D&O Litigation Trends to Watch in 2017

According to a Fitch Ratings report issued last year, the directors & officers (D&O) market “has great notoriety relative to its size.” Representing a small segment of the property/casualty market, D&O coverage equals about one percent of total industry direct premiums.

The rating service noted that “Many large D&O claims arise from incidents that receive wide media coverage, including corporate insolvencies, large stock price declines, financial reporting irregularities or regulatory investigations.”

With a new administration in the White House and a continued upward trend in securities lawsuits against directors and officers, it’s hard to say what 2017 holds for this line of coverage, according to David Topol, a partner with the Insurance Practice Group, Wiley Rein.

“D&O is more volatile than other property/casualty product segments as policy limits and individual claim costs are relatively large and the threat of new lawsuits or claims exposures is constantly looming,” said James Auden, managing director Fitch Ratings.

Last year saw the biggest number of security actions against directors & officers in 15 years, said Topol. This is due, in part, to merger objections. The resulting lawsuits are on the upswing, he said.

It’s hard to say what impact the new administration will have, Topol added, indicating it will likely take three to six months to know for sure. President Trump’s initial pick to head the Securities and Exchange Commission, Wall Street lawyer Jay Clayton, won’t have the typical government experience of prior SEC heads. Jeff Sessions is the Trump administration’s pick for Attorney General. Who fills that position and the next level down will be important too, said Topol.

A recent memo by former U.S. Department of Justice Deputy Attorney General Sally Yates to pursue individuals and corporations could mean new targets, he said.

Last year, Yates delivered remarks at the 33rd Annual International Conference on Foreign Corrupt Practices Act (FCPA).

“The department’s heightened focus on individuals extends beyond the FCPA arena. Across our corporate enforcement work, department attorneys are identifying ways to ensure that individuals are held accountable for their conduct, regardless of where those individuals appear on a company’s organizational chart. The same basic principle applies: to deter wrongdoing, we need to change the risk-reward calculus for corporate decision-makers, and we do that by punishing decision-makers when they decide to break the law,” Yates stated.

Thus, regulatory exposure is expected to remain high, at least until the new administration is in place, Topol said.

Cyber is a new target in D&O lawsuits, he said. For example, if a company experiences a major cyber breach and winds up paying out a lot of money to victims, a derivative lawsuit could be filed against the company’s directors and officers.

In response to the increased focus on a board’s role in cybersecurity oversight, the National Association of Corporate Directors (NACD), and the Internet Security Alliance recently released the latest edition of the director’s handbook on cyber risk oversight.

According to the NACD, significant knowledge and oversight gaps still exist at the boardroom level.

“In our most recent survey of corporate directors, almost 60 percent of respondents reported that they find it challenging to oversee cyber risk,” said Peter Gleason, NACD president and CEO-elect. “Directors don’t need to be technologists to play an effective role in cyber-risk oversight—but every board can take the opportunity to improve the effectiveness of their cyber-oversight practices.”

Topol said that another trend relates to shareholder suits after a merger or acquisition, where shareholders claim disclosures initially made regarding the deal were inadequate. The Delaware Chancery Courts have shown growing hostility towards disclosure only settlements, which involve issuance of only slightly better information and payment of substantial attorneys’ fees.

Section 11 cases related to initial public offerings (IPOs) filed in state court versus federal court is another growing trend, Topol said. There are circuit petitions pending before the U.S. Supreme Court on Section 11 cases to determine jurisdiction in these types of cases. Section 11 cases are being brought in California. One issue is that, unlike federal court, discovery cannot be stayed pending the court’s decision so expenses can soar.

“From a defense perspective, it winds up being a problem because there is not the PSLRA [Private Securities Litigation Reform Act] stay. Discovery becomes a strong lever and some would say they prefer the more experienced federal bar,” Topol explained. “The question is can the state courts keep jurisdiction or not.”