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Directors', officers' exposures grow

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NEW YORK—Directors and officers insurance claims litigation may be waning, but D&O liability exposures continue to grow, with possible new sources of claims sprouting from issues concerning executive compensation and corporate governance, market experts say.

Panelists speaking at the Professional Liability Underwriting Society's 2007 D&O Liability and Insurance Issues Symposium reiterated that message during the conference, which was held Jan. 31-Feb. 1 in New York.

Studies in 2006 showed a major decline in securities fraud class action filings, which dropped more than 40% over historical averages.

But the downward trend cannot be attributed to increased vigilance by auditors as some pundits have said, noted Denise M. Amantea, partner with Woodruff Sawyer & Co. in San Francisco. "I think the filings are down because Milberg Weiss got caught," she said.

Last year, plaintiff law firm Milberg Weiss Bershad & Schulman L.L.P. was indicted on federal charges for allegedly making secret payments to lead plaintiffs. That indictment is the "single biggest reason class actions have dropped off," said Michael Mitrovic, president, worldwide financial services with American International Group Inc. in New York.

Before the indictment, various industry watchers estimated that Milberg Weiss was responsible for more than half of the annual securities class action filings.

Claims 'hotbed'

While the number of D&O suits has declined, new sources of claims continue to develop in the D&O world, panelists said.

A "hotbed for claims" can be found in companies' executive compensation practices, said Stephen J. Sills, president and chief executive officer of Darwin Professional Underwriters Inc. in Farmington, Conn.

Liz Smith, assistant vp, corporate governance, at Moody's Investor Service in New York, said 2007 will be a "watershed year" for investor outcry over companies' executive compensation practices—the most notable issue being the widespread options backdating scandal.

Although most shareholder lawsuits sparked by options-related problems at companies have been of a derivative nature, the increasing number of them means that some D&O underwriters could suffer, panelists said.

"The costs to defend these things are not cheap," said Kevin P. Gadbois, executive vp at Schaumburg, Ill.-based Great American Insurance Group. "It could take a major hit to the D&O industry to get these things out of the system."

While certain directors and officers may be forced to disgorge any allegedly ill-gotten gains, outside directors have a "very low likelihood" of having to pay out of pocket as a result of those cases, said Michael Klausner, a business and law professor at Stanford, Calif.-based Stanford Law School.

Another potential source of D&O claims will revolve around corporate governance, the panelists said.

Anthony S. Galban, senior vp and D&O underwriting manager for Chubb Specialty Insurance in Warren, N.J., said possible exposures can be found in rising animosity between boards and managements at public companies, brought on largely by Sarbanes-Oxley Act requirements for directors to report any illegal behavior.

Protecting outside directors

Dan Bailey, an attorney with Bailey Cavalieri L.L.C. in Columbus, Ohio, suggested that D&O policies need to evolve to account for this "growing wedge" between boards and senior management, and called on the insurance industry to devise better ways to structure policies and ensure that outside directors are getting educated on exposures and the types of insurance that can respond.

Additionally, the increasing role of private investor financing in public companies—with more and more representatives from private equity firms and hedge funds being included on boards of directors—is leading to conflicts of interest where D&O claims can follow, the speakers said.

Whether there is actually wrongdoing, private equity firms are getting named in suits because the firms have "deep pockets" and the cost of defending those claims is expensive for D&O underwriters, said Mark Vandevanter, vp at XL USA in Hartford, Conn.

Speakers during the conference stressed that D&O exposures are arising in jurisdictions outside the United States. Countries to watch for increasing D&O litigation risks include Germany, the Netherlands, Spain, Sweden and the United Kingdom because systems already are in place that allow collective action by multiple claimants.