Risk Management

Subprime Suits Blur D&O Outlook

Directors' and officers' liability insurance coverage could cost more and be harder to come by, according to a policyholder attorney.
Sarah JohnsonMarch 28, 2008

The subprime-mortgage mess will likely tighten the coverage and cost of the insurance policies that cover executives, corporations, and corporate boards for losses and legal fees in securities lawsuits, an attorney predicts.

Indeed, directors’ and officers’ liability insurance coverage could cost more and be harder to get as the number of subprime-related lawsuits wend their way through the federal courts, according to Koorosh Talieh, a lawyer who represents corporate D&O insurance policyholders.

While it’s too early to see the effect yet, the sued companies will eventually start to take a hard look at their policies for recoupable defense costs, Talieh, a partner at Howrey LLP, tells CFO.com. In turn, the insurance companies will likely take an even closer examination of their policies’ small print to dispute those claims.

Generally, in order to collect D&O insurance for this type of litigation, the policyholder must be making a “securities claim,” a broad definition that has grown vaguer and vaguer when it comes to the users of the structured products behind the mortgage meltdown. Of the 38 subprime-related lawsuits filed last year, 95 percent named directors and officers, according to NERA Economic Consulting. Although the organizations targeted were mostly lenders and other financial-services firms, some of the suits were against homebuilders, real estate appraisers, and rating agencies.

A securities claim is one that alleges securities rules and regulations were violated during the purchase or sale of an organization’s securities. Sounds simple enough, right? But when it comes to a securitized product — which in these cases are mortgage-backed securities including subprime loans that were once pooled and sold by lenders — identifying the “organization” isn’t so easy.

Insurance companies may say that the subprime securities claims would be exempt from D&O insurance because the securities belong to the “issuer” and not the organization. The issuer is the trust that was created during the securitization process, explains Talieh. However, he disputes that notion, saying that the organization that created the loan embedded in a mortgage-backed product is still tied to it. “If you look at the securitization process, you can see that the organization is involved in every step of the process, from the time the loans were originated to when the securities were sold to a municipality in Denmark,” says Talieh.

The policyholder lawyer predicts there will be “significant” D&O insurance litigation to come out of the subprime crisis. But it will be a few years before we see whether insurance companies will make changes in their policies to make the definition of a securities’ “organization” more specific — and whether the increasing number of subprime-related lawsuits will lead to higher D&O insurance premiums.

Earlier this year, The Corporate Library similarly wondered if D&O rates would rise. The insurance has been fairly cheap because securities-litigation activity declined before the credit crisis. This year “will be a year of significant activity in securities litigation in general and securities class action…cases in particular,” the corporate-governance research group predicted.