What to Watch in the World of D&O
Every year it’s worth noting the list of the current hot topics in the world of directors’ and officers’ liability. As should be obvious from this year’s list, there is a lot going on now, with further changes ahead. Here is this year’s list:
What Impact Will Dodd-Frank Have on D&O Liability? The massive Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, enacted this past July, represents the most significant financial reform in decades. However, how it might affect D&O liability remains to be seen.
One reason that the Act’s implications remain unclear is that much 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 regulators.
Among the specific parts of the Act that seem particularly likely to lead to future claims are the new whistleblower provisions. The whistleblower provisions include a new bounty pursuant to which individuals who bring violations to regulators’ attention can receive between 10 percent and 30 percent of any recovery in excess of $1 million.
Many have predicted that these incentives could lead to a increase in complaints of accounting misconduct, corrupt practices and other violations. The likely increased enforcement activity also could generate a related upsurge in follow-on civil litigation, as the underlying violations are disclosed.
Although the Act’s effects can be conjectured, only time will tell its ultimate impact. 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.
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 global credit crisis. Beginning in the second half of 2009, the litigation wave began to lose steam, and the related lawsuits dwindled heading into 2010.
However, new filings have not entirely gone away. 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 Sept. 3, 2010).
In the meantime, the vast amount of litigation that accumulated over the past four years continues to work its way through the system. About two-thirds of the 220 subprime and credit crisis-related securities class action lawsuits filed since 2007 remain pending, and many have yet to reach the motion to dismiss stage, although dismissal motion rulings are starting to accumulate.
The cases that survive the initial motions are likely to head toward settlement. Just in the past few months, there have been several 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. Although there have been only 15 subprime and credit crisis-related lawsuit settlements so far, those few settlements alone total more than $1.8 billion.
The total costs of this litigation will be staggering. 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.
Will the Wave of Bank Failures Lead to a New Wave of Failed Bank Litigation? Since Jan. 1, 2008 and through Sept. 3, 2010, 118 banks have failed in the United States, and the total number of failed banks continues to grow. In its most recent “Quarterly Banking Profile,” the FDIC reported that one out of 10 banks in the United States is a “problem institution.”
Although the FDIC, as part of the current bank failure wave, has filed only one lawsuit against former directors and officers of a failed bank, there undoubtedly will be more claims to come. The FDIC has sent claims notice letters to the directors and officers of many failed banks, and taken steps to preserve its right to pursue claims and also to assert its priorities over other claimants.
In the meantime, other claimants also are asserting claims against the failed banks’ former directors and officers. Unlike during the savings and loan 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.
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 there likely 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 year.
What Sector Will Get ‘Hot?’ It can be misleading to generalize from short-term trends. Periodically some industrial sector will get “hot,” and suddenly numerous companies in that sector find themselves the targets of securities class action lawsuits. Companies in the for-profit education sector saw that in August, when, following a government report suggesting the possibility of education loan fraud, nearly a half dozen companies were hit with securities suits.
What Does This Mean for the D&O Insurance Marketplace? The astonishing pace of legislative and judicial changes in the past few months underscores how rapidly liability exposures in the D&O arena can be transformed. Given the whirlwind, 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.
Despite everything, the D&O insurance industry remains competitive, and 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 broad terms and conditions at relatively attractive prices. Pricing is not declining at the pace we saw in recent years, but it remains stable at relatively lower levels.
In the absence of some large external event that substantially erodes insurance capacity, insurance buyers (or at least those buyers outside the financial sector with relatively stable financials) will likely 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.