D&O strategies evolve as class actions rise

Public companies seeking to fortify their protection against the uptick in securities class actions and swelling settlement costs should look to build seamless towers of coverage and consider tapping other types of policies for coverage, experts say.

Although bolstering existing D&O coverage is easily achievable in the current soft market, evolving claims in securities class actions and derivative suits, as well as investigations by regulatory agencies, are becoming more likely to require coverage from other policies, experts say.

Securities class actions and derivative suits are considered long-tail claims by insurers because they can take two to five years to hit their books, said Washington-based Ruth Kochenderfer, D&O products leader for the U.S. and Canada at Marsh LLC.

“We’re absolutely watching and using large tracking data, like National Economic Research Associates and Cornerstone Research reports, to see what the trends are, to see how the filings are going up and when settlements happen,” she said.

An August report by Cornerstone and the Stanford Law School Securities Class Action Clearinghouse showed that the 112 securities class actions filed in 2024’s first half surpassed the 102 filed in the second half of 2023. In the first half of 2023, 113 securities class actions were filed.

Although the risk of litigation is constant, the number of securities class actions filed annually is again rising. A September report by Woodruff Sawyer & Co. forecasts 208 class actions being filed this year, up from 189 in 2023 and 168 in 2022. The highest number of securities class actions filed in a year in the past decade was 268 in 2019.

Experts say several factors are contributing to the upswing in securities class actions and derivative suits, which are suits brought by shareholders on behalf of the company accusing individual executives of breaching fiduciary duties.

Increased regulation from the U.S. Securities and Exchange Commission on the disclosure of cyber incidents and misrepresentations by companies on their profitable use of artificial intelligence are likely to drive securities class actions and derivative suits going forward, experts say.

Additionally, the scope of allegations is expanding, Ms. Kochenderfer said.

“If you look back historically, it used to be financial mistakes, misrepresentation, misstatements, financial reporting errors that classically drove securities class actions,” she said.

Now, any “bad news event” such as cyber incidents, allegations of misconduct by a board member, employment-related issues and product liability issues can trigger lawsuits, Ms. Kochenderfer said.

A more aggressive, experienced and knowledgeable plaintiffs bar is another factor behind the rise in suits, said Washington-based Joseph Saka, a partner at Nossaman LLP, who represents policyholders.

Unlike plaintiffs attorneys in mass torts who can benefit from third-party litigation funding, attorneys leading securities class actions do not need outside financial backing to pursue big cases, said New York-based Maurice Pesso, a financial lines insurance coverage partner at Kennedys Law LLP.

Because the plaintiffs bar is so well funded, it is emboldened to push for bigger settlements, Mr. Pesso said. “They say, ‘You’re either going to give me the kind of the settlement I want, or we’re going to push forward with this case, and I’m not afraid to lose,’” he said.

The success of plaintiffs attorneys in reaching large settlements and fee awards for derivative suits are other driving forces, said San Francisco-based Priya Cherian Huskins, senior vice president of management liability at Woodruff Sawyer.

“The combination of a smart, innovative plaintiffs bar and, frankly, success in derivative suits is naturally going to lead to more,” she said.

For example, on Oct. 13, Walmart Inc. agreed to resolve a shareholder derivative suit filed in Delaware’s Court of Chancery accusing it of breach of its duty of oversight for $123 million.

The increasing number of securities class actions “is definitely not a surprise to the industry,” said Jarrod Schlesinger, head of financial lines in North America at Allianz Commercial, a unit of Allianz SE.

He said that while factors such as artificial intelligence, COVID-19, and the impact of environmental, social and governance strategies also contribute to the rising number of securities class actions, the concern is whether the industry is appropriately pricing products.

The increasing costs of settling securities class actions and derivative lawsuits are “raising meaningful concerns for the industry,” Mr. Schlesinger said.

Risk management

Addressing the risk of litigation requires a multi-faceted approach for companies because it varies by sector.

For example, there is higher volatility in the technology and life sciences sectors, and their stock prices are more reactive to change, Ms. Huskins said.

Regardless of stock volatility, practicing excellent corporate governance is a good strategy, she said.

“What you’re looking for is a process and a set of people that can help companies navigate some of the tougher business moments that a company will face. Being able to demonstrate to insurance underwriters that you have great corporate governance, an excellent board and a mature management team also goes a long way to helping insurance carriers feel more comfortable about the risk and thus able to extend excellent terms and conditions,” Ms. Huskins said.

An effective risk management strategy involves staying on top of current events and being mindful of actual and potential threats. Preparing for the possibility of litigation from a regulatory body is relatively straightforward, but lawsuits triggered by societal backlash from a bad news event are more challenging, said Manny Padilla, New York-based vice president, risk management and insurance, at MacAndrews & Forbes Inc. and a Risk and Insurance Management Society Inc. board director.

“A lot of my thought processes involve trying to figure out what that new threat could be, although it’s not clearly defined. Having a program that addresses these new issues, in some cases, is very difficult because you don’t know where the bullet is coming from, so to speak,” he said.

The best approach to preparing for unforeseeable events is to create a risk committee, Mr. Padilla said.

“We are all risk managers, and an effective risk management platform thrives when these issues are brought to the table and a risk register is created for discussion. The risk champion is key to driving this success, whether they are a professional risk manager or the de facto chief risk officer of the enterprise,” he said.

Companies can prepare for the costs of litigation by establishing a relationship with an experienced litigator and addressing issues beyond hourly rates. For example, companies should ask about the cost of producing documents in response to discovery requests or the range of costs leading up to a motion to dismiss, Ms. Huskins said.

Securing coverage

After calculating the potential costs of litigation, companies can decide how much coverage to buy.

Data analytics can show the estimated costs of a claim based on industry and market cap size, and benchmarking can show how much D&O coverage companies in the same sector are purchasing, Ms. Kochenderfer said.

“The important thing is to get the data and then have a real conversation about where you want to set your coverage,” Ms. Huskins said.

Companies should consider their risk tolerance and examine settlement data for similar companies, she said.

The soft D&O market is providing policyholders with numerous options to increase their coverage for securities class actions and derivative lawsuits, experts say.

So-called social inflation, or increased jury verdicts, which has driven up rates in other liability lines, hasn’t had a drastic impact on D&O rates due to the amount of capacity in the market, Ms. Huskins said.

“Insurance carriers absolutely need to have discipline to make sure that they have the resources needed to pay the claim. It’s also a fact that they must write premiums to stay in business, and it is a competitive marketplace,” she said.

One approach to strengthening D&O coverage is to use follow-form policies from primary through excess levels, Mr. Saka said.

“The coverage should work seamlessly together and there should be no gaps in coverage across the tower,” he said.

Ms. Kochenderfer said that although coverage disputes over slight variations in primary and excess policies are the “exception rather than a rule,” building a seamless tower is important. “You can’t just stop at the primary,” she said.

A company can have comprehensive coverage under a primary policy, but the limits will be anywhere from $5 million to $15 million, which often isn’t enough to cover the costs associated with a securities class action or derivative lawsuit, she said.

For example, a March report by Cornerstone said the average settlement for a securities class action in 2023 was $47.3 million, a 25% increase from 2022.

Policyholders should also seek to limit exclusionary language, Mr. Saka said. Among other things, he recommended adding a final adjudication clause to the fraudulent acts exclusion and narrowing language in insured-versus-insured and prior acts exclusions.

Additional coverage

Companies can also expand coverage inside and outside their D&O policies, experts say.

For example, companies should consider purchasing dedicated D&O and cyber policies to protect against investigatory claims or lawsuits involving cyber incidents or alleged privacy violations, said Dallas-based Paul King, senior vice president, executive and professional risk solutions practice, at USI Insurance Services LLC.

In addition, more private companies are buying Side A difference in conditions coverage as an additional D&O limit, he said.

A few companies only purchase side A D&O coverage to protect their individual executives versus “full” Side A, B and C entity coverage because they have the resources to cover claims against the business. Current D&O market conditions remain soft, so full side A, B and C coverage purchases remain the market norm (see related story below).

Companies are also looking more into entity investigation coverage, Mr. Pesso said.

“Typically, investigation coverage was only available for individuals, insured persons. Now, there’s more discussions in the marketplace about whether the entities can also get that investigation coverage,” he said.

Mr. King said the U.S. Supreme Court’s decision in Loper Bright Enterprises v. Raimondo, curtailing the “Chevron doctrine” that required courts to defer to the expertise of government agencies, will likely lead to more challenges to investigations, more court time and, therefore, higher costs. This may also result in an increased push for D&O entity investigation coverage and expansion of terms.

Entity investigation coverage could be problematic for insurers and policyholders, Mr. Pesso said, because D&O policies are meant to protect the assets of the individual board members.

“The idea that the policy limits could be used up to protect the company for an SEC investigation or a DOJ investigation just means that less money will be available for the individuals,” he said.

As a result, companies should conduct a balancing test and be mindful of what D&O coverage is intended to protect, he said.

“D&O coverage is intended to protect the individual directors and officers,” Mr. Pesso said. “Whether that be through the company’s indemnification obligation to them, which the insurer will reimburse, or if the company didn’t have the money or was unable to provide indemnification for whatever reason, the coverage goes directly to the individuals.”

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Dedicated policies for individual directors and officers plug gaps 

Companies seeking to bolster coverage for individual directors and officers in the soft D&O market should consider purchasing side A difference in conditions policies because they are affordable and provide expansive coverage, experts say.

Side A DIC excess policies provide additional coverage for directors and officers by filling in gaps in typical D&O policies resulting from exclusionary language.

Coverage for executives in standard Side A D&O policies, for example, often have exclusions barring coverage for cyber incidents, disputes between insureds, and misconduct.

A dedicated Side A/Side A DIC excess policy can provide coverage for individual directors and officers for derivative suits, from the first dollar of claims, that may not be covered or covered as broadly under a standard D&O policy, experts say.

A Side A DIC excess policy could also cover the settlement of a derivative lawsuit, if allowed by state law and if the amount exceeds what’s available in the standard D&O policy, they say.

“You’re not going to have nearly as many exclusions on a Side A DIC policy as a full, ABC D&O policy or even an older Side A D&O only form; modern Side A DIC forms allow a Side A DIC excess policy to ‘drop down’ to seek coverage if there is a difference in condition,” said Dallas-based Paul King, senior vice president, executive and professional risk solutions practice, at USI Insurance Services LLC.

“There’s been a significant uptick in companies buying Side A DIC policies,” said New York-based Maurice Pesso, a partner at Kennedys Law LLP who represents insurers.

“They are less expensive to buy because they only pick up coverage for a non-indemnified loss. Companies are buying more Side A insurance, and the big, mega-companies that have a lot of cash don’t really need full D&O insurance (Side A, B and C coverage),” he said.