Risk Management

Backdating Fallout: D&O Coverage

Will shareholder lawsuits stemming from the stock-option scandal hike D&O premiums?
Laura DeMarsNovember 8, 2006

The wave of scandals involving stock-option backdating threatens to push directors’
and officers’ insurance premiums higher in anticipation of a surge in class-action suits.

So far, restatements related to backdating have led to 19 shareholder suits, with many more
expected over the next year. (At recent count, the Securities and Exchange Commission was
investigating more than 100 companies for backdating.) Class actions are extremely expensive to
defend, notes John Rafferty, manager of the D&O liability practice at The Hartford
Financial Services Group.

The scandals could reverse a
trend toward fewer class-action securities
lawsuits. Just 61 cases were filed in the first half of
2006, the lowest number for a six month
period since 1996,
according to data
from Stanford
Law School. It’s
too soon to tell,
though, if the
expected uptick
in lawsuits will
increase D&O premiums across the
board. Currently, insurers say they are
taking a case-by-case approach, so D&O
rates are likely to remain in check for
companies with no backdating exposure.

But they’ll have to prove it. “Insurers
are going to drill down on companies’
practices and could look as far back as 10
years,” says Steve Shappell, of Aon’s financial
services group. “If you can’t show
documentation or explain your practices
in detail, you’re going to get hit.”

The backdating scandal is expected
to widen in the coming months. Sen.
Charles Grassley (R-Iowa), chairman of
the Senate Banking Committee, has
vowed to pursue advisers, including
lawyers, accountants, and consultants,
who promoted backdating as a strategy.

Should the number of backdating
cases continue to grow, pressure to raise
D&O premiums for all executives will
increase. “I think carriers may be downplaying
the significance of these investigations,
and it could prove more costly
than they expected,” says Shappell.