Every fall since I first started writing this blog, I
have assembled a list of the current hot topics in the world of directors' and
officers' liability. This year's list is set out below. As should be obvious,
there is a lot going on right now in the world of D&O, with further changes
just over the horizon. The year ahead could be very interesting and eventful.
Here is what to watch now in the world of D&O:
1. What Impact Will Dodd-Frank Have on
D&O Liability?: The massive Dodd-Frank Wall Street Reform and Consumer Protection Act of
2010, which Congress enacted this past July, represents the most
significant reform of financial regulation in decades. It will affect virtually
every aspect of our financial system. However, exactly what the impact will be
and how that might affect the liability of directors and officers remains to be
Among the few things that are clear at this point is that
some of the proposed reforms were not incorporated into the final version of
the Act. Thus, for example, the law did not, as was proposed, legislatively overturn the U.S. Supreme Court's decision in Stoneridge and enact a
private right of action for aiding and abetting. The Act also did not
incorporate a proposed legislative provision that would have extended
the extraterritorial jurisdiction of the U.S. securities laws in cases brought
by private litigants. (The Act did include a provision regarding the SECs
extraterritorial jurisdiction, however).
One reason that the Act's ultimate implications remain
unclear is that much of the work remains to be done. The Act calls for more
than 240 rulemaking efforts and nearly 70 studies by 11 different regulatory
authorities. Most of the details of the key provisions, and the ways those
provisions will be implemented, remain to be spelled out by the various
regulators in the months ahead.
But though much of the picture has yet to be fleshed out,
there are certain provisions that clearly will impact directors and officers,
even if the ultimate effect is uncertain. First, the Act provides rules
regarding executive compensation and corporate governance generally applicable
to U.S. public companies, including requirements on shareholder "say on
pay;" broker discretionary voting; compensation committee independence;
executive compensation disclosures; executive compensation
"clawbacks;" disclosure regarding employee and director hedging;
disclosures regarding Chairman and CEO structures; and shareholder proxy access.
These provisions do not expressly create new causes of
action against directors and officers, but they do create a host of new
obligations that undoubtedly will drive shareholder expectations. The
probability of claims arising from these new requirements seems high,
particularly with respect to the new disclosure requirements.
Among the specific parts of the Act that also seem
particularly likely to lead to future claims are the new whistleblower provisions. The whistleblower
provisions include the creation of a new whistleblower bounty pursuant to which individuals who
bring violations of securities and commodities laws to the attention of the
Securities and Exchange Commission or the Commodities Futures Trading
Commission to between 10 percent and 30 percent of any recovery in excess of $1
Many commentators have predicted that these incentives could lead to a dramatic
increase in complaints of accounting misconduct, corrupt practices, and other
violations. (The specific possibilities for increased reporting related to the
Foreign Corrupt Practice Act are discussed below.) The likely increased
enforcement activity also seems likely to generate a related upsurge in
follow-on civil litigation, as the underlying violations are disclosed.
There are many ways that the impact of Dodd-Frank Act can
be anticipated or at least conjectured, but the Act's overall impact and
significance remains to be seen. At 2,319 pages, the Act's scope is so sweeping
that many of its specific implications inevitably will reveal themselves only
with the passage of time. Be prepared for years of commentaries about the Act
that begin "Though the provision was little-noticed at the time that the
Dodd-Frank Act was enacted, ..." In the meantime, the laws of unintended
consequences will be hard at work.
2. What Happens Next with the Subprime and
Credit Crisis-Related Litigation Wave?: For several years beginning
in 2007, corporate and securities litigation was largely driven by lawsuits
arising out of the subprime meltdown and the global credit crisis. Beginning in
the second half of 2009, the litigation wave began to lose steam, and the
related lawsuits dwindled as we headed into 2010.
But while the pace of new lawsuit filings has
dwindled, new filings have not entirely gone away. Even now, well into 2010,
the credit crisis-related lawsuits continue to arrive (although as time goes
by, it become harder and harder to maintain absolute definitional certainty
around what makes a particular case "credit crisis-related."). By my count, there have been as many as 19 new subprime and
credit crisis related lawsuits filed during 2010, out of approximately 104 new
securities class action suits so far this year (as of September 3, 2010).
In the meantime, the vast amount of litigation that
accumulated over the last four years continues to work its way through the
system. There have been over 220 subprime and credit-crisis related securities
class action lawsuits filed overall since the first was filed back in 2007.
About two-thirds of the cases remain pending and many have yet to reach the
motion to dismiss stage, though the dismissal motion rulings are starting to
And while a number of courts have seemed skeptical about
the fraud allegations in light of the magnitude of the global financial crisis,
there have also been a number of decisions were the court have found the
plaintiffs' allegations sufficient. My running tally of the various subprime
and credit crisis-related lawsuit dismissal motion rulings can be found here.
With the increasing number of dismissal motion rulings,
the cases that survive are likely to head towards settlement. Just in the last
few months, there have been several very high profile subprime-related lawsuit
settlements, including the $624 million settlement in the Countrywide case, the
roughly $124 million settlement in the New Century Financial case,
and the $235 million total settlement in the Schwab Yield Plus
case. (All settlement figures reflect aggregate settlement amounts) By my
calculation, though there have been only 15 subprime and credit crisis related
lawsuit settlements so far, those few settlements total over $1.8 billion.
The one thing that seems clear is that when all is said
and done on the subprime and credit crisis-related litigation wave, the total
costs will be staggering. The defense costs alone associated with this
litigation will be enormous. (By way of illustration, the defense expenses associated just with the Lehman bankruptcy
are running at about $ 5 million a month, and those costs are likely to
accelerate in the event the SEC files an enforcement action or the DoJ files
criminal charges.) Though not all of these costs will be insured, many of them
In the aggregate the subprime meltdown and credit crisis
represents an enormous event for the D&O insurance industry. Just how big
of an event it is will continue to unfold in the weeks, months and years ahead.
3. Will the Wave of Bank Failures Lead to a
New Wave of Failed Bank Litigation?: Since January 1, 2008 and
through September 3, 2010, 118 banks have failed in the United States, and the
total number of failed banks continues to grow. Indeed, in its most recent
Quarterly Banking Profile, the FDIC reported that one out of ten banks in the United States is
a "problem institution" (meaning rated a "4" or
"5" on a scale of one-to-five on lineup of financial and operational
During the S&L crisis, the banking regulators pursued
claims against the directors and officers of the failed institutions in
connection with about a quarter of the bank failures. These efforts proved
worthwhile for the FDIC, since its S&L crisis D&O claims led to recoveries of
about $1.3 billion, out of total professional liability claims recoveries
of about $3.25 billion. Given that history, it seems probable that the FDIC
will pursue D&O litigation as part of the current bank wave.
Though the FDIC, as part of the current bank failure
wave, has to date filed only one lawsuit against former directors and officers of a
failed banks, there is every reason to expect that there will be more
claims to come, perhaps many more. The FDIC has sent claims notice letters to
the directors and officers of many failed banks, and other wise taken steps to
preserve its right to pursue claims and also to assert its priorities over
During the S&L crisis, the lag between the peak of
the failed banks and the timing of the FDIC's recoveries was about three years.
Since the current wave of bank failures did not really start to take off until
late 2008 and did not really gain serious momentum until 2009, and in light of
the lag in the FDIC's recovery during the S&L crisis, it would seem that
the FDIC's failed bank lawsuit will begin to accumulate in earnest some time
In the meantime, other claimants are also asserting claims
against the failed banks' former directors and officers of the failed
institutions. Unlike during the S&L crisis, when most of the failed
institutions were privately held, many of the banks that have failed during the
current wave were publicly traded. According to a recent NERA report,
about 45 of the roughly 240 subprime and credit crisis related securities class
action lawsuits have involved depositary institutions. Of the 20 failed banks
that produced the largest losses prior to 2010, 13 involved publicly traded
securities, of which eight had been named in securities class actions as of the
end of 2009.
Even in privately held banks' investors are pursuing
claims, although they are crafting their claims very carefully to avoid running
afoul of the FDIC's priority rights to the claims of the failed institutions.
In some respects these investor lawsuit could be
competing with the FDIC for the proceeds of the D&O insurance policies
insuring the directors and officers of the failed institutions. However, while
the FDIC generally has priority, the investors may be able to access the
policies proceeds when the FDIC may not, if, for example, the relevant policies
have exclusions precluding coverage for claims by regulatory bodies.
For now the extent to which the FDIC will pursue
litigation against former directors and officers of the failed institutions
remains to be seen, although the likelihood is that there will be extensive
litigation ahead. In the meantime, numerous investors are pressing ahead with
their own claims. In all likelihood, an extensive amount of litigation related
to failed and troubled banks seems likely to accumulate as we head into next
4. Will the Mix of Litigation Involving
Directors and Officers Continue to Shift Away from Securities Class Action
Lawsuits?: One of the more interesting litigation phenomena of the
last several years, at least as relates to the exposure of directors and
officers, as been the material shift of litigation away from securities class
action lawsuits and towards other types of lawsuits.
This shift was first discernable in the litigation that
arose from the options backdating scandal, beginning in 2006. Though there were
over 30 options backdating related securities class action lawsuit file, there
were over 160 options backdating related shareholders derivative lawsuits
According to the mid-year 2010 corporate and securities litigation study by the
insurance information firm Advisen, this shifting mix of litigation away
from securities class action lawsuits has continued and securities class action
lawsuits have represented a progressively smaller proportion of overall
corporate and securities litigation for several years now. Thus, whereas prior
to 2006, securities class action litigation represented over half of all
corporate and securities litigation, through the middle of 2010 securities
class action litigation represented only half of all corporate and securities
What is making up the remainder of the corporate and
securities lawsuits are a broad mix of kinds of claims including individual
securities lawsuits, shareholder derivative lawsuits, and breach of fiduciary
This shifting mix has a number of important
considerations. The first is that the dialog about litigation levels tends to
focus on securities class action lawsuit filing patterns. Though class action
lawsuit filings levels have always ebbed and flowed over time, it seems that
every time the filing levels decline or climb (as they inevitably do), some
commentator will make some sweeping generalizations about permanent changes in
the filing levels.
The fact is, the dialog about shifting class action
filing levels may be beside the point. The real story may be that the kinds of
cases that are getting filed have changed.
In any event, the growing importance of lawsuits other
than securities class action lawsuits does alter the issues that should be
considered in the context of directors' and officers' liability exposures. The
changing mix of litigation could have important implications for D&O
insurance terms and conditions and limits of liability.
At a minimum, the changing litigation mix provides an
important context within which to consider information relating to securities
class action filing levels. Even if fewer class action lawsuits are being filed
(at least lately, anyway), that does not mean the overall threat of litigation
has declined. To the contrary, the Advisen report shows that the threat of
corporate and securities litigation generally continues to increase. That is,
the litigation threat is not declining, it is simply changing.
5. What Will Be the Impact of the Supreme
Court's Most Recent Securities Law Decisions?:
Every year it seems, at least recently, the U.S. Supreme Court has issued
important decisions affecting securities litigation. The Court's most recent
term, which was completed in June, proved to be no exception. The Court issued
two cases of particular significance that potentially could have significant
impact on future securities lawsuit cases and filings.
First, on June 24, 2010, the Supreme Court issued its long awaited ruling in the Morrison v. National Australia Bank case. The case was
much anticipated because it was expected to provide much-needed guidance on the
questions of the extraterritorial jurisdiction of the U.S. securities laws.
The Court threw everybody a bit of a curve ball, when it
discarded many decades of jurisprudence analyzing when there was sufficient
"conduct" in the U.S to support the application of the U.S.
securities laws to a foreign company. The Court said that rather than a
"conduct" based test, the securities laws required a
"transaction" test, and effectively held that the U.S. securities
laws do not apply to transactions that take place outside the U.S.
The Morrison case clearly rules out so-called "f-cubed" cases,
which involve claims asserted against foreign-domiciled companies by foreign
domiciled claimants who bought their shares on foreign exchanges.
Since the Morrison case came down, plaintiffs in
other cases have tried to argue that Morrison does not preclude so-called
"f-squared cases" - that is, cases in which U.S. investors bought
a foreign company's shares on a foreign exchange. So far, courts have not proven receptive to that argument but the issue is far
In the meantime, the Morrison case seems likely to
affect the many U.S. securities cases that have been filed in recent years
against foreign domiciled companies. At a minimum, the cases in which the
complaints have sought to assert claims on behalf of "f-cubed"
claimants seem likely to be narrowed to exclude those claims. (I know many
plaintiffs' lawyers may contest the extent of this statement, and in
recognition of their arguments I duly acknowledge their objections here.)
The larger impact of Morrison may be there will be fewer,
or at least narrower, U.S. securities lawsuits filed against foreign domiciled
companies. The many claimants who may now be unable to pursue claims in the
U.S. may seek to resort to the courts and laws of their home countries, and
perhaps, to the extent the home country laws fail to provide adequate relief,
seek legislative change to allow greater investor protections.
The other significant decision this past term was the
Court's April 2010 ruling in the Merck case, in which the
U.S. Supreme Court addressed the question of what is sufficient to trigger the
running of the statute of limitations for securities claimants. The Supreme
Court held that the running of the statute of limitations is not triggered
until the plaintiffs have, or with reasonable diligence could have had,
knowledge of facts constituting the violation, including facts constituting
The practical effect of the Court's decision in Merck
is that it could postpone the running of the statute of limitations,
potentially lengthening the time within which plaintiffs might file their claim.
This effect seems particularly significant in light of the relatively recent
phenomenon that has developed in which plaintiffs have been filing securities lawsuits well after the
proposed class period cutoff date.
Although so far there have been relatively few new
filings that have reflected potential longer limitations periods, the
possibility for an increase in belated filings remains. The challenge this
presents for D&O insurance underwriters and companies alike is that it is
harder to be sure when a company that has had adverse developments in the past
may be "out of the woods" as far as possible securities lawsuits.
6. What Will Be the Impact of Securities
Cases the Supreme Court Will be Considering in the Upcoming Term?: For
whatever reason, the U.S. Supreme Court in recent years has seem particularly
interested in taking up securities cases, and the Court's docket for the
upcoming October 2010 term is no exception. With Justice Kagan newly added to
the Court's lineup, the Court will be considering at least two potentially
significant securities cases.
First, the Court has granted a writ of certiorari in the Matrixx Initiatives case.
presented is whether plaintiffs must allege that adverse event information
is "statistically significant" in order to establish that the
defendants' alleged failure to disclose the information was material. Though
the issues involved appear narrow, the case potentially could address broader
issues of securities claim pleading sufficiency.
Even if the Court confines itself just to the narrow
question of statistical significance, the Court's consideration of this issue
has the potential to be important, since companies are regularly receiving
customer complaints and must decide when the level of complaints are
The larger possibility for this case is that the Court
might take the occasion as an opportunity for a more comprehensive
consideration of the issue of materiality. Were the Supreme Court to take up
this larger question, the Court's ruling potentially could have significant
ramifications for many future securities class action lawsuits.
Second, the Court also granted certiorari in the Janus Capital Group case, which
involved the question of who may be a "primary violator" under the
securities laws. The defendants in the case are the holding company and the
management company for a family of mutual funds. Investors claim they were
misled by statements that the funds did not engage in market timing; the funds
later entered a settlement for market timing.
As the Supreme Court recently affirmed in its Stoneridge
case (about which refer here), there is no private action for aiding and abetting
liability under the federal securities laws. Accordingly, the Janus entities
can be liable if at all if they are "primary violators," that is, if
they are directly responsible for the allegedly wrongful conduct. The Janus
entities contend that as mere service entities for the actual funds, they
cannot be held primarily liable.
The Fourth Circuit ruled that "a service provider
can be held primarily liable in a private securities fraud action for 'helping'
or 'participating' in another company's misstatements." The Fourth
Circuit's ruling is at odds with the decisions of other Circuit courts. Some
courts hold that only someone that "makes" a statement and has it
attributed to him can be held liable as a primary violator. Other courts,
similarly to the Fourth Circuit, have held that someone that
"substantially participates" in the activities that led to the
creation of the allegedly misleading statement can be held liable as a primary
violator, even if the statement is not attributed to him or her.
At some level, this "substantial participation"
test starts to sound a lot like the "aiding and abetting liability"
that the Supreme Court had rejected in connection with private lawsuits in the Stoneridge
case. That may, in fact, be why the Supreme Court took up the case - not just
to reconcile an apparent split in the Circuits, but to align the principles of
primary violator liability with those of the secondary violator jurisprudence.
In any event, and at a minimum, the case will draw greater clarity around what
constitutes a primary violation of the securities laws.
7. What Will Happen to the Level of Business
Bankruptcy Filings?: According to the latest report from the Administrative Office of the U.S. Courts,
business bankruptcy filings rose 8.34% for the 12-month period ending June 30,
2010. Not only did the filing levels rise relative to the prior period, but
they remain well above levels in recent years - for example, the filing rate
during the twelve month period ending June 30, 2010 is 76% greater than the
comparable period ending June 30, 2008, and 150% greater than the comparable
period ending June 30, 2007.
The level of business bankruptcy filings directly affects
the overall level of D&O claims activity, because so many bankruptcies
involve claims against the former directors and officers of the failed entity.
These claims are asserted by investors, creditors, the bankruptcy trustee and
others. As long as the business bankruptcy filing rate remains at relatively
elevated levels, D&O claims activity levels will also remain at higher
The one positive note from the recent bankruptcy filing
statistics is that the rate of business related filings may be slowing, albeit
while remaining at relatively elevated levels. Thus, during the period ending
June 30, the number of business-related filings declined during each of the
three months periods during the twelve month stretch. During the first three
months of the twelve month period, there were 15,303 business related filings;
in the second three months, there were 15,156 business-related filings; in the
third three-month period there were 14,697; and in the final three months,
there were 14,452.
We can all hope that the continuing economic recovery
will lead to fewer business-related bankruptcy filings in the months ahead.
However, as long as the filing levels remain elevated compared to historical
norms, D&O claims activity will also be elevated.
These issues are important because the interaction
between the D&O insurance policy and the processes of the bankruptcy court
are intricate and fraught with complexities. The ongoing heightened risk of
business bankruptcy has important implications for D&O claims exposure as
well as for issues surrounding the D&O insurance placement process.
8. What Will be the Next Sector to Get
"Hot"?: One of the well-established patterns of
securities class action lawsuit filings is that periodically some industrial
sector will get "hot" and suddenly numerous companies in that sector
will find themselves the targets of securities class action lawsuits.
Companies in the for-profit education sector saw that
during August this year, when, following a government report suggesting the
possibility of education loan fraud, nearly a half dozen companies in the sector were hit with
securities suits within the space of just a few days. In just about the
same way, late last year, a host of exchange traded funds were hit with securities class action
lawsuits over a very short time period.
The recent industry-specific litigation outbreak in the
for-profit education sector is a reminder of the many odd and
circumstance-specific events that can drive securities class action lawsuit
filings. Many things determine filing levels, many of which cannot be captured
or predicted in historical filing data. As a result, it can be misleading to
try to generalize from short term trends about future filing levels. Simply
put, the numbers vary over time, because, for example, contagion events and
industry epidemics happen.
9. Will Heightened FCPA Enforcement Activity
Lead to Increased Follow-On Civil Litigation?: One
of the relatively well-established trends in recent years has been that
Corrupt Practices Act enforcement activity has led to increasing levels of follow on civil litigation, in which
the claimants assert that mismanagement and poor internal controls allowed the
corrupt activity to occur. In addition shareholders also claim to have been
misled about controls, as was alleged, for example, most recently in the securities
class action lawsuit filed in August against SciClone Pharmaceuticals and
certain of its directors and officers.
For at least a couple of reasons, the heightened level of
anticorruption enforcement activity seems likely to accelerate in the months
First, as noted above, the recently enacted Dodd-Frank
Act contains a whistleblower bounty provision that seems likely to produce heightened whistleblower activity
in connection with FCPA violations. Under these whistleblower provisions,
whistleblowers can receive rewards of up to 30 percent of recoveries over $1
million. These kinds of rewards could produce some enormous bounties in the
FCPA enforcement context, where recent enforcement penalties have been in the
range of tens and hundreds of millions of dollars.
Indeed, the top ten FCPA settlements collectively total $2.8
billion, but the top six, all of which took place just in the last 20 months,
represent 95% of the total. Four of the top six settlements were reached just
in 2010. Because of the massive scale of the settlements that the SEC has been
achieving in this area, the potential rewards for whistleblowers are enormous.
Second, the UK
Bribery Act received Royal Assent on April 8, 2010. On July 20, 2010, the
U.K. Ministry of Justice released
its timetable for the implementation of the Bribery Act, setting April 2011
as the effective date. The Act is widely viewed as in several important respects more
"far-reaching" than the FCPA, and is likely to have significant
impacts on business that either are based in the U.K. or have significant parts
of their operations in the U.K.
Though the U.K. provisions may be somewhat delayed and
though the impact of the new Dodd-Frank Act whistleblower provisions may be as
yet undeveloped, there is no question that this is an area where many things
are happening. Anti-corruption enforcement represents a significant and growing
area of liability exposure for corporate officials, especially in light of the government's
apparent willingness to resort to sting tactics and other
prosecutorial techniques as part of the heightened enforcement.
These developments also have significance for purposes of
the structure and implementation of insurance calculated to enforce corporate
officials. The fines and penalties associated with these kinds of enforcement
actions typically would not be covered under a D&O policy, but the defense
fees, at least for the individuals might well be. However, the Dodd-Frank Act
whistleblower provisions, for example, may raise concerns under the typical
D&O policy's insured vs. insured exclusion.
Finally, the increased levels of anticorruption
enforcement may also represent a growing area of civil litigation exposure, as
these kinds of enforcement actions frequently lead to follow-on civil lawsuits.
Altogether, exposures arising from anticorruption laws represent an important
and growing area of potential liability of corporate officials.
10. What Does All of This Mean for the
D&O Insurance Marketplace?: The astonishing pace of
legislative and judicial changes just over the last few months alone
underscores how rapidly the liability exposures in the directors and officers
arena can be transformed. Given the absolute whirlwind of recent changes,
D&O insurers might be excused for taking a conservative approach to risk.
Indeed, those outside the industry often assume that is what the carriers would
be doing now.
But despite everything, the D&O insurance industry
remains competitive, and all signs are that it will remain that way for the
foreseeable future. Most insurance buyers, particularly those outside the
financial sector and those with reasonably solid financials, can expect to
obtain insurance with broad terms and conditions at relatively attractive
prices. Though pricing is not declining at the pace we saw in recent years, pricing
remains stable at relatively lower levels.
The iron laws of supply and demand are impervious to more
trivial forces like legislative or judicial change. On the supply side, the
insurance industry is operating with ample capacity, largely due to the absence
of large-scale catastrophes. As a result, the D&O insurance marketplace is
characterized by a large number of competitors all of whom are continuing to
seek to write business. On the demand side, the number of businesses has been
cut down by bankruptcies. Shrinking labor forces and diminished budgets have
also reduced insurance demand.
In the absence of some large external event that
substantially erodes insurance capacity, the likelihood is that insurance
buyers (or at least those buyers outside the financial sector with relatively
stable financials) will continue to enjoy a relatively favorable marketplace.
Nevertheless, the liability landscape for directors and
officers is changing rapidly, and well-advised insurance buyers will want to
make sure that their D&O insurance program is properly positioned to
respond to these changing exposures.
Discount for Readers of The D&O Diary: On
November 30 and December 1, 2010, I will be co-chairing the American Conference
Institute's 16th Annual Summit on D&O Liability. This conference is a great
event every year, and once again the conference will feature an impressive
array of the D&O insurance industry's thought leaders. Background information
about the conference, including the event brochure and registration
information, can be found here.
The D&O Diary is a conference media partner
for this event, and as a result the conference organizers are offering a $200
discount to readers of The D&O Diary. In order to obtain this
discount, just use the code "D&O Diary" on the registration form.
Hope to see everyone at the conference.
other items of interest from the world of directors & officers liability,
with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.