Corporate Lawsuit Apathy Worries D&O Insurer

Overconfidence may be laying the groundwork for shareholder litigation at many companies.
Caroline McDonaldJune 22, 2012

Company executives with enough insurance coverage may be lulled into a false sense of security when it comes to lawsuits. More than 80% believe a suit is “unlikely,” according to an insurer survey.

“It’s a little bit of human nature to say ‘it can’t happen to me because I’m not doing anything wrong,’” says Carol Fox, director of strategic and enterprise risk practice for the Risk and Insurance Management Society. “Compounded may be the fact that [executives] are covered by insurance and have confidence in their organization’s risk-management capabilities.” She adds: “It just isn’t on their radar screen, so there is a bit of a comfort level there — warranted or unwarranted.”

According to “The Chubb Public Company Risk Survey,” conducted by Pollara, an independent public-opinion and market-research firm, in 2011, there were a record-high number of settlements for Foreign Corrupt Practices Act violations.

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A majority of Chubb’s survey respondents (78%), however, said they were not worried about an investigation due to an FCPA violation. What’s more, 13% have decreased the financial and human resources their company allocates toward mitigating losses related to the law.

Pollara conducted telephone interviews with decision makers at 145 public companies in the United States and Canada, according to Chubb. Survey contents are confidential because of proprietary client data.

As a liability insurer, Chubb has an interest in keeping the losses of its corporate insureds as low as possible. The finding is “disconcerting,” especially since directors and officers of nearly one in four (23%) of the public companies surveyed already have been sued, says Evan Rosenberg, senior vice president and global specialty lines manager for Chubb.

In addition, activities such as mergers and acquisitions and enforcement of antibribery laws are increasing D&O exposure to potential suits by shareholders, regulators, customers, vendors, and competitors, adds Rosenberg.

The response to this information has been largely indifference. “What happens when I visit clients is they all nod their head, but none of them ever think it’s them,” Rosenberg says. “When you ask if they are concerned, they say, ‘No, we think we do everything right; we’ve got good board structures.’ I think they’re the most surprised when something actually does come in.”

Because D&O coverage is fairly broad, individuals are adequately covered, he says, although some smaller companies may not have enough coverage for the types of lawsuits they might see.

Pound of Prevention
What can companies do to prevent such lawsuits? “The message is, companies should have good practices and procedures in place and create a good paper trail,” explains Rosenberg. In a merger situation, for example, they need to hire experts to get the best advice, review all offers, and, when necessary, go through an auction process, he adds.

“But they should have standard operating procedures in case it doesn’t work out as planned and someone decides to bring an action,” says Rosenberg. Insurance, he observes, is really “the third leg of the stool.” While companies can’t always stop a class-action lawsuit, “if you’ve done everything right, you have a pretty good defense,” he concludes.

“This brings into question an organization’s risk tolerance,” Fox says, noting that more organizations are looking at their portfolio of risks to determine what is important and what they may want to put resources against.

She says people often believe they understand their organization’s risk tolerance; however, there may be no formal way for them to discuss and communicate this “until something happens within their own organization or with a lawsuit.” Executives’ first question is if “there is coverage, and if there is, they breathe a sigh of relief — when there could be other issues,” says Fox.

For example, a company that is moving or making an acquisition in a new geographical area “may not be aware of new exposures there,” Fox says. A risk assessment, however, may show how much risk can be tolerated based on the investment being made. “So I don’t think there is always awareness, particularly at the board level, of what goes into those strategic decisions.”

In a Chubb publication, “Directors and Officers Liability Loss Prevention,” author and attorney Dan A. Bailey gives this advice:

• Learn everything you can about the company’s business and industry, and obtain sufficient expert advice so that you can understand and spot the signals that could indicate financial distress.

• Be alert to emerging issues — such as cyber risk — that are having an increasing impact on D&O liability.

• Review the D&O policy’s terms and conditions to assess if the coverage for independent directors has been diluted by expanded coverage for the entity and to see how the costs of defending some criminal matters may erode the policy’s limits.

• Consult frequently with qualified legal counsel. Advice of counsel not only helps guide directors toward acceptable conduct, but it can also improve the ability to defend their conduct when they act in reliance upon the advice. Don’t feel compelled to use the same counsel for all legal issues, but seek the most competent counsel reasonably available for the issue under consideration.

• The appearance of a conflict of interest should be avoided if possible, and disclosed if unavoidable.

• Companies should adopt a thoughtful document-control program in order to prevent the destruction of important documents or the retention of harmful documents.

• When a significant problem is identified, either internally or externally, directors and officers should promptly address it through a comprehensive investigation and analysis, decisive action, and forthright communications.