Backdating And Your D&O Coverage

Transcription

1 The leading resource on corporate compliance and governance for U.S. public companies. Backdating And Your D&O Coverage By Melissa Klein Aguilar October 11, 2006 With dozens of companies already embroiled in some type of investigation into past option-grant practices, and many facing litigation, the current wave of stock option scandals has no doubt left many companies digging deep to see whether or not they have an issue, even if the U.S. Attorney s Office and the Securities and Exchange Commission haven t come knocking. All of this means companies ought to be getting intimately familiar with the details of their directors and officers liability insurance policies, experts say. It s absolutely critical for companies that are concerned about backdating issues or that may be facing backdating claims to think about their directors and officers coverage and their fiduciary liability coverage, says Matthew Schlesinger, a partner in the insurance recovery group at the law firm Reed Smith. Schlesinger D&O insurance is truly a case where the devil is in the details, says Jay L. Pomerantz, a partner in Fenwick & West s litigation group. There is substantial variation in the terms and conditions of individual policies. Accordingly, directors and officers should focus on key policy provisions that, depending on the precise language, can mean the difference between coverage and no coverage. In particular, officers and directors who may be named in investigations or who eventually may be charged ought to look closely at their D&O liability policy, says Mark Collins, a partner and member of the trial department at McDermott Will & Emery who focuses on insurance coverage. The defense costs for these types of problems can be significant and to the extent that D&O coverage is available, they should become familiar with its terms and conditions and make their claims, says Collins. One immediate issue experts say companies must consider is whether and when to provide notice to their carrier of a claim or potential claim.

2 Collins Timely notice is important for any D&O claim, says Collins. Since coverage is issued on a claims-made basis, coverage is provided for claims made against the insured during the policy period, regardless of when the action that gave rise to the claim allegedly occurred. Considerations For Future Claims Companies also can give notice of facts or circumstances that may give rise to future claims, so future claims would be deemed to have been made at the time notice was given, allowing companies to lock in more favorable coverage. It may be advantageous to have any future claims fall within the current policy because upon renewal, a policyholder s limits may be lower or its self-insured retentions or deductibles may be higher, notes Schlesinger. He says providing such notice is especially important because some insurers are suggesting that they may exclude backdating claims in future policies. Insurer AIG reportedly has sent a questionnaire to certain policy holders asking questions about stock options practices. The questionnaire, a copy of which was obtained by Compliance Week, includes a statement that, It is agreed, with respect to the above questions, that if such knowledge or information exists any claim or action arising therefrom is excluded from the proposed coverage. Schlesinger says companies that receive such a questionnaire should resist answering it, and if they re forced to answer, they should either provide notice of circumstances under their current policies or make sure there s no endorsement or agreement that future option dating claims are going to be excluded as a class. Pomerantz agrees that, Stock option issues have become part of the insurance renewal process. In the past six months, he says carriers have begun to ask insureds for representations or warranties regarding stock-option issues in connection with the renewal. Directors and officers should carefully consider any such requests and Pomerantz seek advice from their broker and outside counsel on how to respond, says Pomerantz. While it s certainly possible that insurers could exclude options-backdating claims in the future, Collins says he s not aware of such exclusions being added to policies being issued now. But if the pain of this issue becomes too great for the insurance industry, they ll certainly take steps to quantify and if necessary, to exclude this risk from future policies. Cautious Underwriting Like Pomerantz, Collins says carriers are taking a cautious approach in their underwriting by asking questions in the application form concerning past options practices. The insurer will take the position that the information sought is material, and if the information turns out to be incorrect, or worse, misrepresented, it could give rise to a rescission defense at the worst time,

3 when a claim comes in and coverage is needed, he says. While companies can t rule out that possibility that carriers may exclude options backdating from future coverage, Kevin LaCroix, an attorney and director of Oakbridge Insurance Services who writes a blog on D&O issues, says companies most likely to have that problem are a narrow group where the company s named has LaCroix surfaced in the paper but the company hasn t yet announced anything, which would cause the carrier to be very wary. Schlesinger says any company that can answer the question, did you backdate? positively ought to be thinking about whether it should provide notice under its current program. If a company doesn t preserve coverage under their current policy for possible backdating claims by telling their insurance company that they know about facts or circumstances that might lead to a claim, then next year they may have no coverage for such claims or only limited coverage, he says. It s particularly important to provide notice of facts or circumstances if the company is going to switch carriers at renewal, adds Schlesinger. A claim can fall between the cracks of an old and new policy if the policyholder is not careful, he says. For example, if a company switches carriers and doesn t give the old carrier notice of facts and circumstances that could lead to a claim, the new carrier may deny coverage for a claim noticed under its policy on the basis that the policyholder knew about the potential for a claim before, and the prior insurer may deny coverage on the basis that the claim was brought and reported after the prior policy expired. LaCroix says a company that has particular concerns but isn t sure yet if they have an issue would be wise to have a well-prepared presentation for the carrier at the time of their renewal. Still, Collins at MWE points out that various considerations go into determining when to provide a carrier notice. Typically, if an insured gets a written demand request for relief, monetary or non-monetary, the clock starts running to provide notice," says Collins. If you don t, you jeopardize your coverage. While it may be prudent in some cases to provide notice of circumstances to lock in more favorable coverage terms, Collins says business considerations must also be taken into account. Business considerations may dictate that shouldn't be done when there s uncertainty over whether a claim will come to fruition, he says. Directors and officers also should look at their policy s definition of claim to determine whether it encompasses the type of investigation they are or may become subject to. Whether coverage exists for defense costs incurred due to a civil or criminal investigation often turns on the policy s

4 definition of claim, but that definition can vary among policies, says Collins. On certain issues, including the definition of claim, Collins says specific policy language could make a significant difference in whether coverage exists for options backdating investigations or proceedings. LaCroix also suggests checking the policy s retroactive date to ensure a potential action would be covered under the policy period. Since some options investigations are going far into the past, the retroactive date is an important consideration, says LaCroix. That date could be more recent if the company is newly public or recently changed insurance carriers. The Bottom Line While internal investigations costs typically aren t covered under D&O policies, LaCroix says regulatory investigations may be covered, depending on the policy wording. Shareholder derivative lawsuits or securities fraud lawsuits should be covered; however, he notes, actions that ultimately result in a director or officer making restitution or disgorging profits typically aren t covered. The bottom line, says LaCroix, is get expert legal advice. Even a company that has significant options timing problems, where they ve ousted the CEO, may be able to secure significant coverage for attorney fees and indemnity amounts they may have to pay, depending on the facts and circumstances of the case, he says. Given the amounts involved, companies should make sure they do everything they can to maximize coverage.

5 Reed Smith s Matthew Schlesinger offered the following tips to Compliance Week. What Companies Need To Do Now Review D&O policies and fiduciary liability policies to make sure they understand what coverage they have and determine whether the company or its directors have any Side A excess or independent director policies that might drop down if their primary insurer attempts to deny or rescind coverage. Work with policy holder coverage counsel (and the insurance broker as appropriate) to determine whether they are aware of existing backdating lawsuits or claims, or facts or circumstances that may lead to future claims, either against the company or individual officers and directors that should be noticed and under which policies to provide notice. Have coverage counsel involved in the discussion about whether or not to provide notice, as well as how those notices should be drafted, since notice letters can result in unintended consequences, says Matthew Schlesinger at Reed Smith. For example, notice, particularly of facts or circumstances, needs to be specific enough to holdup. At same time, companies should be careful not to make admissions in notice letters because some conduct or fraud exclusions can be triggered by an admission of wrongdoing. If a company admits wrongdoing when providing notice, they may give their insurance company a readymade argument to deny coverage, says Schlesinger. He also notes that conversations solely between a company and its insurance broker, as opposed to between a company and its coverage counsel, about coverage for back-dating claims or other issues may not be privileged. Involve policy holder counsel in the renewal process. Coverage counsel can help improve the terms of the renewal significantly, for instance by tweaking various terms or exclusions or making sure there s no language or an endorsement that precludes backdating or other claims as a class. Source Matthew Schlesinger, Partner At Reed Smith