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Overloaded D&O policies can leave executives without adequate coverage

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Overloaded D&O policies can leave executives without adequate coverage

NEW YORK — Placing entity coverage, including investigative costs, into directors and officers insurance policies may leave the executives themselves without adequate coverage.

Directors and officers are “pretty protected” through their D&O policies right now, said Dan Bailey, a member of law firm Bailey Cavalieri L.L.C. in Columbus, Ohio. The “big issue” is that “we have too much entity coverage in that policy today,” he said.

Mr. Bailey said his view is that a D&O policy “should protect directors and officers first and foremost, and we should not be diluting that protection through a lot of entity-type coverages.”

In addition to entity coverage, employment practices liability and other employees have been added to D&O policies in this “post-SOX world,” said Ann M. Longmore, New York-based executive vice president at Willis North America Inc., referring to the Sarbanes-Oxley Act of 2002. “There's lots of ways they've been cramming more than 5 pounds of flour into a 5 pound sack,” she said.

Coverage for investigative costs cannot be shoehorned into D&O policies, said Chris Warrior, London-based head of management liability for Hiscox Ltd. The coverage can be offered, he said, but it would be a corporate policy, not a D&O policy, “and we can't do it with a $250,000 retention.”

“Fundamentally, the industry must figure out which way to go, “ he said.

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These speakers issued their warnings during a panel at the Professional Liability Underwriting Society's annual D&O Symposium in New York last week, where they also discussed emerging D&O risks, including whistle-blowers and cyber risks.

The “key to the whole issue is who makes the decision on the buyers' side,” said Mr. Bailey. If directors were asked whether it is OK to dilute their coverage, “I can't imagine directors saying that's what they want. The directors want to hear how they're protected, not how the company's protected,” he said.

“There are products available for this coverage and they're not selling,” however, said Brenda Shelly, New York-based managing director for Marsh Inc.'s FINPRO unit, who moderated the panel.

Matt Shulman, New York-based executive vice president at Arch Insurance Group Inc., said as a stand-alone product, cover for investigations requires an additional premium, much higher retentions and perhaps coinsurance.

Even clients who express interest in this coverage do not want it for investigations that occur in the normal course of doing business, but rather for investigations that lead to D&O claims, said Ms. Longmore.

Coverage for clawbacks was also discussed. The clawback provision in Sarbanes-Oxley related to enforcement actions against CEOs and chief financial officers for bonus compensation stemming from restatements made because of wrongdoing.

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Even if a clawback could be covered under a D&O policy, the question is whether that would be “a direct frontal attack” on a congressional provision, said Mr. Bailey. “I think there's a very good argument it is.”

The panel also discussed emerging issues. These included:

• The U.S. Supreme Court's eventual decision in Halliburton Co. and David Lesar v. Erica P. John Fund Inc., FKA Archdiocese of Milwaukee Supporting Fund Inc. The focus of the case is the Supreme Court's 1988 ruling in Basic Inc. v. Max Levinson, in which the court endorsed the “fraud-on-the-market presumption theory.”

The theory says plaintiffs in class actions do not have to demonstrate that each individual class member relied on the company's alleged misrepresentation of information.

If, as appears likely, the Supreme Court decides to “tweak” this theory, “it's going to change dramatically a lot of the strategy” of securities class action litigation, said Mr. Bailey.

• Whistle-blowers. Pointing to last year's whistle-blower award of $14 million by the U.S. Securities and Exchange Commission, Mr. Shulman said, “This really has the makings of the biggest issue to affect our business.”

• Cyber risks. “We've always known that big bad product liability claims had the potential of becoming D&O claims” on the basis that supervisors failed to protect the organization, said Ms. Longmore. Cyber claims “are another twist” on the same phenomenon, she said.

About 1,200 people attended this year's PLUS D&O Symposium. The next meeting will be held Feb. 4-5, 2015, in New York.