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Derivative shareholder lawsuits are on the rise and bring D&O liability risks

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Derivative shareholder lawsuits are on the rise and bring D&O liability risks

Derivative shareholder lawsuits are a growing area of concern for companies, as plaintiff attorneys, somewhat stymied in filing class action lawsuits, consider other options, say observers.

However, one critical factor in the development of this type of litigation will be the U.S. Supreme Court's ruling in Halliburton Co. and David Lesar v. Erica P. John Fund Inc., FKA Archdiocese of Milwaukee Supporting Fund Inc., which will affect how easily plaintiffs can file class action certification lawsuits (see related story).

Shareholder derivative lawsuits, unlike class action suits, are filed on the company's behalf, and any funds are put back into their coffers rather than going to shareholders, an important difference. They first gained popularity over the issue of options backdating, but merger and acquisition activity and executive compensation have since become a focus. Still, plaintiffs attorneys can earn substantial fees on these cases alleging that corporations are benefiting from bad behavior.

“As the Supreme Court has made it more difficult to successfully plead securities class actions,” the plaintiffs bar has filed an increasing number of derivative suits, said Will Fahey, New York-based senior vice president in Zurich North America's management liability group. “We've seen an uptick in derivative suits over the past few years and would expect to continue to see” an increase in both frequency and severity.

“We're seeing a higher percentage of derivative litigation” following a securities class action litigation, said Steve Boughal, New York-based vice president and chief underwriting officer of Hartford Financial Products, a unit of The Hartford Financial Services Group Inc. These lawsuits are also being filed in connection with regulatory exposures, such as Foreign Corrupt Practices Act fines and penalties.

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“It's absolutely a real exposure for our clients and something we need to be concerned about, and something they should address within their insurance coverage,” said Brenda Shelly, New York-based directors and officers practice leader for Marsh Inc.'s FINPRO unit.

The frequency of these cases, rather than their severity, makes them a “big driver,” said Mr. Boughal. “The defendants are usually successful in having the case dismissed, but we are seeing a fair amount of small settlements.”

Given the increased frequency, these claims can have an effect on the primary D&O insurer, he said. And occasionally there are large settlements.

For instance, in April 2013, a $139 million settlement was reached in a shareholder derivative lawsuit filed on behalf of New York-based News Corp., which plaintiff attorneys claimed was the largest cash settlement ever in such a lawsuit.

While such large settlements are still rare events, “they have been occurring a bit more often the last few years,” perhaps providing an incentive to the plaintiffs bar, said Mr. Boughal.

“Generally the derivative suits may settle in a more expedient fashion and maybe for less money,” but there are exceptions, Ms. Shelly said.

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Ann Longmore, New York-based executive vice president of FINEX North America, a unit of Willis North America Inc., said one of the driving forces behind an uptick in derivative claims is that securities class actions can be filed only by shareholders who bought company stock, then sold it at a loss because of alleged misinformation or fraud.

Shareholders who held on to their stock cannot participate in this class action litigation, but they may participate in derivative lawsuits. The two types of claims against companies can be filed side by side, she said.

“If the Supreme Court rules in the defense's favor in Halliburton, there will be more derivative suits,” said Steve Shappell, Denver-based managing director at Aon Risk Solutions' financial services group.

Such cases “don't make the plaintiffs wealthy,” Mr. Shappell noted, because “all it does is put money back in corporate coffers.” But they do pay plaintiff attorneys, who may receive corporate benefit awards ranging from a couple of hundred thousand dollars to millions, he said.

Derivative securities lawsuits “have been around a long time and will continue to be an issue that companies have to face,” and that there will continue to be rare outlier settlements, Mr. Boughal said.

But observers say the best way to avoid and/or defend against such lawsuits is with strong corporate governance policies.

To prevent those lawsuits and reinforce to the plaintiffs bar the idea that “corporate America is not going to put up with” such claims, companies should continue to introduce “great” corporate governance procedures, Mr. Shappell said, and respond in a thorough manner when claims come in.

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