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CALGARY, Alberta--Ontario's amended Securities Act has shot to the top of the list of concerns for independent directors of Canadian companies, although they appear to be covered by directors and officers liability policies for claims alleging violations of the revised law.
Independent directors of several large Canadian companies described their questions and concerns about D&O insurance policies and Canada's current litigation environment during the 31st annual Canadian Risk & Insurance Management Society Inc. conference in Calgary, Alberta.
The amended provisions of Ontario's Securities Act--known as Bill 198--impose civil liability for inaccurate or incomplete corporate disclosure in the secondary market. The amended law allows secondary-market investors to seek compensation for damages suffered if the issuer or responsible individuals make written or oral public disclosures that contain an untrue statement of a material fact or fail to make a timely disclosure (BI, Nov. 14, 2005).
The law has significant implications for independent directors who serve on the boards of companies registered in Ontario, said Douglas Hayhurst, a Vancouver, British Columbia-based accountant who serves on the boards of several Canadian organizations.
"Any director who is paying attention will be scared to death by Bill 198 and will understand that there are no clear answers yet--that this is an evolving issue," Mr. Hayhurst said.
In particular, directors on audit committees have increased responsibilities under Bill 198, often overseeing risk management within the organization, he said. His concern was heightened recently because he is the chair of the audit committee of Vancouver-based Northgate Minerals Corp., which announced in September that it would restate earnings for the second quarter. When company officials and board members were contemplating how to address the situation, the first concern expressed by the lawyers was in relation to Bill 198, advising the directors and officers to move quickly and cautiously when restating the company's earnings, Mr. Hayhurst said.
In performing due diligence on whether D&O liability insurance policies will adequately protect directors in the event of a lawsuit alleging Bill 198 violations, Mr. Hayhurst has asked whether the audit committee chair or audit committee members would be more liable for Bill 198 claims than other members of the board. Mr. Hayhurst received varying responses from legal counsel, with some saying that audit committee members would be held more accountable while others said they would not be.
"The audit committee chair... wants to be able to go back to the rest of the board and give them assurance that they are properly protected," Mr. Hayhurst said.
Due to the uncertainty, Mr. Hayhurst assumes a worst-case scenario that as an audit committee member he would be more liable for such claims. "I have to act on that basis," he said, adding, though, that assuming a worst-case scenario breeds good discipline.
While the secondary-market exposure is a major issue, the potential liability for directors should not be a terribly frightening prospect because D&O policies, unless they include a Bill 198 exclusion, will provide coverage for such claims, said Richard Shaw, a partner with Calgary-based McCarthy Tetrault L.L.P., who vets D&O policies on behalf of independent directors.
For example, directors will be covered for allegations of fraud related to restated earnings, he said. "If you're not a guilty party, you will have coverage on a restatement of earnings," Mr. Shaw said. "If it's an innocent financial error, you should be covered."
Aside from Bill 198 claims, independent directors have a number of other concerns about their exposures and their D&O coverage, the panelists told the Canadian gathering.
For example, income trusts, which have been increasing in popularity in Canada, are unique and evolving structures that initiate a host of issues, including examinations of the roles of directors and whether U.S. insurers that have modified their domestic policies for Canadian customers have taken into account the distinct features of Canadian income trusts, Mr. Hayhurst said.
Another major concern for independent directors are cross-border listed companies--organizations that are traded on exchanges in Canada and the United States--because that creates additional issues, particularly the need to navigate the deluge of U.S. shareholder lawsuits.
"That litigation mentality is much of what D&O insurance is about," said Harry Schaefer, a corporate director and business adviser with Schaefer & Associates Ltd. in Calgary, who serves on a number of boards, including as audit committee chair of Calgary-based TransCanada Corp.
In some cases, plaintiffs' lawyers are receiving bonuses if they can ensure that directors are forced to participate in any settlements, he said. "Shareholders are paying bounties to get directors," Mr. Schaefer said.
Read the policy
As the lawsuits emanating from the collapses of Enron Corp. and WorldCom Inc. demonstrate, directors need to ensure that the company and risk managers purchase coverage that is exclusively for directors' benefit, rather than for the company, as plaintiffs pursue the resources of the company's D&O policy, Mr. Schaefer said. "You need to focus on who the policy is for and what it covers," he said.
Having indemnification contracts in which companies agree to hold their directors harmless for claims is particularly important, especially in situations where there is a hostile takeover and the incoming board does not want to indemnify the outgoing members. In those situations, the outgoing directors can sue the company to force it to provide indemnification, but the process is time consuming and expensive, Mr. Shaw said. "This is really quite an area of risk for directors and officers," he said.
Another key limitation on indemnification is the financial stability of the company, Mr. Shaw said. If the company becomes insolvent, "the indemnities aren't worth the paper they're written on," he said.
Due to the risks inherent in serving as an independent director, many now insist that lawyers, such as Mr. Shaw, review the company's D&O policies so directors know the exact scope of coverage.
In such reviews, facets of D&O policies that are examined include policy limits, deductibles, terms and exclusions, he said. Some of the more common exclusions involve insider trading profits, deliberately fraudulent acts or omissions, and insured vs. insured exclusions that allow the company to sue the directors. Mr. Shaw said he asks insurers to expand coverage, for example, to cover directors who are sued by a bankruptcy trustee--an exception to the insured vs. insured exclusion that insurers are willing to provide.
Examine claim terms
For D&O policies that cover both directors and the company, Mr. Shaw advocates the addition of a priority of payment clause that would ensure directors would be paid first in the event of a claim.
Carefully examining severability clauses is necessary to ensure that the statement and knowledge of one insured cannot be imputed onto the other insured parties, he said.
The ability of insurers to rescind coverage under D&O policies is another factor that directors need to examine to learn which circumstances enable carriers to bring rescission actions, Mr. Hayhurst said. Directors as well as risk managers securing D&O coverage should carefully examine the wording and phrasing in these policies to check for any language that would allow insurers to deny coverage--even statements that are not explicit exclusions, but may function as exclusions because of broad phrasing.
With regard to rescindability of D&O policies, though, insurers in Canada do not rescind coverage very often and usually do so only because of prohibitions against the coverage, Mr. Shaw said. "The policies do provide decent coverage in my view," he said.
The session was moderated by Andrea Orviss, the Vancouver-based senior vp of Marsh Canada Ltd.'s Western D&O practice.