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Goldman legal woes could hit insurers

AIG leads coverage for investment bank's directors, executives


NEW YORK—Goldman Sachs Group Inc. has insurance in place to protect directors and executives should they become embroiled in the controversy over the investment bank's subprime mortgage-related deals, but whether that coverage will be called into play remains unclear.

New York-based Goldman purchases only Side A directors and officers liability coverage, with American International Group Inc. leading a “massive tower” of limits, arranged by Aon Corp., market sources said. Most of the world's largest D&O insurers participate in providing the tower, the sources said.

But whether that coverage ultimately will fund a defense against recent Securities and Exchange Commission allegations will hinge on “indemnification” considerations, experts said.

And tapping Goldman's D&O coverage for any securities litigation that could potentially ensue after the bank's stock dived when the SEC's allegations were revealed would depend on whether claims are considered “non-indemnifiable,” meaning the company cannot or will not provide a defense or indemnify individuals for a lawsuit settlement, the experts added.

The SEC alleges in a complaint filed April 16 that Goldman made material misstatements and omissions in connection with a synthetic collateralized debt obligation linked to subprime mortgages and that it did not disclose to investors that it had received a Wells notice from the SEC. A Wells notice is an SEC letter stating it intends to begin enforcement proceedings (see story, page 55).

In addition to Goldman, the SEC's complaint names Fabrice Tourre, an executive director of Goldman Sachs International.

Meanwhile, the law firm of Shepherd Smith Edwards & Kantas L.L.P. issued a statement last week that it is investigating claims on behalf of Goldman clients as a result of the SEC's legal action.

And AIG reportedly is looking at recovering some of its roughly $2 billion in losses related to guarantees on Goldman CDOs.

Few D&O policies exclude coverage for claims arising from providing professional services. So a D&O policy would likely cover lawsuits brought by buyers of Goldman products, and not just claims of shareholders, as long as the plaintiffs are alleging wrongdoing by the directors and officers, sources said.

But it remains unclear whether any potential defense costs or settlements will be funded by D&O insurance coverage.

Side A policies provide coverage only for individuals, not their companies, and the policies only trigger when individuals are not indemnified by their companies, for example, when companies are insolvent or legally barred from acting for the individuals.

Public policy prohibitions, company bylaws or indemnification agreements addressing issues such as a person's conduct are among considerations that can prevent a company from indemnifying individuals, said Carolyn H. Rosenberg, a Chicago-based insurance recovery partner at law firm Reed Smith L.L.P.

If it were called on, however, Side A coverage typically would defend individuals against an SEC complaint, such as the one filed against Goldman and Mr. Tourre, said Susanne Murray, a New York-based executive vp of executive risk at broker Alliant Insurance Services Inc.

Most policies do not provide coverage for fines and penalties when they actually are awarded, Ms. Murray said. But there may be coverage for any settlement because settlements are not considered fines or penalties, although the SEC could object to insurance funding for a settlement.

Legal sources say Mr. Tourre could qualify as an insured officer under Goldman's D&O coverage, depending on policy language.

But D&O policies usually state that it is presumed that if a company is capable of indemnifying an individual, the company's indemnification—not insurance—should first meet costs associated with D&O-related actions, said Mary E. McCutcheon, a securities and insurance expert at Farella Braun + Martel L.L.P. in San Francisco.

Additionally, Goldman bylaws could obligate it to defend its employees, and failure to do so essentially would be an admission that an employee's conduct was improper, which ultimately could hurt Goldman's defense, said attorneys specializing in D&O coverage.

Therefore, companies in joint defense cases generally are reluctant to cut their employees loose to fend for themselves, attorneys said.

“They would rather work with those employees rather than alienate them,” Ms. McCutcheon said. But, in some cases, a company may choose to do so.

Such issues mean insurers ultimately may not fund any defense by Goldman against the SEC charges or provide indemnification for any penalties, attorneys said.

While there appears not yet to have been any securities lawsuits filed against Goldman, such lawsuits are often filed against companies that experience significant drops in their share price over a short period. Goldman's shares closed at $157.40 last Friday, down 14.6% from their close on April 15, the day before the lawsuit was filed.

Should a lawsuit arise and name Goldman directors and officers, Side A coverage theoretically could respond, experts said.

But the same indemnification issues would determine whether Goldman or its insurers ultimately provide a defense and settlement indemnity for any individuals named in a lawsuit, sources say.

In typical class action lawsuits, unless there is a determination that an individual is not entitled to indemnification by a company—for example, because of potential public policy violations, egregious fraud or insolvency—then the policyholder would advance its defense costs and indemnify the individual, sources said.

In that case, the Side A coverage would not pay.

But Goldman may not be allowed to indemnify individuals should securities plaintiffs pursue a derivative claim, attorneys said. Derivative cases are often brought by shareholders on behalf of corporations against third parties, such as directors and officers of the corporation. In derivative cases, companies can indemnify individuals named in a suit for defense costs, but not for settlement costs.