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A U.S. Supreme Court ruling earlier this year that held class actions related to initial public offerings can be heard in state court already has led to increased directors and officers liability rates for IPOs and higher retentions, say experts.
The higher costs related to state court litigation, and the perception that state courts are more plaintiff-friendly, has resulted in insurers reconsidering their IPO D&O coverage following the high court’s ruling in Cyan Inc. et al. v. Beaver County Employee Retirement Fund, experts say.
They say unlike federal courts, where dismissals are also higher, litigation brought in different state courts cannot be consolidated, which leads to a greater volume of cases.
Much of the IPO litigation is being filed in Northern California, especially in Santa Clara and San Mateo counties, which are considered to be particularly plaintiff-friendly, experts say.
One possible way to avoid state court suits could be having corporate by-laws that require litigation to be filed in more defense-friendly federal courts, although it is still unclear whether this effort will ultimately be successful. A case on this issue is now before the Delaware Chancery court.
Establishing an early relationship with a D&O insurer is among the advice given by experts to address this issue (see related story).
On March 20, the high court ruled unanimously in Cyan that amendments to the federal Securities Act of 1933 do not give federal courts exclusive jurisdiction over these cases.
Matthew W. Close, a partner with O’Melveny & Myers LLP in Los Angeles, said the Cyan ruling has “energized the plaintiffs in the class action bar to bring more of these cases in state courts.”
“My sense is plaintiffs lawyers are scouring for stocks or bonds that have not performed well over the last year or two and looking to see if they can pin a case on them” now that they can file suit in state court, he said.
“It’s kind of open season with respect to the state courts, and litigation has shifted from federal court to state court” in these cases, said James C. Dugan, a partner with Willkie Farr & Gallagher LLP in New York.
“Plaintiffs are bringing cases in state courts to take advantage of the procedural difference between state and federal courts,” said Mr. Dugan.
He said unlike federal courts, state courts do not have automatic stays of discovery, and it is generally harder to have successful motions to dismiss. The cases then proceed to the expensive discovery process, which drives up their settlement value and increases the amount of time it takes to resolve them, he said.
Furthermore, unlike federal litigation, cases filed in different state courts cannot be consolidated, “so they must deal with litigation in several different jurisdictions,” said Jackie Waters, Chicago-based managing director of the Aon Risk Solutions financial services group’s legal and claims practice.
Rob Yellen, New York-based executive vice president of Willis Towers Watson PLC’s FINEX North America practice, said, “You could see a new cottage industry springing up, where lawyers who are a lot more comfortable in state court — and not just in California — realize they’re actually better litigating in state court” IPO claims because of their knowledge of discovery rules. “It’s their home town,” he said.
Litigation is “bleeding now over into secondary offerings … and we’ve even seen” a claim that is part of a merger and acquisition, said Rachel Turk, London-based focus group leader, D&O, for Beazley PLC. IPO-related claims have to date been filed in 10 state courts, including Massachusetts, New York and Colorado, she said.
Mr. Close said California courts in particular are attracting the IPO cases, in part because of the large number of IPOs in the state as well as because it is relatively convenient to file litigation there for cases involving foreign jurisdictions including China.
Mr. Close said also, however, that in the past six to 12 months there has been some pushback by California judges. “I am seeing some indication that some of the judges in some of the higher-volume courts are increasingly taking a hard look at these cases,” and are sensitive to their volume, and to their courts becoming a magnet for this litigation, he said.
Meanwhile, insurers have reacted to the Cyan ruling, say experts. “If you’re planning an IPO, the insurance is a lot more expensive and the retentions are a lot harder,” said Ms. Turk.
Colin Daly, Denver-based executive vice president of JLT Specialty USA, a unit of Jardine Lloyd Thompson Group PLC, said even before the Cyan ruling, “carriers were adjusting their underwriting stance for IPOs, especially California IPOs, because of their exposure,” and were either getting out of the IPO space or moving to excess lines, as well as trying to get higher retentions.
“Then Cyan gets decided, and it becomes an even more difficult marketplace” to write D&O coverage for IPOs, he said.
“We saw, overnight, deductibles go to five times what they were before,” with some insurers cutting limits and premium rates increasing dramatically as well in some cases, he said.
“The whole tower has become very expensive,” he said. Nor does company size matter, he said. There is a “completely different market than you would have two years ago, or even a year ago.”
Measures firms can take to avoid becoming the focus of the increased initial public offering litigation being filed in more plaintiff-friendly state court include developing a relationship early with their directors and officers liability insurers.