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Strong IPO market expected to continue and bring more litigation


While the number of initial public offerings so far this year is less than at this time last year, more litigation reflecting last year's high volume is expected.

But insurers' appetite for IPO-related directors and officers liability coverage remains robust, with the possible exception of life sciences-related offerings, many experts say.

There were 38 U.S. IPOs in the first quarter this year, down 46.5% from the comparable period a year ago, according to London-based Ernst & Young L.L.P. While the IPO market now is taking time to absorb 2014's strong activity, it is expected to gain strength, according to the accounting and consulting firm.

“Litigation correlates with IPO cases. Obviously, there's more litigation activity when there's more IPOs,” said Jacqueline Urban, Chicago-based senior managing director and practice leader in Aon Risk Solutions' financial services group.

Litigation typically is filed within three years of an IPO, usually in response to lower stock prices sparked by a company announcement. IPOs are governed by Section 11 of the Securities Act of 1933, under which plaintiffs do not have to prove there was intent or knowledge of issuer wrongdoing in their registration statements.

“The further you get away from the IPO date, the tougher it is for the plaintiffs to maintain a Section 11 claim,” said Joseph Monteleone, a partner at Rivkin Radler L.L.P. in Hackensack, New Jersey.

Observers say it is crucial that companies going public have experienced, knowledgeable advisers and are upfront about possible risks.

“If you're going to go public, you really need to be prepared for the kind of scrutiny you're going to be under,” said Kevin LaCroix, executive vice president at RT ProExec, a division of R-T Specialty L.L.C. in Beachwood, Ohio.

“The one way to avoid lawsuit is not only initial transparency, but continual transparency,” said Heidi A. Lawson, a member of law firm Mintz Levin Cohn Ferris Glovsky & Popeo P.C. in Boston.

“But at the end of the day, every company that goes public is still subject to the vagaries of the stock market,” said Brendan Dolan, Los Angeles-based managing director and part of the management and professional risk group at Crystal & Company.

“You never can completely eliminate the risk of IPO-related securities claims, so it is critical for any company whatsoever that is conducting an offering to make sure that it has strong protections like strong D&O insurance in place,” said Carl E. Metzger, a partner at Goodwin Procter L.L.P. in Boston.

Meanwhile, a recent registration statement-related ruling by the U.S. Supreme Court is not expected to have a dramatic effect on the IPO market. In its March 24 ruling in Omnicare Inc. v. Laborers District Council Construction Industry Pension Fund et al., the high court held that under Section 11, a statement of opinion in a registration statement may be incorrect but does not necessarily create liability if it was “sincerely held.”

The ruling's bottom line is that statements made based on honestly held beliefs and developed from relevant and reasonable data points “can be wrong without having Section 11 liability,” said Priya Cherian Huskins, a partner and senior vice president at broker Woodruff-Sawyer & Co. in San Francisco.

Observers say the ruling was in line with many circuits' rulings on this issue.

The ruling's impact “will largely be neutral,” said Steve Boughal, New York-based vice president and chief underwriting officer of Hartford Financial Products, a unit of The Hartford Financial Services Group Inc.

The bigger impact on litigation will be how stocks perform, said Rob Yellen, New York-based executive vice president of Finex North America, a unit of Willis Group Holdings P.L.C.

Generally, D&O insurers welcome IPO business.

“The underwriters see it as a good opportunity,” said Peter Taffae, managing director at Los Angeles-based Executive Perils Insurance Services. “The severity of claims is down, and the frequency is down,” he said, adding that this could be a reflection of the slower IPO market in 2011 and 2012.

However, life sciences companies such as pharmaceutical and biotechnology firms have more trouble lining up coverage.

“It's extremely difficult for them to find a primary carrier at a reasonable price and fair terms,” Mr. Dolan said. “They need to be very proactive in telling their story to D&O underwriters to secure best terms for the capacity they require.”

“Many of these companies are one-product owners,” and if they do not, for example, get U.S. Food and Drug Administration approval for their product, “their stock is going to tank, and the question is, "What did they know?' “ and when such information should have been disclosed, Mr. Monteleone said.

Some experts say it is not uncommon for life sciences companies to be able to obtain only $5 million primary coverage, then have to build additional coverage in $5 million segments through excess layers.