Risk Management

A Deceptive Calm

A slow year for M&spamp;A may have lulled companies into a false sense of security about their D&spamp;O liability coverage.
David Katz and Caroline McDonaldMarch 21, 2013

Finance chiefs might be forgiven for being complacent about the state of their companies’ directors-and-officers (D&O) liability coverage. After all, the past year saw a lull in merger-and-acquisition activity, and that was accompanied by a decline in federal class-action lawsuits. Overall, there were 152 federal securities-fraud class-action suits filed in 2012, according to a report by Cornerstone Research and Stanford Law School. That was the second-lowest total in 16 years, 21% below the annual average between 1997 and 2011. Federal filings associated with M&A transactions dropped from 43 cases in 2011 to 13 cases in 2012.

But M&A-related class actions are now being pursued almost exclusively in state courts, according to Cornerstone. And if mergers and acquisitions increase this year, as consultancies like PricewaterhouseCoopers expect, lawsuits may not be far behind. In 2010 and 2011, almost every acquisition by a U.S. public company valued over $100 million “elicited multiple lawsuits, which were filed shortly after the deal’s announcement and often settled before the deal’s closing,” according to another Cornerstone report.

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If more mergers and acquisitions mean more lawsuits, then finance chiefs would do well to take more interest in their D&O coverage. Chances are high that any company involved in M&A activity could see a class action, or, more likely, a smaller-scale lawsuit. If there’s a merger, acquisition, or takeover, “a civil lawsuit is filed every time. It’s guaranteed they’re going to get sued,” observes Will Fahey, senior vice president of corporate markets with Zurich, a leading carrier of D&O liability coverage. Directors and officers can be blamed for paying too much for an acquisition or for bad judgment, observes Richard Betterley, president of Betterley Risk Consultants.

Private-company leaders often believe D&O coverage is more of a necessity for companies with shareholders, notes Betterley. But while D&O risks do differ according to whether a company is publicly or privately held, they are not as different as private-company leadership thinks, he says. Private companies “have partners, they have investors, and they have bank relationships,” he points out. And they have exposures to price-fixing and antitrust allegations as well, he adds.

William G. Passannante, co-chair of the insurance recovery group at Anderson Kill, a law firm that defends corporate policyholders, observes that executives and directors of publicly held companies tend to be more knowledgeable about their insurance coverage than their peers at private companies. They sometimes make suggestions to risk managers about options they have seen used for other boards, he says.

Side-A Coverage
CFOs should regularly review their D&O insurance, “because what’s available in the market changes, the forms change, and the exclusions change,” says Passannante. While experts agree that standard D&O policies provide decent coverage, there are areas in which boards and top management could be vulnerable to personal loss. For example, directors and officers may find their personal assets at risk if a bankrupt company is unable to compensate them for their legal fees — and if recoveries under the company’s D&O policy are determined to be assets of the bankruptcy estate.

Such cases are where so-called stand-alone Side-A D&O coverage comes in. Filling a gap in traditional policies, this coverage protects executives against nonindemnifiable claims, those for which the company cannot legally or financially provide protection. Whether a company is publicly traded or privately held, its ability to indemnify or “hold harmless” its executives and boards is controlled by the law of the state where the company is headquartered or incorporated.

Corporate risk managers typically buy Side-A coverage as part of a bigger traditional insurance package that also includes protection for directors and officers against indemnifiable losses (Side-B coverage) and coverage for the company itself (Side-C coverage).

While any company may want to consider buying Side-A coverage for their officers and directors, Betterley says, such insurance is purchased mainly by publicly traded companies. The managements of private organizations, he adds, may “believe they have more control of their company than one that’s publicly held.” Whether that turns out to be true in 2013 remains to be seen.

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