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Sharp rise in D&O litigation signals change in legal strategy

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A dramatic increase in class action securities lawsuits can be attributed partly to a handful of plaintiff law firms that are pursuing smaller companies, say experts.

But, at least in the immediate future, the rise in litigation is not expected to affect the directors and officers liability insurance market, where rates are still declining, because of the high amount of capital in the market and the fact that many of the claims fall within policyholders’ retentions.

In 2016, the number of federal securities class action litigation filings rose to their highest level in 20 years

That trend continued in the first quarter of 2017, with plaintiffs filing a record 127 federal class action securities cases, which was almost twice the 64 filed in 2016’s first quarter, according to a report issued by Boston-based Cornerstone Research and Stanford Law School Securities Class Action Clearinghouse in Stanford, California.

“It’s an interesting phenomenon because we typically see an increase in securities litigation filings when the market is more volatile,” said Glenn K. Vanzura, a partner with Irell & Manella L.L.P. in Los Angeles.  Given the eight-year bull market, litigation rates would typically be expected to decline “or at best remain steady,” he said.

Experts say at least one factor contributing to the trend is a handful of plaintiff law firms that are pursuing litigation against smaller companies. “There’s a segment of the plaintiffs bar” consisting of smaller firms “that were less active prior to 2009, but they’ve gotten to the point where they’re filing nearly half of the (Securities and Exchange Commission) class action lawsuits,” particularly against life sciences companies, said Kevin LaCroix, executive vice president of RT ProExec, a division of R-T Specialty L.L.C. in Beachwood, Ohio.

“You almost have this split in the plaintiffs bar between larger, more established firms that are filing relatively fewer cases and these more active, emerging firms that are pursuing a high-volume case strategy,” he said.

One reason these law firms may be targeting smaller companies is they are less likely to attract larger firms’ attention, making the smaller firms more likely to be named as class counsel in litigation rather than being pushed aside, Mr. LaCroix said.

The lawsuits targeting smaller companies “may not be as attractive to some of the marquee plaintiff firms,” because they may not consider it worthwhile to invest in the litigation, said Jackie Waters, Chicago-based managing director and practice leader of Aon Risk Solutions’ financial services group legal and claims practice.

Lawsuits are being filed “any time there seems to be any bad news, or any noticeable decline in the stock price, frankly, without regard to the merit of their claims,” said Mr. Vanzura of Irell & Manella.

Ms. Waters said, however, “The dismissal rate is still very high, so it remains to be seen how successful that group will be.”

Experts say there are other factors contributing to rise in litigation, including the shift of merger-objection lawsuits from federal to state courts, following the rejection in January 2016 of a disclosure-only settlement by the Delaware Chancery Court. 

A disclosure-only lawsuit is litigation filed by plaintiff attorneys following a merger or acquisition that results in them being awarded legal fees when all they did was force defendants to provide largely immaterial disclosures about the deal.

“Rather than pushing and pushing in the state of Delaware” many moved to federal court, said Ms. Waters.

Increasing M&A activity has also contributed to the increase in shareholder litigation, said Mr. Vanzura. As those deals continue, “one would expect to see increased filings,” he said.

Mr. LaCroix said the increase also reflects the large number of lawsuits being filed against life science companies, particularly biotechnology and pharmaceutical firms.

 “The plaintiff lawyers seem to be targeting that industry class,” said Mr. LaCroix.  Although these firms have always been litigation targets, “it just seems like part of the plaintiffs bar is really bearing down,” on this segment.

But the rise in filings over the past quarter may not reflect a trend, he said. “A single calendar quarter might be too short  to use as a basis for generalization,” he said.  “I think we need to keep an eye on it and see how it’s going to develop as the rest of the year progresses.”

A continuation of the rise will likely depend on future developments, said Mr. Vanzura. For example, if the there is a “bursting of the bubble” and a stock market slide, there will be more “traditional” shareholder litigation.

“But if the market continues its run, we can expect to see some of the plaintiffs firms continue their business approach of filing any time there is the slightest decline” in individual companies’ stock price, he said.

And the outcome of the M&A suits filed in federal courts will also affect the volume of future litigation, Ms. Waters said.

In addition, “if there’s some traction” by the lawsuits being filed against smaller firms “then maybe the larger plaintiffs firms will be interested in driving those as well, but I still think the dismissal rate is good,” she said. 

Meanwhile, excess insurance capacity and higher self-insured retentions than in the past will likely suppress rate increases, despite the rise in litigation, experts said.

A survey issued earlier this month by Aon Risk Solutions reported lower D&O insurance rates for both the fourth quarter of 2016 and the entire year.

Mark Weintraub, Atlanta-based vice president, insurance, and claims counsel for Lockton Cos. L.L.C., said, “The market has set retentions at such a point,” certainly for merger objection lawsuits, that insurers are “not feeling the pain at this point.”

The retentions “are doing what they’re designed to do,” and there are not a disproportionate number of claims breaching their retention levels from the additional claims, he said.

“Because a number of these cases either settle for small dollars, or never make it beyond the pleading stage in many instances, it’s the companies that are out of pocket, because the defense costs only marginally exceed, or don’t exceed, the retention amount,” said Mr. Vanzura. “You haven’t shifted the landscape much for D&O insurers.”