The market for directors and officers liability insurance has been out of kilter since the start of the year, with more demand than supply. Now, the D&O market is nearly frozen, and companies are scrambling to adequately insure those serving on their boards or as part of management.
Premiums for D&O coverage in the U.S. market have risen around 100 percent from this time last year and could go a lot higher. Even with the higher premiums, insurers are still trimming available coverage, sometimes by increasing deductibles and lowering caps on payouts.
The disruption of the D&O market has also resulted in some companies being unable to afford coverage; others are choosing to forgo it. In late April, Tesla founder and CEO Elon Musk said instead of D&O insurance, he would “personally provide coverage substantially equivalent to such a policy for a one-year period.” It’s unclear if Musk’s promise to stand behind directors and officers will convince them to keep serving.
What’s driving the “hard market” in D&O coverage? Shareholder litigation.
Class action securities suits set a record in 2019, with 428 new cases filed in U.S. state and federal courts. That’s about double the 1997-2018 average, according to Cornerstone Research and Stanford Law School’s Securities Class Action Clearinghouse. A North America representative of Chubb told Business Insurance that one out of every 11 companies is now being sued.
Why is there a deluge in shareholder litigation? Here are some causes:
Litigation funders. With third-party funding widely available, plaintiffs lawyers are more likely to take on expensive shareholder suits against big corporations and their directors and officers. Whenever a company’s stock falls far enough, for any reason, shareholder litigation can happen.
IPOs. Any time an initial public offering doesn’t perform as expected, shareholder suits follow. There’s been a flurry of IPOs in 2020. Insurance providers have been raising the bar when evaluating whether to write D&O coverage for companies headed for an IPO or those recently involved in one.
Bankruptcies. Companies that resort to Chapter 11 or Chapter 7 filings usually face related shareholder litigation. Since the start of the year, the energy sector has seen an increase in bankruptcies and other attempts to restructure debt, with accompanying shareholder lawsuits. Private companies and their directors and officers are also vulnerable to shareholder suits related to bankruptcy filings.
Covid-19. The pandemic has driven more companies into bankruptcy and exposed others to allegations that they weren’t financially or operationally prepared for a predictable crisis. As of June 23, fifteen Covid-19-related shareholder lawsuits had been filed, according to Kevin LaCroix, a lawyer and insurance professional who writes the authoritative D&O Diary. The first-wave suits involve Norwegian Cruise Lines, Inovio Pharmaceuticals, iAnthus Capital Holdings, Zoom Video Telecommunications, Phoenix Tree Holding Ltd., SCWorx, Elanco Animal Health, Sorrento Therapeutics, Carnival Corporation, Wells Fargo & Company, Forescout Technologies, Co-Diagnostics, Inc., Chembio Diagnostics, United States Oil Fund LP, and Colony Capital.
FCPA-related investigations and enforcement actions. Shareholder litigation follows nearly every disclosure of a new FCPA-related investigation. Currently, there are more than 110 verified pending FCPA-related investigations, according to data provided by FCPA Tracker. And whenever companies resolve FCPA enforcement actions, they and their leaders are likely to face new shareholder suits. What’s the overall impact of the FCPA on D&O coverage? It’s hard to quantify. But Petrobras’ $3 billion settlement of shareholder litigation based on its FCPA offenses accounted for nearly two-thirds of the total amount paid for all 78 shareholder settlements in 2018, according to the D&O Diary.
Other factors. #MeToo, data breaches, wildfires, jet crashes, cryptocurrency frauds — all have contributed to the record level of new shareholder litigation over the past few years.
How much actual risk — in dollars and cents — do directors and officers face? Plenty.
According to Kevin LaCroix (citing Cornerstone Research), in 2019 there were 74 securities class action settlements for a total aggregate settlement value of $2.029 billion. The average settlement in 2019 was $27.4 million.
How about serving on a board with Elon Musk? In January (while Tesla Inc. still had D&O coverage), all directors except Musk agreed to pay $60 million to settle shareholder lawsuits that alleged Tesla overpaid when it acquired solar panel maker Solar City.
Kevin LaCroix, by the way, warns directors and officers about accepting”personal guarantees” in lieu of D&O coverage. In Tesla’s example, he said the directors’ need for coverage “could arise in a set of circumstances that could itself undermine Musk’s ability to honor his commitment.”
LaCroix also cautioned that relying on CEO Musk’s personal guarantee “puts the directors in a position in which they have a direct financial interest in Musk being able to maintain his financial well-being.” Does that trigger conflict-of-interest problems for board members and compromise their independence? If so, they may have even more exposure to liability through securities class action suits.