A string of shareholder derivative cases culminating last year in Activision Blizzard and Freeport-McMoRan has hoisted the bar on settlements and the potential impact for directors and officers insurance.
Advisen data show that, while filings for shareholder derivative actions in the U.S. declined for a third year in 2014, to 160, the average loss has continued to widen, to $7.2 million. In fact, the cost of settlements, financial damages, fines and penalties, and legal fees in these cases has more than quintupled since 2012.
The findings point to an “increased frequency of severity, with seven or eight of these nine-figure derivative settlements in the last five or six years,” attorney Joseph Monteleone told Advisen. A partner at Rivkin Radler, he represents insurers in coverage litigation.
A string of shareholder derivative cases culminating last year in Activision Blizzard and Freeport-McMoRan has hoisted the bar on settlements, and the potential impact for directors and officers insurance.
Advisen data show that, while filings for shareholder derivative actions in the U.S. declined for a third year in 2014, to 160, the average loss continued to widen, to $7.2 million last year. The cost of settlements, financial damages, fines, penalties and legal fees has more than quintupled since 2012.
The findings point to an “increased frequency of severity, with seven or eight of these nine-figure derivative settlements in the last five or six years,” said Joseph Monteleone, a partner at Rivkin Radler who represents insurers in coverage litigation.
READ: Data Spotlight: Derivative shareholder actions in focus
Shareholder derivative actions, brought on behalf of a corporation, result in damages that are usually payable to it, as well as in prescribed governance improvements or “corporate therapeutics.” The suits threaten to impact Side A-only policies, which specifically indemnify directors and officers.
“The question is, will these layers be breached?” Monteleone told Advisen. “My answer is ‘yes,’ because in states like Delaware, where derivative shareholder settlements are not indemnifiable, that’s all going to fall on Side A.”
While the Activision settlement set a high-water mark of $275 million, Freeport introduced a dramatic twist when its $137.5 million settlement, minus attorneys fees, went to shareholders in the form of a dividend. The company’s board and executives were alleged to have had conflicts of interest when they overpaid for two affiliates, including McMoRan.
“It’s a little early to say if these megasettlements are a trend,” Kristin Kraeger, national D&O practice leader with Aon Risk Solutions’ financial services group, told Advisen.
“But the potential is there for impacting Side A, which has been largely immune” to such effects because of the capacity in the market, she said.
“In our book, 90 percent of clients are buying some form of Side A,” as part of their D&O programs, she said. “The issue for us will be one of risk differentiation, as to an individual client’s exposure to megasettlements.”
Brenda Shelly, D&O practice leader in Marsh’s FINPRO practice, has seen no pullback on coverage from carriers or effect on pricing since the recent settlements, but said she expects to see more cases.
Derivative suits are easier to bring than securities class actions, she told Advisen, and this attracts plaintiffs attorneys. The size of recent settlements and the “new things being done, like in Freeport, only adds fuel.”
Jeroen van Kwawegen, whose firm co-led for plaintiffs in the Freeport case, expects steady to increased frequency and severity of suits that involve oversight and self-dealing.
“A confluence of circumstances has contributed to the severity” of recent settlements, said Kwawegen, a partner in Bernstein Litowitz Berger & Grossman LLP, in an interview with Advisen.
“First, in the last decade, less willingness by the federal government to hold people accountable for corporate wrongdoing,” he said. At the same time, an increase in deferred prosecutions and corporate integrity agreements with the government is supporting claims.
The agreements, which often require more information-sharing within an organization, make it harder for boards to deny knowledge of wrongdoing, Kwawegen said.
Another circumstance fueling claims, he said, is the amount of “self-dealing going on. When companies steal from shareholders, they steal big. And the settlements are big.”
Kwawegen said during a panel discussion at the PLUS D&O Symposium earlier this month that the decline in filings could be attributed partly to a decrease in securities class action suits, after which “tag-along” derivative actions are often filed.
Jay B. Kasner, a partner at Skadden, Arps, Slate, Meagher & Flom, told the same panel that other factors could account for the decrease shown in Advisen data.
“The legal standard for these cases has been rigorously enforced by the courts,” he said. “By and large, these are tough (to bring) if no demand on the board can be shown and, then, that it was wrongfully refused.”
Another reason could be that there are fewer management liability mediators, he said, citing Advisen’s report, D&O Claims Trends: 2014.
Kasner also said derivative suits were being supported by an “enormous number” of books and records requests.
“We are seeing shareholders lawyers send letters requesting books and records related to the topic that is the subject” of the derivative suit, he said. “It’s a game changer.”
Records requested under the law “can show a demand was made on the board,” helping plaintiffs to fulfill a major requirement, he said.
But he added that Freeport was unique.
“Governance settlement will remain the norm in shareholder derivative suits, where the remedy is to augment policies and procedures,” Kasner said.
“Freeport is not a one-off, it’s a tool,” Kwawegen said. “It’s limited to self-dealing. These are controlled companies, where the COB pushes something through.
“We will continue to push for a dividend settlement in such cases,” he said.
