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Securities litigation on the rise Study finds class actions, damages, trials all increasing By Phil Zinkewicz Serving as a director or an officer of a public corporation has become much more burdensome in the last few years, primarily because of costly securities class action lawsuits. Consequently, directors and officers are looking to their firms for more comprehensive directors and officers liability insurance as well as new forms of coverage. That’s the gist of a recent white paper from ACE USA, the U.S.-based retail operating division of the ACE Group of Companies. Titled Trends in Securities Class Action Litigation and Directors and Officers Liability Insurance, the white paper was written by Carol A.N. Zacharias, senior vice president and counsel, ACE Professional Risk. Says Zacharias: “Amounts paid to resolve securities class action litigation more than tripled last year [2005], reaching record levels. In 2005, there were settlements totaling $17.9 billion, up threefold from $5.5 billion in 2004. Even median and average case settlements reached historic high levels in 2005. The average case was resolved for $71.3 million, excluding the WorldCom and Enron settlements, an increase of 156% over the 2004 average of $27.8 million. The median case value in 2005 reached $9.25 million, a 40% increase over the 2004 median of $6.25 million.” Zacharias says these numbers were driven by 12 settlements of over $100 million, including seven cases that settled in the billions. “The burgeoning cost of securities class actions represents a significant drain on corporate America since such actions are, by far, the most common type of class action, exceeding other kinds of class actions by nearly 400% or more,” according to Zacharias. What gives? Why the increase in settlement numbers? Zacharias says there are many factors. First, she says, securities class action cases are taking longer to resolve. Second, they involve vastly higher alleged damages. In addition, these cases assert costly accounting irregularities, are pursued by institutional investors with fiduciary responsibilities, and increasingly go to trial. “In the years following passage of the Private Securities Litigation Reform Act of 1995 (PSLRA), the case life of a securities action became much longer,” says Zacharias. “Before the PSLRA, 61% of all cases took three years to resolve, and 77% were resolved within five years. By contrast, in the seven years after PSLRA, only 44% of cases were resolved in three years, and only 62% of cases were resolved within five years. Thirty-eight percent of the cases took longer than five years. This longer case life naturally drives up litigation costs.” Zacharias says that another reason for larger settlements and longer case life is that plaintiffs have been forced to meet the higher pleading standards imposed by the PSLRA. Plaintiffs must specify what statements were made, how they were misleading and what facts give rise to a “strong inference” that the defendant acted with fraudulent intent. Says Zacharias: “To meet the higher standard and prevent dismissal, factors such as accounting transgressions or insider selling that is unusual as to either timing or amount become more important, since they can be presented as persuasive ‘hard evidence’ of fraud.” The white paper points out that institutional investors were lead plaintiffs in more than 35% of all 2005 settlements. While they filed just five cases 10 years ago, they were lead plaintiffs in dozens of class actions in 2005. “The increase in cases with the institutional investor as lead plaintiff does not bode well for defendants, as the value of a case is much higher when an investment fund’s institutional investor is the plaintiff,” says Zacharias. “The median settlement amount of a case with an institutional investor as plaintiff was $16.3 million in 2005, in contrast with $5.6 million for cases without the institutional investor.” Zacharias’s white paper goes into great detail about other factors affecting the cost of securities class action litigation, such as the demand for more transparency in companies, primarily the result of the Sarbanes-Oxley Act and other legislative and regulatory developments. She also points out that her paper addresses primarily securities litigation, which does not include lawsuits involving stock option trading and derivatives. If you include those, the frequency of securities class action suits would be much higher, she says. Impact on D&O coverage The thrust of her white paper, Zacharias says, is what all these trends and developments have meant to directors and officers liability insurance. “Some D&O purchasers prefer coverage that provides such things as protection when the insured entity is precluded from indemnifying the executive, full severability for insured persons, coverage for executives only, an express promise that the policy is not rescindable, defense costs even in the event of fraud or illegal or unentitled personal profit, payment to the individual insured first, and thereafter to the entity in the event of bankruptcy. “Many of these provisions are found in an increasingly popular form of coverage known as Side ‘A’ policies,” she says. “There are also policies that insure only independent directors, and there are some directors and officers policies that insure only independent investors, and there are some policies that offer a combination of these features.” Concludes Zacharias: “Today, directors and officers are asking more questions about corporate governance, what various committees are doing, and what auditors are doing. In the old days, only the Fortune 500 were much affected by increased securities litigation costs. Today, the middle market is being affected as well.” A broker’s view Kevin LaCroix, of OakBridge Insurance Services of Bloomfield, Connecticut, a specialist in directors and officers liability insurance, agrees with the findings of Zacharias’s white paper, noting that several studies indicate that settlement amounts in securities class action cases are rising significantly. He says this began occurring right after the stock market bubble burst in 2001. “And then, there have been the headline cases such as WorldCom, Tyco and Enron. Settlements in cases like these tend to pull everything northward.” LaCroix says there is no question that serving on the board of a public company is more burdensome than in the past. As a result, he notes, directors and officers are demanding better insurance coverages from their companies. “In the past, there was not a lot of attention paid on the part of a company to the purchase of comprehensive directors and officers liability coverage. Now, directors and officers want a greater breadth of coverage. There is a good deal of interest in Side ‘A’ difference in conditions coverage, which is a kind of catastrophic coverage for individuals who are directors and officers of companies.” The good news, according to LaCroix, is that these coverages are available and the prices are stable. “You might assume that these coverages would be hard to place, but it’s just not so. One reason is that new capital has come into the marketplace and has kept pricing reasonable. What will happen tomorrow? Who knows?” * |
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