There is a great deal of information available about the liabilities of publicly traded companies, as well as about the D&O insurance implications arising from those liabilities. It can be a bit of a challenge to locate the same of information concerning private companies. For that reason, it is fortunate that Advisen and AIG have teamed up to produce a new report focused just on private companies.

 

The report, entitled “The Private Eye: Spotlight on the U.S. Private D&O Market”  (here) provides a brief overview of the liabilities of directors and officers of private companies as well as of the private company D&O insurance marketplace. The report also includes useful information about private company D&O insurance buying patterns and the results of a D&O insurance buyer survey. The report also includes a brief review of emerging exposures as well an analysis of D&O insurance pricing trends.

 

The report’s analysis of D&O insurance buying takes a look at patterns over the last ten years. Among other things, the report shows that the average premium paid by private companies with annual revenues of up to $50 million is $15,851 for an average policy limit of $2.6 million. Companies with revenues between $50 million and $100 million pay an average of $50,000 for average limits of around $5 million. Industries that pay higher premiums include manufacturing, transportation, communications, utilities and the general services sector.

 

According to the report, the “most useful” metric for analyzing premiums and buying patterns is the average rate per million paid by private companies. The report presents a graphic analysis of the rate per million paid by industry and year, as well as by company size and year. The report shows that over time since 2003, the rate per million paid by private and non-profit companies of all sizes has tended downward. The biggest declines during that period have been for companies with revenues over $1 billion. As shown later in the report, the rates have started to trend up in more recent years.

 

The report also incorporates a client survey. As the report itself emphasizes the survey of over 260 private company D&O insurance buyers is heavily weighted toward larger companies, with well over half of the respondents representing companies with over $1 billion in revenues and only about 17% of respondents representing companies with revenues under $250 million.

 

The survey of these generally larger companies showed that over 90 percent of respondents purchase D&O insurance, with around a third of the respondents buying limits of $10 million or less. On the other hand, 16% of these mostly larger company respondents purchased limits of greater than $96 million.

 

Among the survey respondents reporting an increase in limits purchased, the most common reason for the increase was to buy a separate tower of A-Side insurance or to an excess layer of A-Side protection. The report notes that “this uptick in A-Side D&O purchase is further evidence of the product’s heightened importance.”

 

The survey also noted that only 17 percent of respondents had been the subject of a D&O claim during the previous three years. Of those who suffered a claim, 48 percent were shareholder suits, 33 percent were client lawsuits, and vendor lawsuits represented 21 percent. 50 percent of the claims that resulted in a settlement were resolved for under $250,000 with only 25 percent settling for greater for greater than $1 million. On the other hand, from interpreting the bar graph in the report, it does look as if just about 20 percent of the claims settled for over $5 million, which is consistent with the oft-stated principle that D&O claims tend to be low frequency and high severity. Interestingly, 88% of the respondents who reported a claim reported satisfaction with the claims handling process.

 

The survey also revealed that there are a host of emerging boardroom concerns, including cyber liability, M&A, and private equity litigation, as well as claims relating to the Fair Labor Standards Act. The report includes a brief survey of these and other emerging issues.

 

The report also includes an overview of current private company D&O insurance pricing trends. The report notes that “private company D&O rates are increasing across the board,” with a consistent increase in renewal premiums and rate per million over the last 18 months. Advisen’s own data analysis shows that while rates remain below 2008 levels, pricing has been on the rise since the third quarter of 2001.

 

The report also notes that “anecdotally, carriers tell us that rate increases of around ten percent are being achieved” during 2013 on private company D&O insurance accounts, “with up to 30 percent rate increases being applied at renewal on certain accounts” – although this analysis does not account for companies that change hands between insurers on renewal, which may be renewing at rates reflecting little or no increase. Overall, the increases are not necessarily focused just on “claim-afflicted accounts,” but rather are the result of a “re-underwriting process” across the entire portfolio. Underwriters are assessing premiums, retentions and coverage in order to try to “reflect the actual risk profile of private and non-profit accounts.”

 

The report also includes a brief overview of private company D&O claims trends. The report notes that “private company D&O claims are varied in the source and in their process.” While there is a perception that shareholders are the principle source of D&O claims, “this perspective overlooks the fact that the plaintiffs in D&O claims include a much broader array of claimants than just shareholders. D&O claims plaintiffs also include customers, vendors, competitors, suppliers, regulators, creditors and a host of others.” The report concludes with a brief review (with claims examples) of private company liability exposures in four areas: bankruptcy; shareholder suits; consumer suits; and competitor actions.

 

Those who work frequently will find this report useful. Though the data in the report have a definite emphasis toward larger companies, even those practitioners who do not regularly work with private companies with, say, revenues over $1 billion, will find this report worthwhile. In particular, practitioners may find it helpful to be able to cite this report to help their private company D&O insurance clients understand recent pricing trends, to be able to put the premium increases they are seeing on their renewals into context.

 

Practitioners may also find it helpful to refer to the claims information showing that D&O claims originate from a wide variety of claimants, which helps to explain why smaller companies that have few shareholders nevertheless should consider buying D&O insurance.

 

We can certainly hope that Advisen will continue to produce this report on an annual basis and perhaps in future years provide more detailed information with respect to companies with revenues under $250 million—that is, information that would be relevant and of interest to the vast majority of private companies and to their advisors.

 

As many readers will recall, a couple of years ago there was an intense barrage of securities litigation class action lawsuit filings against U.S.-listed Chinese companies. Many of the cases involved Chinese companies that obtained their U.S. listings by way of a reverse merger with publicly traded shell, and almost all of the cases involved alleged accounting improprieties or violations. The wave of Chinese reverse merger case filings diminished in last year and seemed to have come to an end

 

However if the suit recently filed in the Southern District of New York against PetroChina Company, Ltd. and four of its directors and officers is any indication, a new round of securities lawsuits against U.S.-listed Chinese companies could be in the offing, this time involving corruption allegations. Indeed, given the sequence of events involved and the growing global focus on anti-corruption investigation and enforcement, the trend might not be limited just to Chinese companies. 

 

As well-detailed in a September 6, 2013 memo from the Morrison Foerster law firm entitled “Corruption Allegations in China Lead to a Shareholder Class Action in the U.S.” (here),, the company itself, the Chinese government and various media sources have recently disclosed a corruption investigation involving several PetroChina officials, as well as officials affiliated with China National Petroleum Corporation (CNPC), PetroChina’s controlling shareholder. Among persons implicated in the apparent corruption investigation is a former CNPC senior manager who was a purported ally of Bo Xilai, the disgraced former Chinese politician whose own corruption trial was just completed. Subsequent reports suggested that the investigation had been extended to the former Chairman of PetroChina and CNPC.

 

According to their September 3, 2013 press release, (here), plaintiffs’ lawyers filed an action in the Southern District of New York against the company and four of its officials. According to the press release, the plaintiffs’ complaint, a copy of which can be found here, alleges that the defendants made misled investors by failing to disclose that:

 

(1) the Company’s senior officials were in non-compliance with the Company’s corporate governance directives and code of ethics; (2) as a result, the Company was subject to investigation and disciplinary action by various governmental and regulatory authorities; (3) the Company’s financial statements were materially false and misleading as they contained direct references to the Company’s Code of Ethics, and statements regarding its compliance with regulations and internal governance policies; (4) the Company lacked adequate internal and financial controls; and (5), as a result of the foregoing, the Company’s financial statements were materially false and misleading at all relevant times.

 

The law firm memo points out that there have been prior securities class action lawsuits against U.S.-listed Chinese companies containing corruption allegations. But perhaps more significant is the fact China is in the midst of a campaign, led by its new Premier Xi Jingping,  against public corruption. The lawsuit against PetroChina shows that “Chinese companies have been, and remain, on the radar screen of the U.S. securities plaintiffs’ bar.” As China’s campaign against corruption continues, the potential liability extends not only to heightened regulatory scrutiny, but also includes the possibility that shareholders will “seek to hold companies and their executives accountable for shareholder losses as a result of the alleged corruption and its fallout.”

 

According to the law firm memo, it is not just China’s government that is focusing on corrupt activities; governments around the world are stepping up enforcement of anti-bribery laws.  As this enforcement activity expands, so too does the possibility of follow on civil litigation against companies involved in a corruption investigation in their home country whose shares trade in the U.S. This possibility of follow on civil litigation seems to include in particular the possibility of further suits against U.S.-listed Chinese companies caught up in the current campaign against public corruption.

 

Continued Heightened U.S. Securities Suit Filing Activity Against Non-U.S. Companies: One of the more interesting phenomena in the U.S class action securities arena has been the level of filings targeting non-U.S. companies. Following the U.S. Supreme Court’s 2010 decision in Morrison v. National Australia Bank, there was much speculation that filings against non-U.S. companies were likely to decline. As it turned out, though, in 2011 and 2012, largely driven by the flood of lawsuits against Chinese reverse merger, the percentage of all securities suits involving non-U.S companies was well above historical norms. Indeed, in 2011 33% of all filings involved non-U.S. companies as did 21% of all 2012 filing, both figures above any prior year in percentage terms, as shown here.

 

In the first half of 2013, it seemed that the rate of filings against non-U.S. companies declined compared to 2011 and 2012 – although still well above historical levels –with about 14.9% of first half filings involving non-U.S. companies. But so far in the year’s second half, the pace of filings against non-U.S. companies seems to have picked up again. Of the roughly 36 new securities lawsuits filed since June 30, 2013, seven have involved non-U.S. companies, or about 20% –roughly on par with the percentage of 2012 filings that involved non-U.S. companies.

 

The 17 securities class action lawsuits filed so far during 2013 against non-U.S. have involved companies from nine different countries, but the country with the most companies sued in U.S. securities class action lawsuits is China, with five so far this year. (As well as one more from Taiwan.) Coming in a close second behind China is Canada, with four. As the case discussed above shows, though new filings associated with the Chinese reverse merger companies have died down, Chinese companies continue to attract the attention of the U.S. plaintiffs’ securities bar.

 

Canadian Courts May Attract Securities Claims, But Claimants Still Must Show They Belong There: Much has been written (on this site and elsewhere) about the possibility that Canada might become a destination for would-be securities plaintiffs. That perspective gained an apparent boost in March 2012, when the Ontario Court of Appeals held that the liability regime under the Ontario securities laws applied to a company whose shares traded only on the NASDAQ stock market.

 

However, in a September 4, 2013 decision by the Quebec Superior Court in a securities class action lawsuit filed by a Facebook IPO investor underscores that would-be claimants must still meet jurisdictional requirements and show that the Canadian court is the appropriate forum. Though the case was decided under Quebec law, rather than the Ontario law that has applied in many of the recent Canadian securities cases, it still highlights that there are practical and prudential constraints on the availability of Canadian courts as a securities litigation destination.

 

As reflected in the Quebec court’s September 4, 2013 Judgment (here), a Canadian claimant who lost money investing in the Facebook IPO filed suit in Quebec against Facebook, certain of its directors and officers, and its offering underwriters. The claimant alleged that she had been induced to purchase Facebook shares based on misrepresentations in the offering documents.

 

The defendants moved to dismiss the case on the grounds that the claimants’ allegations lacked a sufficient connection to Quebec to support jurisdiction, and that even if the Court had jurisdiction, it should nevertheless dismiss the case in favor of similar cases already pending in New York, based on the doctrine of forum non conveniens. The claimant argued that her claims had a sufficient connection to the province to support jurisdiction in its courts, because she had suffered injury there. In support of her claims, the claimant offered statements from her brokerage account showing the purchase of the shares and the subsequent sale of the shares at a loss.

 

In its September 4 ruling, the court granted the defendants’ motion. The court held that the claimant’s brokerage account records did not show where her Facebook share transactions had occurred or where she paid for the shares. The court said that “nothing in the record indicates that the sales transactions occurred in Quebec,” adding that under Quebec statutory principles, “the Facebook shares would have been notionally delivered either at the NASDAQ exchange in New York or at Facebook’s head office in California.” On this basis, the court concluded that the claimant’s alleged overpayment and loss would have occurred in the United States. The court said that “there is no basis to conclude that a real and substantial connection exists between the alleged facts of her motion and this Court,” and so the Court lacked jurisdiction.

 

The court when on to say that even were there jurisdiction, the court would have declined the jurisdiction (“a tenuous jurisdiction at best”) in favor of the Southern District of New York, under the principles of forum non conveniens. The court noted that the consolidated New York actions raised the same allegations; that the putative class in the consolidated action included the claimant and the class of Quebec purchasers she purported to represent; that New York law would govern the claims; that the underwriting defendants are domiciled in New York; and that any judgment would have to be executed in the United States.

 

Canadian courts may still represent a potentially attractive forum for prospective securities law claimants. However, this case shows that there are certain basic requirements involved in order for would-be securities claimants to have access to its courts. To be sure, this action was decided under the law of Quebec, and not under the law of Ontario, where much of the high-profile securities litigation in Canada has taken place. However, the legal principles involved in this case are basic and do not appear to be unique to Quebec. While this case may have no precedential effect in Ontario or elsewhere in Canada, it does suggest that prospective securities litigants who want to try to pursue their claims in Canadian courts are going to have to meet some basic prerequisites.

 

What are the Legal Obligations That Reps and Warranties Insurance Insures?: As I have noted in prior posts, most recently here, M&A reps and warranties insurance is becoming an increasingly common component of M&A transactions. As I have also recently noted, the product is not always well understood. Among the elements that are not always fully understood are the legal undertakings in the merger agreement that provide the obligations to which the insurance applies.

 

An August 2012 memorandum from the Venable law firm entitled “What to Expect When You’re Selling Your Company – Indemnification” (here) explains the indemnification undertakings provided in the typical merger transaction. As the memo notes, the seller in the merger transaction provides the buyer with a host of representations and warranties about the seller’s business. The seller is required to stand behind those reps and warranties through an indemnification provision in which the seller agrees to reimburse the buyer for the losses it suffers as a result of the representations turning out to be inaccurate or untrue.

 

The memo points out that there a variety of considerations to be taking into account in providing the indemnification undertaking. These include the question of how long after the transaction the reps and warranties should “survive”; what “caps” or maximum amounts will be allowed for reps and warranties-related losses; whether or not there will be “baskets” (minimum threshold amounts) that must be suffered before the indemnification obligation is triggered; how the losses associated with third-party claims will be handled (including in particular, who will control the defense); and specification of the types of losses to which the indemnification applies (including in particular unanticipated losses).

 

The memo’s authors also note that another consideration with respect to the indemnification has to do with escrows or holdbacks, which are amounts set aside out of the transaction proceeds to provide a source of funds to pay indemnification amounts. This aspect of the indemnification arrangement is one place where the reps and warranties insurance can provide significant value for the deal participants, as the insurance may be accepted as an alternative to escrow amounts, allowing the parties to reduce the amount of funds required to be held in escrow.

 

The authors also highlight a number of other features that should be considered in connection with the indemnification provisions in the merger transaction documents, including for example an materiality requirement. As the authors note, the indemnification provisions can be critically important to how the merger transaction plays out after the closing. From my perspective, the potential benefits of the reps and warranties insurance should be an important part of that dialog. The authors’ memo provides a good, brief background of the context within which the insurance product fits.

 

Ways to Maximize Coverage for Corruption Probes: One of the significant trends over the past several years has been the growth in the number of Foreign Corrupt Practices Act investigations and enforcement actions. These types of regulatory and prosecutorial actions can be enormously expensive. For example, Wal-Mart Stores recently disclosed that it expects to spend more than $150 million in connection with anti-bribery investigations of its Mexican operations, on top of the $150 million it has already spent.

 

Given the magnitude of the expenses involved, companies have every incentive to try to ensure that they have taken steps to maximize the amount of insurance coverage available. A September 5, 2013 Law 360 article (here, subscription required) provides a number of “tips” for companies to consider in trying to allow companies to position themselves to maximize coverage.

 

The first of the tips discussed in the article is for the company to make sure that its D&O insurance policy does not have an express exclusion for loss relating to anti-bribery and corruption claims. These exclusions, sometimes referred to as the commissions exclusion (because the exclusion’s list of the types of things exclude often leads often by specifying “commissions”), formerly were a standard part of D&O insurance policies. Though these exclusions are now less common they still sometimes appear on some policies. Even where these exclusions appear, the insurers often will agree to remove them upon provision of a completed supplemental questionnaire. Even if the carrier will not agree to remove the exclusions, companies “should try to limit the FCPA exclusion to encompass limited types of conduct or seek carve-outs for nonindemnifiable claims against individual insureds.”

 

Because much of the expense associated with an anti-bribery event can arise from the company’s own internal investigation, the commentators quoted in the article also suggest the company’s try to ensure that their D&O insurance policies provide coverage for internal investigations. While this coverage is often subject to a sublimit, “some coverage is better than no coverage.”

 

The commentators also note that the question of who is insured may also be important, as they persons caught up in an anti-bribery investigation may or may not have officer or director titles, but nevertheless may be functioning in equivalent positions in other jurisdictions. A related issue is ensuring that the conduct of insured persons is severable, so that the misconduct of any on insured person does not preclude coverage for insured persons who were not involved in the misconduct.

 

The commentators also note that in this context, it may be particularly important for the companies caught up in the anti-bribery investigation to be attentive to the notice requirements under the policy. Even if at the outset the matter may not meet the policy’s definition of Claim, it could be very important to submit the matter as a notice of potential claim, to set a coverage anchor in the then-current policy. If the company waits until the matter matures into a full-blown claim, the company may then have to turn to an insurance policy that has been narrowed in the interim.

 

Though the article does not discuss the issue, companies should also think about how their policies would respond to follow-on civil actions brought by shareholders, which are a frequent accompaniment of an FCPA investigation or enforcement action. These claims, which typically take the form of the traditional shareholder derivative action, are more likely to fall within the policy’s coverage – at least if the policy does not contain the kind of commissions exclusion noted above. Though these kinds of claims are more likely to be covered, the possibility of these kinds of claims do raise practical questions about the adequacy of limits of liability (if for example the follow-on claim were to arise at the same time as an FCPA enforcement action) as well as about policy structure (that is, ensuring that the company’s insurance program includes supplemental Side A coverage to protect against the non-indemnifiable settlement of any derivative claim).

 

The Origins of the Financial Crisis: On September 7, 2013, The Economist magazine posted the first of what will eventually be five articles on the origins and consequences of and the lessons of crisis. The first article, entitled “Crash Course” (here), focuses on the origins of the crisis.

 

The article of course focuses on the problems that financiers created. But though “failures in finance were at the heart of the crash,” the bankers “were not the only people to blame.” Among others, “central bankers and other regulators bear responsibility too, for mishandling the crisis, for failing to keep economic imbalances in check and for failing to exercise proper oversight of financial institutions.”

 

According to the article, the regulators ‘ “most dramatic error” was allowing Lehman Brothers to fail, because it multiplied the panic in markets. Ironically, the decision to allow Lehman to collapse “resulted in more government intervention, not less” because “regulators had to rescue scores of other companies.”

 

But, the article notes, regulators made mistakes long before Lehman failed, “most notably by tolerating global current-account imbalances and the housing bubbles that they helped to inflate.” Asia’s excess savings and European banks’ aggressive acquisition of “dodgy American securities” financed by borrowing from American money-market funds exacerbated the imbalances and fueled the real estate bubble. Internal imbalances within the Eurozone fueled credit flows from Europe’s core to its periphery, leading to overheated real estate markets in places like Ireland and Spain.

 

Central banks, the article says, could have done more to address all of this. The Fed did nothing to stem the housing bubble and the European Central Bank did nothing to restrain the credit surge on the periphery.

 

But of all of the regulators’ shortcomings, lax capital was the “biggest.’ Though international bodies had been redefining the amount of capital that banks had to set aside relative to their assets, the rules were not sufficiently rigid in defining capital strictly enough, and so the banks smuggled in forms of debt that lacked sufficient loss-absorbing capacity. Banks, in turn, operated with little equity, leaving them vulnerable when things went wrong.

 

In a concluding paragraph that suggests the likely direction of the next article in the series, the article notes that the central bankers and regulators were not along in making misjudgments. Politicians and humble consumers “joined in the collective delusion that lasting prosperity could be built on ever-bigger piles of debt.”

 

Upcoming PLUS Global Events: I want to make sure that all readers – particularly those based outside the U.S. — are aware of a couple of upcoming PLUS events.

On October 9-10, 2013, PLUS will be sponsoring an educational and networking event in Zurich. The Professional Liability Regional Symposium will address a wide range of issues relating to the liabilities of directors and officers and to the insurance implications arising from those liabilities. The program includes a number of interesting sessions and a stellar lineup of speakers. I will be participating as a moderator of two of the panels at the event, including sessions addressing current and emerging D&O liability trends and liability and insurance issues arising from regulatory and investigative proceedings. The event’s first day will include a networking reception. I hope that D&O insurance professionals from around Europe and around the world will plan on attending and take advantage of the opportunity to attend the informative sessions and to meet industry colleagues. Further information about this event can be found here.

 

PLUS is also sponsoring an educational session in Hong Kong on September 24, 2013. This regional symposium includes a number of panels addressing important topics such as the lessons of the U.S. litigation against Chinese companies; the changing regulatory and enforcement environment; and the liability and insurance issues arising from White Collar crime investigations and prosecutions. The day’s events conclude with a networking session following the last panel. I attended the inaugural PLUS event in Hong Kong in April 2012, which was a terrific success. I hope that industry professionals from around the region will plan to attend this PLUS event. A good turnout will help to ensure that PLUS will continue to offer these kinds of events in the region. Further information about the event can be found here.

 

Every fall, 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 myriad of things worth watching in the world of D&O.

 

How Will the Interrelatedness Issue Continue to Affect D&O Claims?: One of the most vexing issues that can arise in the D&O claims context is the question of whether or not two claims are interrelated. The typical context in which the question arises is that there have been two (or more) claims filed in separate policy periods. If the claims are related, they trigger coverage under only a single year’s policy, with the subsequent claims deemed to have been made at the time of the first related claim. If the claims are not related but instead are separate, multiple policies are triggered.

 

 

Because the determination of the interrelatedness issues can have an enormous impact on the amount of insurance available to resolve claims, it is a frequently litigated issue. Another reason the issue is so frequently litigated is that there are few reliable guideposts to help sort out disputes over relatedness. The court decisions in this area are all over the map and often very fact-intensive.

 

This issue has been around (and has been a problem) for years. Bur for whatever reason, it just seems that more and more lately, the D&O insurance coverage disputes increasingly are focused on interrelatedness issues. A number of recent posts on this blog have involved case developments in lawsuits involved disputes over the interrelatedness issue (refer for example here and here).

 

One particularly important context in which the interrelatedness issue has arisen in recent years is in the litigation involving the financial crisis. Many of the companies involved in the crisis have been hit with multiple lawsuits, often filed over the course of several years. The question whether these various lawsuits are separate and trigger multiple insurance policies or programs, or whether they are interrelated and therefore trigger only a single policy or program, has arisen in connection with many of the high-profile companies involved in credit crisis litigation.

 

One noteworthy case that raises these issues and involving the failed IndyMac bank is now pending in the Ninth Circuit. As discussed here, in June 2012, Central District of California Judge R. Gary Klausner concluded, based on the relevant interrelatedness language, that a variety of lawsuits that first arose during the bank’s 2008-2009 policy period were deemed first made during the policy period of the bank’s prior insurance program, and by operation of two other policy provisions were excluded from coverage under the 2008-2009 program. The upshot of Judge Klausner’s opinion is that only a single insurance tower of $80 million will apply to the various claims, rather than two $80 million insurance towers.

 

Judge Klausner’s coverage decision took on even greater significance in December 2012, when the FDIC obtained a $168.8 million jury verdict against three former IndyMac officers (about which refer here). The verdict may be of little value to the FDIC if only a single $80 million tower of insurance is available for the various claims arising out of IndyMac’s collapse. Prior settlements and defense fees have largely eroded the single $80 million tower Judge Klausner said applies to the various IndyMac claims.

 

Judge Klausner’s coverage decision is now on appeal to the Ninth Circuit. The parties have been filing their legal briefs over the summer. The bank’s former directors and officers have argued to the appellate court that Judge Klausner erred in ruling that all of the various claims were interrelated and therefore triggered only a single insurance tower. A number of other parties are also challenging the ruling, including the FDIC and the trustee for the bankruptcy of the bank’s holding company. The insurers have argued that all of the claims are interrelated and therefore that only a single tower of insurance was triggered.

 

The parties are in the final stage of the briefing process and it will be many months before the case is decided. Because of the stakes involved and because of the high profile nature of the case, the Ninth Circuit’s ruling in the case will be closely watched and could be very influential. Just the same, the decision is also likely to be very dependent on the specific circumstances involved. The likelihood is that even after the Ninth Circuit issues its opinion that interrelatedness issues will continue to vex insurers and policyholders alike.

 

What are the D&O Insurance Implications of the SEC’s New Policy Requiring Admissions of Wrongdoing?: On August 19, 2013, in connection with its entry into a settlement with New York-based hedge fund adviser Phillip Falcone and his advisory firm Harbinger Capital Partners, the SEC for the first time implemented its new policy requiring defendants seeking to settle civil enforcement actions to admit wrongdoing, in contrast to the long-standing practice of allowing defendants to resolve the enforcement actions with a “neither-admit-nor-deny” settlement.

 

The SEC’s new policy requiring – in “egregious” cases — wrongdoing admissions in order to settle an enforcement action not only has important implications for the enforcement action itself, but potentially also has important implications for related civil or criminal proceedings. Another issue that inevitably will also arise is the question of the impact of factual admissions on the continuing availability of D&O insurance..

 

The SEC and the Harbinger defendants, including Falcone, had actually reached an earlier  settlement in principle to resolve the case that reflected the traditional “neither admit nor deny” approach. However, in July 2013, the SEC advised Harbinger that the SEC Commissioners had voted to reject the deal. The vote apparently reflected the SEC’s new policy, announced in June by new SEC Chair Mary Jo White, that going forward the SEC would require defendants settling enforcement actions to admit wrongdoing, at least in “egregious” cases.

 

In the revised settlement, Falcone and the Harbinger entities agreed to extensive admissions of wrongdoing. The factual admissions are set out in a detailed Annex to a Consent that Falcone signed on August 16 on his own behalf and on behalf of the Harbinger entities. The admissions are also set out verbatim in the proposed Final Consent Judgment filed with the Court. Pursuant to the settlement, the defendants agreed to pay a total of over $18 million in disgorgement, civil penalties and interest. As part of these payments, Falcone himself must pay over $11.5 million. Falcone also agreed to a five-year ban from the securities industry.

 

The admissions in the Consent are comprehensive – the defendants basically admitted all of the SEC’s allegations. Moreover, it appears that in pursuing its new settlement approach, the SEC will be requiring other defendants to provide similar admissions in order to settle SEC actions against them. For example, there are reports that the agency is seeking to require J.P Morgan to provide admissions of wrongdoing in connection with the agency’s actions against the firm in connection with the “London Whale” case.

 

The SEC’s admissions requirement has a number of significant implications. First, it means that, at least in the SEC enforcement actions where the agency will require admissions that the cases will be much harder to resolve. The defendants, wary of the possible impact the admissions could have in other proceedings, will be reluctant to provide admissions. One consequence of the new policy could be that the SEC will be compelled to try more cases, which could strain the agency’s resources.

 

A defendant’s provision of admissions potentially could have enormous consequences for related proceedings. The recitation in the Consent that the Harbinger defendants have been provided no assurances about the possibility of criminal proceedings has to be particularly chilling, especially for Falcone. The admissions in the Consent may or may not suffice to draw criminal charges, but at least some commentators have suggested that criminal charges could follow.

 

Another question about the admissions is their collateral effect in related civil proceedings. As it happens, there is a pending civil action that Harbinger investors had filed against Falcone and the funds that could provide an early test of the civil litigation collateral estoppel consequences of admissions in an SEC enforcement action. In an August 20, 2013 post in her On the Case blog (here), Alison Frankel examines the possible impact that the admissions could have on the fund investors’ pending civil action. As she explains, despite the differences between the cases, the admissions could bolster the plaintiffs’ allegations.

 

Yet another issue that the admissions raise is the question of their impact on the availability of D&O insurance. The specific question is whether the admissions are sufficient to trigger the fraud and criminal misconduct exclusion in the D&O policy. The wording of these exclusions varies, but they typically preclude coverage for loss arising from fraudulent or criminal misconduct, but only after a final adjudication determines that the preclusive conduct has taken place. If the admissions were found to be sufficient to trigger this exclusion, coverage would no longer be available for the wrongdoer, and the insurer arguably could even have the right to try to recover amounts that had already been paid.

 

On the one hand, there would seem to be reason to be concerned that a settlement of this type represents a “final adjudication.” The specific factual admission to which the defendants agreed were not only stated in the public court record, but they are incorporated verbatim into the Final Consent Judgment filed with the court. Upon the Court’s entry of the Judgment, there would seem to be grounds upon which it could be argued that there had been a final adjudication. (A related question is whether this adjudication occurred in “the underlying proceeding” as many policy exclusions require.)

 

On the other hand, there is a question whether the admissions satisfy the exclusion’s misconduct requirement. While the admissions represent an extensive concession that the defendants engaged in wrongdoing – and while the admissions expressly recite that the defendants acted “improperly” and “recklessly” — at no point do the defendants admit to “fraud” or to any other level of conduct that would expressly trigger the typical D&O policy’s conduct exclusion.

 

A related issue that could arise is the question of exactly how bound the admitting parties are by their admissions. The Harbinger defendants’ Consent specifically recites that nothing in the agreement affects the defendants “right to take legal or factual positions in litigation or other proceedings or other legal proceedings in which the Commission is not a party.” In effect, the Harbinger defendants seemed to have tried to preserve the right to argue that while they made certain admissions for purposes of the SEC enforcement action, they did not make those admissions for all purposes and for the benefit of all other parties who might seek to rely on them. The Harbinger defendants might well argue that notwithstanding their admissions in the Consent, they have the right to contest the factual matters in other proceedings, including for example, in the context of an insurance coverage dispute.

 

The Harbinger settlement represents a significant development with important potential implications for other defendants in SEC proceedings. The admissions these defendants may be required to provide in order to settle the enforcement action pending against them could have important collateral consequences, many of which at this point remain uncertain. Among other questions that likely will also have to be addressed is whether admissions of this type have any impact on the continued availability of insurance coverage for the defendants that provide these kinds of admissions.

 

What are the D&O Insurance Implications of the Massive Derivate Lawsuit Settlements?: In April 2013, the parties to the News Corp. shareholder derivative litigation agreed to settle the consolidated cases for $139 million,to be funded entirely by D&O insurance.

 

There have been several shareholder derivative suit settlements that were nearly as large as the News Corp. settlement but none quite as big:

 

  • The El Paso/Kinder Morgan merger-related derivative suit settled in September 2012 for $110 million (refer here).
  • In 2005, the Oracle derivative suit settled based on Oracle CEO Larry Ellison’s payment of a total of $122 million (refer here and here).
  • In September 2009, the parties to the Broadcom Corp. options backdating-related shareholders’ derivative suit agreed to settle the case, as to most but not all of the defendants, for $118 million (as discussed here).
  • In September 2008, the parties to the 2002 AIG shareholders’ derivative lawsuit agreed to settle the case for a payment of $115 million (about which refer here).

 

In addition, in December 2007, the UnitedHealth Group options backdating-related derivative lawsuit settled for a total nominal value of approximately $900 million, as discussed here. However, the value contributed to the settlement consisted of individual defendants’ surrender of certain rights, interests and stock option awards, not cash.

 

These settlements are all dwarfed by the $2.876 billion judgment entered in June 2009 against Richard Scrushy in the HealthSouth shareholders’ derivative lawsuit in Jefferson County (Alabama) Circuit Court, and the $1.262 billion judgment that Delaware Chancellor Leo Strine entered in October 2011 in the Southern Peru Copper Corporation Shareholder Derivative Litigation (about which refer here). Both of these case outcomes involve judgments following trial, rather than settlements.

 

Aside from the question its sheer size is the fact that the News Corp. settlement was funded entirely by D&O insurance. This large settlement represents not only a serious and unwelcome development for the specific carriers involved but also represents an unwelcome event for the D&O insurance industry in general, for what it might represent as far as the severity potential of shareholders’ derivative litigation.

 

In the past, going back ten years or so, shareholders’ derivative suits typically did not present the possibility of significant cash payouts for settlements or judgments. As the significant examples above show, that clearly has changed.

 

This trend gained particular momentum with the options backdating scandal. Many of the options backdating cases were filed as derivative suits rather than as securities class action lawsuits (largely because the options backdating disclosures did not always result in the kinds of significant share price declines required to support a securities class action lawsuit). As illustrated by the Broadcom case mentioned above, some of the options backdating derivative suit settlements included very substantial cash components

 

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The inclusion of a significant cash component has also been a feature of the settlements of some of the merger objection suits that have been filed as part of the current upsurge in M&A-related lawsuit that have been filed in recent years, as illustrated by the El Paso settlement mentioned above.

 

For many years, D&O insurers have considered that their significant severity exposure consisted of securities class action lawsuits. The undeniable reality is that in at least some circumstances, derivative suits now represent a severity risk as well. And the settlement amounts themselves represent only part of the D&O insurers’ loss costs. The D&O insurers also incur millions and possibly tens of million of defense cost expense in these derivative suits

 

Another issue is that these settlement amounts represent so-called “A Side” losses. That is, the losses are paid out under the portion or the D&O insurance policy that provide insurance for nonindemnifiable loss. A derivative suit settlement is not indemnifiable, at least under the laws of many jurisdictions, because if it were to be indemnified, the company’s would make the indemnity payment to itself. For the “traditional” D&O insurance carriers, there is perhaps no particular pain associated with the fact that the loss is paid under the “Side A” portion of the policy, as opposed the other policy coverage (that is, the “Side B” or “Side C” coverage that are more typically called into play). But these days many companies carry –in addition to their traditional D&O insurance that includes all three coverages (that is, they include Sides A, B and C coverage) — additional layers of excess Side A insurance.

 

The increasing risk of this type of settlement represents a significant challenge for all D&O insurers, but particularly for those D&O insurers concentrating on providing Excess Side A insurance. Those insurers will have to ask how they are to underwrite the risks associated with these kinds of exposures, and how they are to make certain that their premiums adequately compensate them for the risk.

 

Will By-Law Forum Selection Clauses Withstand Judicial Scrutiny and Help to Diminish the Multi-Jurisdiction Litigation Curse?: Over the past several years, one of the more troublesome litigation trends has been the rise of multiple lawsuits involving the same circumstances but filed in separate jurisdictions. As a way to try to avert the inefficiencies and added expense associated with multi-jurisdiction litigation, reformers suggested that a provision could be added to company by-laws requiring shareholders to litigate claims in a specified jurisdiction (usually Delaware). The boards of a number of companies adopted forum selection by laws.

 

The first judicial challenge to a forum selection bylaw resulted in a set back for the idea. As discussed here, in January 2011, a judge in the Northern District of California refused to enforce a forum selection by-law that had been adopted by Oracle, because it had not been approved by shareholders, but rather had been adopted only by the company’s board of directors.

 

However, on June 25, 2013, in a judicial development that may help ease the curse of multi-jurisdiction litigation, Chancellor Leo E. Strine, Jr. of the Delaware Court of Chancery held that forum selection bylaws adopted by Chevron and Federal Express are statutorily and contractually valid. A copy of the Chancellor’s opinion can be found here.

 

According to Chancellor Strine’s opinion in the Chevron case, in the last three years over 250 publicly traded companies adopted forum selection bylaws. Chancellor Strine recites in his opinion that Chevron’s board adopted the bylaw due to concerns about “the inefficient costs of defending the same claim in multiple jurisdictions” and in order to “minimize or eliminate the risk of what they view as wasteful duplicative litigation.”

 

Chancellor Strine’s determination that Chevron and Fed Ex’s forum selection by-law are valid is of course far from the final word. The Delaware Supreme Court may yet take a different view. In addition, the question will still remain whether or not the courts of other jurisdictions will enforce the forum selection clause when faced with a motion to dismiss a case pending in their courts. Whether or not the bylaws are valid under Delaware law will not necessarily be determinative of whether the bylaws are in fact enforceable elsewhere.

 

Nevertheless, in the wake of Chancellor Strine’s opinion, a number of companies have acted to adopt their own bylaws. It will be very interesting to see if these by-law provisions prove to be effective in diminishing the curse of multi-jurisdiction litigation.

 

How Far Will Courts Extend the Broad Judicial Support for the Enforceability of Arbitration Clauses?: In the latest in a series of decisions in which it upheld the enforceability of arbitration agreements, the U.S. Supreme Court ruled on June 20, 2013 that an arbitration agreement with a class action waiver is enforceable even it meant that an individual’s cost of pursuing a claim exceeded the economic value of the individual’s potential recovery. A copy of the Court’s opinion in American Express Co. v. Italian Colors Restaurant can be found here.

 

Although the decision is consistent with other recent Supreme Court rulings, it has its own important implications – and it also raises a question of just how far the principle of broad enforceability of arbitration agreements can be taken. In particular, does the broad enforceability of arbitration agreements reach far enough to include the enforceability of arbitration agreements and class action waivers in corporate articles of incorporation or by-laws?

 

The question about the inclusion of arbitration provisions and class action waivers in corporate by-laws is not far-fetched. In fact, at least one court has already held these kinds of by-law provisions to be enforceable. As discussed here, in May 8, 2013, a Maryland Circuit Court held that Commonwealth REIT could enforce a by-clause requiring shareholders to arbitrate their claims.

 

In a July 8, 2013 Law 360 article commenting on the Commonwealth REIT decision (here, subscription required), Andrew Stern, Alex J. Kaplan and Jon W. Muenz of the Sidley Austin law firm note that though it remains to be seen how other courts will address the question of the enforceability of arbitration clauses in corporate bylaws, the Maryland decision “should be seen as, at the very least, a significant incremental victory for boards and trustees who view arbitration as an effective means to manage the typically highly public nature of corporate activism.” At a minimum, the authors note, the decision could be seen – at least for Maryland companies — as “a green light for boards … to include broad arbitration clauses in their bylaws without seeking shareholder approval.”

 

The Maryland trial court decision has no precedential value and may or may not be followed by other courts. Nevertheless, the fact remains that at least this one court did enforce a by-law arbitration clause. As the law firm memo’s authors state, this decision does represent an “incremental victory” for those who advocate for the inclusion of these types of provisions in corporate bylaws as a way to forestall costly and burdensome shareholder litigation.

 

With the U.S. Supreme Court’s willingness to enforce arbitration agreements including class action waivers in commercial and consumer contracts, and with case law developments like the one in Maryland, more companies may be encouraged to attempt to use their bylaws as a way to control shareholder litigation. We undoubtedly will see more – both from companies and from the courts – on the topic of arbitration clauses in corporate bylaws.

 

What Will Be the Impact of the Conflict Minerals Disclosure Rules?: Among the many hundreds of pages of the Dodd-Frank Act was a provision unrelated to the financial crisis that triggered the legislation. Congress included in the Act a provision directing the SEC to promulgate rules requiring companies to disclose their use of conflict minerals originating in the Democratic Republic of Congo (DRC) or an adjoining country. It has taken some time for the regulatory process to unfold, but the conflict mineral disclosure requirements are now in effect. The consequences for companies could be significant.

 

On August 22, 2012, the SEC adopted the conflict mineral disclosure rules. The SEC’s August 22, 2012 press release can be found here and the rule itself can be found here. The specific minerals at issue are tantalum, tin, tungsten and gold. The countries covered by the disclosure rules are, in addition to the DRC, Angola, Burundi, Central African Republic, the Republic of Congo, Rwanda, South Sudan, Tanzania, Uganda and Zambia (the “Covered Countries”)

 

The rule applies not just to companies with SEC reporting obligations (including both domestic and foreign issuers) but it also applies to any company that uses the specified minerals if the minerals are “necessary to the functionality or production” of a product manufactured by or “contracted to be manufactured” by the company. Companies are required to comply with the new disclosure rules for the calendar year beginning January 1, 2013, with the first disclosures due May 31, 2014 and subsequent disclosures due annually each year after that.

 

Many companies had deferred preparations to meet the disclosure obligations in the hope that a pending legal challenge to the rules might succeed. However, in a July 2013 order, Judge Robert Wilkins of the District Court for the District of Columbia struck down the legal challenge. An appeal of the ruling has already been filed. However, as Broc Romanek wrote in a July 24, 2013 post on his TheCorporateCounsel.net blog (here), the ruling means “the SEC’s rules go forward as they currently exist (ie. no de minimis exception, etc.).” He adds that, despite the appeal, “with the first report due May 31, 2014, all companies should be operating on the assumption that the rules are indeed the rules and start preparing now.”

 

In a recent post (here), I detailed how extraordinarily difficult the conflict minerals determinations and disclosures may be for many companies. There is a lot of risk here for the companies involved. First and foremost, companies face a serious potential PR risk. Companies found to be out of position on conflict minerals could face a publicity firestorm from humanitarian groups and activist investors. Although it remains to be seen, adverse publicity could prove to be a problem not just for companies that must declare their use of conflict minerals but even for those that are unable to declare themselves conflict mineral free.

 

As with any disclosure requirement, there is also a significant litigation risk as well. Companies compelled to reveal their use of conflict minerals could well be the target of shareholder suits. A particularly difficult problem would involve companies that had declared themselves to be conflict free that are later shown have been using conflict minerals after all. The negative publicity and likely share price decline could be followed by a securities class action lawsuit. Activist shareholders could also launch derivative suits against companies based on allegations such as the failure to implement adequate procedures to ensure that the company’s products were conflict mineral free.

 

Of course, whether any of these kinds of suits actually emerge remains to be seen. However, the disclosure deadline that had seemed so far in the future is now rapidly approaching. In coming months, we will be hearing more about companies’ struggles to ready themselves for the disclosure requirements. In addition, questions surrounding companies’ preparations for the conflict minerals disclosure requirements increasingly will become a part of the D&O insurance underwriting process.

 

How Will the Mass of Failed Bank Litigation Finally Play Itself Out?: The peak of the recent financial crisis is now nearly five years in the past. Though banks are still continuing to fail, we can hope that the worst of the bank failure wave is now behind us. Along those lines, in its most recent Quarterly Banking Profile, the FDIC reported that the number of “problem institutions” continues to decline — although still troublingly high.

 

Though we can hope that the number of bank closures will continue to decline, the litigation that the FDIC is filing against the banks’ former directors and officers continues to mount. As of the agency’s latest report on August 8, 2013, the agency has filed 76 lawsuits against the directors and officers, including 32 so far this year. (By way of comparison, the agency filed 25 lawsuits during all of 2012.)

 

The number of failed bank lawsuits is likely to grow. As of August 8, 2013, the FDIC has also authorized suits in connection with 122 failed institutions against 987 individuals for D&O liability. The number of suits authorized is inclusive of 76 lawsuits that the agency has already filed naming 574 former directors and officers. In other words, there is a backlog of as many as 46 additional lawsuits yet to be filed. In addition, for some time now, the FDIC has increased the number of lawsuits authorized each month. There could be many more lawsuits yet to be authorized and filed.

 

The FDIC has already authorized lawsuits to be filed in connection with about 25% of all the 485 banks that have failed since January 1, 2008. (By comparison, during the S&L crisis, the agency filed D&O lawsuits in connection with about 24% of bank failures). With a total of 76 lawsuits actually filed, the agency has now filed suit in connection with about 15% of bank failures.

 

Given the litigation already filed and the lawsuits yet to come, there is and will continue to be a mountain of failed bank litigation to work its way through the courts. These cases are a burden for the courts and for the litigants. They also represent a challenge for the D&O insurers involved as these claims move toward resolution. The losses associated with these cases will continue to weigh on the insurers’ financial results, which in turn will affect their premiums and their risk appetites.

 

A mass of D&O litigation was also one of the side-effects of the S&L Crisis. Insurance coverage disputes from those cases contributed many of the important judicial decisions applicable to the interpretation of D&O insurance policies. As illustrated above in connection with the IndyMac case, there likely will be significant judicial interpretations of the D&O policy language as a result of coverage disputes arising from the current bank failure litigation wave as well. In any event, the bank failure related litigation will be working its way through the courts for years.

 

How Will Cyber Security Threats Affect the Liabilities of Corporate Directors and Officers?: it is not news that cybersecurity risks represent a significant concern for just about every company involved in the current economy. Prior posts on this site (for example, here) have detailed the liability exposures that these risks represent for all of these companies and for their directors and officers. But while these issues are not new, it seems that as time progresses, the volume on these issues has been turned up.  It now seems clear that cybersecurity is going to be one of the hot button issues for the foreseeable future, both in the media and for the affected companies.

 

The heightened scrutiny of cybersecurity issues has a number of important implications for potentially affected companies, and not just from an operational standpoint. These developments also have important implications for public company’s public disclosure statements, and, as a consequence, for the company’s potential regulatory and litigation exposures.

 

Indeed, according to a February 21, 2013 memo from the King & Spalding law firm entitled “Cybersecurity: The New Big Wave in Securities Litigation?” (here), “it is likely that this issue will continue to gain momentum among both government regulators and opportunistic plaintiff lawyers seeking to catch the next wave of shareholder litigation.” In particular, the failure to promptly disclose a cyber breach “may put a company at risk of facing formal SEC investigations, shareholder class actions, or derivative lawsuits.”

 

As the memo notes, the SEC “has already taken a firm stand on cybersecurity disclosures, and clearly views this issue as ripe for enforcement actions.” In October 2011, the SEC’s Division of Corporate Finance issued “Disclosure Guidance” on cybersecurity related issues. Among other things, the Guidance clarified that the agency expects companies to disclose the risk of cyber incidents among their “risk factors” in their periodic filings and also expects companies to disclose material cybersecurity breaches in their Management Discussion and Analysis.

 

The law firm memo notes that so far, the SEC’s Guidance “seems to have had little impact on corporate disclosure,” and that in many instances companies experiencing cyber breaches are “choosing to keep those events confidential.” However, “given the increasing awareness of this hot issue,” it seems “likely” that the SEC “will increase pressure on companies to disclose such events.” The memo adds that “companies that have experienced significant cybersecurity breaches should prepare themselves for potential SEC investigations and lawsuits.”

 

In addition to the risk of SEC enforcement action, companies experiencing cyber breaches also face the possibility of a securities class action lawsuit. However, the memo notes, a company experiencing a cyber breach “will likely not be a target of a securities class action unless the disclosure of the breach can be linked to a statistically significant drop in the company’s share price.” In that respect, it is worth noting that several high profile companies announcing cyber breaches have not experienced a significant drop in their stock price following the announcement. (For example, recent announcements by Facebook, Apple and Microsoft that they have been the target of sophisticated cyber attacks did not affect the companies’ share prices.) Nevertheless, it seems likely that at least some companies experiencing cyber breaches or subject to cyber attacks will also suffer a drop in their share price, and “thus result in securities class action litigation.” (For further analysis of the effect of a cyber breach disclosure on share prices, refer here.)

 

Companies that do not experience a share price decline following a cybersecurity incident may not get hit with securities class action litigation, but they are still susceptible to derivative lawsuits alleging, for example, that company directors breached their fiduciary duties by failing to ensure adequate security measures. As the law firm memo notes, shareholder may claim that senior management and directors “were either aware of or should have been aware of the breach and the company’s susceptibility to hacking incidents.” Of course, any lawsuit of this type would face significant hurdles, including the requirement to make a formal demand on the board as well as the business judgment rule.

 

In any event, it is clear that cybersecurity issues are going to be an increasing source of scrutiny for companies and their senior officials. This heightened scrutiny not only means that companies will be under pressure to take steps to ensure that their networks and information are secure, but also means that the companies will face pressure both to “disclose the risks associated with potential cybersecurity breaches and provide timely updates when actual breaches occur.” Companies that fall short on these disclosure expectations “will face a substantial risk of regulatory scrutiny and shareholder litigation.”

 

As Rick Bortnick discussed in a guest post on this site (here), cyber security disclosures have already been the source of securities class action litigation, in the high profile case involving Heartland Payment Systems. Although that case was dismissed, Bortnick points out how different the circumstances and disclosures involved in that case might look if viewed through the prism of the SEC”s 2011 Disclosure Guidance.

 

Among other implications from these developments is that cybersecurity disclosure seems likely to be the subject of greatly increased scrutiny, suggesting that this disclosure – particularly precautionary disclosure forewarning investors of the possible adverse effects the company could expect in the event of a serious cyber attack – should become a priority for reporting companies.

 

Finally, these developments and the possible regulatory and litigation implications underscore the fact that cybersecurity exposures represent an important issue to be addressed as part of every company’s corporate insurance program. Indeed, the SEC itself considered the question of insurance for cybersecurity exposures to represent such a critical issue that, in its Disclosure Guidance, it specifically identified the insurance issue as one of the topics companies should address in their disclosure of cybersecurity issues.

 

The insurance issues related to cybersecurity include not only the question of whether companies should acquire dedicated cyber and network security insurance, but also includes the question of the protection available to the companies’ senior officials under their management liability insurance policies. These issues relating to the scope of a company’s insurance protection for cyber-related risks present specific questions directors should be asking company management.

 

How Will These Trends and Developments Affect the Market for D&O Insurance?: As should be apparent from this discussion, there is a great deal happening in the World of D&O. Nor do the above trends and developments noted above represent everything that is happening. The surge in M&A litigation, in which virtually every merger or acquisition attracts at least one lawsuit, continues unabated. The SEC whistleblower program, which recently announced that it had made its second whistleblower bounty award, threatens an upsurge in whistleblower-driven enforcement actions and related securities claims. Anti-bribery enforcement actions are but one of the many regulatory risks involved in an increasingly global economy. And all of these developments arise following the wave of litigation relating to the subprime meltdown and the credit crisis that continues to work its way through the courts.

 

Given everything that is going on, it is hardly surprising that the D&O insurance carriers might be taking a more defensive position. Indeed, many companies – including both public and private companies — have seen the cost of their D&O insurance go up at their most recent renewal. The pricing increases are more concentrated in the primary D&O insurance policies; the increased pricing trend is less pronounced for excess insurance coverage.

 

In addition, in at least some cases and for some kinds of risks, carriers have started to try to pull back on terms and conditions as well. In some instances, this may consist of an attempt to increase retentions. In other cases, carriers have identified certain terms that they will no longer offer.

 

But though there are some areas where carriers are attempting to pull back, overall the coverage that remains available for most insurance buyers is broad. In addition, ample capacity remains available in the marketplace. Indeed, the sheer number of available market participants, augmented by the arrival of new players, raises the possibility that the premium increase and tightening of terms (however slight) could prove to be short-lived.

 

How all of this ultimately will play out remains to be seen. The one certainty is that the World of D&O will continue to be interesting to watch.

 

D&O Diary Readers Get Discount for ACI D&O Conference: On October 21 and 22, 2013, I will be co-Chairing the American Conference Institute’s D&O Liability Conference in New York. The event has a comprehensive agenda covering the current state of the D&O insurance marketplace as well as important developments in the world of directors’ and officers’ liability. The conference will feature an impressive line-up of knowledgeable speakers discussing topics that will be of particular interest to this blog’s readers. Background information regarding the conference, including the program agenda and registration details, can be found here.

 

Readers of The D&O Diary are eligible for a $200 discount when registering for the conference. In order to obtain The D&O Diary discount, readers should reference “DOD200” when registering by calling 888-224-2480 or online at www.AmericanConference.com/DandO

 

Have a Look Before You Leave: If you are not a regular reader of this blog, you may not have seen any of the photos that readers have taken of their D&O Diary mugs and that I have been posting on this site over the summer. The pictures are a lot of fun. The most recent post of readers’ mug shots, which contains links to all of the prior galleries, can be found here. Before you leave, take a moment to have a look at the great pictures that readers have been sending in.

 

Season’s End: According to the calendar, summer does not officially end for another three weeks or so. But for me, summer ends with the last sunset before leaving Lake Michigan for the season. Summer’s end is always bittersweet.But just the same, I welcome autumn’s approaching arrival and look forward to the opportunity to see and greet many of this blog’s readers at a variety of industry events on the calendar this fall..

 

The FDIC’s Quarterly Banking Profile for the second quarter of 2013, which the agency released on August 29, 2012, shows that the general positive trends in the banking industry are continuing, but revenue growth is weak and the low interest rate environment is creating challenges for many banks. In addition, the number of problem institutions, though down, remains stubbornly high. The FDIC’s Quarterly Banking Profile can be found here. The agency’s August 29, 2013 press release about the quarterly profile can be found here. 

 

The overall statistics show that banking industry profits are up by a substantial percentage from the second quarter a year ago. . The growth in profits represents the 16th consecutive quarter that earnings have registered a year-over-year increase. The earnings increases are a result of increased noninterest income, lower noninterest expenses and reduce provisions for loan losses.

 

The press release accompanying the report quotes the agency’s Chairman as saying “overall these results show a continuation in the recovery in the banking industry.” However, the Chairman is also quoted as saying that “industry revenue growth remains weak, reflecting narrow margins and modes loan growth.” In addition the current low interest rate environment “creates an incentive for institutions to reach for yield, which is a matter of ongoing supervisory concern.”

 

There is some good news about the number of problem institutions as well. (The agency calls those banks that it rates as a “4” or “5” in a 1-to-5 scale of risk and supervisory concern “problem institutions.”) The number of problem institutions declined to 553 from 612 during the quarter. The number is down significantly from the end of the second quarter 2012, when there were 732 problem institutions. The number of problem institutions is down by over 40 percent from the high quarter-end number of 888 problem institutions at the end of the first quarter of 2011. The quarterly decline in the second quarter represented the ninth consecutive decline in the number of problem institutions.

 

But while the number of problem institutions is going down, it is worth noting that here we are nearly five years from the peak of the financial crisis and there are still well over 500 problem institutions. At the same time, which the number of problem institutions is down, so too is the overall number of banks. There were 6,940 institutions reporting to the FDIC at the end of the second quarter of 2013, compared to 7,245 at the end of the second quarter of 2012.

 

One of the more noteworthy effects of the crisis in the banking sector has been the dramatic shrinkage in the number of banks. At the end of 2007, there were 8,534 banking institutions, meaning that between December 31, 2007 and June 30, 2013, 1,584 banks went out of existence, representing a decline of over 18.5%. Yet despite that substantial decrease (resulting from closures, mergers and so on), there are still 553 problem institutions in the industry, as of June 30, 2013.

 

With the declining number of banks, the percentage of banks that are rated as problem institutions still remains high, despite the decline in the absolute number of problem banks. The 553 problem institutions at the end of the second quarter still represent nearly eight percent of all reporting institutions (down slightly from the 8.7% of all banking institutions at the end of the first quarter of 2013). . In other words, roughly one out of twelve of every bank in the United States is still regarded by the FDIC to be a “problem institution.”

 

And not only that – banks are continuing to fail. Just this past Friday evening, two more banks failed, bringing the year to date total number of failed banks to 20. While it seems likely that the number of banks that fail in 2013 will be below the 51 that failed in 2012 and a far cry from the 157 that failed in 2010, the fact is that banks are continuing to fail. Even at this late date, five years after the peak of the financial crisis.

 

The banking industry as a whole remains on the road to recovery. However, the problems from the credit crisis continue to haunt the industry. The number of problem institutions, though improving, persists at an elevated level.

 

The pictures readers have taken with their D&O Diary mugs have continued to arrive. The range of settings and locations continues to impress and entertain.

 

Readers will recall that in a recent post, I offered to send out to anyone who requested one a D&O Diary coffee mug – for free – but only if the mug recipient agreed to send me back a picture of the mug and a description of the circumstances in which the picture was taken. In previous posts (here, here, here,  here, and here), I published prior  rounds of readers’ pictures. The pictures have continued to arrive and I have published the latest round below.

 

The first shot in the latest gallery comes from north of the border. Shelley Lloyd of AON in Toronto sent in this photo taken at the Hockey Hall of Fame (La Temple de la Renommée du Hockey). The photo includes a D&O Diary mug, which Shelley described as “the cup that may be rarer and almost as coveted as Lord Stanley’s.”

 

 

 

 

 

 

 

 

 

 

 

 

Today’s second mug shot also comes to us from north of the Border. Damian Brew of Marsh sent in several nice pictures from his family’s vacation trip to Montreal, including this picture of the Montreal Botanical Garden, where the mug took in the Mosaicultures Intertionales 2013, an exhibit consisting of 50 horticultural works of exhibitors from 25 different countries.  The exhibit is described here and the mug is prominently featured below (I am thinking of doing D&O Diary-themed watering cans next time around).

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

It wouldn’t be a D&O Diary mug shot gallery without at least one picture from Asia. This time, our Asia photo comes to us from Jopet Santos of Asia Capital Reinsurance Group in Hong Kong. Jopet reported that this picture was taken from his firm’s conference room overlooking Victoria Harbour. He noted that “you can probably make out two of the taller buildings in HK, IFC2 (left) and ICC (right), in the background on this dreary day in the aftermath of typhoon Utor.” For those readers interested in seeing the same buildings appearing in Jopet’s mugshot in a photo taken outside and from Victoria Peak on a much sunnier day, please refer to my Hong Kong travelogue from last April, here.

 

 

 

 

 

 

 

 

 

 

 

 

And next, a shot from the Parthenon. No, not that Parthenon, that one is all in pieces. No, this is a photo of full-size replica of the Parthenon located in Centennial Park in Nashville, submitted to us by loyal reader Hailey Aldren of Nashviile. Hailey reports that unlike the original in Athens (at least in its current state), the replica has a full-sized statute of Athena inside the building.

 

 

 

 

 

 

 

 

 

 

 

 

Harry Bryans of AON also sent in a picture featuring a prominent landmark in his home town, one that captures the spirit of the entire D&O Diary mug project. The Free Library of Philadelphia, like the D&O Diary mug that Harry received, and indeed like The D&O Diary itself, is free, as are all of the best things in life.

 

 

 

 

 

 

 

 

 

 

 

 

Finally, our good friends the husband and wife team of David Murray of AIG and Suzanne Mast Murray of Alliant Insurance Services send in this picture of their two D&O Diary mugs relaxing by the pool. Yes those are the mugs behind those shades and under the towels.

 

 

 

 

 

 

 

 

 

 

 

 

I can’t tell you how much fun it is receiving the pictures and seeing the interesting places readers have taken their mugs and the striking pictures that have resulted. I look forward to receiving and publishing many more pictures.

 

I recently ordered another supply of mugs, so if there are more readers out there who would like to have a mug, please just let me drop me a note. Just remember, if you get a mug, you have to send back a picture. If you order a mug, please be patient, it may take a few days to mail the mug to you.

 

Thanks to everyone for their pictures. Cheers!

Back in 2009, when the current bank failure litigation wave was in its very earliest stages, I noted that in its preliminary efforts to lay the groundwork to pursue failed bank litigation, the FDIC had resurrected FIRREA, a statutory vestige from the S&L crisis in the late 80s and early 90s that had in the intervening time largely gone dormant. Though the FDIC’s reliance on Financial Institutions Reform, Recovery and Enforcement Act of 1989 in connection with the failed bank litigation is hardly surprising, what has been surprising has been the use that other regulators and prosecutors are now making of the statute.

 

As detailed in an August 21, 2013 memo from the King & Spalding law firm entitled “FIRREA – Aging but Agile, the Government’s Newest Formidable Weapon of Enforcement” (here), prosecutors have “added FIRREA to their arsenal by using its provisions to bring claims of financial fraud against major financial institutions.”

 

Since its passage over nearly 25 years ago, the statute was rarely used for civil fraud enforcement actions. Perhaps the statute’s first significant recent attempted use as a civil enforcement tool was the action that the DoJ filed in February 2013 against the three McGraw-Hill and its rating agency affiliate Standard & Poor’s. As discussed here, in reliance on claims asserted under FIRREA, the government is seeking $5 billion in penalties and alleging mail fraud. The government has filed other actions relying on FIRREA against several other major financial institutions.

 

There are a number of reasons that FIRREA has proved to be an attractive option for prosecutors and regulators. As the law firm memo notes, FIRREA has a lengthy statute of limitations, an “arguably low burden of proof, and the also provides the government with the ability to issue administrative subpoenas to conduct a civil investigation in advance of filing a civil complaint.

 

As the peak of the credit crisis recedes further into the past, the statute’s lengthy statute of limitations could prove to be particularly important. As the law firm memo notes, the statute of limitations period applicable to most anti-fraud suits is five years, which could put conduct in 2007 or 2008 beyond reach. However, FIRREA “offers a ten-year statute of limitations, which enables prosecutors to bring new lawsuits that extend back through the entirety of the crisis period.”

 

FIRREA also affords the opportunity for substantial financial recoveries. The statue provides for fines of various amounts, including in particular the right to recover the “actual loss incurred,” which could “aggregate to tens of millions.”

 

The prosecutors’ reliance on FIRREA received boost recently in two decisions out of the Southern District of New York. The government had filed actions directly against several major financial institutions in reliance on FIRREA’s provisions allowing recoveries for violations “affecting a federally insured financial institution.” The defendants in these suits questioned whether the statute authorized prosecutors to rely on this provision to bring actions against federally insured institutions for allegedly engaging in financial fraud that “affects” itself.

 

In an earlier decision by Judge Lewis Kaplan and in an August 19, 2013 decision by Judge Jed Rakoff (here), the courts held with respect to these so-called “self-affecting” claims that prosecutors may indeed pursue a bank for its own misdeeds. As the law firm memo notes, “without a ‘victim’ in play, this interpretation could greatly expand the class of defendants sued under FIRREA for financial fraud.” The memo’s authors add that these rulings, which endorse the expanded use of FIRREA, “likely will embolden the Justice Department to pursue financial institutions for fraud against third parties where the ultimate financial impact on the bank and its shareholders is substantial. “

 

As a result of these developments, the memo concludes that “the government’s actions appear to promise a host of suits targeting many financial institutions.” The government’s “renewed use of an creative theories regarding [FIRREA]…should be closely watched given the potential risks for financial institutions.”

 

Special thanks to a loyal reader for providing me with a copy of Judge Rakoff’s decision.

 

On August 19, 2013, in connection with its entry into a settlement with New York-based hedge fund adviser Phillip Falcone and his advisory firm Harbinger Capital Partners, the SEC for the first time implemented its new policy requiring defendants seeking to settle civil enforcement actions to provide admissions of wrongdoing, in contrast to the long-standing practice of allowing defendants to resolve the enforcement actions with a “neither-admit-nor-deny” settlement.

 

The SEC’s new policy requiring – in “egregious” cases — admissions wrongdoing in order to settle an enforcement action not only has important implications for the enforcement action itself, but potentially also has important implications for other related civil or criminal proceedings. Another issue that inevitably will also arise is the question of the impact of factual admissions on the availability of D&O insurance for related defense expenses and indemnity.

 

In June 2012, the SEC filed an enforcement action against Falcone and various Harbinger entities alleging that in October 2009, Falcone had used $113 million in fund assets to pay his personal taxes; that he had favored certain fund customers’ redemption requests at the expense of other investors; and that he had conducted an improper “short squeeze” in the bonds of financially troubled Canadian manufacturing firm.

 

The SEC and the Harbinger defendants, including Falcone, had actually reached an earlier agreement to settle the enforcement action. In May 2013, the agency and the defendants reached a settlement in principle to resolve the case. That earlier settlement agreement reflected the traditional “neither admit nor deny” approach. However, in July 2013, the SEC advised Harbinger that the SEC Commissioner has voted to reject the deal. The vote apparently reflected the SEC’s new policy, announced in June by new SEC Chair Mary Jo White, that going forward the SEC would require defendants settling enforcement actions to admit wrongdoing, at least in “egregious” cases.  

 

In connection with the revised settlement announced on August 19, Falcone and the Harbinger entities agreed to extensive admissions of wrongdoing. The factual admissions are set out at length in detailed Annex to a Consent that Falcone signed on August 16 on his own behalf and on behalf of the Harbinger entities. The admissions are also set out verbatim in the proposed Final Consent Judgment that was filed with the Court. Pursuant to the settlement, the Harbinger entities agreed to pay a total of over $18 million in disgorgement, civil penalties and interest. As part of these payments, Falcone himself must pay over $11.5 million. Falcone also agreed to a five-year ban from the securities industry.

 

The factual admissions detailed in the Annex and incorporated into the Final Consent Judgment make for some interesting reading. Among other things, the factual recitations detail that Falcone did not just walk down the hall and pull $113 million out of one of the Harbinger funds to pay his taxes, as if he were taking money out of a piggy bank; the transaction was actually suggested to Falcone by a prestigious outside law firm that counseled Falcone and Harbinger. The law firm prepared an extensive power point presentation proposing the transaction and also prepared a written loan agreement documenting the loan.

 

The admissions also detail the “short squeeze” Falcone orchestrated in connection with the bonds of MAAX Holdings, a Canadian manufacturing company. In a series of moves that seemingly defy the laws of physics, Falcone and the funds “purchased more than the available supply of bonds” (accomplishing this seemingly impossible feat by taking the long side of short sales in the open market). By capturing the supply of the MAAX bonds, Falcone and the Harbinger funds prevented Goldman Sachs from covering a short position that the investment bank held in the MAAX bonds.

 

The Consent also contains another of other provisions to which Falcone and the Harbinger defendants also agreed. Among other things, the defendants agreed that they “shall not seek or accept, directly or indirectly, reimbursement or indemnification from any source, including, but not limited to, payment made pursuant to any insurance policy, with regard to any civil penalty amounts” paid pursuant to the Final Consent Judgment.

 

The Harbinger Defendants also “acknowledge” in the Consent that “no promise or representation has been made by the Commission … with regard to any criminal liability that may have arisen or may arise from the facts underlying this action.”

 

The defendants also agreed that they “will not make or permit to be made any public statement to the effect that the Harbinger Defendants do not admit the allegations of the complaints, or that this Consent contains no admissions of the allegations.” However, the Consent also goes on to state that nothing in this agreement affects the defendants “right to take legal or factual positions in litigation or other legal proceedings in which the Commission is not a party.”

 

The admissions in the Consent are comprehensive – the defendants basically admitted all of the SEC’s allegations. Moreover, it appears that in pursuing its new settlement approach, the SEC will be requiring other defendants to provide similar admissions in order to settle SEC actions against them. For example, there are reports that the agency is seeking to require J.P Morgan to provide admissions of wrongdoing in connection with the agency’s actions against the firm in connection with the “London Whale” cases.

 

The SEC’s apparent requirement for admissions of wrongdoing in at least some cases has a number of significant implications. First and foremost, it means that, at least in the SEC enforcement actions where the agency will require admissions in order to settle that the cases will be much harder to settle. The defendants, wary of the possible impact the admissions could have in other proceedings, will be reluctant to provide admissions. One consequence of the new policy could be that the SEC will be compelled to try more cases, which could strain the agency’s resources.

 

The provision of the admissions potentially could have enormous consequences for related proceedings. The recitation in the Consent that the Harbinger defendants have been provided no assurances about the possibility of criminal proceedings has to be particularly chilling, especially for Falcone. The admissions in the Consent may or may not suffice to draw criminal charges, but at least some commentators have suggested that criminal charges could follow.

 

Another question that follows from the Harbinger defendants’ admissions is the collateral effect the admissions could have in related civil proceedings. As it happens, there is a pending civil action that Harbinger investors had filed against Falcone and the funds that could provide an early test of the civil litigation collateral estoppel consequences of admissions in an SEC enforcement action. In an interesting and detailed August 20, 2013 post in her On the Case blog (here), Alison Frankel examines the possible impact that the admissions could have on the fund investors’ pending civil action. As her post explains, the pending action may not be the perfect test of the admissions’ preclusive consequences, as the civil action is not filed under the federal securities laws and also largely relates to matters other than those involved in the SEC enforcement action. Nevertheless, the admissions could have an important impact on the case and bolster the plaintiffs’ allegations.

 

An issue that occurs to me is the question of the impact of the admissions on the availability of D&O insurance. The specific question is whether or not admissions of the type that the Harbinger defendants provided in the SEC settlement are sufficient to trigger the fraud and criminal misconduct exclusion in the D&O policy. The wording of these exclusions varies, but they typically preclude coverage for loss arising from fraudulent or criminal misconduct, but only after a final adjudication determines that the preclusive conduct has taken place. If the admissions were found to be sufficient to trigger this exclusion, coverage would no longer be available for the wrongdoer, and the insurer could even have the right to try to recover amounts that had already been paid (for example, the attorneys’ fees the wrongdoer incurred in defending himself or herself in the SEC proceeding).

 

On the one hand, there would seem to be some reason to be concerned that a settlement of the type that the Harbinger defendants entered into represents a “final adjudication.” The specific factual admission to which the defendants agreed were not only stated in the public court record, but they are incorporated verbatim into the Final Consent Judgment filed with the court. Upon the Court’s entry of the Judgment, there would seem to be grounds upon which it could be argued that there had been a final adjudication.

 

On the other hand, there would appear to be a substantial question whether the specific admissions to which the Harbinger defendants agreed rise to the level to satisfy the exclusion’s misconduct requirement. While the admissions represent an extensive concession that the defendants engaged in wrongdoing – and while the admissions expressly recite that the defendants acted “improperly” and “recklessly” — at no point to the defendants admit to “fraud” or to any other level of conduct that would expressly trigger the typical D&O policy’s conduct exclusion.

 

A related issue that could arise is the question of exactly how bound the admitting parties are by their admissions. The Harbinger defendants’ Consent specifically recites that nothing in the agreement affects the defendants “right to take legal or factual positions in litigation or other proceedings or other legal proceedings in which the Commission is not a party.” In effect, the Harbinger defendants seemed to have tried to preserve the right to argue that while they made certain admissions for purposes of the SEC enforcement action, they did not make those admissions for all purposes and for the benefit of all other parties who might seek to rely on them. The Harbinger defendants might well argue that notwithstanding their admissions in the Consent, they have the right to contest the factual matters in other proceedings, including for example, in the context of an insurance coverage dispute. 

 

The Harbinger settlement represents a significant development with important potential implications for other defendants in SEC proceedings. The admissions that these defendants may be required to provide in order to settle the enforcement action pending against them could have important collateral consequences, many of which at this point remain uncertain. The impact of these kinds of admissions in related civil cases remains to be seen. Among other questions that likely will also have to be addressed is whether admissions of this type have any impact on the continued availability of insurance coverage for the defendants that provide these kinds of admissions. 

 

D&O Diary Readers Get Discount for ACI D&O Conference: On October 21 and 22, 2013, I will be co-Chairing the American Conference Institute’s D&O Liability Conference in New York. The event has a comprehensive agenda covering the current state of the D&O insurance marketplace as well as important developments in the world of directors’ and officers’ liability. The conference will feature an impressive line-up of knowledgeable speakers discussing topics that will be of particular interest to this blog’s readers. Background information regarding the conference, including the program agenda and registration details, can be found here.

 

Readers of The D&O Diary are eligible for a $200 discount when registering for the conference. In order to obtain The D&O Diary discount, readers should reference “DOD200” when registering by calling 888-224-2480 or online at www.AmericanConference.com/DandO

 

On July 24, 2013, in a case the court said was one of “first impression,” the First Circuit held that, due to the nature of its involvement in the management of its portfolio company’s operations, a private equity firm was potentially liable for the portfolio company’s pension obligations. The decision has significant implications for the way private equity funds structure their relationship with the portfolio companies. The decision may have important insurance implications as well. A copy of the First Circuit’s opinion can be found here.

 

In 2007, two Sun Capital Investments funds invested in Scott Brass, Inc., which went bankrupt in 2008. The New England Teamsters and Tracking Industry Pension Fund asserted that the funds were liable for the unfunded vested benefits in the bankrupt company’s pension fund. The union argued that the funds acted as a part of controlled group and therefore were jointly and severally liable for the pension liability. The funds argued that because they were merely investors in the bankrupt company, they were not participating in a “trade or business” that could be a “controlled group” or under “common control” with Scott Brass sufficient to make them liable under ERISA for the pension fund. The district court agreed with the funds and the union appealed.

 

In a July 24, 2013 opinion written by Chief Judge Sandra Lynch for a unanimous three-judge panel, the First Circuit held that the funds were sufficiently involved in the management and operation of the portfolio company for their activities to qualify as being involved in a “trade or business” but remanded the case to the district court for further proceedings to determine if the funds and Scott Brass were under common control.

 

As noted in an August 14 2013 memo about the decision (here), the Sherman & Sterling law firm notes that private equity funds have traditionally taken the view that, as passive investors, the funds are not a “trade or business.” The Court applied an “investment plus” test to determine whether the private equity firm’s activities met the legal standard.

 

In concluding that the test had been met, the Court cited such factors as the fact that the funds’ limited partnership agreements and private placement memoranda explicitly described the funds as actively involved in their portfolio companies’ management; and that the partnership agreement also gave the general partner the authority to make decisions about hiring, firing and compensation agents and employees of portfolio companies. The funds’ controlling stake gave the funds the right to place two of their employees on the portfolio company’s board, giving the funds effective control of the board.

 

As the law firm memo notes, the First Circuit’s decision “creates potential ERISA liability risk for private equity funds that engage in active management.” If the fund is involved in the management and operation of its portfolio companies – as many funds are – “there is potential for the fund to be held responsible for the portfolio company’s ERISA liabilities.” The memo notes the potential liabilities include the “joint and several liability for withdrawal from a multiemployer pension fund” (which is what was at issue in the First Circuit case) and “joint and several liability for missed contributions to and underfunding upon the termination of a pension plan.”

 

As many commentators have noted, this decision has important implications for the way private equity funds structure there relationships with their portfolio companies. It also has implications for the way fund documents describe the private equity firm’s role. The Sherman & Sterling memo that many of these same implications could also extend to venture capital firms as well, where venture capital firms taking an active role in management could also risk incurring ERISA liability for the portfolio companies.

 

This case also has interesting insurance implications. Many organizations carry fiduciary liability coverage to protect the firm and its officials from liability under ERISA. However, these policies typically apply to loss from claims alleging wrongful acts in connection with the operation of Sponsored Plans. The Sponsored Plans to which the policy coverage applies typically are those operated by the insured organization itself (or jointly by the insured organization and a labor organization). The liability protection under the policy typically would not extend to liability arising from the operation of a third party organization’s plans, such as, for example, those of a private equity firm’s portfolio company.

 

To be sure, even if there otherwise were coverage under the policy for this type of liability, the policy would likely exclude coverage for “benefits due” (such as pension benefits that were due but not paid into the plan fund). Many of the potential  ERISA liabilities described in the law firm memo might well be excluded from coverage, even if a portfolio company’s pension plan were otherwise within the scope of the private equity firm’s fiduciary liability coverage, by operation of the “benefits due” exclusion

 

It may be that there is in fact no liability here that would not run afoul of the benefits due exclusion. However, if there is liability for which the exclusion would not otherwise preclude coverage, there appears a substantial likelihood that the liability would be uninsured.

 

These issues are at (or perhaps beyond) the very outer edges of my knowledge about the scope and reach of fiduciary liability insurance. Just the same, I think the First Circuit’s recognition of the potential for private equity firm’s to incur ERISA liability for the portfolio companies’ pension funds, and the seeming likelihood that that liability would be uninsured, raises interesting questions.

 

I know that many of readers know a great deal more about the intricacies of the scope of coverage under fiduciary liability insurance policies. I strongly encourage those who have greater insight into these issues and that have view on this topic to add their comments to this post using the blog’s comment feature.

 

A recurring question under the management liability insurance protection that banks typically acquire is the extent of the protection afforded under their policies’ professional liability provisions. One particular question that often arises is whether the policy affords coverage for customers’ excessive overdraft fees claims.. An August 7, 2013 decision by Northern District of Georgia Judge Richard W. Story, applying Georgia law, held that a bank’s policy did not cover the settlement of a customer overdraft fee class action. A copy of Judge Story’s opinion can be found here. An August 9, 2013 post on the Class Action Lawsuit Defense Blog about the decision can be found here.

 

Fidelity Bank was sued in Georgia state court in a customer class action alleging that the bank’s flat $29 overdraft fee, charged regardless of the size of the overdraft, amounted to a usurious interest charge in violation of Georgia law. The bank tendered the overdraft fee suit to its insurer, which had issued a Management and Professional Liability Insurance for Financial Institutions policy to the bank. The insurer accepted the defense of the claim, but denied coverage for any settlements or judgment amounts. The bank settled the underlying claim and filed an action seeking a judicial declaration that the  policy covered the settlement amount. The parties filed cross-motions for summary judgment.

 

The relevant portion of the policy provided coverage, among other things, for loss arising from a claim alleging a wrongful act of the insured “in the rendering of the failure to render professional services.” The policy defines professional services as services “rendered by an Insured pursuant to a written agreement with the customer or client as long as such service is rendered for or on behalf of a customer or client of the Company.”

 

Policy Exclusion (h) specifies that the insurer is not liable to make payment for loss “alleging, arising out of, attributable to, directly or indirectly, any dispute involving fees, commissions or other charges for ay Professional Service rendered or requiting to be rendered by the Insured, or that portion of any settlement or award representing an amount equal to such fees, commissions or other compensations; provided, however, that this exclusion shall not apply to Defense Costs incurred in connection with a Claim alleging a Wrongful Act.”

 

In his August 7, 2013 opinion, Judge Story granted the insurer’s motion for summary judgment, on two grounds: first, that the underlying settlement represents uninsurable restitution; and second, that Exclusion (h) excludes coverage for loss arising out of fee disputes, other than defense costs.

 

First, with respect to the restitution issue, Judge Story said that the money at issue in the underlying dispute did not represent amounts the bank had lost, for example by negligently negotiating a forged check. Rather, Judge Story noted, the allegation was that “Plaintiff was deducting to its own use funds from its customers’ accounts in a manner that was not legally authorized.” Because of the underlying lawsuit, the bank “was required to return to return its customers’ funds in the same manner that it would if Plaintiff has mistakenly deducted funds from a customer’s account because of, for example, a computer error.”

 

Judge Story added that to require the insurer to “pay restitution for amounts Plaintiff collected pursuant to illegal practices would result in a windfall to Plaintiff.” If the Court were to require the insurer to make a payment in these circumstances, “it would amount to a ruling that Plaintiff is free to collect fees and make profits from its customers through illegal conduct, and the insurer is on the hood when the customers sue while Plaintiff keeps the ill-gotten gains.”

 

Judge Story also held that Exclusion (h) “speaks exactly to this type of claim” because it “excludes from indemnification (but not defense) disputes involving fees and commissions or, in other words, amounts that Plaintiff was accused of wrongfully or excessively charging its customers.” Judge Story acknowledged that the plaintiffs in the underlying lawsuit had referred to the overdraft fees as “usurious interest,” but, he said, “the fact that Georgia law treats a fee as interest in a certain context does not mean that it cannot also be a fee.”

 

The outcome of this insurance coverage dispute is noteworthy not only in and of itself, but also because plaintiffs’ lawyers are filing a host of overdraft fee class actions these days, and so the question of insurance coverage is coming up with some frequency. Obviously coverage will depend in part on the nature of the fees charged and the facts alleged and claims asserted in the underlying lawsuit, as well as the wording of arguably applicable exclusions if any. Nevertheless, despite these case and circumstance specific factors, insurers’ are likely to rely on this case to try to argue that their policy does not cover the amount of any settlement of a customer overdraft fee class action.