Demystifying D&O Liability & Insurance: Numbers, Basics, & Trends

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Recording of this session via any media type is strictly prohibited.

Carol A.N. ZachariasDeputy General Counsel

ACE North America

Leslie A. LambDirector of Global Risk ManagementCisco Systems, Inc.

Edward M. JoycePartnerJones Day

Demystifying D&O Liability & Insurance:Numbers, Basics, & Trends

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The views expressed by the speakers are not those of the speaker’s employer, firm, clients, or any other organization.

The opinions expressed do not constitute legal or risk management advice.

The views discussed are for educational purposes only, and provided only for use during this session.

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• The Numbers• The Basics of D&O Coverage• International Coverage• Current Trends in D&O Liability

Agenda

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4

The Numbers: SCA Filings

Number of Securities Class Action Filings, 1997-2013 (Average: 191)

19971998

19992000

20012002

20032004

20052006

20072008

20092010

20112012

20130

50

100

150

200

250

300

174

242209 216

180224

192228

182

120

177

223

167 176 188152 166

Cornerstone Research, “Securities Class Action Filings: 2013 Year in Review”, www.cornerstone.com.

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5



Number of Companies Listed on U.S. Exchanges1997-2013

• Listings• 1997: Over 8000• 2013: Just over 4,000

• 46% decline• Declined 6% annually 1998-2004• Declined 3% annual decline thereafter

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Industry Sector Avg. Filings1997-2012

2011Filings

2012Filings

2013Filings

Financial 37 25 15 18Consumer/Non-Cyclical 45 45 49 45Industrial 17 25 14 16Technology 25 21 12 20Consumer Cyclical 21 21 15 19Communications 31 24 19 23Energy 7 18 14 17Basic Materials 4 5 9 5Utilities 3 4 3 1Unknown/Unclassified - - 2 2Total 190 188 152 166


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Filings By Statute (Percentage of Total Filings)

Statute

2009 2010 2011 2012 2013

Sec. 10(b)5 Claims

69% 66% 71% 85% 84%

Sec. 11 Claims

23% 15% 11% 10% 9%

Sec. 12(2) Claims

25% 10% 9% 9% 7%

None of above

claimed

1% 23% 23% 9% 11%

Percentages do not add to 100% as complaints may include multiple statutory allegations

Cornerstone Research, “Securities Class Action Filings: 2013 Year in Review”, ww.cornerstone.com

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Filings by Allegations (Percentage of Total Filings1)Allegations 2009 2010 2011 2012 2013

Misrepresentations in financials (Halliburton) 89% 93% 94% 95% 97%

False forward looking statements 51% 45% 56% 62% 54%

Insider trading 14% 16% 12% 17% 17%

GAAP violations2 37% 26% 37% 23% 24%

Announced Restatements3 10% 7% 11% 11% 11%

Internal Control Weaknesses4 14% 23% 24% 20% 20%

Announced Internal Control Weaknesses5 4% 3% 6% 8% 8%1Percentages do not add up to 100% as complaints may include multiple allegations

2Allegations represent GAAP allegations even if GAAP not expressly referenced3First identified complaint alleges GAAP violation even if GAAP not expressly referenced, and refers to restatement announcement

4First identified complaint t alleges internal control weakness over financial reporting 5First identified complaint alleges internal control weakness over financial reporting and refers to an internal controls weakness announcement

4

4



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0%

20%

40%

60%

80%

100%

99%

80%

40%CEOCFOOutside Director

Note: Percentages are for cases filed between 2000 and 2003. Michael Klausner and Jason Hegland, 2010, “How protective is D&O insurance in securities class actions? - Part I”, Professional Liability Underwriting Society Journal, Vol. 23, No. 2, pp. 1-4, cited by Jason D. Schloetzer, ”Corporate Misconduct and the Market for Directorships”, Director Notes, No. DN-016, November 2010.

Defendants in Securities Class Actions

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• Cases without public pension fund lead plaintiff: $ 3mm• Cases with public pension fund as lead plaintiff: $23mm • 43% of settling cases had public pension fund as lead plaintiff:

The Numbers: SCA Settlements

Series10%

10%

20%

30%

40%

50%

12% 14%22%

26%33% 34%

38% 40%47% 43%

Median Settlements 2013

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Cornerstone Research, “Securities Class Action Settlements: 2013 Review and Analysis”, www.cornerstone.com.

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Settlements by Select Industry Sectors 1996-2013 (Dollars in Millions)

Industry No. Settlements Median Value

Financial 169 $8.1

Telecommunications 141 $6.5

Pharmaceuticals 94 $10.3

Healthcare 56 $6.0

Technology 324 $12.0

Retail 117 $8.7

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Settlements by Select Industry Sectors

• Credit crisis cases settling out:

2011: 18% 2012: 30% 2013: 22%

• Shift of settlements to pharmaceutical sector:

1996-2012: 6% 2013: 18%

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Settlements By Statutory Basis(Dollars in Millions)

Statutory Basis

Number of Settlements

Median Settlement

Section 11 and/or 12(a)(2) Only

80 $3.4

Both Rule 10(b)5 and Section 11

and/or 12(a)(2)

246 $11.7

Rule 10(b)5 Only 1,049 $6.8

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Agenda

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Types of D&O Coverage

• Side A:–Covers losses of D&Os which are not

indemnified by the company–No coverage for claims against the entity

• Side B:–Reimburses entity for its indemnification

of losses incurred by D&Os–No coverage for claims against the entity

15

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• Side C:–Covers losses of entity on account of claims

against the entity–No coverage for losses of D&Os–Typically limited to securities claims if the

entity is a public company; no such limitation if the entity is a private or not-for-profit company.

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• Side A Policies: –Non-indemnifiable loss:

• Derivative settlements or judgments (circular)• Some statutory violations (FCPA; adjudicated

securities violations)–Non-indemnified loss:

• Changes to right to indemnity under law/articles• Financial inability• Polarized former D&O

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• Side A Policies: –Non-dilution of limits by entity–Broad coverage (DIC; exclusions)

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“Claim”

• Written demand

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“Claim”

• Written demand

• Civil proceeding

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“Claim”

• Written demand


• Criminal proceeding

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“Claim”

• Written demand



• Regulatory, administrative proceeding

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“Claim”

• Written demand




• Investigations- formal/informal

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“Claim”

Complaint

Indictment

Formal Order

Subpoena

• Written demand





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“Claim”

Complaint

Indictment

Formal Order

Subpoena

• Written demand





• Against an insured

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“Claim”

Complaint

Indictment

Formal Order

Subpoena

• Written demand






• Seeking damages/relief

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“Claim”

Complaint

Indictment

Formal Order

Subpoena

• Written demand






• Seeking damages/relief

• Monetary/non-monetary

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“Claim”

SEC investigation may not be a claim or a securities claim:

• Binding adjudication for relief not possible• Insured person may not be identified as

object of potential proceeding• May be excluded by policy language

Foster v. Summit Med. Sys. Inc., 601 N.W.2d 350 (Minn. App. 2000), Office Depot, Inc. v. National Union Fire Ins. Co. of Pittsburgh, Pa., 734 F. Supp. 2d 1304 (S.D. Fla. 2010), aff’d 453 F. App’x 871 (11th Cir. 2011)

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“Claim”

SEC investigation may be a claim:• Policy language expressly covers informal

inquiries• SEC subpoenas and orders seeking

testimony and documents are ‘demands’ for ‘relief’

Minuteman Int’l, Inc. v. Great Am. Ins. Co., 2004 U.S. Dist. LEXIS 4660 (N.D. Ill. March 18, 2004), MBIA, Inc. v. Fed. Ins. Co., 2009 U.S.Dist. LEXIS 124335 (S.D.N.Y. Dec. 30, 2009), aff’d in part, 652 F.3d 152 (2d Cir. 2011)

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“Claim”

State criminal investigation may be a claim:

• Threat of criminal indictment constitutes a demand for non-monetary relief, in policy definition

• Investigation constitutes a criminal proceeding as well as a state or local proceeding, in policy definition

Gold Tip, LLC v. Carolina Cas. Ins. Co., 2012 U.S. Dist. LEXIS 120166 (D. Utah Aug. 23, 2012)

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“Claim”

Grand jury proceedings may not be a claim:

• No adjudication for liability for damages or other relief.

• No indictment or demand for relief • No allegation of wrongful act of insured

JB Oxford Holdings, Inc. v. Certain Underwriters at Lloyd’s, London, 2001 Cal. App. Unpub. LEXIS 111 (Cal. Ct. App. Oct. 5, 2001); Diamond Glass Cos., Inc. v. Twin City Fire Ins. Co., 2008 U.S. Dist. LEXIS 86752 (S.D.N.Y. Aug. 18, 2008); Fed. Ins. Co. v. Illinois Funeral Director’s Ass’n, 2010 U.S. Dist. LEXIS 129747 (N.D. Ill. Dec. 8, 2010)

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“Loss”

• Damages

• Defense costs

• Insured legally obligated to pay

• On account of a claim

• For a wrongful act for which coverage applies

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“Loss”

Disgorgement: Return to shareholders of the value of overpayment for stock

Level 3 Communications, Inc. v. Federal Insurance Company, 272 F.3d 908 (7th Cir. 2001) and progeny

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“Loss”

Disgorgement: Settlement with the SEC – for overpayment by shareholders

Vigilant Insurance Company v. Credit Suisse First Boston, 800 N.Y.S.2d 358 (N.Y. Sup. Ct. 2003), aff’d on appeal, 782 N.Y.S.2d 19 (N.Y. App. Div. 2004)

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“Loss”

Disgorgement:Express disavowals in settlement agreement

CNL Hotels & Resorts, Inc. v. Houston Cas. Co., 505 F. Supp. 2d 1317 (M.D. Fla. 2007)

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“Loss”

Disgorgement:Coverage for associated defense costs

Millennium Partners, L.P. v. Select Ins. Co., 882 N.Y.S.2d 849 (N.Y. Sup. Ct. 2009)

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“Loss”

Disgorgement:Settlement with the SEC – for improper profits acquired by customers

J.P. Morgan Sec. Inc. v. Vigilant Ins. Co., 21 N.Y.3d 324 (N.Y. 2013)

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Executive Compensation

• Loss

• Remuneration

• Personal Profit

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Interrelated Wrongful Acts

Policy definitions:• ‘Causally connected’• ‘Common nexus’

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Impact:• Late notice

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Impact:• Late notice• Prior claim

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Impact:• Late notice• Prior claim• Multiple limits

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Impact:• Late notice• Prior claim• Multiple limits• Multiple retentions

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Impact:• Late notice• Prior claim• Multiple limits• Multiple retentions• Multiple policy terms and conditions

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Personal Conduct Exclusions

Illegal or improper profit/advantage• “arising out of, based upon or attributable to the

gaining in fact of any profit or advantage to which the Insured was not legally entitled“

Fraud, willful violations or criminal conduct• “arising out of, based upon or attributable to the

committing in fact of any deliberate criminal or deliberate fraudulent act by the Insured”

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Personal Conduct Exclusions

“Final adjudication” v. “in fact”• “final adjudication” – established in the underlying

action, not the insurance coverage action• “in fact” – established by any fact finder

Non-imputation clause (severability)• facts pertaining to or knowledge possessed by one

insured shall not imputed to another insured

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Other Exclusions

Insured v. insured exclusion• excludes any claim “brought or maintained by

or on behalf of any insured”• exceptions:

o shareholder derivative claimso claims by bankruptcy trustee/examiner or other

officials appointed by court re bankrupt estateo whistleblower claims – maybe?

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Other Exclusions

Contractual liability exclusion• “for any actual or alleged liability of any Insured

under any express contract or agreement”• exception/carve back for defense costs – maybe• insurer funds uncovered settlement to avoid further

defense costs• future estimated defense costs if no settlement• allocation provisions promising 100% defense costs

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Advancement of Defense Costs

• Payment of defense costs per policy provisions• Allocation determination – who controls• Pay on a “contemporaneous basis” – means what?• Failure to make timely payments – breach?• Duty to defend v. advancement of defense costs

Gon v. First State Ins. Co. (9th Cir. 1989); Federal Ins. Co. v. Kozlowski (N.Y. App. Div. 1st Dept. 2005)

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Excess

Limits:• Failure of primary to pay full limit• Insolvency of underlying causing

failure to pay full limit • Ability of insured to pay gap

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Excess



Inconsistent terms between layers

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Excess



Inconsistent terms between layersSub-limits within layers

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Agenda

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Option 1: U.S.- based tower

Option 2: U.S.- based tower and international tower

Option 3: U.S.- based tower + individual country policies/FOS

Option 4: U.S.- based tower + Lloyd’s USA coverholder Side A wrap

Global Programs Today

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U.S

. To

wer

Excess DIC

Side A

Excess D&O Follow Form

U.S. Primary D&O ABC

Option 1: U.S. – Based Tower

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U.S

. To

wer

Excess DIC

Side A



International Tower?

Option 2: U.S. – Based Tower & International Tower

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Limits Tied to U.S. Primary

Local Germany

Local France

Local Brazil

U.S

. To

wer

Excess DIC

Side A



EXCESS INTERNATIONAL D&O COVERAGE?

Option 3: U.S. – Based Tower & Individual Country/FOS Policies

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Jurisdictions in which Lloyds has a license or is otherwise authorized and where D&O is permitted*

Anguilla Bulgaria Finland Hungary Liechtenstein Namibia South AfricaAntigua Canada France Iceland Lithuania Netherlands SpainAustralia Cayman I. French Guiana Ireland Luxembourg Norway St. Barthelemy

Austria Cyprus Germany Isle of Man Malawi PolandSt. Kitts & Nevis

Bahamas Czech Rep. Gibraltar Israel Malta Portugal St. LuciaBarbados Denmark Greece Italy Martinique Reunion St. MartinBelgium Dominica Grenada Jamaica Mauritius Romania St. VincentBelize Estonia Guadeloupe Japan Monaco Singapore SwedenBermuda F. Polynesia Guernsey Jersey N. Caledonia Slovakia Switzerland

British V.I. Falkland I. Hong Kong Latvia N. Zealand SloveniaTrinidad & Tobago

United Kingdom USA Vanatu

Wallis & Futuna Zimbabwe

Lloyd’s accesses up to 75 countries through licenses:

*Certain countries may require individual policies to be issued

• Simplified access to coverage• Ease of use — one underwriter handles transaction• Common terms and conditions, except on local forms

Option 4: U.S. – Based Tower & Lloyd’s USA Side A Wrap

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• Same terms and conditions;• Same English language; and • Access up to 75 jurisdictions where Lloyds is licensed

U.S. Policy + Lloyd’s USA Side A Policy:

U.S

. To

wer Excess DIC

Side A



Lloyd’s USA Side A Wrap

Valid for France and Germany (and up to 75 other countries)

Option 4: U.S. – Based Tower & Lloyd’s USA Side A Wrap

Lloyd’s USAPolicy

Local Brazil Policy(Limits Tied)

Valid for France and Germany (and up to 75 other countries)

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AgendaAgenda

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• U. S. “class actions”:• similarly situated plaintiffs• motion for class certification

• U.S. securities fraud action:• misrepresentations case• reliance• at class motion stage

Halliburton

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Halliburton

Filings by Allegations (Percentage of Total Filings1)Allegations 2009 2010 2011 2012 2013

Misrepresentations in financials 89% 93% 94% 95% 97%

False forward looking statements 51% 45% 56% 62% 54%

Insider trading 14% 16% 12% 17% 17%

GAAP violations2 37% 26% 37% 23% 24%

Announced Restatements3 10% 7% 11% 11% 11%

Internal Control Weaknesses4 14% 23% 24% 20% 20%

Announced Internal Control Weaknesses5 4% 3% 6% 8% 8%1Percentages do not add up to 100% as complaints may include multiple allegations

2Allegations represent GAAP allegations even if GAAP not expressly referenced3First identified complaint alleges GAAP violation even if GAAP not expressly referenced, and refers to restatement announcement

4First identified complaint t alleges internal control weakness over financial reporting 5First identified complaint alleges internal control weakness over financial reporting and refers to an internal controls weakness announcement

4

4



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Old rule: Prove individual reliance New rule, 1988: Reliance presumed

(Basic v. Levinson) Misrepresentations impact price In a stock traded in an “efficient market” Hence reliance may be presumed for

that stock

Halliburton

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Halliburton v. John Fund U.S. Supreme Court Argued March 5, 2014; decision by June? Issues: 1. Should class-wide reliance be derived from the

fraud on the market theory?2. Whether the presumption of reliance may be

rebutted by evidence that the alleged misrepresentation did not distort market price?

Halliburton

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Options:

Affirm Basic Only recovery vehicle for many smaller

investors Impact: Litigation and coverage

environment stays the same

Halliburton

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Options:

Overrule Basic- require proof of individual reliance

Fewer SCA filed? But still:

- Omissions cases- Section 11 and 12 cases- Individual actions- Collective actions- Regulatory actions- State actions

Halliburton

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Options:

Permit the resumption of reliance to be rebutted by evidence that the alleged misrepresentation did not distort market price

Impact: More discovery, experts, motions, hence

higher costs Potentially more dismissals, but at the

higher cost Potentially cheaper settlements?

Halliburton

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Private Bar:

3,050 SCA 1997-2012 $73.1 billion recovered ($12B/yr)

Securities & Exchange Commission

Halliburton Co. v. Erica P. John Fund, Inc., Brief for Former SEC Commissioners and Officials and Law Professors as Amici Curiae.

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Series1620640660680700720740760

664681

735 734

686

SEC Enforcement Actions Per Fiscal Year

2013:• 20% increase in formal orders of investigations by Enforcement Division• 3.4B in disgorgement and penalties for resolved cases

• 10% higher than FY2012• 22% higher than FY2011 (which was highest number of filings in

agency history)SEC Press Release 2013-264, SEC Announces Enforcement Results for FY 2013 (Dec. 17, 2013).

2009 2010 2011 2012 2013

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SEC Press Release 2013-264, SEC Announces Enforcement Results for FY 2013 (Dec. 17, 2013).

Securities Offer-ing

20%Market Manipu-

lation10%

Financial Fraud/Issuer Disclosure

13%

Insider Trading8%

Investment Ad-visor/Invest-

ment Company27%

Broker-Dealer23%

2013: Types of Enforcement Actions

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SEC Press Release 2013-264, SEC Announces Enforcement Results for FY 2013 (Dec. 17, 2013).

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013$0.0

$0.5

$1.0

$1.5

$2.0

$2.5

$3.0

$3.5

$1.90 $1.60$2.30

$1.09 $0.77

$2.09 $1.82 $1.88 $2.08 $2.26

$1.20 $1.50

$0.98

$0.51

$0.26

$0.35 $1.03 $0.93$1.02

$1.17

Monetary Sanctions in SEC Enforcement Actions (in billions & by fiscal year)

Disgorgement Penalties

22%

10%

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Three major shifts:

1. Looking first at individuals (targeting) 2. Admissions may be required3. Increased aggressive use of penalties


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Three exposure issues:

Removal of corporate indemnification Application of policy exclusions Application of state law on

uninsurability of intentional wrongful acts


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Questions?


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Carol A.N. ZachariasDeputy General Counsel

ACE North America

Leslie A. LambDirector of Global Risk ManagementCisco Systems, Inc.

Edward M. JoycePartnerJones Day

Demystifying D&O Liability & Insurance:Numbers, Basics, & Trends

Demystifying D&O Liability & Insurance: Numbers, Basics, & Trends

Documents

media type

trends page

gaap allegations

liabilityagenda page

sca filingsfilings

gaap violations237

22total1901881521 research

sca filingsindustry