D&O CLAIMS TRENDS: Q April Sponsored by:

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1 D&O CLAIMS TRENDS: Q April 2014

2 Executive Summary The first quarter of 2014 had the fewest securities and business litigation filings and enforcement actions since prior to the financial crisis. Although it is still early in the year and much can change, if these numbers continue to hold steady, annual totals could approach pre-crisis levels. The quarter saw nearly across the board declines in new filings with securities individual actions experiencing the largest percentage drop of the major categories. The quarter saw nearly across the board declines in new filings with securities individual actions experiencing the largest percentage drop of the major categories. The always-important category, securities class actions, saw the number of filings remain relatively flat compared with the previous quarter but increase slightly as a percentage of the total filings. The financial sector remained the top sector for new securities litigation and enforcement actions. In fact, it matched the highest percentage of total filings of any quarter during the past three years. Along with the total number of filings, declines also occurred in the number of settlements and the average settlement value. By a wide margin, capital regulatory actions represented the highest number of settlements while FCPA settlements averaged the highest value. For the remainder of 2014, a number of variables will determine whether or not securities and business litigation filings and enforcement actions continue their decline towards precrisis levels. Some examples include a shift in priorities and a reallocation of resources by the SEC as it moves past the financial crisis, the pending Halliburton case in the U.S. Supreme Court challenging the fraud-on-the-market theory, and new regulations such as the conflict mineral rule adopted under Dodd-Frank that goes into effect on May 31st of this year. 2 April 2014 Advisen Ltd.

3 The purpose of this report is to examine all sources of securitiesrelated suits that impact the underwriting and placement of management liability insurance other than ERISA liability suits. Securities suits defined The purpose of this report is to examine all sources of securities-related suits that impact the underwriting and placement of management liability insurance other than ERISA liability suits. In addition to securities class action suits, this report encompasses a much broader set of suits, including securities fraud, breach of fiduciary duties, derivative actions, collective actions and Ponzi scheme cases. Several analytic firms publish tallies of securities class action suits filed, but rarely do these tallies agree. In addition to the broad array of securities class actions that Advisen covers, another difference is the way events are counted. In some cases, multiple companies (and their respective directors and officers) are named in the same complaint. Advisen counts each company for which securities violations are alleged in a single complaint as a separate suit. The specific definition of each type of suit can vary as well, resulting in different lawsuit tallies. Advisen defines the major types of suits in the report as follows: Securities Class Actions: suits alleging violations of federal securities laws, principally the Securities Act of 1933 and the Securities Exchange Act of 1934, filed by private party on behalf of a class of persons injured by alleged violations, specifically styled as a class action at the time of filing. Capital Regulatory Actions: actions by the SEC and other regulators against organizations raising capital through issuance of regulated securities. These cases represent a distinct exposure that led Advisen to segment them from the prior type of securities fraud cases. Securities Individual Actions: cases brought by purchasers of securities that are not styled as a class action at the time of initial filing. This includes non-class action cases involving multiple plaintiffs. Breach of Fiduciary Duties: Securities: suits alleging breach of fiduciary duties owed under the federal securities laws, primarily 15 USC Sec. 80a-35, or direct claims of breach related to securities and products whose sale or transfer is covered by securities laws. Merger Objection: suits filed by disgruntled shareholders of a company that has been, or is about to be, acquired. 3 April 2014 Advisen Ltd.

4 If the first quarter is an indication of what to expect in 2014, it appears that this downward trend may continue. Derivative Action: cases against directors and officers brought by shareholders, creditors and Boards of Directors on behalf of the company. Summary of findings As noted in the 2013 end of year wrap-up released in January, of the various types of lawsuits and enforcement actions tracked by Advisen that could trigger coverage under a D&O policy, in the aggregate new events fell for a second consecutive year. If the first quarter is an indication of what to expect in 2014, it appears that this downward trend may continue. The first quarter a traditionally busy quarter for D&O lawsuits saw a 35 percent decrease in new activity as compared to the same quarter a year ago and a 17 percent decline from the previous quarter (Q4 2013). The 238 total events represent the lowest quarterly total since prior to the financial crisis. (Exhibit 1) Exhibit 1: Securities Suits Filed (Annualized) Quarterly declines were seen nearly across the board in the first quarter with the one exception being proxies and solicitation violations which increased slightly from zero filings in Q4 of last year to 2 filings in Q1 of this year. Of the major case types, securities individual actions experienced the largest drop falling 58 percent (12 Q vs. 5 Q1 2014), followed by breach of fiduciary duties: securities at 57 percent (7 vs. 3), merger objections at 29 percent (65 vs. 46), derivative shareholder actions at 23 percent (41 vs.33), securities class actions at 9 percent (43 vs.39), and capital regulatory actions at 2 percent (112 vs. 110). 4 April 2014 Advisen Ltd.

5 Securities class actions and securities individual actions were the only major case types to experience year over year increases in new filings. The quarterly declines occurred despite some plaintiff s firms sitting on huge war chests due to big credit crisis settlements. This was likely due to a combination of factors, including the continued wind down of credit crisis litigation, fewer US public company targets, and a limited ability to settle due to fewer mediators among other reasons. Also important to note is that although lawyers report that the vast majority of large mergers trigger lawsuits, the number of merger related suits continues to decline. Securities class actions and securities individual actions were the only major case types to experience year over year increases in new filings. Rising about 3 percent, securities class actions increased from 38 in Q to 39 in Q and securities individual actions rose from 2 in Q to 5 in Q1 of this year. At 46 percent of the total filings, capital regulatory actions remained the leading type of new securities-suit filing in the first quarter. Merger objections accounted for 19 percent of the quarterly total, and securities class actions accounted for 17 percent (Exhibit 2). Seventeen percent is the highest quarterly percentage for securities class actions since the third quarter of Coming on the heels of two consecutive years of growth as a percentage of total events, this is a trend that is certainly worth following. Exhibit 2: Events by Type Q April 2014 Advisen Ltd.

6 The average settlement for all types of suits was $15 million in the first quarter. This is down substantially from $55.2 million in the fourth quarter of last year and the $50.2 million 2013 average. Consistent with previous quarters, at 29 percent of the total, financial services companies and their directors and officers remained the leading target of new filings. This is a 4 percentage point increase from the fourth quarter and 5 percentage points higher than the 2013 average. Although the spike in financial services-related suits experienced in the height of the financial crisis from 2008 through 2011 has subsided, the sector continues to be a lightning rod for D&O related litigation. Other active sectors included consumer discretionary at 17 percent and health care at 13 percent. There were 94 settlements in Q1 down from 115 in Q4. The average settlement for all types of suits was $15 million in the first quarter. This is down substantially from $55.2 million in the fourth quarter of last year and the $50.2 million 2013 average. Settlement includes, in addition to final approved settlements, proposed and tentative settlements, plus jury awards. New events The annual number of new events has been trending downwards over the previous two years pointing to the end of an era of high frequency credit crisis litigation. With the first quarter recording the lowest total in years, and barring another unforeseen crisis, it appears that this downward trend will continue in The nearly across-the-board decrease in lawsuits in the first quarter is unusual when compared to historical trends. Typically, plaintiff firms allocate resources to different types of litigation to respond to changing conditions. If this is in fact occurring, these resources are not being allocated among the various types of D&O lawsuits, but rather are being assigned outside the realm of D&O-related litigation. By type of event As has been the case in nearly every quarter since the beginning of the financial crisis, capital regulatory actions continued to reign as the leading cause of D&O-related lawsuits in the first quarter of 2014 accounting for nearly half (46 percent) of all recorded events. Although they remain the leading source percentagewise, the absolute total number has declined over the past couple of years (851 in 2011, 762 in 2012, and 622 in 2013). The capital regulatory action event type was introduced in Q3 of 2013 and includes a majority of the cases Advisen previously categorized under securities fraud. 6 April 2014 Advisen Ltd.

7 Although the absolute number of securities class action suits fell slightly from the fourth quarter (from 43 in Q4 to 39 in Q1), as a percentage of the total events they increased from 15 percent to 16 percent. At the direction of Mary Jo White, the head of the SEC, a new financial fraud Task Force was developed for the purpose of identifying and prosecuting individuals involved with financial and reporting fraud. With continuous leads pouring into the SEC due to the new whistleblower statutes under Dodd-Frank and the use of new analytical tools designed to look for numerical anomalies and textual indicators of fraud, there is a high probability that the number of actions in this category will increase in the coming years. Although the absolute number of securities class action suits fell slightly from the fourth quarter (from 43 in Q4 to 39 in Q1), as a percentage of the total events they increased from 15 percent to 16 percent. The longer-term trend, however, has been towards securities class actions representing a decreasing portion of all D&O-related claims. While there has been considerable discussion as to whether the general decline in the number of securities class action suits are a true reduction or whether it is driven by a reduction in the number of companies traded on US Stock Exchanges, fewer suits involving Chinese firms in recent years, and the winding down of credit crisis litigation also are likely contributing factors. The longer term trend, however, may also reflect a change in emphasis by plaintiffs firms, due in large part to a string of Supreme Court decisions favoring defendants. Another such decision is currently pending in Halliburton Co. v Erica P. John Fund, Inc., in which the Supreme Court is reconsidering the fraud-on-the-market theory. A reversal of the precedent set in the 1988 decision, Basic Inc. v Levinson, could make it more difficult for plaintiffs to purse class actions against businesses. Merger objection suits usually are filed shortly following the announcement of a proposed merger or acquisition by shareholders of the company to be acquired. Typically they demand more favorable terms, such as more bidders or a more transparent auction process. It was reported that nearly all M&A s valued at over $100 million were involved in a shareholder lawsuit in It was also noted that the vast majority of settled cases were disclosure only settlements. It has been suggested that these suits are driven more by plaintiff s attorneys seeking new sources of fee revenue than by the economics of the merger or acquisition. Some judges presiding over these cases seem to agree. For example, Chancellor Strine of the Delaware Chancery Court commented that The social utility of cases like this continuing to be resolved in this way is dubious. 7 April 2014 Advisen Ltd.

8 Merger objection filings generally maintained a strong growth trend through 2011 but have decreased materially Merger objection filings generally maintained a strong growth trend through 2011 but have decreased materially over the previous two years. If the first quarter is any indication, it appears this trend will continue in (Exhibit 3) Exhibit 3: Merger Objection Cases: Annual Count of Filed Cases (2014 Annualized) over the previous two years. The frequency of cases filed varies by a number of factors including size of company. Using Advisen s Loss Insight Foundation tool, we examined the relative frequency of cases being filed by market capitalization group. We divided the US Exchange Traded plus Over the Counter companies into five market capitalization ranges (expressed in millions of dollars) shown in the table below: Name Micro Small Mid Large Mega Start ,000 10, ,000 End 250 2,000 10, ,000 2,000,000 We then examined the frequency of cases per company in the market cap ranges evaluated on a quarterly basis but expressed as a rolling annual basis. The results are shown in the Exhibit 4 below. 8 April 2014 Advisen Ltd.

9 Financial firms continued to dominate new filings, as they have every quarter since before the financial crisis. Exhibit 4: Merger Objection Cases: Count of Filed Cases by Market Cap Group as Annual Frequency The graph reveals that the highest frequency of merger objection cases arises among the smallest market cap groups Small and Micro and decrease as companies get larger. By industry Financial firms continued to dominate new filings, as they have every quarter since before the financial crisis. About 29 percent of new filings in Q named companies and their directors and officers in the financial services sector. (Exhibit 5) While the industry remained a magnet for litigation in 2013 it appeared to have leveled out from the high s experienced as a result of credit crisis activity. It will be interesting to follow whether the five percentage point increase in Q1 from the 2013 average was a quarterly anomaly or the start of a new trend. Exhibit 5: Suites by Sector Q April 2014 Advisen Ltd.

10 Among the common triggers for D&O claims in non-u.s. courts are bankruptcy and regulatory enforcement actions. It has been previously noted that filings involving financial firms and those involving technology firms have been historically negatively correlated: as the number of suits naming financial firms increase, the number naming IT firms decrease, and vice versa. For example, over a 5 year period , suits involving financial firms have fallen from 40 percent to 24 percent, while suits involving IT firms have risen from 12 percent to 15 percent. This trend holds true again in the first quarter of 2014, filings involving financial firms increased 5 points from the 2013 average and filings involving IT firms decreased 6 points. Non-U.S. companies Securities litigation in Europe, Asia, and Latin America is less frequently a matter of public record as compared to the United States, making it difficult to get as complete a picture of litigation activity. Typically only the largest of cases attract media attention, and non-u.s. companies are far less likely to provide details of litigation in their public disclosures. In spite of these data limitations, it is increasingly clear that litigation activity outside the United States has become more common in recent years. Among the common triggers for D&O claims in non-u.s. courts are bankruptcy and regulatory enforcement actions. In the first quarter, events involving non-u.s. companies, filed both in the U.S. and elsewhere accounted for 16 percent of the total. This was 3 points higher than both the fourth quarter and the same quarter a year ago (Q1 2013).(Exhibit 6) Of the events involving non-u.s. companies, Hong Kong, Chinese, and Canadian companies accounted for the highest percentage at 23 percent, 15 percent, and 15 percent respectively. Exhibit 6: Non-U.S. Companies 10 April 2014 Advisen Ltd.

11 Companies conducting business in foreign countries have increasingly become a target for violations of the Foreign Corrupt Practices Act (FCPA). Settlements and Awards By a wide margin, capital regulatory actions had the most settlements in the first quarter with 74. Including proposed and tentative settlements, the average settlement cost for all case types was $15 million, down substantially from the $55.2 million reported in the fourth quarter and the $50.2 million 2013 average. The $15 million average Q1 settlement value is in line with the average settlement values experienced from On the average, FCPA (SEC) actions were the most significant source of large losses with the average settlement at $24.7 million. Securities class actions came in a close second averaging $23.8 million, followed by merger objections at $14.6 million, and capital regulatory actions at $13.9 million. Companies conducting business in foreign countries have increasingly become a target for violations of the Foreign Corrupt Practices Act (FCPA). The FCPA prohibits payments to foreign officials to obtain or retain business. FCPA is jointly enforced by the SEC and the DOJ. In the first quarter there were four FCPA settlements. FCPA settlements were the most significant source of large losses because of a $97.3 million dollar settlement against oilfield services company Weatherford International Ltd. The SEC charged Weatherford with violating the FCPA by authorizing bribes and improper travel and entertainment for foreign officials in the Middle East and Africa to win business, including kickbacks in Iraq to obtain United Nations Oil-for-Food contracts. The SEC alleged that Weatherford and its subsidiaries falsified its books and records to conceal not only the illicit payments, but also commercial transactions with Cuba, Iran, Syria, and Sudan that violated U.S. sanctions and export control laws. Weatherford failed to establish an effective system of internal accounting controls to monitor risks of improper payments and prevent or detect misconduct. The case settled on January, The largest settlement of the quarter was a $275 million proposed capital regulatory action settlement by Morgan Stanley in a subprime mortgage-related case. Morgan Stanley reached an agreement in principle with the SEC to resolve an investigation related to certain subprime RMBS transactions sponsored and underwritten by the company in A second suit the received approval of settlement for a large sum in the first quarter was a $196.5 million capital regulatory action against Credit Suisse Group AG. On February 21, 2014, The Securities and Exchange Commission announced charges against Zurichbased Credit Suisse Group AG for violating federal securities laws by providing cross-border 11 April 2014 Advisen Ltd.

12 It should be noted the D&O insurance recoveries often are not a matter of public record, so the impact of these and other large cases on the D&O market is not readily apparent from public sources. brokerage and investment advisory services to U.S. clients without first registering with the SEC. Credit Suisse agreed to pay $196 million and admit wrongdoing to settle the SEC s charges. The largest securities class action settlement was for $98 million by Cobb Electric Membership Corporation (EMC). According to the complaint, Cobb EMC should have retired all Capital Credits of former members and adopt a Revolving Plan with a Rotation Cycle of 10 to 20 years. Former Member Plaintiffs contended that the cooperative revolve the Patronage Capital of its members so that equity will be provided primarily by current customers in proportion to their use of the cooperative. Former Member Plaintiffs further contended that if no Revolving Plan was implemented, or the Rotation Cycle was too long, a substantial proportion of the cooperative s equity was provided by former members who no longer utilize the cooperative and/or by long-term members who were providing equity out of proportion to their use of the cooperative, all in violation of generally-accepted cooperative principles. It should be noted the D&O insurance recoveries often are not a matter of public record, so the impact of these and other large cases on the D&O market is not readily apparent from public sources. In many cases, especially those involving fines, penalties, or disgorgement, recovers are not available under most D&O policies, though defense costs and some costs related to investigations may be recovered. n 12 April 2014 Advisen Ltd.