Risk Management

D&O Rates Rise on Flood of Merger Lawsuits

Almost every acquisition is being accompanied by abundant shareholder litigation.
David KatzJuly 25, 2013

Most finance chiefs working for companies involved in a recent merger or acquisition are well aware of the irritating abundance of legal protests against their deals.

Now, however, the omnipresence of so-called “merger objection” lawsuits is hitting companies on another front, helping to drive up the cost of directors’ and officers’ liability coverage by 5 to 10 percent or even higher in the second quarter, insurance brokers say. And that’s been occurring at a time when the rates of cost increase for other kinds of insurance have been slowing

The number of  such suits has become “overwhelming” to insurers as well as the companies being sued, according to Brian Wanat, a managing principal of the financial services group at Aon, the insurance brokerage firm. Such claims drove rate hikes for D&O insurance of 5 to 10 percent in the second quarter and are doing the same in the current quarter, he said.

According to a 2012 Cornerstone Research study of recent developments in M&A shareholder lawsuits reported in Securities and Exchange Commission filings, valued over $100 million and announced in 2010 or 2011, “almost every acquisition of that size elicited multiple lawsuits, which were filed shortly after the deal’s announcement and often settled before the deal’s closing.”

In such suits, shareholders typically charge that the target company’s board violated its fiduciary duty via a flawed deal process that failed to produce maximum shareholder value, according to the study. Commonly, the litigation may allege a noncompetitive auction; the discouragement of added bidders; conflicts of interest; or a failure to disclose enough information to enable informed votes on the deal.

The flood of M&A lawsuits is hitting middle-market companies as well as larger ones, according to the study, which found that 789 such actions were filed in 2010 relating to acquisitions of U.S. public companies valued at or over $100 million and announced in 2010, and 696 such cases were filed in 2011. Indeed, most deals valued at between $100 million and $500 million were challenged with multiple lawsuits per deal.

On major reason D&O carriers are charging more is that they haven’t been able to keep up with a changeover in the course of this decade from infrequent but very severe lawsuits to a torrent of what amount to nuisance claims, according to Wanat.

“Basically, the industry is built for severity,” he says. While insurers have been able to avoid particularly big payouts by choosing their risks carefully, they have problems dealing with large numbers of small-bore claims.    

To be sure, D&O cost trends can differ wildly by industry. For instance, premiums paid by companies in the S&P Telecommunications sector shot up 32.8 percent in the first quarter of this year compared with the same quarter last year, according to Aon’s D&O quarterly pricing index report. For the same quarters, however, rates fell 4.3 percent for companies in the S&P Consumer Discretionary sector.

Going forward, Wanat says that two other forms of litigation may provide added fuel for prices hikes on the coverage. Companies issuing initial public offerings under the JOBS Act may spawn shareholder lawsuits if issuers short-cut the capital-raising process, the broker says, although it may be “too early to tell” whether there will be much litigation in that area.

Cyber liabilities may be another source of suits against directors and officers. “How are companies going to disclose breaches?” he asks.

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