Securities Litigation and
D&O Insurance:
Understanding Your Exposure
and Minimizing Your Risk
Nina (Nicki) Locker
Steven Guggenheim
Michael Winograd
The “Truth” Is Revealed
Share
Price
$35.00
Restatement 2009/
missed guidance
release
30.00
25.00
FY 2009
Form
20-F filed
Q3/Q4
2010
guidance
20.00
SEC informal
inquiry
15.00
Securities
class action
filed
10.00
5.00
0.00
June
2010
July
2010
September
2010
October
2010
2
midOctober
2010
January
2011
The Basics
• Who are the plaintiffs?
– Investors who purchased during the class period and
held through the bad news
• What is their basic claim?
– Company made a false statement upon which
plaintiffs relied in purchasing or selling the
Company’s stock
– Section 11 versus 10b-5
Intent to defraud
Circumstantial evidence enough
• Who do plaintiffs typically sue?
– Company, CEO,CFO
– Directors?
3
What Plaintiffs Look For
Bad News
+
Significant stock drop
+
Insider trading/offering
=
4
A Really Bad Week For MyStockDropped.com
• Day 1 – Contrary to company’s revenue recognition
policy, major reseller claims no obligation to pay
until resale; GC investigates
• Day 2 – Reseller sends GC email supporting its
claim
• Day 3 – Sales person admits agreement but claims
isolated instance
• Day 4 – Earnings announcement and conference
call
5
A Really Bad Week (cont’d)
• Day 5 – GC’s investigation uncovers evidence
suggesting widespread practice and raising
questions regarding CFO knowledge
• Day 6 – Audit Committee retains regular outside
counsel to conduct investigation
• Day 7 – CEO sells 50,000 shares
6
The Aftermath
• Two year restatement of company’s financial
statements
• Government commences investigation
• Shareholders file securities class action lawsuit
7
What Went Wrong?
• Problem – Disclosures mishandled
• Solution – Best practices for disclosing bad news
– Don’t “spin” news
– Provide updates when necessary
– Stick to historical facts
– Avoid premature explanations
– Designate single spokesperson
8
What Went Wrong?
• Problem – No insider trading policies
• Solution – Control insider stock sales
– Insider trading policy
Prohibition against trading on the basis of material,
non-public information
Procedures to communicate policy to directors,
officers and employees
Pre-clearance
Blackout periods
Compliance officer
– Proactively closing trading window
– 10b5-1 plans
9
What Went Wrong?
• Problem – Investigative counsel lacked credibility and
objectivity
• Solution – Carefully consider who should conduct
investigation
– Inside counsel, regular outside counsel vs. independent
counsel
Relationship of counsel to issues under review
Seniority of employees potentially involved
Seriousness and nature of suspected activity
10
What Went Wrong?
• Problem – Emails that make a bad situation worse
– Board member to Board member email: “I had
concerns about his [the CFO’s] integrity from the
outset. But I was overruled. Turns out I was right. ”
• Solution – Educate directors, officers and employees
to treat email with caution
– Limit discussion of sensitive topics via email
– Avoid post-mortems
– Understand that email/instant messaging creates a
permanent message
11
You Got Sued: Now What?
• Call your Board
• Notify your insurance broker/insurance consultant
• Notify your outside counsel/auditors
• Preserve your documents
• Consider communication to employees and
customers
• Hurry up and wait
12
Selection of Limits: MyStockDropped.Com
Total shares outstanding
35,339,781
(1)
Deduction of insider shares
Potential class member shares
Reduction in share price following a drop of 60% from $25.00
Potential SEC class action exposure
Settlement value at 75th percentile
(2)
Defense Costs (3)
Example of Policy Limit
$
$
(102,485)
35,237,296
15.00
528,559,440
$
17,934,864
$
$
3,302,351
22,000,000
Footnotes:
(1) In a Securities Class Action, Directors,Officers and affiliates are generally excluded from the Class.
Data obtained from recent financial reports indicates that 0% of shares are owned directly or
beneficially by MyStockDropped.Com directors, officers and affiliates.
(2) Database indicates that for cases with this potential class action exposure,
75% of the cases settle for 3.4% or less of exposure.
(3) The defense cost amount shown above is an example only.
(4) Settlement values and defense costs for shareholder derivative actions are not included in these calculations.
13
Directors and Officers Insurance
Hot Issues: Dishonesty Exclusion
• Problem: Carrier can deny coverage for “dishonest
conduct”
• Solution: Language requiring some kind of “final
adjudication”
• Pitfalls:
Avoid soft or vague triggers
14
Directors and Officers Insurance
Hot Issues: Severability
• Problem: An insurer can rescind (revoke) the policy
•
•
against all insured persons if there are false
statements in the insurance application.
Solution: Language limiting rescission to those
who knew of the false statements and forcing the
insurer to sue to rescind.
Pitfalls: Avoid so-called “non-rescindable”
endorsements.
15
Directors and Officers Insurance
Hot Issues: “Exhaustion”
• Problem: Language in excess policy may allow
excess insurer to avoid paying under policy if
underlying insurer paid less than its full policy limits
• Solution: Language specifically allowing insured to
pay reminder of underlying limits where underlying
insurer fails to pay
• Pitfalls: Avoid language that requires “admission of
liability” by underlying insurer or language which
only requires payment by excess carrier under
limited circumstances
16
Out of Pocket Contributions by Directors and
Officers
• Empirical studies show that out-of pocket
contributions are still rare
– Officers less than 5% of settlements
– Outside Directors less than 1% of settlements
17
Out of Pocket Contributions by Directors and
Officers – The Perfect Storm
• Factors
– Bankruptcy
– Inadequate insurance
– Strong merits
Section 11
SEC imposed penalties
Suspicious insider selling
– Wealthy directors
• Enron, Worldcom
18