2007 SPECIAL SUPPLEMENT Boardroom Liabilities Protecting Directors in a Sea of Risk
Securities Claims against Directors and Officers: D&O Insurance, a Bridge over Troubled Waters By CAROLYN H. ROSENBERG AND SARAH R. WOLFF Similarly, when notified of restatements, some D&O In the blockbuster movie Jaws , the shark insurers are asserting that, like shareholders, they based seemed to bite just when everyone thought agreements to provide insurance on false financials, and it was safe to go back in the water. Directors are threatening to bring rescission actions to void entire and officers today may well question whether the waters policies, thereby potentially leaving the directors and are safe for them. The Enron shareholder lawsuits live on, officers with no coverage. and we anticipate another significant Supreme Court opinion resulting from them next term. Meanwhile, the No wonder a recent survey by Towers Perrin found that Securities and Exchange Commission continues to directors are increasingly concerned about their personal announce new options backdating investigations even as liability. Outside directors continue to be squarely in the it files complaints arising from current investigations SEC’s sights. And just last year, five former outside against directors and officers. directors of the bankrupt company Just for Feet paid a combined $41.5 million to settle claims brought against On the flip side, the Supreme Court recently issued its them by the bankruptcy trustee—payments reportedly much-anticipated decision in the Tellabs case, adopting a made personally by the directors. heightened pleading burden for plaintiffs bringing securities fraud claims under the Private Securities Faced with a potentially wild ride ahead, what should Litigation Reform Act. Although directors and officers can directors and officers look for in their D&O coverage? 1 take comfort from the opinion, the court declined to 1) A Broad Definition of Claim that impose a more draconian pleading burden on future Covers Investigations plaintiffs. Directors and officers also need to be concerned with the growing number of institutional Because coverage is generally triggered under a shareholder lawsuits, shareholder class actions, and D&O policy when a claim is made, the definition of claim is regulatory investigations filed in foreign jurisdictions important. That definition typically encompasses lawsuits against U.S. companies. and may include written demands for monetary or nonmonetary relief. Criminal, regulatory, and investigative These days, companies and their directors and proceedings should also be covered, including formal and officers are also increasingly exposed to triple informal requests for information. jeopardy – private securities class actions, SEC and 2) Choice of Counsel and Advancement Department of Justice investigations, and state of Defense Costs regulatory proceedings. As the SEC and DOJ continue to pursue parallel investigations, directors and officers need Most D&O policies allow the insured to choose counsel to consider how corporate cooperation with the with the carrier’s consent, with the payment of defense government, including waiver of attorney-client privilege, costs depleting the limits of the policy. For defense of may impact them. For example, will having a deferred securities claims, at least one major D&O carrier requires prosecution agreement with the DOJ make it more likely its insureds to use law firms designated on a panel that a company’s directors and officers will be pursued? counsel list, unless the insureds can show a conflict or other justification to go outside the panel list. Insureds Finally, companies continue to restate their who wish to select their own counsel may want to financials. The SEC inevitably investigates these cases, negotiate to include additional firms on a panel counsel often with significant implications for directors and list or seek to delete this requirement. Defense costs officers. In May, the SEC pulled another weapon from its incurred by individual insureds are typically indemnified arsenal in settling the Mercury Interactive options by the company, which then seeks reimbursement from backdating case. Even as the SEC settled with Mercury, it the carrier. D&O policies should provide that the carrier filed securities fraud charges against Mercury’s former will advance defense costs on a current or periodic basis. CEO and CFO and for the first time used a provision of the Individual directors and officers are well served to Sarbanes-Oxley Act that allows the commission to seek negotiate a provision that obligates the insurer to repayment of bonuses and stock sale profits received by advance defense costs where the company may be CEOs and CFOs when financial results are later restated. disputing advancement obligations, without the individual
insured incurring what could be a high retention before 6) Nonrescindable Coverage for triggering the coverage. Nonindemnifiable Claims against Directors and Officers 3) Severable Conduct Exclusions That Side A coverage responds to loss that the company Apply Only When Misconduct Is cannot (because of insolvency) or is not permitted to Adjudicated in the Underlying Claim (under its bylaws or applicable law) indemnify for Two exclusions frequently asserted by carriers, directors and officers. Most policies provide that no particularly with respect to securities claims, are conduct retention will be applied to Side A claims. As the Side A exclusions: the deliberate fraudulent acts or dishonest coverage is typically the last resort for directors and conduct exclusion and the illegal personal profit or officers if they are not indemnified, directors and officers advantage exclusion. The requirements of Sarbanes-Oxley are best protected when the insurer agrees it will not with respect to the conduct of, and remedies imposed rescind the coverage for any reason. against, directors and officers may increase insurers’ attempts to deny coverage based on these exclusions. 7) Separate Side A Coverage Where possible, these exclusions should be negotiated so Directors and officers are increasingly demanding that that the carrier may not rely on them to defeat coverage they be provided separate Side A coverage. They desire unless there is a final adjudication of fraudulent or separate limits of coverage untapped by claims against dishonest conduct, or personal profit or advantage, in the 2 the company. The Side A stand-alone policy that is most context of the underlying claim. Insureds should try to favorable is a drop down, difference–in-conditions (DIC) make these exclusions severable as well. coverage. In this case, the policy drops down and functions as primary coverage in the event the full-side 4) A Broad Definition of Loss policy’s Side A coverage does not apply. This could occur D&O policies often exclude such things as taxes, fines, if the underlying policy contains an exclusion that the penalties, the multiplied portion of any multiplied damage Side A stand-alone policy does not. The Side-A-only policy awards, and punitive damages from the definition of loss. also functions as traditional excess coverage for Insurers have, however, agreed to cover at least some nonindemnifiable claims against directors and officers in punitive and multiplied damages awarded. Some carriers that it sits on top of the underlying full-side coverage. cover punitive damages for securities claims if they are Typically, Side A DIC policies are nonrescindable. insurable under the law pursuant to which the policy is construed. Other carriers cover all punitive or multiplied Although proposing these seven suggestions may be damages, so long as it is not against public policy to taken as a lucky omen, most directors and officers we insure them. Policies may further provide that the law of counsel prefer to avoid chance and proactively negotiate the jurisdiction most favorable to coverage will be applied their coverage, saving the shark-infested waters for more to the disputes. The efficacy of and any restrictions on daring souls. these most favorable law provisions, however, should be reviewed under the law of any jurisdiction that may apply Carolyn H. Rosenberg is a senior partner in the to a policy or claim. Insurance Recovery Group and Sarah R. Wolff heads the Securities Litigation and Enforcement Practice Group 5) Worldwide Coverage at Reed Smith LLP. Directors and officers should assess if their current program will adequately cover them for claims and regulatory proceedings in foreign jurisdictions. Possible issues to consider include requirements to purchase policies in the host country, adequacy of limits, and the For more information about Reed Smith choice of law and forum to resolve a coverage dispute. visit www.reedsmith.com
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