ALLOCATION AND SECURITIES LITIGATION REFORM: ARE INSUREDS REALLY WINNING?
Two of the potentially most important developments to occur in recent years relating to D&O liability and insurance are now happening. The publicity given the recent Ninth Circuit Court of Appeals decision in Nordstrom, Inc. v. Chubb & Son, Inc. relating to allocation and the proposed Federal securities litigation reforms has suggested that corporations and their D&Os will have less exposure and greater coverage for claims under the Federal securities laws. In reality, the impact of these two developments is far from certain and ironically may be as harmful to corporations and their D&Os as it is helpful.
A. NORDSTROM DECISION
On April 14, 1995, the U.S. Court of Appeals for the Ninth Circuit upheld a District Court's 100% allocation to the D&O insurance policy of a settlement in a Federal securities law claim. The insurer unsuccessfully argued that because the corporation was a co-defendant with the D&Os, a portion of the $7.5 million settlement should be allocated to and paid by the corporation, not the D&O insurer.
Among other things, the Court ruled:
- Washington law permits allocation even in the absence of an express allocation clause in the policy.
- The D&O insurer is not obligated to fund the entire settlement simply because the D&Os are jointly and severally liable with the corporation for the settlement amount.
- A portion of a settlement amount for which both the defendant D&Os and the corporation are liable may he allocated to the corporation only to the extent there is some amount of corporate liability that is both independent of and not duplicated by liability of the D&Os. In other words, the settlement may be allocated to the corporation only to the extent the corporation alone is liable for a particular claim or to the extent the corporation's liability exceeds that of the D&Os. This allocation methodology is referred to as the "larger settlement rule".
- A corporation may have direct liability for securities fraud, although the insurer here failed to show that any such direct liability increased the settlement amount.
If this "larger settlement rule" is applied by other courts in other cases, it appears likely that, in most cases, all or virtually all to a settlement for which a corporation and its D&Os are jointly liable will be allocated to the D&O insurance policy, thus significantly increasing loss payments by D&O insurers. In that event, D&O insurers will likely respond with either substantial premium increases or revised cover- age terms.
The 1994 Wyatt D&O Liability Survey reported an average D&O allocation of 60%. If that allocation is suddenly increased to 90% or 100%. D&O insurers will likely be compelled to choose between operating at a substantial loss, increasing their premium income, or returning to a lower allocation through policy wording.
It is far from certain, though, whether the Nordstrom opinion will be followed in future allocation cases. The following summarizes some of the potentially unique aspects of the opinion which may distinguish it from other cases:
- The court applied Washington insurance law, which required the court to determine what allocation rule best effectuates the reasonable expectations and intentions of the parties under the insurance contract. This rule of policy interpretation is inapplicable under various other state laws and insurance policies.
- The decision expressly limited its ruling to the particular facts in that case, which in some respects were rather unusual.
- The underlying claim against the defendants alleged violations of Sections 10(b) and 20 of the Securities Exchange Act of 1934, not Sections 11 or 12 of the Securities Act of 1933. Because those 1933 Act sections create significantly different liability exposures for the corporation than for D&Os, it is doubtful the decision applies to securities offering claims under those 1933 Act sections.
- The decision expressly limited its ruling to Chubb's 1984 Executive Liability Policy form, which did not reference allocation of settlement amounts. Some courts have held that the "larger settlement rule" does not apply under a D&O policy which expressly recognizes the need to allocate loss between the corporation and the D&Os when both are defendants in the same claim. See, e.g., First Fidelity Bancorporation v. National Union Fire Ins. Co., 1994 U.S. Dist. LEXIS 3977 (E.D.Pa. March 30, 1994).
- Decisions of the Ninth Circuit are not binding on state courts, courts of the other ten Federal circuits, or arbitrators.
The decision expressly recognizes that the "large settlement rule" does not apply to subrogation claims by the insurer against the corporation for contribution. At least in the near term, the Nordstrom decision and its publicity will likely further aggravate the difficulty of reaching allocation agreements. The allocation expectations of insureds may be increased, while D&O insurers may be motivated to insist upon relatively modest allocations in order to avoid at least the appearance of adopting the Nordstrom analysis.
Thus, the Nordstrom decision, at a minimum, emphasizes the continued importance of addressing the need to allocate and the methodology for that allocation in the pre-claim underwriting context in order to minimize the potential for surprises and disagreement in the claims context.
B. SECURITIES LITIGATION REFORM
The single most important development involving Federal securities law litigation since the enactment of the Securities Act of 1933 and the Securities Exchange Act of 1934 initially appeared to be occurring in 1995, when the Republican-controlled Congress attempts to curtail frivolous securities litigation consistent with the Republicans' "Contract with America".
Some of the highly publicized legislative proposals introduced in early 1995 contained meaningful deterrents to securities litigation abuses. Not surprisingly, though, the legislative process has substantially diluted those proposals. As a result, it is now unlikely that any legislation which is ultimately enacted will significantly reduce either the frequency of securities law claims against D&Os or the magnitude of settlements and judgments in those claims.
On March 8, 1995, the U.S. House of Representatives passed H.R. 1058 by an overwhelming vote of 325 to 99. Two related Bills are pending in the Senate, although both generally provide less protection for defendants than the House version. Thus, any legislation ultimately enacted will likely be no more, and probably less, protective of defendants than the House Bill.
The more significant elements of the House Bill and their implication to future litigation are briefly summarized below:
1. Recklessness. The Bill codifies existing case law by allowing liability under Section 10(b) of the 1934 Act to he based upon reckless rather than intentional wrongdoing. The Bill defines recklessness as conduct involving an extreme departure from standards of ordinary care and presenting a danger of misleading investors that was either known by the defendant or so obvious that the defendant must have been consciously aware of it. If a defendant deliberately refrains from taking steps to discover whether his statements are false or misleading, his conduct constitutes recklessness; but if the failure to investigate was not deliberate, the conduct is not reckless.
Except for this latter provision, which is likely to be deleted from any legislation ultimately enacted, this portion of the Bill largely codifies existing law and will not meaningfully increase the ability of defendant D&Os to be dismissed. Some earlier proposals would have required intentional, not merely reckless, conduct to establish liability but such a requirement was rejected because, among other things, claims for intentional wrongdoing would not generally be insurable.
2. Joint and Several Liability. The Bill would modify existing law by eliminating joint and several liability among co-defendants if the defendants are liable based upon reckless misconduct. Joint and several liability remains if the defendants committed intentional wrongdoing. This provision, which the accounting industry strongly supports, may have an impact on the allocation of loss between a corporate defendant and its D&O defendants. A "proportionate liability" method of allocating loss among co-defendants (including the corporate defendant) arguably would defeat the larger settlement rule adopted in Nordstrom.
3. Fee Shifting. The Bill provides that if a securities claim is resolved other than by settlement, the losing party must pay the legal fees of the prevailing party if the prevailing party demonstrates that the position of the losing party was not substantially justified; that an award against the losing party would be just; and that the cost of such fees to the prevailing party is substantially burdensome or unjust. By establishing such high standards for fee shifting and by largely deferring to the discretion of the court, this provision will likely have virtually no deterrent effect on plaintiffs commencing a securities lawsuit and will not likely result in any payment of defense costs by plaintiff.
4. Abusive litigation Practices. The Bill precludes any person from being a named plaintiff in more than five securities class action lawsuits during any three year period; eliminates "bounty" payments to the named plaintiffs; prohibits plaintiff referral fees; and bans any attorney who would otherwise be a member of the class from participating in the prosecution of the lawsuit. These procedural provisions are substantially diluted from prior proposals (which among other things would have required the named plaintiff to own at least $10,000 of stock in the defendant corporation) and will likely have little impact upon the well organized professional plaintiffs' bar.
5. Steering Committee. The Bill provides for a court-appointed plaintiffs' steering committee in each securities class action case to ensure client control of the litigation. The steering committee will have authority to retain or dismiss counsel and to reject or preliminarily accept an offer of settlement. Named plaintiffs in the lawsuit can serve on the committee but cannot constitute a majority of the committee. Although intended to avoid abuses in the prosecution of securities claims, this provision may make securities class action lawsuits more difficult to settle since members of the steering committee, who individually may have little at stake in the lawsuit, may be more willing than the plaintiff lawyers to "role the dice" with a jury trial rather than agree to a settlement which will involve only nominal payments to the individual plaintiffs.
6. Projections Safe Harbor. The Bill provides that oral or written statements that project, estimate or describe future events cannot be the basis for a securities claim if the statement includes both a brief summary of the information relied upon in making the forward-looking statement and a disclaimer of reliability. This statutory safe harbor is probably the most helpful clement of the Bill and, if enacted, will force plaintiffs to focus future securities litigation primarily upon misrepresentations and omissions of existing or historical information.
7. Pleading Requirements. The Bill requires a plaintiff to make specific allegations that, if true, would be sufficient to establish scienter as to each defendant. This provision would effectively nullify a recent Ninth Circuit Court of Appeals decision which permitted plaintiffs in a securities lawsuit merely to allege scienter generally by simply staling that scienter existed. If enacted, this provision will somewhat increase the frequency of dismissals in the few Federal Circuits which have adopted a less stringent pleading requirement. However, plaintiffs will undoubtedly be permitted to replead, thus making it unlikely the dismissed case will simply go away.
In summary, except with respect to the steering committee provision, the proposed legislation would be somewhat helpful to defendants, but will not significantly curtail the frequency or severity of securities litigation. To the extent the legislation would result in a somewhat higher frequency of dismissals, professional plaintiffs' lawyers are expected simply to prosecute more aggressively and force higher settlements in the remaining suits. Thus, the net benefit to the D&O insurance industry from any enacted securities litigation reform is likely to be negligible, other than its potential effect on allocation. More troubling, however, is the prospect that the creation of investor steering committees will prolong or thwart reasonable settlement opportunities, thus causing increased defense costs and perhaps more D&O jury trials. Like the Nordstrom decision, it is far too early for corporations and D&Os to take much comfort from the prospects of securities litigation reform.
D&O INSURANCE CHANGES AT ACE
Like the insurance industry generally, significant change is occurring at ACE with respect to its D&O insurance management and products. Charles D. Smith, Senior Vice President, Underwriting, recently retired after nearly eight years of service to ACE. During his productive tenure, the Company has grown to he the leading underwriter of excess D&O liability insurance in the world, based on premium volume.
Mark Herman, who joined ACE on June 1, 1995 as Senior Vice President, Underwriting, now leads the D&O operations. With over eleven years of U.S. and international D&O underwriting experience with Chubb, Mark is uniquely qualified to fulfill ACE's commitment to become an even stronger force in the D&O market.
In May 1995, ACE announced modifications to its excess D&O policy program for non-U.S. domiciled companies. These changes, when combined with the 1993 acquisition of Corporate Officers & Directors Assurance Ltd., ("CODA") and the 1994 creation of a London office, position ACE as one of the foremost excess insurers for global D&O risk.
The minimum ACE D&O attachment point for non-U.S. is now:
- U.S. $7.5 million (or foreign currency equivalent) for privately held companies, charities, government organizations, trade associations and similar groups;
- U.S. $15 million (or foreign currency equivalent) for publicly traded companies that do not have U.S. securities exposure;
- U.S. $25 million (or foreign currency equivalent) for all other publicly traded companies.
In addition, the ACE and CODA D&O application forms for non-U.S. companies have been simplified. CODA also recently introduced a new policy form specifically tailored for Australian risks, which would make available limits up to A$100 million, on a primary, excess or excess and difference-in-conditions basis.
ACE remains strongly committed to providing responsive D&O insurance products and services of the highest quality to the worldwide marketplace and is confident that these recent changes will further enhance its ability to fulfill that commitment.