequent calls I have with reporters and others in which I am asked whether this or that development is going to affect D&O pricing. The questions are perfectly reasonable, because it is rational to assume that the insurers might adjust their pricing in response to claims activity. The reality is that pricing in the D&O arena is largely determined by supply and demand, rather than upon experience-based factors. Because supply is currently abundant, the insurance marketplace remains competitive. D&O underwriters may lack the ability to adjust their pricing to experience consideration, such as the level of incident-driven D&O claims activity. However, even given the current competitive marketplace, D&O insurers must still be able to assess their overall premium adequacy in order to be able to fund claims and to seek to obtain an underwriting profit.
One final thought about these kinds of cases. It is worth noting that all five of the specific cases mentioned by name above involved the same plaintiffs’ securities class action law firm. In its small way, this observation validates the assertion that the recent ramping up in securities class action lawsuit filings is a reflection of changes in the plaintiffs’ bar and, in particular, of the increased activity of smaller plaintiffs’ law firms. These generalizations are more formally and objectively supported in the research of Prof. Michael Klausner and of Jason Hegland of Stanford Law School, as described in their recent guest post on this blog, here.