D&O INSURANCE: PROTECTING BUSINESS “ELITES” ACROSS NATIONAL LINES IN A POPULIST AGE
A new administration poses fresh challenges for D&O carriers and their insureds
“Yankee, stay home!”
In light of recent political developments, directors and officers of U.S. corporations might be inclined to take that imperative as good advice.
The British referendum vote to leave the European Union, Donald Trump’s election as president of the United States, and the rise of nationalist political parties in Europe all share a common driver: popular discontent over immigration and perceived imbalances in economics and trade.
Even before the latest storm broke, a review of directors and officers coverages available from insurer Zurich provided a sobering reminder of the personal risks facing officers and directors in the global economy. A Zurich brochure dating from 2011 promotes coverage for, among other things:
Extradition costs, including travel and accommodations, for insureds and their families;
Arrest, detention, and/or incarceration in a foreign jurisdiction; and
“Kidnap response” coverage, available under a separate limit.
At the very least, the populist backlash has slowed the general push toward multilateral agreements on trade, labor, and corporate practices. In particular, the United States has formally withdrawn from participation in the creation of a Trans-Pacific Partnership, an initiative the Obama Administration pursued over seven years, but which remained widely unpopular in the United States.
In all probability, the election of President Trump will bring initial relief to U.S. corporate directors and officers and the carriers that insure them for management liability.
Although no one can predict the future, it’s a pretty safe bet his administration will be less zealous in its scrutiny of corporate practices than its predecessor. In particular, the Trump Administration is unlikely to embrace the letter or the spirit of the “Yates Memo” of September 2015.
In that memo, Deputy Attorney General Sally Quillian Yates emphasized that investigations of corporate wrongdoing were to focus on identifying and pursuing responsible individuals. As a general rule, cases were not to be closed simply because an organization had settled or been found guilty; rather, individuals were to be pursued regardless of whether they had the means to restore losses or pay damages.
(In January Yates was dismissed as acting attorney general for refusing to support President Trump’s executive order restricting travel by nationals of certain Muslim-majority countries.)
Buy American, hire American
There are two areas of commerce where President Trump has cast a critical eye on private business practices, however: outsourcing of production and the use of immigrant labor.
Shortly after his election in November, then President-elect Trump made a well-publicized visit to a Carrier air-conditioning plant in Indianapolis to urge the company not to transfer some jobs to Mexico. Among other things, Trump threatened to place a tariff on Carrier exports from Mexico to the United States. Whether such an action is possible or practical, the threat of it suggests that Trump’s “America First” orientation may become a public, and possibly legal, expectation for U.S. corporations.
Married to Trump’s “buy American” emphasis is a “hire American” emphasis that seeks to strictly enforce immigration laws and add new restrictions for entry through the H1B visa program and special visas allowed to Canadians and Mexicans under the North American Free Trade Agreement (NAFTA).
Some organizations, particularly in the high-tech sector, claim these special visas are essential to acquiring the talent they need to be competitive.
“A tighter immigration policy could have a tremendous impact on U.S. labor costs and on senior management decision-making,” says Thomas Zona, vice president of the public D&O division for Allied World North America. “With the [emphasis on] ‘buy American and hire American,’ the increased production costs anticipated could impact the bottom line.”
It’s challenging enough for insurers of D&O and employment practices liability to keep pace with domestic variations in employment law, says Beth Goldberg, chief underwriting officer of financial lines for Starr Companies.
“One of the biggest issues for companies and their directors and officers is how to navigate federal, state, and even local law,” she says. “Employment laws vary from state to state, and in some cases even from county to county.
“Companies need to have a broad understanding of jurisdictional issues when implementing company policies,” Goldberg adds. “California, in particular, has a flurry of new employment laws, a number of which require employer action.”
If there is heightened enforcement of immigration law in employment, organizations may find themselves without protection under common D&O liability policies.
In a much-discussed 2014 case, a federal court ruled that a franchisee for several fast food restaurants was not entitled to coverage under a combined employment practices liability and D&O policy for defense costs and penalties arising from a federal immigration enforcement action. In the case, the government alleged the company acted against the law when it accepted false documentation of immigration status from an employee.
Although the policy in question was underwritten by Lloyd’s of London, the provisions at stake in the ruling were similar to those in many such policies. Among other things, the court found that:
Employment practices coverage did not apply because the action was not brought by an employee, but by a government agency;
The action did not meet the definition of a claim under the policy, as the government was not seeking damages or other relief; and
The insured did not suffer a “loss” under the terms of the policy, which specifically excluded coverage for fines and penalties.
The ruling underscores the importance of immigration violation coverage endorsements, an emerging but still rare coverage added or extended to combined EPL-D&O policies.
According to the International Risk Management Institute, immigration violation endorsements typically provide coverage under a sub-limit for defense costs, criminal fines and penalties, and for civil fines and penalties. IRMI adds, however, that it is yet to be fully determined whether public policy in some states or at the federal level will prevent insureds from recovering criminal fines and penalties.
When it comes to manufacturing, many U.S. companies now operate within complex international design, supply, and assembly chains that often make it impossible to claim that a product was “made” in one particular country. Thus any meaningful attempt to increase the American share of products used in the U.S. must take account of two key factors:
Restriction of competition from foreign suppliers, either through tariffs or legal restrictions; and
Reporting on the respective levels of U.S. and foreign input into a product or value chain.
The latter would establish disclosure requirements that become duties for officers and directors and fodder for litigation, even if no government enforcement action results.
Although trade deficits have driven American angst over globalization, there are two related “services” we have been increasingly successful at exporting, to the chagrin of officers and directors: class action and collective investor litigation, and third-party litigation financing to fund it. (Third-party litigation financing involves third parties who do not have a legal stake in a possible claim agreeing to finance tort litigation in exchange for a profitable return on any court award.)
According to a November 2016 report from Allianz, “Third-party litigation funders are changing the global litigation map, with their influence pivotal in the development of collective actions against financial institutions and commercial entities and their directors and officers. Litigation funders are front and center in some of the largest multi-jurisdictional claims.”
Zona adds that “increasing shareholder activism, as well as intensifying class action litigation, keep insureds and insurers up at night. In turn, the claims are more expensive to defend as legal costs reach alarming rates.”
Significant, but ironic
There’s an irony in all this, says Kevin LaCroix, executive vice president of RT ProExec; he is perhaps best known as the writer-editor of the widely read “D&O Diary” blog.
LaCroix characterizes the rise of investor litigation outside the U.S. as “one of the most significant recent developments in the global D&O claims arena.” This is ironic because, he adds, “these things have come together despite what is perhaps an almost universal disdain outside the U.S. for U.S.-style litigation.”
Major industrialized countries throughout the world, including free market bastions like Hong Kong and Singapore, have established or allowed for negligence actions against officers and directors for decisions once regarded as purely business risks.
There may be no better example than Germany, where corporate boards have long included representatives of unions and other non-owner stakeholders and thus have enjoyed far-reaching deference. Today, however, German managers confront an “internal liability” requirement that corporate boards pursue managers for recovery of losses
resulting from wrongdoing or negligence.
D&O product response
In response to the growth of class-and investor-based litigation worldwide, officers and directors are advised to have locally admitted “Side A” coverage to protect themselves individually from liability for overseas operations.
“For decades, risk managers have safeguarded the wealth of those executives by covering them under master global D&O insurance policies written in the United States,” reads a November 2013 report from Zurich. “But because of the evolution of litigation, insurance laws, and regulations in many foreign jurisdictions, traditionally orchestrated global coverages hardly guarantee ironclad protection for foreign executives today.”
Among the reasons for this change, according to the Zurich report, are:
Securities class action cases are now permitted in 32 European countries;
Overseas awards and settlements have “ballooned”;
Many foreign jurisdictions explicitly or effectively prohibit companies from indemnifying officers for defense costs and awards or settlements; and
Many foreign jurisdictions do not allow for non-admitted management liability insurance.
As a result, the Zurich report states, “a traditional master global D&O policy—with Side A and Side B insuring provisions—could leave foreign executives with a far weaker financial backstop than they had counted on. … [O]nly a robust, locally written Side A-only D&O liability insurance policy would protect foreign executives’ assets …”
A number of investor actions are brought in the wake of mergers and acquisitions. Investors, disappointed in the level of value created by a transaction, are increasingly inclined to file suit against officers and directors for failure to execute adequate due diligence.
In response, Allianz finds, more organizations are purchasing “transactional liability insurance,” which covers losses arising from inaccuracies that occur in the course of mergers, acquisitions, and divestitures. According to Allianz, use of transactional liability insurance grew by 240% globally from 2011 through 2015.
Within the United States, developing admitted D&O coverage is less of a challenge, says Steve Blayney, associate vice president and program manager for Distinguished Programs.
“We have a consistent, stable, and solid relationship with our carrier partner and have not seen the need to do any wholesale changes to filing in a number of years,” Blayney says. “That said, we have made changes in the past and find that our ability to develop or alter filed forms varies dramatically by jurisdiction.
“Within that context, however, our experience has been relatively consistent—not getting harder or easier—and we generally know what to expect when undertaking any changes.”
One area where the Trump Administration may be greatly at odds with the rest of the world is the subject of climate change and the potential liability.
Trump was, at times, almost dismissive of climate change during the 2016 election campaign. Even if his views have changed, it’s hard to imagine his administration aggressively pursuing actions against corporate officers and directors over climate-related issues.
Moreover, Trump will have an opportunity to substantially shape the federal judiciary, as he has one Supreme Court seat and 102 other federal court vacancies to fill, plus 18 pending judicial retirements to replace. Presuming that nominated judges reflect his priorities and those of Republicans who control the U.S. Senate, this will probably curb the effectiveness of climate actions brought in civil courts by environmental activists and investors.
Outside the U.S., however, rising temperatures and sea levels are combining with the rising tide of civil litigation to put officers and directors on notice that they may be held personally accountable for actions that harm the environment, including global warming, and for any negligence in failing to monitor and report their enterprises’ exposures to loss from global warming.
“Climate change has affected and will affect human health, agriculture, food security, water supply, transportation, energy, and other systems,” says Zona. “These changes will force U.S. and foreign companies to comply with changing regulations, and the decisions made by directors and officers will directly affect the bottom line. Companies that do not comply will open themselves up for exposure.”
More generally, a global retreat from multilateralism may stall the drive to establish common rules for conducting international business and a convergence in standards of care expected of officers and directors.
As much as a respite from investigative zeal may be welcome in the short term, a patchwork of ever-shifting laws and regulations would not be welcome to companies seeking to compete in global markets, many of which are growing faster than the United States.
For more information
Allied World North America www.alliedworldinsurance.com
D&O Diary www.dandodiary.com
Distinguished Programs www.distinguished.com
RT ProExec www.rtspecialty.com
Starr Companies www.starrcompanies.com
Joseph S. Harrington, CPCU, is an independent business writer who specializes in property and casualty insurance coverages and operations. For 21 years Joe was communications director for the American Association of Insurance Services (AAIS), a P-C advisory organization. Prior to that, Joe worked in journalism and as a reporter and editor in financial services.