Cover Story Spring Forward
Liability: Protecting Your Reputation
For most directors, securities litigation is a mysterious world ruled
by sinister plaintiffs’ lawyers, powerful judges, and a unique legal
framework that must be navigated by fancy defense lawyers who
charge exorbitant fees. Directors react to this litigation with everything from unnecessary panic to an unjustified feeling of invincibility. The right approach is somewhere in the middle: “attentive
concern.” Securities litigation can pose personal risk to directors as
well as to their companies, but if directors educate themselves and
pay attention, this risk is almost always manageable.
Why Should You Care?
Although much of the current discussion revolves around meritless
merger litigation, securities class actions and associated shareholder derivative actions pose greater risk. A securities class action alleges that a company and its representatives made false or misleading statements that artificially inflated the stock price. Directors
are virtually always included in Section 11 cases, which challenge
statements in registered offerings, and increasingly are also named
in Section 10(b) actions, which can challenge any public corporate statement. Directors are often named in “tag-along” shareholder derivative actions, as well, which allege that the directors
failed to properly oversee the company’s public disclosures.
Often, it is difficult to know from the initial complaint whether
a securities case will pose a personal risk to directors because it is
merely a placeholder. Only after the court selects the lead plaintiff
and lead counsel will the plaintiffs’ attorneys draft more substantial
allegations and add defendants. Regardless of any personal risk, directors have a duty to oversee the significant potential liability the
company faces. For these reasons, directors should treat these cases
as if they are personally named from the beginning.
New trends in securities litigation mean that a greater number
of directors and their companies are at risk. In the past, these actions were initiated by an oligopoly of larger plaintiffs’ firms with
significant resources and mostly institutional clients that tended
to bring larger cases against larger companies. But recently, smaller plaintiffs’ firms with retail-investor clients have been initiating
more cases, primarily against smaller companies. Indeed, in recent
years, half of all securities class actions were filed against companies with $1 billion or less in market capitalization.
This combination of factors means that no company or its directors can fly under the securities class-action radar anymore. If
handled in the right way by the right counsel, the vast majority of
securities actions can be defended and either won or settled, with-
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NACD Directorship January/February 2016
in D&O insurance policy limits, leaving no residual liability for
either the company or its directors. With just a little time and effort
at the beginning of the litigation, directors can put these cases on
the right track and avoid a number of hazards.
Most important, directors must ensure their company selects the
right counsel. Securities litigation is a specialty field, and it can be
nearly impossible to differentiate between the claims of expertise
and experience made by the herd of lawyers that descends upon a
company after a suit is filed. And it is a serious error—especially for
mid-size and smaller companies—to use a law firm brand name as a
proxy for quality and fit. Fortunately, many pitfalls of counsel selection can be avoided if directors keep in mind a few key principles:
■■ Select a securities litigation specialist.
■■ Educate yourself about the strategic differences between
firms.
■■ Avoid defaulting to your regular corporate firm.
■■ Conduct an interview process.
Economics Matter
One emerging risk to companies is that ever-increasing securities
defense fees no longer match the economics of the smaller cases being brought and are quickly outpacing D&O policy limits.
Although the typical securities case has shrunk in size to a level
last seen in 1997, the litigation costs of most defense firms have
increased exponentially. This mismatch creates the danger that a
company’s D&O policy will be insufficient to cover the fees for a
vigorous defense and the price to resolve the case.
Historically, most securities defense firms have marquee names
with high billing rates. Epecially in smaller cases—which now
make up more than half of all securities cases—it is more difficult
for these firms to vigorously defend an action without risking that
there will be too little D&O insurance left for settlement. To avoid
this result, firms either cut corners or settle early for bloated amounts
that make the defendants look like they did something wrong.
Directors should use the interview process to insist on a better
­alternative. This may mean interviewing smaller firms that offer a rationally priced defense paired with sufficient experience
and expertise (and thus encouraging more such firms to enter
the market). Or it may mean pushing larger firms for significant
price concessions. The key is for directors to pay attention and to
use the leverage of a competitive hiring process to find counsel
to help them through the litigation safely, strategically, and economically. —Douglas W. Greene and Claire Loebs Davis