The liability and regulatory landscape in the U.S. continues to evolve and remains one of the highest risk areas for FI/D&O insurers worldwide. As in past years, 2015 had a mix of both positive and negative developments from the standpoint of FI/D&O exposures.
We provide below an overview of developments relevant for FI/D&O insurers with U.S. exposures, including a review of the current litigation landscape, regulatory investigations and actions, current and potential trends to watch and recent coverage decisions.
Current Litigation Landscape
Securities Class Actions
Securities class actions continued to be the most dangerous types of lawsuits for public companies and their D&Os. The 189 new filings in 2015 was an increase of 11% from 2014 and above the average annual number of filings (188) for the first time since 2008. Despite the elevated numbers, there were no new major filing trends in 2015 and most of those cases were so-called "traditional filings" alleging Rule 10b-5 and/or Sections 11 and 12 violations.
The likelihood that a public company in the U.S. will be named in a securities class action continues to increase as the number of publicly listed companies decreases. In 2015, 4% of U.S. listed companies were sued, compared to an average of 2.9% from 1997-2014. The most targeted industries were biotech, healthcare and pharmaceutical. Interestingly, filings against financial institutions dropped by 35% in 2015, and no banks were named in a securities class action for the first time since 2006.
Securities class actions are being filed faster (with a median of 10 days from the end of the class period to filing), but dismissed or settled more slowly. This will likely lengthen the litigation and increase defence costs as well as plaintiffs' settlement expectations as they invest more time and money in their cases.
The average securities class action settlement was up 46% in 2015 to $52 million, although a few large settlements drove this number up. Most cases were not much more expensive to settle in 2015 than in 2014.
Market capitalisation losses and potential damages were also up in 2015, but they were still not as high as in previous years.
Merger Objection Lawsuits
In the past few years, plaintiffs filed significant numbers of lawsuits following the announcement of a merger or acquisition. In 2014, almost every M&A transaction was accompanied by litigation (95%), often multiple lawsuits. These merger objection lawsuits are often filed in the form of shareholder derivative lawsuits against the companies and their D&Os. The litigation is often resolved through so-called disclosure only settlements in which the defendants agree to additional disclosures about the transaction, plus a payment for the plaintiffs' attorneys' fees.
In the second half of 2015, there was a sharp drop in the number of new M&A lawsuits as a result of some favourable developments in the Delaware Chancery Court, where many of these cases are filed. In a number of decisions, the court was highly critical of merger objection lawsuits and/or rejected disclosure only settlements. The judges found that the value provided to shareholders by such settlements was
Merger Objection Lawsuits
- May 2015, Vice Chancellor Laster refused to approve the disclosure only settlement of Cobham's acquisition of Aeroflex
- September 2015, Vice Chancellor Glasscock III granted approval of a settlement in the Riverbed case, but indicated reluctance to approve disclosure only settlements and attorney fees awards
- October 2015, Vice Chancellor Laster rejected disclosure only settlement re Hewlett-Packard's acquisition of Aruba Networks
January 2016, Chancellor Bouchard rejected disclosure settlement arising out of Zillow's acquisition of Trulia insufficient consideration for the broad releases granted to the defendants. 1
As a result, it appears that we will see a sharp drop in merger objection lawsuits in 2016. This is good news for D&O insurers who may be asked to foot the bill for defence costs and plaintiffs' attorneys' fees paid in such settlements.
Regulatory Investigations and Actions
In 2015, U.S. regulators continued to aggressively pursue companies and their D&Os on a number of fronts.
SEC enforcement actions increased by 7% to 807 in 2015, with 85% of SEC actions alleging violations of reporting and disclosure provisions of federal securities laws or FCPA. These cases are often pursued in the SEC administrative court, making it easier for the SEC to prosecute, although there has been push back regarding the constitutionality of such actions.
In addition, SEC investigations have increased in length to an average of 21 months, which will increase the cost to respond to such matters.
But there is some good news - the total value of SEC settlements in 2015 (USD 547m) was less than half of what was recovered in 2014 (USD 1.254bn) and below the 2010-2015 average (USD 620m).
A number of factors contributed to the increase in regulatory actions in 2015, including the SEC's use of administrative proceedings, initiatives to detect fraudulent financial reporting, such as the Robocop program, and the SEC Whistleblower program, which continues to gain in popularity around the world due to the sizeable bounties being paid out. In 2015, there were 3923 reports made under the SEC Whistleblower program, an increase of 8.3% from 2014. These reports involved a wide range of activity, including corporate disclosures and reporting, offering fraud, manipulation, insider trading and FCPA violations. To date, USD 55m has been paid out to 22 individuals, USD 37m of which was in 2015, and approximately USD 400m is in the Investor Protection Fund for further bounty payments.
New DOJ Directive Against Individuals
In September 2015, the Department of Justice (DOJ) announced a new directive to target and hold accountable corporate executives. Pursuant to the so-called Yates Memo, to earn cooperation credit, companies must turn over evidence of wrongdoing by individuals at the company. According to the DOJ, "it's all or nothing." Going forward, the DOJ reportedly will not agree to corporate resolutions that include dismissal of charges against or immunity for individuals and it intends to file actions regardless of the ability to collect fines from individuals. This will likely result in broader and more costly actions against individuals, who will increasingly rely on D&O insurance to defend themselves.
Trends to Watch
Foreign Companies Increasingly Targeted
One of the current trends to watch is the rising number of securities class actions filed against foreign companies in the U.S. Although the Morrison v National Australia Bank decision in 2010 limited actions by investors in foreign securities, plaintiffs have increasingly focused on foreign companies trading on U.S. exchanges. In 2015, 35 cases were filed against foreign issuers, which is well above the 1997-2014 average of 22 per year.
In particular, plaintiffs' firms have shown a renewed interest in Chinese companies trading on U.S. exchanges. In 2015, 15 securities class actions were filed against Chinese companies and their D&Os. A number of factors have contributed to this trend, including the downturn in the Chinese economy, inconsistencies in reporting, weak corporate governance and questionable accounting practices by some companies.
Cyber Related D&O Actions?
Cyber risks continue to be a major cause for concern in the U.S., although the anticipated lawsuits and regulatory actions against D&Os relating to cyber have not yet materialized.
It is inevitable, however, that companies will incur a data breach or cyber attack at some point, and the potential for significant harm is well-known, particularly in light of headline attacks during 2014, including those on Target, Sony, Home Depot and several U.S. banks. There is an ever expanding and complex web of regulations that companies must comply with regarding cyber security and, in 2015, regulators were quite active in examining companies' cyber securities and compliance.
Cyber risks are increasingly recognised as a top corporate risk, and could surpass financial reporting as the number one concern for corporate boards. Boards will be expected to address cyber risks in a number of ways and may be sued if they fail to do so.
During 2015, two regulatory actions may foreshadow the types of actions that may be filed against companies and their D&Os when they do not properly address and disclose cyber risks. In RT Jones Capital, the SEC found that by failing to establish cyber policies to safeguard customer information a company wilfully violated Rule 30(a) of Regulation S-P. In FTC v Wyndham Worldwide Corp, the FTC determined that a company's failure to employ reasonable cyber security measures constituted an unfair business practice under the FTC Act. These cases also demonstrate that a number of regulators can bring actions for cyber breaches under different regulations.
IPO Litigation
Although the number of IPOs was down by 43% in 2015 compared to 2014, the large number of IPOs in 2013-2014 may produce a large number of IPO securities class actions in view of the three year statute of limitations. Such cases, brought under Section 11 of the Securities Act, are easier to bring than Section 10(b) cases under the Exchange Act as plaintiffs are not required to plead reliance, scienter or causation, and may be costlier to defend and settle.
U.S. Supreme Court
During 2015 and into 2016, the U.S. Supreme Court continued to show an interest in business litigation issues, particularly class actions.
In its March 2015 Omnicare decision, the court set a higher standard for liability for opinions under Section 11 of the Securities Act, requiring actual knowledge of falsity, or that the speaker omitted a material fact needed to make the opinion not misleading
In January 2016, the Court held in Campbell Ewald that plaintiffs cannot remove a lead plaintiff and defeat a class by merely offering to pay the lead plaintiff's damages (i.e., the so called "pick off" defence), therefore removing standing for the class representative.
Looking down the road, the Court will address, in a case called Spokeo, whether a plaintiff who alleges his/her statutory rights were violated but can show no concrete harm has standing to bring a claim, which could impact liability for cyber and data braches where damages are often not determined until some later date.
With the recent death of Justice Scalia, who drafted numerous significant business decisions, including Morrison and Tellabs, we may not see as much activity by the Court this year as the battle rages over his replacement.
Environmental and Climate Change Disclosures
There has also been renewed interest by both regulators and plaintiffs' counsel regarding disclosure of climate change and other environmental risks. In 2015, the SEC reviewed what companies should disclose with respect to climate change, and it is possible that we will see new rules in that regard during 2016.
The energy sector is already being targeted. In November 2015, the New York Attorney General (NYAG) subpoenaed Exxon Mobil regarding the sufficiency of its disclosures on the impact of climate change on their business.
Also in November 2015, NYAG reached a settlement with Peabody Energy in which it agreed to disclose more about climate change risks.
These types of actions could spill over into other industries, including insurance
Recent Coverage Decisions
In view of the increasingly aggressive regulators and their push to hold individuals accountable, we could see higher defence costs claims and more guilty pleas or adjudications of guilt by insured D&Os and companies. As a result, there may be more disputes between insurers and their insureds regarding whether dishonest acts exclusions or other provisions triggered by judgments or adjudications apply. If such exclusions are triggered after the insurer has advanced defence costs, we might see more efforts by insurers to recoup or obtain repayment of defence costs advanced under a reservation or rights.
During 2015, two appellate courts grappled with these issues. In Protection Strategies, the 4th Circuit found that guilty pleas by the insured D&Os triggered dishonesty and personal profit exclusions, which entitled the insurer to recoup defence costs advanced prior to the plea agreements. In that case, the policy specified that the insurer could obtain repayment of costs if there was a finding that the insureds were not entitled to coverage.
In GDC Acquisitions, the 2d Circuit found that the imposition of a fraud sentence was a "final adjudication" within the context of a dishonest acts exclusion, and that the insurer was entitled to a finding of no coverage and recoupment of previously advanced defence costs, even though the insured officer's appeal of the sentence remained pending.
Another coverage issue that insurers and insureds have struggled over in the U.S. is whether separate claims involving interrelated wrongful acts should be deemed a single claim made at the time the earliest claim was first made.
In Nomura Holdings v Federal, the 2nd Circuit held that because five residential mortgage-backed securities actions relating to the subprime crisis related back to a lawsuit filed before the policy inception, the claim was not first made in the applicable policy period and the claims made coverage was not available. The court was critical of the factual nexus test applied in other cases, but reached its holding based on the unambiguous definition of "interrelated wrongful acts" in the relevant policy.
- In another case, W.C. and A.N. Miller Devel. Corp, the plaintiff alleged that the defendants fraudulently transferred assets to frustrate enforcement of a judgment. The 4th Circuit found that the interrelated wrongful acts definition was expansive and unambiguous. The court determined that the two lawsuits were a single claim as they arose from the same land development project, the same contract, a dispute over the same fee and were brought by the same claimant. 2
Footnotes
1 For example, in May 2015, Vice Chancellor Laster refused to approve a disclosure only settlement relating to Cobham's acquisition of Aeroflex. In September 2015, Vice Chancellor Glasscock granted approval of a settlement in the Riverbed case, but indicated reluctance to approve disclosure only settlements and attorney fees awards. In Oct. 2015, Vice Chancellor Laster rejected another disclosure only settlement relating to Hewlett-Packard's acquisition of Aruba Networks. In Jan. 2016, Chancellor Bouchard rejected a disclosure settlement arising out of Zillow's acquisition of Trulia
2 In producing this article we consulted a number of sources for which we give thanks. These are:
- Cornerstone Research, Securities Class Action Filings 2015 year in Review, NERA Economic Consulting and SEC Enforcement Activity Against Public Company Defendants
- Recent trends in Securities Class Action Litigation: 2015 Full-Year Review
- Berkeley Law (Cain & Solomon), Takeover Litigation in 2015
- 2015 Annual Report to Congress on the Dodd-Frank Whistleblower Program.
To view the original article please click here.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
