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Directors and officers lawsuits increase for midsize firms

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Directors and officers lawsuits increase for midsize firms

CHICAGO—Although lawsuits charging directors and officers of large, publicly traded companies with malfeasance may capture the headlines, experts say middle-market and small firms also are becoming frequent targets of such litigation.

Whether they are publicly traded, privately held or a nonprofit, midsize and smaller firms also risk lawsuits filed by employees, competitors, vendors and regulators, they say.

Some 160 securities lawsuits have been filed against publicly traded companies in the first half of this year, more than any first-half of the year since 2002, said Ann Gron, vp at NERA Economic Consulting in Chicago. If second-half filings follow the pattern of prior years, “you can expect more in the second half than in the first,” she said during a session on trends in claims against directors and officers during the Crittenden Middle Market Insurance Accounts Conference held Sept. 11-13 in Chicago.

But it's not just publicly traded middle-market companies that are at risk, said Debbie Schaffel, managing director of the financial services group at Aon Risk Solutions in Chicago, a unit of brokerage Aon Corp. “A lot of middle-market companies, especially closely held private companies, forget they have exposures beyond shareholders,” she said during a conference session highlighting the chief insurance concerns for midsize companies.

“All it takes is one family member to get upset with other family members, and all of a sudden you have infighting issues. There's more exposure out there than you might think,” Ms. Schaffel said.

Family claims are especially difficult to resolve because they involve intense emotional ties, said De'Andre Salter, CEO of Professional Risk Solutions L.L.C. in Warren, N.J., who spoke during a session on emerging specialty coverage for middle-market companies.

Recent publicity over the massive class action lawsuit against Bentonville, Ark.-based Wal-Mart Stores Inc. charging violations of the Fair Labor Standards Act is triggering similar wage-and-hour litigation against small and midsize companies nationwide, said Alton Moore, San Francisco-based assistant vp of specialty casualty underwriting at Liberty International Underwriters, a unit of Liberty Mutual Group Inc. The fact that this suit was denied class action status because the court felt that the class was too large does not preclude other employees from filing wage-and-hour suits, he said.

“FLSA claims have gone through the roof in California,” Mr. Moore said. “The bottom line is, we are in a bad economic environment. Regulators are looking for places to find recoveries and this is one of the ways they are doing that. They are going after employers.”

Keith Lavigne, senior vp, professional risk, at ACE USA in New York, said he has seen situations where midsize companies had to defend themselves after complaints by their competitors triggered Justice Department investigations into their business practices.

Oftentimes, middle-market companies involved in mergers or acquisitions become embroiled in litigation filed by shareholders concerned that they may be paying too much or getting too little out of the deal, said Mike Early, assistant general counsel at Chicago Underwriting Group Inc. in Chicago.

It's an almost automatic reaction, he said. After a company announces an M&A, a plaintiffs law firm issues a news release stating it is investigating the transaction. While terms of the deal don't change in most cases, what Mr. Early called “nuisance suits” generate legal fees and an insurance claim for businesses that have purchased appropriate coverage, usually directors and officers liability insurance.

About one-third of such cases are being filed in federal court, but the rest are in state courts and oftentimes in multiple jurisdictions, he said.

“I've got one case where the company being acquired is being sued in state court and federal court for selling out for too little; while in another jurisdiction, the acquiring company is being sued for paying too much,” Mr. Early said.

“There's obviously a correlation between the economy and these lawsuits,” said Anjali Das, a partner at Wilson Elser Moskowitz Edelman & Dicker L.L.P. in Chicago. “Lots of companies are very flush with cash, looking to acquire companies. This may be good for investors, but the plaintiffs bar wants their cut, too.”

As more middle-market companies conduct business overseas, they also are being charged with violations of the Foreign Corrupt Practices Act, said Jerome Tomas, a partner at Baker & McKenzie L.L.P. in Chicago. Those especially vulnerable are companies doing business in emerging markets such as India and China, he said.

While it may seem to be standard business practice in many of those countries to pay civil servants “gratuities” to expedite the processing of permits, for example, such payments may be barred under FCPA, he said.

“The anti-bribery provisions state you can't make a payment, promise or offer of anything of value to a foreign government official to obtain business,” Mr. Tomas said. “That also includes payments made through third parties, whether it's your consultant, distributor or wholesaler. Who is a government official? The U.S. government says it can be employees of state-owned industries...therefore making a payment to them runs afoul of FCPA just as much as making a bribe payment to a minister of China,” he said.

“Some middle-market companies don't understand they have all of these exposures to deal with when they're running their business,” Mr. Moore concluded. While the allegations are often without merit, “defense costs can drive some of these companies into the ground, and they will go bankrupt trying to defend themselves,” he said.