The directors’ and officers’ liability environment is always changing, but 2021 was a particularly eventful year, with important consequences for the D&O insurance marketplace. The past year’s many developments also have significant implications for what may lie ahead in 2022 – and possibly for years to come. I have set out below the Top Ten D&O Stories of 2021, with a focus on the future implications. Please note that on Thursday, January 13, 2022 at 11:00 AM EST, my colleague Marissa Streckfus and I will be conducting a free, hour-long webinar in which we will discuss The Top Ten D&O Stories of 2021. Registration for the webinar can be found here. I hope you will please join us for the webinar.
1. Securities Filings Declined in 2021 Relative to Recent Elevated Years, Closer to Long-Term Levels
The number of federal court securities class action lawsuits filed during 2021 declined significantly compared to the number filed in 2020, and the number of 2021 filings was sharply below the elevated number of securities suits filed each year during the period 2017-2019. The most significant factor in the 2021 drop-off is the decline in the number of federal court merger objection class action lawsuit filings during the year, although there were other factors at work as well. Though the number of filings in 2021 declined relative to the elevated number of annual filings during period 2017-2020, the number of 2021 filings was above longer-term historical annual filings levels prior to 2017, as discussed below.
According to my tally, there were 210 federal court securities class action lawsuits filed in 2021, representing a 34% decline from the 320 federal court securities suit filings in 2020. (Please note that these figures reflect only federal court securities class action lawsuit filings; the filing numbers do not include state court securities class action lawsuit filings during the year.) The 2021 securities suit filing numbers represent an even more dramatic decline compared to the annual average number of lawsuits filed during the 2017-2019 period, a period during which the number of securities lawsuits surged. The annual average number of securities suit filings during the 2017-2019 period was 405; the 210 securities suit filings in 2021 represents a decline of about 48% compared to the elevated filing levels during that period.
The most significant factor in the decline in the number of securities suit filings in 2021 was the decline in the number of federal court merger objection class action lawsuits. By my count, there were only 18 federal court merger objection class action lawsuits during 2021, representing only about 8.5% of all federal court securities class action lawsuit filings. By way of comparison, there were 102 federal court merger objection class action lawsuit filings in 2020, representing 31.8% of all securities suit filings during the year.
The 2020 merger objection lawsuit filings themselves represented an even sharper decline in merger objection suit filings compared to the three years during the 2017-2019 period; there were 160 merger suit filings in 2019, 182 in 2018, and 198 in 2017. The 18 merger objection class action filings in 2021 represent a massive drop from the numbers of these types of lawsuits that were filed during the years 2017-2020.
It is important to note that the plaintiffs’ lawyers are still filing merger objection lawsuits, they are just filing the lawsuits as individual actions rather than as class actions. The threat of merger-related litigation has not gone away, but the current form of the threat just is not reflected in class action litigation statistics.
When the merger objection lawsuit effect is taken out of the equation, the drop off in the number of securities suit filings during 2021 compared to 2020 is significantly less severe. Thus, there were 192 “traditional” securities suit filings in 2021, representing only about an 11.9% decline from the 218 traditional filings in 2020.
And everything is relative – though the number of 2021 securities suit filings reflect a decline both respect to 2020 and with respect to the years 2017-2019 when filings surged, the 2021 filing levels are much closer to historical filing numbers. Indeed, the 210 securities suit filings in 2021 is actually above the annual average number of filings during the pre-surge years from 1997 to 2016, when an average of 193 securities class action lawsuits were filed each year.
I suspect that many commentators and observers discussing the level of 2021 securities lawsuit filing activity are going to get stuck on the headline that securities suits filings are down more than a third compared to 2020. The fact is that much of the movement in the filing levels over the last few years, including also in 2021, was due to increases and decreases in the number of federal court merger objection securities class action lawsuit filings. As the number of these filings ramped up in the 2017-2019 period, the total number of securities suit filings skyrocketed; as the numbers of these filings fell in 2020 and declined more sharply in 2021, the overall number of filings declined. But as I noted above, when the effects of the merger activity class action filing activity are stripped out, the relative declines in the number of filings are much more modest. The filing levels in 2021 simply returned to long-term historical levels, compared to the artificially elevated levels that prevailed during the 2017-2020 period.
From my perspective, the question is not what happened to securities suit filings in 2021, since the filings levels simply returned to more normal levels; the question is what was going on during 2017-2020 that drove the filing number up above the historic levels. The answer has to do with merger objection class action lawsuit filings. During the period 2017-2020, the plaintiffs’ lawyers were filing merger objection suits as federal court class action lawsuits. During 2021, the plaintiffs’ lawyers continued to file merger objection suits, but they filed them as individual actions rather than class actions, causing the class action numbers to decline while overall litigation activity remained essentially unchanged.
For a more detailed analysis of the 2021 federal court securities class action lawsuit filings, please refer here.
2. SPAC Activity and SPAC-Related Litigation Surge During the Year
The amount of SPAC IPO activity in 2021 was nothing short of astonishing. According to SPACInsider (here), there were a total of 613 SPAC IPOs completed in 2021, raising total proceeds of $162.4 billion. Both the number of SPAC IPOs and the amount of funding raised in 2021 far exceed the then-record setting levels in 2020, when 248 SPAC IPOs raised $83.3 billion. Given the volume of SPAC-related financial activity, there was bound to be a certain amount of litigation activity as well. And in fact, there was a significant volume of SPAC-related litigation in 2021.
By my count, there were a total of 31 federal court SPAC-related securities class lawsuits filed in 2021. The 31 SPAC-related securities suit filings represent approximately 14.7% of all federal court securities class action lawsuits filed in 2021. In addition to the securities lawsuits, there were also at least 14 SPAC-related derivative lawsuits filed in 2021; all of the derivative suits involved companies that were also hit with securities suits.
Beyond the securities and derivative suits, there were other types of SPAC-related D&O lawsuits filed in 2021. For example, there were at least three state court direct action lawsuits filed during 2021, alleging fiduciary duty violations and contending that the SPAC transactions should be assessed using the “entire fairness” standard. In addition, during 2021, there were three lawsuits filed against SPACs alleging that the SPACs are in fact Investment Companies within the meaning of the Investment Companies Act of 1940, and that the companies had failed to register with the SEC as required by the ’40 Act. Finally, there were also two SPAC-related SEC enforcement actions filed during 2021 as well (refer here and here).
There were certain patterns among the SPAC-related securities lawsuits filed during the year. For example, nine of the 31 SPAC-related securities suits filed during 2021 (29%) involved companies in the electric vehicle industry. 14 of the 31 SPAC-related lawsuits (45%) involved companies that had experienced stock price drops following the publication of short-seller reports. (There is a reason that short sellers are targeting SPACs; selling SPAC-acquired companies short has been very profitable for short sellers.) And in 20 of the 31 SPAC-related suits (64.5%) the defendants named in the complaint included not only the post-merger company and certain of its officers and directors, but also former directors and officers of the SPAC itself.
While many SPAC-related securities lawsuits were filed in 2021, few of the cases have reached the motion to dismiss stage. It remains to be seen how these lawsuits will fare. There is relatively little historical track record for these kinds of cases. There was one settlement in 2021 of a SPAC-related lawsuit from an earlier era, relating to Akazoo, a music streaming company that had merged with a SPAC in January 2019. (The SPAC itself was in the SPAC IPO class of 2017.). The company was hit with a securities class action lawsuit in April 2020. In April 2021, the parties to the securities lawsuit reached a partial settlement of $35 million.
As a general matter, most of the SPAC-related securities lawsuits have arisen a short time after the merger was completed (or in a few cases, shortly after the merger was announced). In other words, the SPAC lifecycle events that give rise to the possibility of a securities suit are the SPAC’s announcement of and completion of its merger.
I emphasize the significance of these SPAC lifecycle events because there are enormous numbers of post-SPAC IPO companies that are currently in the search phase and that will be announcing and completing mergers over the next 24 months. According to SPACInsider, as of December 31, 2021, there were 575 SPACs seeking to identify a merger target. Since, at least historically, very few SPACs liquidate for lack of finding a target (there were a total of only 27 SPAC liquidations during the period 2009-present), it is likely that most of the searching SPACs will find and merge with a target company. Indeed, as others have written, the SPAC sponsors have huge financial incentives to complete a deal, any deal.
In short, over the next 12-24 months, a huge number of SPACs will be going through the SPAC lifecycle events that historically have given rise to SPAC-related litigation risk. I don’t think I am going out on a limb here by saying that among hundreds of SPAC mergers that will be taking place over the next 24 months, a certain number of the SPACs (or, more likely, the post-SPAC-merger companies) are going to be hit with securities suits.
In thinking about the possibility for future lawsuits involving those 575 searching SPACs, consider this: of the 31 SPAC-related securities lawsuits filed during 2021, only one involved a SPAC that completed its IPO in 2021. All of the other 2021 SPAC-related securities suits involved SPACs from the IPO classes of 2020 or prior. In other words, there is a lag between the time of the SPAC IPO and the time when the lawsuits begin to emerge. This certainly reinforces the likelihood that there will be a future surge of suits involving SPACs from the gigantic SPAC IPO classes of 2020 and 2021.
As if all of that were not bad enough, the SEC has signaled to investors and to the marketplace that it is also focused on SPACs. In recent remarks, Gary Gensler has underscored the agency’s concerns with many SPAC transactions. In addition, during 2021, the SEC also initiated two SPAC-related enforcement actions.
On July 13, 2021, as discussed here, the agency filed settled administrative charges against Stable Road Acquisition Corp., a SPAC; the SPAC’s CEO; and its proposed Merger target, Momentus, an early-stage space travel company. The agency separately filed a civil enforcement action against Momentus’s CEO. The agency alleged that the defendants had falsely stated that the target company’s rocket system had been successfully tested in space. The SPAC and SPAC CEO were also charged for inadequate due diligence in connection with the proposed merger.
The SEC filed a second SPAC-related enforcement action in late July 2021 when, in conjunction with the presentation of a criminal indictment against electric vehicle company Nikola’s founder, Trever Milton, the SEC filed parallel enforcement charges against Milton, as discussed here. (Many of the allegations in the SEC enforcement action are also alleged in a separate securities class action lawsuit that was filed against Nikola in September 2020.) In addition, in December 2021, the SEC instituted a settled proceeding against Nikola itself (as discussed here).
The bottom line is that SPACs remain in the spotlight and the likelihood is that scrutiny and potentially litigation will continue in 2022 and possibly beyond.
3. COVID-19-Related Litigation Continued to Arise in 2021
Just as we are all surprised to find ourselves 22 months into the pandemic still dealing with the coronavirus outbreak, so too it is surprising to find that COVID-19-related securities litigation is continuing to be filed as well. And just as with the passage of time new coronavirus variants have emerged, the COVID-19-related litigation has continued to change and evolve as well.
By my count, between March 1, 2020 and December 31, 2021, 42 coronavirus-related federal court securities class action lawsuits were filed. Of these 42, 24 were filed in 2020 and 18 were filed in 2021. There have also been at least 16 coronavirus-related shareholder derivative lawsuits, of which nine were filed in 2021. In addition, there have also been at least ten SEC coronavirus-related SEC enforcement actions, as well.
Until the latter half of 2021, the coronavirus-related securities class action lawsuits generally fell into one of three categories: first, claims against companies that experienced coronavirus outbreaks in their facilities (cruise ship lines, private prison systems, meat-packing plants; second, claims against companies that claimed to be in a position to profit from the coronavirus outbreak (vaccine development companies, diagnostic testing companies, online learning platforms); and third, companies that experienced disruption in their operations or financial results due to the coronavirus outbreak (hospital systems, real estate development companies).
In the final months of 2021, a fourth category of coronavirus-related securities suits emerged. The lawsuits in this fourth category were filed against companies that had prospered at the outset of the coronavirus outbreak but whose fortunes ebbed as government shut-down orders were withdrawn and as businesses re-opened.
An example of one of these “fourth category” lawsuits is the securities class action suit that was filed in November 2021 against the exercise equipment company, Peloton Interactive. The company’s revenues soared at the outset of the pandemic as consumers stuck at home clamored for the company’s exercise devices. The company ramped up its inventory, assuring investors that its COVID-related growth was sustainable. The company’s share price later declined after the company announced weaknesses in its financial controls relating to its inventory levels.
Other companies that were hit with one of these “fourth category” lawsuits include the web meeting hosting platform ON24, which had also experienced at early surge in demand at the outset of the pandemic, followed by a later decline, and the consumer product company The Honest Company, which experienced an early pandemic-related spike in sales of its health and hygiene products, followed by a later slump. Similarly, as discussed here, the technology company Citrix Systems also was hit with one of these “fourth category” lawsuits. In late December, there were two more of these fourth category lawsuits filed, against DocuSign and Chegg (both of which new suits are discussed here).
Few of the coronavirus-related securities suits have reached the motion to dismiss stage. Of the eight cases out of the 42 total cases filed that have reached the dismissal motion stage, the motion to dismiss has been granted in six. The dismissal motions in the securities suits against vaccine manufacturers Inovio and Vaxart were denied, at least in part (as discussed here and here, respectively). The securities suits filed early in the coronavirus outbreak against the cruise ship line companies fared particularly poorly; all three of the securities suits filed against cruise ship companies were dismissed (as discussed here). As far as I am aware, only one of the coronavirus-related securities suits has settled; on December 27, 2021, SCWorx, which had been hit with a COVID-19-related suit in April 2020, announced that it had settled the lawsuit in exchange for its D&O insurers agreement to pay an undisclosed amount of cash and the company’s agreement to issue $600,000 worth of stock.
Despite the plaintiffs’ track record in these cases so far, which is decidedly mixed, plaintiffs’ lawyers have continued to file these cases, particularly the new “fourth category” cases I described above. It seems likely that pandemic-related lawsuits will continue to be filed in the weeks and months ahead. Future cases may develop relating to second-level effects of the pandemic, such as supply chain disruption, labor shortages, and economic inflation, as discussed below.
As the ongoing effects of the pandemic continue to ripple through the economy the causal connection between the coronavirus and the lawsuits may become increasingly challenging to discern. Simply trying to characterize lawsuits as being coronavirus-related may become increasingly difficult. But while the tracking may become increasingly complicated, the fact is that developments resulting from the pandemic are likely to continue to produce circumstances that lead to further pandemic-related litigation.
4. Pandemic-Related Effects Roiling the Economy, Threatening Further Litigation
As we head into 2022, there are (at least) three threats bearing down on the economy and that could have a big impact in the months ahead. These threats are at least in part follow-on effects from the pandemic, although they are not exclusively so. These three threats are: supply-chain disruption; labor shortages; and economic inflation. These threats not only have implications for the domestic and global economies; they have litigation implications as well. Indeed, there has already been litigation activity arising from these factors.
For example, as discussed here, ATI Physical Therapy, a national chain of physical therapy clinics, was sued in August 2021 shortly after the company merged with a SPAC, after the company announced that it was experiencing higher than expected attrition of its staff physical therapists and encountering increased competition for replacement staff, resulting in higher labor costs and operating disruption.
Similarly, as discussed here, Romeo Power, which manufactures batteries for electric vehicles, was sued in April 2021 shortly after the company merged with a SPAC, after the company announced that its production had been hampered due to a shortage of an important component part due to supply chain disruption.
In addition, in December 2021, the bedding and mattress company Sleep Number was hit with a securities class action lawsuit relating to the company’s disclosures about the extent of the disruption to its mattress foam supply as a result of the Texas winter storms.
Some economists and politicians believe that these current economic factors will prove temporary; eventually, it is hoped, the supply chain constraints will ease and that labor market disruptions will lessen, which in turn could alleviate inflationary pressures. However, the Omicron variant outbreak in the final weeks of 2021 could cause even further disruptions and could further set back the return to stability.
Even if these various economic factors prove to be temporary, they are still going to be affecting companies in the short term, which could create both operating and litigation risk for many companies. The larger concern is what might happen if these economic factors prove to be more enduring. Many of these issues are going to play out during 2022, with potentially serious implications.
The lawsuits cited above arguably reflect “second level” effects of the pandemic. As I noted in the previous section, the length of the causal connection between the pandemic and the circumstances that caused problems at the defendant companies underscores how it may become increasingly difficult in the months ahead to say whether or not a lawsuit is or is not pandemic-related. This circumstance may make the tracking of the coronavirus-related litigation phenomenon increasingly difficult.
The lawsuit filed against Sleep Number noted above arguably represents yet another litigation category. The lawsuit involves allegations that the company overstated its supply chain resilience and understated the disruptive impact on company operations arising from the the 2021 Texas winter storms on the company’s bedding foam sources in Texas and Louisiana. It is worth thinking about these circumstances in the context of the concerns of some climate scientists that extreme weather events may become more frequent and more severe in response to global climate change. The fact pattern in the Sleep Number case may represent the prototype for the kind of litigation that might ensue if climate change impacts do lead to more and more severe extreme weather events.
5. Despite Mixed Record, Plaintiffs’ Lawyers Continue to File Cybersecurity-Related D&O Claims
A recurring theme in recent years has been the risk of D&O claims following in the wake of cybersecurity incidents. Beyond the question of the extent to which plaintiffs’ lawyers may seek to pursue these kinds of claims is the related question of whether these kinds of cybersecurity-related D&O lawsuits actually make good cases for the plaintiffs’ lawyers. In fact, the track record for the plaintiffs in these cases has been mixed, particularly recently.
In 2021 alone, several of the pending high-profile cybersecurity-related D&O lawsuits were dismissed: in February 2021, the FedEx/NotPetya securities class action lawsuit was dismissed (as discussed here); in June 2021, the long-running federal court Marriott data breach securities suit was dismissed, as was the related federal court shareholder derivative suit (discussed here), and in October 2021, the related-but- separate state court Marriott derivative suit was dismissed as well (as discussed here); and in September 2021, the cybersecurity-related securities class action lawsuit against title insurer First American was also dismissed (discussed here).
While these dismissals may comfort companies that may in the future be targeted with these kinds of lawsuits, developments in another cybersecurity-related securities suit may provide cause for concern. In June 2021, the Ninth Circuit reversed the district court dismissal of the securities lawsuit filed against Google-parent Alphabet based on allegations that the company had wrongfully failed to disclose a breach of Google+ user data. The appellate court’s reversal of the dismissal, and especially the court’s willingness to give credence to many of the plaintiff’s allegations, puts the cybersecurity incident-related D&O claims in a new light, as I discussed in detail in a post about the appellate court’s decision.
Notwithstanding the outcome of the Ninth Circuit appeal in the Alphabet case, the plaintiffs’ track record in cybersecurity-related D&O claims is at best mixed. Perhaps because of the very high-profile settlements in recent years of the Equifax cybersecurity-related securities class action lawsuit (which, as discussed here, settled in February for $149 million) and of the Yahoo class action lawsuit (which settled in March 2018 for $80 million, as discussed here), plaintiffs’ lawyers continued to file cybersecurity related D&O claims in 2021, despite the mixed overall record in these kinds of cases.
Thus, for example, during 2021, plaintiffs’ lawyers filed cyber incident-related securities class action lawsuits against Solar Winds (as discussed here) and against Ubiquiti (discussed here). In addition, plaintiffs’ lawyers also during 2021 filed shareholder derivative lawsuits against the boards of Solar Winds (as discussed here) and against T-Mobile USA (as discussed here).
The derivative suits against the Solar Winds and T-Mobile boards are particularly interesting as the plaintiffs’ lawyers appear to be relying on allegations of breach of the duty of oversight to try to support their claims, apparently trying to take advantage of recent Delaware case law arguably revitalizing these kinds of claims, as discussed below.
A series of securities suits filed this summer against U.S.-listed Chinese companies also highlights another sort of cybersecurity-related D&O risk. In July 2021, shareholder plaintiffs filed securities class action lawsuits against four U.S.-listed Chinese companies: Didi Global (about which refer here); Kanzhun Limited (discussed here); Full Truck Alliance Co. Ltd. (here), and 360 DigiTech (here). Three of the four had recently completed IPOs in the U.S. In each of the cases, the companies had experienced share price declines after announcing that they had been subject of regulatory action by the Chinese cybersecurity regulator.
Although these new cybersecurity regulation-related lawsuits reflect political circumstances unique to China, the suits do show how cybersecurity-related regulatory actions can lead to D&O claims. The twist in these lawsuits is that the D&O claims were not filed following on a data breach or other cybersecurity incident; instead, the D&O claims arose after the cybersecurity regulator raised concerns about the defendant companies’ cybersecurity protocols and protections. Clearly, increased regulatory scrutiny of cybersecurity issues could lead to further D&O claims.
In that regard, the SEC has recently stepped up its enforcement activity in connection with cybersecurity disclosure. The agency has of course filed cybersecurity-related disclosure enforcement actions in the past. But the agency’s recent actions suggest a renewed and heightened focus on the topic.
The first of these latest cybersecurity enforcement actions involved settled charges filed in June 2021 against title insurer First American Financial Corp., as discussed here. After the company learned from a journalist’s inquiry about a vulnerability in the company’s online systems that potentially exposed hundreds of millions of title and escrow records, the company issued a press release and statement about the vulnerability. However, the company officials responsible for the press release and statement were unaware the company’s IT security officials had discovered the vulnerability earlier; though known, the vulnerability had not been remediated prior to the journalist’s contact, and the prior discovery had not been disclosed. In its statement about the settled charges, the agency said that it is the responsibility of every issuer to “maintain disclosure controls and procedures designed to ensure that information required to be disclosed by an issuer in reports it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified by the Commission’s rules and forms.”
The second recent SEC cybersecurity enforcement action involved the U.S.-listed U.K. education services firm Pearson plc, as discussed here. In March 2019, the company discovered that an intruder had accessed and downloaded data pertaining to students and school officials. The company provided breach notices to the affected individuals but elected not to disclose the incident in its next SEC report; instead, the company’s report merely said, repeating prior disclosure statements, that a data breach could cause damage to customer experience and the company’s reputation. The SEC later alleged that in this way, the company “referred to a data privacy incident as a hypothetical risk, when, in fact, the 2018 cyber intrusion had already occurred.” The SEC also alleged that the company failed to disclose the incident in a subsequent media inquiry. The SEC filed settled administrative charges against the company in August 2021. The company agreed to take remedial steps and paid a $1 million civil money penalty.
These enforcement actions against First American and Pearson underscore that cybersecurity-related disclosure issues are an important SEC priority and that the agency is prepared to take actions relating to cybersecurity disclosures. The agency’s press release in connection with the Pearson enforcement action emphasized the priority the agency is giving to cybersecurity disclosure issues; the press release quotes the chief of the enforcement division’s cyber unit as saying that “As public companies face the growing threat of cyber intrusions, they must provide accurate information to investors about material cyber incidents.”
It seems likely as we head into 2022 that cybersecurity issues are going to remain a priority for both plaintiffs’ lawyers and for the SEC
6. Board Diversity Concerns Trigger Legislation, Regulation, and Litigation
In the wake of the social unrest that followed George Floyd’s May 2020 death, social justice issues came sharply into focus. Many settled practices were questioned, some for the first time. Among other things, this scrutiny drew attention to the lack of diversity in many corporate boardrooms. Board diversity concerns have in turn led to legislation, regulatory action, and even litigation.
The most specific legislative actions addressing board diversity issues are two California bills that have been enacted into law, the 2018 California legislation requiring board gender diversity and the 2020 legislation mandating the inclusion on boards of California-headquartered companies of representatives of “underrepresented communities.” Both of these bills have been subjected to legal challenge, and indeed in June 2021, the Ninth Circuit revived the previously dismissed legal challenge to the California board gender diversity statute.
A development of even greater potential impact involves the Nasdaq “comply or explain” board diversity guidelines, which the SEC approved in early August 2021, as discussed here. Under the Nasdaq guidelines, every Nasdaq-listed company (other than Foreign Issuers, Smaller Reporting Companies, and Companies with Smaller Boards) is required, according to timetables specified in the guidelines, to have, or to explain why it does not have, at least two members of its board of directors who are “Diverse,” including at least one Diverse director who self-identifies as Female and at least one Diverse director who self-identifies as an Underrepresented Minority or LGBTQ+. The SEC-approved Nasdaq guidelines are also subject to legal challenge, as a non-profit directors organization filed a petition for review of the guidelines (as discussed here).
In addition to legislation and regulatory action, board diversity issues have also been the subject of litigation. In late 2020 and early 2021, the boards of ten companies were hit with shareholder derivative suits in which the shareholder plaintiffs alleged that the board members breached their fiduciary duties by failing to elect or appoint diverse board members. These lawsuits have fared poorly. Courts have granted motions to dismiss in the board diversity lawsuit filed against the boards of Facebook (discussed here); The Gap (here); Oracle (here); the Danaher Corporation (here); NortonLifeLock (here); OPKO Health (here) and Qualcomm (here). In all of the board diversity lawsuits in which a court has ruled on the dismissal motions, the motions have been granted. None of the lawsuits have yet survived the initial pleading hurdles.
Though the California statutes and the Nasdaq guidelines have been subjected to legal challenge, and though the board diversity lawsuits have failed to survive the initial pleading hurdles, board diversity issues remain a high-profile issue and a concern for many companies. Among other things, several prominent institutional investors have made it clear that board diversity is a priority issue for them. Companies without diverse boards likely will continue to find themselves subject to scrutiny and pressure. And though the California statutes and the Nasdaq guidelines have been challenged in court, they remain in effect and companies subject to their requirements will need to take steps to comply. And all of the recent board diversity developments — including not just the California statutes and the Nasdaq rules but also including the board diversity lawsuits as well – highlight the fact that for well-advised boards, diversity and inclusion issues (including diversity and inclusion on the board itself) are board-level issues. The bottom line is that board diversity issues will continue to be a concern and a priority for all corporate boards.
7. D&O Litigation Arising Out of Sexual Misconduct or Hostile Workplace Allegations Continues to Be Filed
Over the last several years, there have been a number of D&O claims filed against companies that are alleged, or whose boards are alleged, to have permitted an atmosphere in which sexual misconduct or harassment was tolerated or to have misrepresented to investors the measures the companies had taken to prevent or respond to misconduct.
Some of these earlier claims remain pending or have only recently been resolved. For example, as discussed here, in late July 2021, the parties to the L Brands shareholder derivative lawsuit, in which the plaintiffs alleged that the companies’ senior management permitted a hostile work environment in which women were demeaned or disadvantaged in terms of their pay and opportunities for promotion, agreed to settle the case for a payment of $90 million and the company’s agreement to adopt a number of remedial measures.
There is a perception in certain quarters in the D&O insurance industry that the risk of D&O claims of the type that followed immediately in the wake of the #MeToo movement has declined and is becoming a thing of the past.
The securities class action lawsuit filed in August 2021 against the gaming company Activision Blizzard suggests that the risk of these types of claims is continuing. In July 2021, Activision had been named as a defendant in a state court civil rights complaint filed by the California Department of Fair Housing and Employment (DHFE). In response, the company put out a statement saying that while it took allegations of misconduct seriously, the DFHE complaint was “meritless” and painted a “false” picture of the company’s past and does not accurately portray the company’s present workplace. In response to the company’s statement, over 2,000 current and former Activision employees signed a petition saying the that the company’s response was “abhorrent and insulting” and stating that for the company to call the DFHE complaint “meritless and irresponsible” was “simply unacceptable.” Activision workers staged a walkout. The company issued a statement apologizing the “tone deaf” response to the DFHE complaint and a management shakeup followed. The securities suit alleges that the company and senior management had failed to inform investors about the reality of its workplace environment and the risks it presented to the company’s reputation and for the possibility of regulatory action.
If nothing else, the Activision lawsuit shows that the risk of D&O claims arising out of allegations of sexual misconduct or harassment, or of a hostile workplace, continues, even though it has now been several years since the #MeToo movement first emerged. These kinds of claims seem likely to continue as long as these kinds of workplace circumstances persist. The recurrent message from these cases, and especially from the numerous settlements in these kinds of cases, is that boards have a responsibility to ensure that their companies maintain a safe atmosphere where all employees are treated fairly and respectfully.
8. Encouraged by Recent Successes, Plaintiffs’ Lawyers Increasingly Rely on Breach of the Duty of Oversight Allegations
The legal theory behind claims against boards for their alleged breach of their duty of oversight was first articulated in the 1996 Delaware Court of Chancery decision in the Caremark case, and thus these types of claims are often referred to as Caremark claims. Caremark cases are notoriously difficult to sustain; in the words of a much-quoted statement about these kinds of claims, breach of the duty of oversight is “possibly the most difficult theory in corporation law upon which plaintiff might hope to win a judgment.” However, in a series of decisions starting with the Delaware Supreme Court’s 2019 decision in Marchand v. Barnhill, Delaware’s courts have sustained a number of breach of the duty of oversight claims.
The most recent example of a breach of the duty of oversight claim surviving a dismissal motion is the high-profile Boeing 737 Max Air Crash derivative suit. In her September 7, 2021 opinion, Vice Chancellor Morgan Zurn in substantial part denied the defendants’ motion to dismiss, holding that the defendant directors faced sufficient risk of potential liability for the alleged breaches of the duty of oversight that that demand on them for the company to take up the claims would have been futile. Vice Chancellor Zurn identified numerous parallels between the allegations in Marchand and the plaintiffs’ allegations against Boeing. In both cases, safety issues were “essential and mission critical.” The Vice Chancellor found that the directors failed to take action in response to the “red flags” about the Max 737 navigational and piloting system. Just two months after Vice Chancellor Zurn issued her opinion, the parties in the Boeing lawsuit settled the case for $237.5 million.
These developments, and in particular the dismissal motion ruling in the Boeing case, have prompted some commentators to suggest that these kinds of breach of the duty of oversight claims may no longer be as difficult to establish as may have previously been the perception.
At the time of the Delaware Supreme Court’s 2019 Marchand v. Barnhill ruling, I speculated that a newly revitalized breach of the duty of oversight claim could represent a legal theory on which plaintiffs might seek to rely in asserting claims against boards of companies that had experienced cybersecurity incidents. As I noted at the time, cybersecurity is for many types of operations “mission critical.” With the benefit of post-incident hindsight, plaintiffs’ lawyer could, I speculated, seek to portray the ups and downs of daily operations as presenting “red flags” that should have triggered boards’ monitoring of key operations.
And indeed, in November 2021, the boards of two companies were hit with breach of the duty oversight claims arising out of cybersecurity incidents. On November 3, 2021, a breach of the duty of oversight claim was filed against the board of Solar Winds based on a cybersecurity incident at the company, and on November 21, 2021, a plaintiff shareholder filed claims alleging that the board of T-Mobile USA had breached their “failure to monitor” and failed to heed “red flags” in connection with data security incidents at the company.
In thinking about the potential of these latest lawsuits for success, the October 2021 decision in the Marriott state court data breach-related derivative lawsuit needs to be considered. As I noted in a post at the time, Vice Chancellor Lori Will granted the defendants’ motion to dismiss, ruling that the plaintiffs’ obligation to make a pre-suit demand on the board was not excused. With respect to the plaintiff’s breach of the duty of oversight claims under Caremark, Vice Chancellor Will specifically said that the “allegations in the complaint do not meet the high bar required to state a Caremark claim.”
In her opinion in the Marriott case, Vice Chancellor Will did say some things that the plaintiffs in the SolarWinds and T-Mobile USA cases may find to be helpful. For example, she said that cybersecurity risks are an increasingly important part of the corporate landscape, and that as risks of cybersecurity become manifest “corporate governance must evolve to address them,” adding further that “the corporate harms presented by non-compliance with cybersecurity safeguards increasingly call upon directors to ensure that companies have appropriate oversight systems in place.”
However, in granting the motion to dismiss, Vice Chancellor Will also said that in the end the plaintiff in the Marriott case has not shown “that the directors completely failed to undertake oversight responsibilities, turned a blind eye to know compliance violations, or consciously failed to remediate cybersecurity failures.”
Vice Chancellor Will’s opinion in the Marriott case highlights how difficult it will be for the plaintiffs in the new SolarWinds and T-Mobile USA cases to meet the “high bar required to state a Caremark claim.” Nevertheless, it will be very interesting to watch what develops in this case as it goes forward. The recent massive settlement in the Boeing breach of the duty of oversight claim underscores how steep the stakes are.
9. Non-U.S. Companies Face Increasing D&O Claims Risk – Not Just in the U.S, But in Their Home Countries as Well
It has long been understood in the D&O insurance underwriting community that U.S.-listed non-U.S. companies face a heightened litigation risk compared to their home country peers due to their U.S. exposure. However, it has recently become clear that the possibility of a U.S. securities class action lawsuit is not the only U.S. litigation exposure that non-U.S. companies may face. In addition, non-U.S. companies – or at least those based in certain countries – could face a growing risk of collective investor action litigation in their home countries, as well.
In recent months, a new U.S. litigation threat to non-U.S. companies has emerged. As detailed in a September 2021 paper published by AIG in conjunction with the Clyde & Co law firm, plaintiffs’ lawyers have recently filed at least ten derivative actions in New York State courts on behalf of non-U.S. companies, alleging violations of the companies’ home country laws. Among the companies involved are five European banks and two pharmaceutical companies.
The white paper does not name the specific companies involved, but at least one of the companies is the German pharmaceutical firm Bayer AG, certain of whose directors and officers were, as I detailed in a post at the time, sued in March 2020 in a New York state court derivative action alleging violations of substantive German law. The Bayer lawsuit alleges wrongdoing by the company’s management board in connection with the company’s ill-fated merger with Monsanto.
The claimants in these various actions may be seeking to pursue these claims in U.S. courts rather than in the courts of the company’s home country to try to avoid “what are perceived as onerous procedural requirements of the foreign jurisdiction.” The claimants may hope to take advantage the opportunity to pursue the claims in “the more plaintiff-friendly U.S. litigation system.” The lawsuits undoubtedly face substantial hurdles. But if they were to succeed, these kinds of lawsuits potentially could represent a significant new source of U.S. litigation exposure and D&O liability risk for directors and officers of non-U.S. companies.
The potential scope of the litigation exposure that these lawsuits represent arguably is suggested in the recent settlement in the Renren derivative litigation, which I discussed here. Renren is a China-based company organized under the laws of Cayman Islands. Renren shareholders sued Renren directors and officers in a derivative lawsuit in New York state court. The trial court judge denied the defendants’ motion to dismiss, finding that numerous wrongful acts had been alleged to have taken place in New York. An intermediate appellate court affirmed the lower court’s ruling. The parties ultimately settled the action for a minimum of $300 million (which would in fact represent one of the largest derivative lawsuit settlements ever in the U.S.). To be sure, in a December 10, 2021 order, the trial court judge rejected the Renren settlement on multiple grounds. But the Renren case shows that New York derivative suits against directors and officers of non-U.S. companies can in at least certain circumstance survive a motion to dismiss, and potentially could lead to substantial settlements.
Indeed, this litigation risk is sufficiently serious that the insurer Allianz identified the threat of these kinds of U.S. derivative suits against non-U.S. companies as one of the “five D&O mega trends companies should watch for and guard against in 2022.”
Not only are the U.S. litigation threats against non-U.S. companies increasing, these companies may face increased threats of shareholder litigation in their home countries as well, as developments during 2021 in three substantial non-U.S. collective investor actions show.
First, in a first of its kind result under new provisions of the Chinese securities laws, on November 12, 2021, a Chinese court entered a 2.46-billion-yuan ($385.26 million) verdict in a collective investor action against Kangmei Pharmaceuticals, certain of the company’s executives, and the company’s outside auditor, as discussed in detail here. The claimants in the case had alleged that the company had engaged in massive accounting fraud by inflating its revenues, profits, and cash. The verdict in the case follows a July 2021 public hearing in the case.
Second, as discussed here, in June 2021, Volkswagen announced that the company, several former executives, and the company’s D&O insurers had reached an agreement to settle damages claims the company had asserted in a German court against the executives relating to the company’s “Dieselgate” scandal. The settlement, worth in the aggregate approximately $351 million in U.S. dollar terms, includes substantial payments both by the individual executives and by the company’s D&O insurers. (Though the settlement was approved in July 2021 at a meeting of VW shareholders, as discussed here, the settlement is currently subject to an action filed in a German court by a minority shareholder who opposes the settlement.)
Third, in September 2021, a South African court approved the South African portion of the complex multi-jurisdiction settlement that the parties had reached in the Steinhoff International investor actions. The comprehensive settlement, which has an aggregate value well that could exceed $1 billion, resolved legal proceedings pending in the Netherlands, South Africa and Germany. (Details of the complex settlement can be found here.) The legal actions relate to a massive accounting scandal involving the company’s financial statements that first emerged in December 2017.
These developments underscore the fact that many companies now face substantial risk of collective investor actions in their home countries, not just in the U.S. Indeed, the rise of collective investor actions outside the U.S. arguably is one of the most significant developments in the D&O liability arena in recent years, and it is likely to be an even more significant factor in the coming years. Refer here for a detailed overview of the global rise of collective investor actions outside the U.S.
10. For Now, The D&O Insurance Industry Remains in a Hard Market
Insurance is a cyclical business. For many years, the D&O insurance industry was in a sustained “soft” market, characterized by abundant insurance capacity, low pricing, and broad coverage. More recently, the industry has been in a “hard market” phase. Pricing for D&O insurance began to rise in late 2018. After years of underpricing and adverse claims development and activity, insurers began pushing for rate, and the rate increases were supported in the market. The increases accelerated in 2019; and the increases were further exacerbated by the coronavirus outbreak in 2020. Pricing increases continued through 2021, although for some buyers the magnitude of price increases began to decelerate during the year. The hard market has been characterized not only by higher prices, but also by reduced capacity (as many insurers seek to reduce their limits exposed) and increased retentions.
As part of the process that makes insurance a cyclical business, the higher pricing levels have attracted new market entrants. There are a number of new D&O insurers, domestically, and in London and Bermuda. Many of these newer players are up and running, which means that additional capacity is available, at least for some buyers. Eventually, this new capacity will lead to increased competition, which in turn should cause the cycle to move into the next phase. To a certain extent, these processes are already evident, at least with respect to high attachment excess D&O insurance, where rates have in some cases started to ease for some buyers.
For now, as we head into 2022, D&O insurance overall remains in a hard market, with most buyers seeing their renewal premiums coming in at the elevated levels set over the most recent years. For certain buyers, such as IPO companies, SPACs, de-SPAC companies, and financially troubled companies, pricing remains at distressed levels. The likelihood is that the current hard market conditions will remain in effect at least well into the first half of 2022.
When the cycle turn will kick in is at this point difficult to discern. The current hard market conditions have persisted much longer than anyone might have predicted, making visibility much further ahead difficult. For now at least, D&O insurance buyers should continue to expect elevated pricing and retentions to continue.
In the meantime, the disrupted market conditions mean that more than ever policyholders need the assistance of an experienced and knowledgeable adviser for their D&O insurance placement. This is a time when specialized D&O insurance expertise and deep knowledge of the insurance market are indispensable. Well-informed D&O insurance buyers will ensure that their adviser has the requisite capabilities to navigate this difficult market phase.