Event-Driven Litigation Shakes Up D&O Market

2017 marked 193 federal court merger objection lawsuits—comprising nearly half of the 415 securities class action lawsuit filings for the year and more than doubling the previous year’s total of 80, according to Kevin M. LaCroix, attorney and executive vice president at RT ProExec and author of the D&O Diary.

The number marks an important shift of these types of lawsuits from state to federal court, thanks in large part to a series of Delaware state court rulings that were hostile to disclosure-only settlements and created an unfavorable climate for plaintiffs.

“The cynical person would say everybody wants to get the deal done, so you throw a lawsuit in there, and all the parties in the transaction want to do is get rid of the lawsuit. They don’t care about the lawsuit, so they just pay the claimants some money so that it goes away—it just becomes part of the cost of the deal,” LaCroix explains.

The problem, LaCroix says, is that “the state court judges are getting sick of these kinds of cases. One of them referred to it as ‘junk litigation.’ The courts don’t want to be used for what’s almost like a holdup.”

It’s too early to tell yet, but if plaintiffs can continue to make money off this kind of litigation by shifting their cases to the federal level, “it’s going to contribute to loss costs for directors & officers insurers, and it’s probably going to continue to change the coverage,” LaCroix predicts.

Already, D&O insurers have begun adding large self-insured retentions as high as $1 million or more for merger-related litigation, “and it’s fair, because it’s no longer a real D&O loss cost—it’s just part of the cost of doing business,” says LaCroix, who notes that coinsurance, sublimits or even exclusions relating to M&A litigation could be next if federal courts allow lawyers to pursue these types of cases.

That’s especially relevant considering current federal court vacancies, says Sean Jordan, research analyst at the International Risk Management Institute (IRMI): “There are still a lot left to fill, and that’s going to change the litigation landscape. That slides a little bit under the radar, but filling these vacancies with business-friendly judges is going to have a massive impact for years to come.”

“And that’s great for insurers, because if you get a whole generation of business-friendly judges interpreting laws, that’s going to keep a lid on D&O liability,” adds Bob Bregman, senior research analyst at IRMI.

Of course, this type of lawsuit is “much less prevalent among private companies,” LaCroix says. “It certainly does happen on the private company side, but it’s categorically different. Public companies are under time pressures and it is all happening in the open, which creates its own dynamic.”

So what about the other 222 securities class action lawsuits filed in 2017? Many of them fall into the realm of “event litigation,” says Peter R. Taffae, managing director at ExecutivePerils: when plaintiffs sue directors & officers of both private and public companies for a lack of oversight or mismanagement associated with a major event.

“It could be cyber, it could be sexual harassment, it could be pollution, it could be a contract they entered that went south—whatever it is, the directors & officers, the board, have a fiduciary duty of care,” Taffae says. “For the plaintiff, the D&O policy is a safety net. It’s a backstop.”

So far, cyber-related lawsuits against management have not been incredibly successful. Consider the suit against the directors & officers of Home Depot, which settled for $1 million with a governance agreement including documentation requirements, maintenance of a data security executive committee, and regular reporting on the IT and cybersecurity budget, Jordan notes.

“That’s not a big blockbuster amount. These claims haven’t really taken off—a number of other cyber-related claims have been dismissed,” Bregman says.

Why? “Primarily because the courts perceive companies as vulnerable. If the Department of Defense and Microsoft are vulnerable, how can Acme Manufacturing hope to evade a data breach?” LaCroix points out. “As long as a board is able to demonstrate they took reasonable steps to protect against a breach, and that has been the case so far, the courts are not going to hold them accountable.”

But after last year’s high-profile suits, that could change moving forward. “The common factor among Yahoo, Equifax, Paypal—all companies that got hit with data breach security suits in 2017—is that there was a delay between discovery and disclosure,” LaCroix explains. “In the case of Equifax, between the discovery and the disclosure, insiders sold shares of the company stock. That creates a picture plaintiff’s lawyers can exploit to make their claim look more sympathetic.”

Next up in big-time litigation for the management liability space: sexual harassment and misconduct claims arising out of the #MeToo movement. Keep an eye on IAmagazine.com and the Markets Pulse e-newsletter in the coming weeks for details.

Jacquelyn Connelly is IA senior editor.