A wave of class-action securities litigation brought by an active plaintiffs’ bar, as well as a rise in event-driven litigation, has caused a significant uptick in volume and volatility in the directors and officers (D&O) claims environment and has increased insurer underwriting scrutiny.
As plaintiffs’ lawyers have become more creative and entrepreneurial, the nature of shareholder litigation has evolved beyond only financial restatements or accounting issues.
Today, the litigation landscape is frequently driven by corporate events — for instance, cyberattacks, litigation related to the Me Too movement, lack of diversity or wildfires. Litigation filed related to the impact of the COVID-19 pandemic might become part of this event-driven litigation trend, with such suits possibly destined to become a larger factor in executive risk claims activity.
While the actual loss from a cyberattack or wildfire would not fall under the company’s D&O policy, shareholder litigation that triggers executive risk claims could be formed on the basis of class-action litigation focusing on one of the following: potential breaches of the fiduciary duties of the directors and officers in response to the event, disclosures made to investors about the event or any alleged impact on share price.
While the number of new securities class action filings in the U.S. dropped in 2020, largely in relation to court closures from the pandemic, the rate and total number of claims remain significant.
Emerging Claim Risks, Including SPAC Impact
The growing use of special purpose acquisition companies (SPACs) — listed shell companies formed to acquire private companies — may also contribute to future event-driven D&O claims.
The field of SPAC litigation is still evolving, so the impact of SPACs on the shareholder litigation landscape remains uncertain. SPAC shareholder litigation has been filed, however. The current cases are unique, focusing on novel issues and stretching traditional types of shareholder litigation causes of action, so their impact remains to be seen.
Other items are emerging as potential exposures at the board level from a corporate governance perspective. Among them are environmental, social and governance (ESG) issues. There are signs that ESG may emerge as a potential source of securities litigation — again, of the event-driven variety.
For U.S. organizations considering initial public offerings (IPOs), the Delaware Supreme Court ruled in 2020 that companies could designate in their charters the forum for securities fraud claims arising from IPOs, preventing those companies from potentially having to defend such suits in both federal and state courts.
The Claims Climate in Canada
Shareholder litigation is far less common in Canada, with only 15 cases filed in 2020. There is, however, a history of litigation trends making their way north from the U.S. into Canadian courts. For now, litigation based on topics such as COVID-19 or diversity is far less common in Canada than it is in the U.S., but that could change in the years ahead.
Most securities litigation in Canada today tends to center around disclosure issues. While the frequency of claims has been fairly consistent, the severity has increased in some notable cases recently, driven by the U.S. settlement portion of the cases.
The situation speaks to the difference in exposure between companies traded only in Canada and those listed on exchanges in both Canada and the U.S. The result is that insurers are charging much higher D&O premiums for Canadian companies trading on U.S. markets than for their counterparts trading only in Canada.
Some Canadian insurers believe they simply don’t have adequate premium volume to write the executive risks of businesses with both Canadian and U.S. exposures. Securing adequate coverage, then, means looking to insurance markets in the U.S., Bermuda or London.
Increasing pressure on ESG issues is also becoming a potential executive risk claims driver for Canadian companies, particularly regarding corporate disclosures.
Insurers’ Claims Response and the Importance of an Advocate
Insurers have responded in various ways to the rising frequency and volatility of executive risk claims. Some are taking a closer look at coverage and are perhaps less willing to write policies in areas in which the exposures are potentially less predictable. Others are tightening claims practices or taking a closer look at defense costs.
As executive risk insurers more closely examine D&O claims, a broker with a sophisticated claims department can be an important asset. Whether it’s by engaging with insurers early or by keeping them on board over the course of a claim, the advocacy role can take on considerable importance as claims frequency and severity grow.
In this environment, communication becomes essential between the defense counsel, risk management team, brokers, and underwriters — not just for the purposes of the current claim but to also manage the impact on the next renewal.
As retentions grow, there can be a tendency for companies not to address claims management or engage insurers until an organization is well into its retention. But early engagement of insurers is critical to ensuring that they understand how defense costs are accruing against the retention and the likelihood the insurer will be paying on the risk.
Navigating the Current Claims Environment
A hardening insurer market, coupled with insurers’ responses to increasing the frequency and severity of executive risk claims, creates additional challenges for companies.
In this environment, it’s essential for organizations to understand the factors driving executive risk claims and, when claims occur, to engage partners who can help them navigate those claims successfully and communicate effectively with all the stakeholders in the claims process.