Rise in bribery probes may hit D&O insurers

NEW YORK—The expected sentencing this week of a Connecticut investor for conspiring to bribe foreign government officials highlights an emerging area of concern for directors and officers liability insurers and policyholders, observers say.

Frederic Bourke Jr. was convicted in July by a federal jury in Manhattan of violating the Foreign Corrupt Practices Act, among other charges, in connection with an alleged scheme to bribe Azerbaijan government officials.

The FCPA prohibits paying foreign government officials to obtain or retain business. Mr. Bourke, co-founder of handbag manufacturer Dooney & Bourke Inc., did not pay bribes himself. But he invested $5.7 million with a Czech expatriate whom he knew—or should have known—planned to bribe Azerbaijani government officials, jurors found.

Viktor Kozeny, the Czech man who paid Azerbaijani officials as part of a failed scheme to privatize Azerbaijan's state-run oil industry, is in the Bahamas, fighting extradition.

Mr. Bourke lost his invested money, as did Kozeny's other investors, including American International Group Inc. and former Senate Majority Leader George Mitchell. But the FCPA bars attempted bribes, even if unsuccessful, and jurors found that Mr. Bourke must have known Mr. Kozeny's intentions. Mr. Kozeny was sometimes called the “Pirate of Prague” for allegedly stealing investor money as part of a similar scheme in the Czech Republic, and two witnesses said Mr. Bourke knew of the bribes.

The case is part of a pronounced effort by the federal government in recent years to enforce the 1977 statute more aggressively, legal observers say. The Securities and Exchange Commission has established a dedicated FCPA enforcement unit, and the Justice Department says it is investigating at least 120 companies on five continents.

The number of SEC and DOJ enforcement actions has increased 500% between 2004 and 2009, according to Washington-based Gibson, Dunn & Crutcher L.L.P., which tracks such actions.

Observers say the FCPA could become a significant exposure for D&O liability underwriters.

“It is absolutely a concern of directors and officers and has received attention in D&O insurance policies,” said Carolyn Rosenberg, a Chicago-based insurance recovery partner at law firm Reed Smith L.L.P.

Fines and disgorgement penalties paid in connection with SEC or DOJ probes likely would be excluded from coverage under most D&O liability policies, legal observers agree. But defense costs for such cases likely would be covered by D&O liability policies. Those costs often can be significant and sometimes blow through D&O liability limits, said Kay Wilde, a Chicago-based consultant in Lovells L.L.P.'s insurance and reinsurance group.

In addition, observers say FCPA violations make follow-on litigation—a securities fraud or derivative suit—more likely. In addition to its bribery prohibition, the FCPA also requires companies to maintain adequate internal accounting controls and accurate and transparent records. Violations of this “books and records” provision of the FCPA often provide a foundation for suits alleging that directors and officers breached their fiduciary duty, observers say.

“I liken it to price fixing,” said Steve Shappell, managing director of Aon Financial Services Group in New York and Denver. “When there's a big price-fixing (incident), shareholder suits are following frequently because you're booking revenue based on money illegally earned and people wouldn't have bought securities if they knew you were making a lot of money because you were price fixing. I can see the same argument being made for the FCPA.”

The SEC has begun enforcing the “books and records” provision of the FCPA more aggressively, which provides more targets for potential plaintiffs lawsuits, said Brad Ockene, a Chicago-based partner at Lovells.

“It gives shareholders and plaintiffs more legal avenues to get to either a derivative suit or a (securities) lawsuit, following the investigation,” he said.

Mr. Shappell and Ms. Rosenberg said they have seen some D&O liability policies with exceptions that allow coverage for some civil fines. Mr. Shappell said underwriters have resisted these coverage carve-backs, and will resist more if a wave of FCPA-related litigation materializes.

“If we see flood of 50, 60 suits a year based on FCPA violations and announcements, the carriers are going to react and they're going to push back,” he said.

Mr. Shappell also said he expects underwriters to increase their attention and inquiries into a company's practices in foreign countries with an eye toward FCPA exposure. Only 31% of companies report having a “comprehensive” FCPA compliance program, according to a September survey by Deloitte Financial Advisory Services L.L.P.