Corporate spying raises questions on D&O coverage

Despite potential criminal charges and damage claims that corporate espionage cases-like the one in which Hewlett-Packard Co. is embroiled-can generate, the executive masterminds behind such spying may not be left out in the cold without insurance, according to experts.

But directors and officers liability insurance may not cover all of the costs those executives could face, said an insurer attorney and two brokers.

All three experts spoke in general terms about the D&O liability insurance issues that could arise in internal or external company espionage capers that are exposed-not specifically about the Hewlett-Packard situation.

California's attorney general's office said it likely will file criminal charges against some executives at Palo Alto, Calif.-based HP for their alleged roles in illegally collecting personal phone records of company board members and several reporters. The vendors that HP retained to collect the records through a process known as pretexting-which involves duping phone companies into assuming they are releasing personal records to their customers-also could face charges, according to the attorney general's office.

Leaks of confidential corporate information to the press triggered HP's internal investigation of its board, according to the company.

As the company's boardroom drama unfolded last week, Chairman Patricia Dunn issued a statement in which she apologized to the board and announced that she would resign as chairman in January but would continue as a director.

But in her statement, posted Sept. 12 on the company's Web site, Ms. Dunn also defended the company's investigation of its board-an investigation that she said spun out of control.

"These leaks had the potential to affect not only the stock price of HP but also that of other publicly traded companies. Unfortunately, the investigation, which was conducted with third parties, included certain inappropriate techniques. These went beyond what we understood them to be, and I apologize that they were employed." Ms. Dunn said in the statement.

Companies that engage in similar subterfuge against either competitors or their own management could face various lawsuits and criminal investigations if their actions are exposed, the experts noted.

But unless a derailed corporate espionage mission hurts the culprit's financial performance and leads to a significant and sustained drop in the company's share price, a shareholder class action lawsuit would be unlikely, the experts agreed.

Even so, an organization's espionage escapades may prompt a shareholder derivative action lawsuit designed to recover any losses the company sustains as a result of wrongdoing by its management, the experts agreed. Those losses could include the company's defense costs in a criminal case, any fines and penalties it is ordered to pay, any diminution in the value of the company's reputation, and the value of any acquisitions or contracts the company lost because of such a scandal, the experts said.

Coverage questions

Whether the defendants could tap their D&O policies to cover the damages related to fines and penalties the company paid is questionable, said broker Nicholas Conca, a managing principle with Integro Ltd. of New York.

Mr. Conca said "there may be an argument" that those fines and penalties amount to damage and economic loss to the company and therefore should be covered as part of the damages sought in a derivative action lawsuit.

"If I'm sued as a director because I failed to oversee the company, I'm being sued for economic damages-I'm not being fined by the shareholders," Mr. Conca said.

But, Mr. Conca also noted that "the definition of loss generally excludes fines and penalties," and garnering coverage for them would be difficult "under any circumstances."

That issue may be moot, however, according to insurer attorney Dan A. Bailey, a partner with Bailey Cavalieri L.L.C. of Columbus, Ohio. Mr. Bailey said the economic damage to a company tripped up while spying on its own management may not be "a large enough number to attract a plaintiffs attorney."

Broker Ann Longmore was not so certain. "In today's world, it's hard to imagine this situation not leading to a shareholder suit," said Ms. Longmore, a New York-based executive vp and the D&O product leader for the Willis Executive Risks practice in North America at Willis Group Holdings Ltd.

A more likely lawsuit would be an invasion-of-privacy case filed by directors who were targets of a probe, Mr. Bailey said.

But if a director were to sue fellow board members for invasion of privacy, the defendants could not tap their traditional D&O policy for coverage since D&O policies exclude coverage when one insured individual sues another insured, Mr. Bailey noted.

Side A policies

If the company had purchased a separate Side A-only difference-in-conditions policy, however, the defendants might be able to tap it, the experts said. While those policies typically include a company vs. insured individual exclusion, many do not contain an insured vs. insured exclusion, they noted.

Most D&O policies still would be in play, however, if corporate espionage exposes the perpetrators to criminal charges, the experts noted.

The policies would cover the defendants' legal costs, the experts agreed.

But any fines or penalties would be left to the defendants to cover personally, Mr. Bailey said.

Even a guilty verdict would not necessarily require the defendants to return their defense coverage, Mr. Bailey noted.

For example, while policies typically exclude coverage for deliberate fraudulent acts, Mr. Bailey said he doubted that a conviction on charges related to corporate espionage could be characterized as fraud.

Of course, coverage under traditional D&O policies would depend on an organization first agreeing to indemnify its directors and officers for their legal costs and then seeking recovery from its D&O insurers. As allowable under state law, organizations generally agree to indemnify their executives-even those convicted in a criminal case-as long as the defendants maintain they did not believe they were violating any laws and were acting in their organization's best interests, the experts said.

As support for their claims that they did not intentionally commit any wrongdoing, defendants could argue they relied on outside data-gathering companies and the advice of the company's general counsel.

But Ms. Longmore questioned whether that defense could succeed if the only way to obtain certain intelligence would be through illegal measures, even if operatives were not authorized to collect the information through any means. "Can I play ostrich? Is that enough of a defense?" Ms. Longmore asked.

Another coverage problem for defendants could arise if, to avoid a public relations backlash, a company's board refuses to cover the defendants' defense costs even when the company's governance rules would allow it, Mr. Bailey said.

Even in that scenario, the defendants still may have coverage-if the company purchased a separate Side A-only policy, Mr. Bailey said.

Side A policies may even cover the six- or seven-figure corporate deductible that the company would have had to assume if it indemnified the defendants and then sought a recovery from its traditional D&O insurers, Mr. Bailey said.

But, in that situation, the Side A insurer would have the right to seek reimbursement of the deductible from the company, which already had decided against covering its executives, Mr. Bailey noted. "That could be an interesting show."