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The Securities Litigation Reform Act that became law over President Clinton's veto last month may well prove a mixed blessing for business, resulting in fewer but more costly class-action securities suits.
Meanwhile, uncertainty over the new law's ultimate impact, coupled with an already competitive directors and officers liability insurance market, should prevent any significant changes in D&O rates for the immediate future.
Among the ways the act aims to protect companies and their officers from frivolous lawsuits are:
Providing certain protections from lawsuits over company statements.
Establishing a procedure for choosing "lead plaintiffs" in suits.
Limiting attorneys' fees.
Delaying discovery proceedings until after motions to dismiss a suit are considered.
Establishing proportional liability for defendants who didn't knowingly violate securities laws.
From a business perspective, most welcome the reforms. The reduced liability for company statements and a provision that discovery be suspended while motions to dismiss are considered are seen by many as particularly beneficial.
"Securities litigation had gotten really out of hand with suits being filed it seemed off word processors if a company's stock value happened to go down," said William J. Kelly, senior vp at J.P. Morgan & Co. Inc. in New York.
"I think it will be a positive thing to try to reduce some of the frivolous suits that seem to be filed to produce settlements rather than to address grievances," said Mr. Kelly, who also is president of the New York-based Risk & Insurance Management Society Inc.
"It's a step in the right direction. It is going to be of value," said Brian L. Smith, senior vp at the Willis Corroon Financial Services division of Willis Corroon Group P.L.C. in New York. "And I think longer term, the value might be better realized than in the short term."
Skip Orza, vp and directors and officers liability product manager at Warren, N.J.,-based Chubb Corp., agreed the reforms are "a move in a positive direction." He added, though, it's hard to say how it's going to affect insurance."
"We don't know what the direct results are going to be," Mr. Orza said. "We believe that some provisions are going to increase costs and thus expenses to us, some provisions are going to decrease costs and some are going to do both."
And Kristian P. Moor, president of National Union Fire Insurance Co. of Pittsburgh, Pa., a unit of New York-based American International Group Inc., stressed that "the law is intended to be litigation reform, not liability reform. It does not reduce the personal liability of directors and officers."
The act should bring some relief to some industries, particularly high tech and bio tech, Mr. Moor said. However, he noted that it only applies to shareholder class actions stemming from federal securities laws, and does not apply to cover shareholder derivative suits or cases arising from initial public offerings.
Dan A. Bailey, a D&O specialist with the Arter & Hadden law firm in Columbus, Ohio, predicted the securities law will result in fewer cases being filed and more being dismissed once they are filed, though "the numbers are not going to be dramatic."
"The counterbalance to that is, for those cases that do survive the procedures in the statute, the settlement numbers are going to be increased," Mr. Bailey said.
There are several reasons why costs associated with lawsuits that do go forward could be higher.
A requirement in the new law that members of the class bringing suit be notified of what any proposed settlement represents as a percentage of total recoverable damages for all plaintiffs could prompt more class members to reject settlements, Mr. Bailey said. "I believe plaintiffs lawyers, to avoid that risk, are going to insist upon larger settlements," he said.
What's more, a requirement that attorneys' fees be limited to a "reasonable percentage" of the class recovery could give plaintiffs lawyers another incentive for demanding larger settlements, Mr. Bailey said.
Another measure some believe could actually drive up securities suit costs is the act's "most adequate plaintiff" provision, which designates a procedure by which class members may come forward to be designated "lead plaintiff"-the class member then responsible for selecting legal counsel for the class. The requirements would increase the likelihood that the largest shareholders would be designated the lead plaintiff.
Congress' intent in the measure, most believe, was to weed out "professional plaintiffs," ideally replacing them with institutional investors as lead plaintiffs.
But institutional investors could be "more formidable adversaries" than many of those who've led securities class actions in the past, said Kevin M. LaCroix, president of PRMS Advisory Services in Beachwood, Ohio. PRMS is the underwriting manager for General Reinsurance Corp.'s Genesis Insurance Co. unit.
Given their greater financial stake and fiduciary responsibilities to their beneficiaries, the institutional investors could be more likely to take suits all the way to judgment or demand larger settlements, saidMr. LaCroix.
Chubb's Mr. Orza sees the lead plaintiff provision as a plus overall, but agreed that, "if they seek to play this out all the way to the end, that's going to increase costs."
Mr. Bailey isn't convinced that will occur, however.
"If in fact institutional investors step up and become the lead plaintiffs, I think that's a valid observation," he said. "I have difficulty seeing them do that, though. They really have little motivation."
Some also see added costs in the volume of litigation that will no doubt be devoted to clarifying details of the new act's language.
"There's going to be a fair amount of litigation just until these issues get sorted out a little bit by the courts," Mr. LaCroix said. "My guess is there are still going to be factual situations that are going to provoke lawsuits and they're still going to have to sort out some of these issues."
As an example, he cited the act's provision creating a safe harbor from liability for certain forward-looking company statements, provided those projections are accompanied by "meaningful cautionary statements identifying important factors" that could cause actual results to differ from those projected in the statement.
"I think Congress felt they had a very clear idea of what 'meaningful' means," Mr. LaCroix said. "But until the courts can come up with some sort of reliable measure for what that language means, I think there are going to be some conflicts."
Most see the forward-looking statement safe harbor as one of the most significant provisions of the new securities litigation law. But, it appears company directors and officers will have to be careful if they're to preserve the protection from litigation the act offers.
"There is a message here that you must take certain steps with respect to your public communications in order to get the benefit of this defense," Mr. LaCroix said. "And hopefully companies are going to."
"Within the safe harbor it is absolutely critical that directors and executive managers identify the procedures they have to follow in order to capture the safe harbor benefit," Mr. Smith said. "It looks like it will be so easy to blow it. One off-the-cuff statement can come back to haunt them."
And boilerplate language in company statements won't be enough to satisfy the law's requirements, he said.
"They have to actually give fairly specific examples and reasons of where the forward-looking statements may not work," Mr. Smith said. For example, he said, a discussion of revenue growth with a caution that revenue goals might not be met must be accompanied by "pretty specific examples" of what events could prevent the company from reaching its revenue goals.
Mr. Bailey isn't convinced, however, that the safe harbor provision is that significant for minimizing liability.
The provision "will be helpful in defending these cases, but I don't think that it's going to be the panacea that a lot of people are predicting," he said. "My suspicion is the plaintiff lawyers will find a lot of ways to plead around that safe harbor."
National Union's Mr. Moor also emphasized the safe harbor's limits, saying that the biggest D&O cases National Union has faced wouldn't have benefited from it.
"Our most severe cases have not involved forward looking statements, but rather misleading current or past financial statements, such as overstated inventory, early recognition of revenue, late recognition of expenses and, more generally, financial restatement," he said.
Costs could also be driven up by plaintiffs lawyers seeking to circumvent the new federal law by filing cases in state courts, Mr. Moor believes.
"To the extent that cases are brought more frequently in state court...litigation and claims could become more expensive, since pleading requirements and discovery vary widely by jurisdiction," he said.
Another provision aimed at reducing directors' and officers' exposure-a provision that unknowing violators of securities laws are only responsible for the proportion of damages related to the harm they've caused-will also result in considerable additional litigation, Mr. Bailey predicted, at least in the short run.
"It's going to be awfully interesting to see how that plays out in the allocation context," he said. He noted that recent federal appeals court rulings on liability allocation have suggested that the corporation is its own entity with its own liability.
"You put those two together, and there's fair argument that the Ds and Os only have to pay a small part of the liability and the corporation has to pay a larger part of the settlement," he said. "I'm confident you will see carriers argue that."
But, in providing new reasons for allocation disputes, the securities litigation act should also provide added incentive for D&O insurers and their policyholders to resolve allocation issues during the underwriting stage rather than when claims are filed, Mr. Bailey said.
"If you don't address allocation in the underwriting context you've got some issues you have to resolve in the claims context, which is not the preferred way to do it," he said.
Given the uncertainty over the act's ultimate impact, most D&O underwriters seem to be taking a "wait and see" approach toward how it will affect premiums, Mr. Smith said. "I think the market pressures are going to keep the premiums down right now more effectively than this piece of legislation," he said.
And J.P. Morgan's Mr. Kelly said he isn't sure how much room there is for downward movement in D&O rates, even if the new law is perceived as significantly reducing securities litigation losses.
"You have to look at the D&O market as it presently exists," he said. "And it's probably softer than it's been for quite some time, so how much more room there is for elasticity I guess we'll see."
At underwriting manager PRMS, the uncertainty surrounding the act only reinforces the company's approach of encouraging companies to take steps to reduce exposure to securities suits, Mr. LaCroix said.
"Our view here is it's too early to tell, but one thing we're sure of is that we will continue to give premium discounts to companies that have implemented securities litigation loss prevention measures," he said.
At Chubb, D&O rates won't be adjusted until the company gets a clear picture of the act's effect on losses over time, Mr. Orza said.
"We're going to start monitoring the effects of the law on our book going forward from a loss standpoint," he said.
"There's going to be a tremendous amount of pressure out there from some people who view this positively and believe that our losses must be down, so we should reduce rates accordingly," said Mr. Orza. "I don't know that that's in the cards at this point."