Harvard Business School Professors Francois Brochet and Suraj Srinivasan recently published an interesting study regarding independent directors in public companies sued in securities actions. The study, available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2285776, should be read by independent directors of public companies or those considering taking on such a role. The study addresses issues such as the likelihood of being named as a defendant if the company issued for securities fraud (relatively low), which independent directors are most often sued (audit committee members are much more likely to be named as defendants than other independent directors), and the risk of independent directors paying a judgment or settlement (very low, there are only a handful of instances). Most cases are addressed by indemnification or D&O insurance; inadequate D&O insurance and insolvent issuers are unsurprisingly risk factors for independent directors having to personally make payments. Of course, simply being named as a defendant, even with no personal liability, has negative effects for independent directors: loss of time, distraction, reputational impacts, among others. Interestingly, the study addresses other forms of accountability for independent directors, such as the likelihood that independent directors will be the subject of withheld or negative votes, and the relationship of those types of actions for directors whose issuer is sued or independent directors who are themselves sued.
Brown, Neri, Smith & Khan LLP Blog
A recent decision by New York's highest court, J.P. Morgan Securities, Inc., et al. v. Vigilant Insurance Company, et al., provides good news for D&O insureds on several points. The case arises from Bear Stearns' $250 million settlement with the SEC relating to its allowing certain favored hedge funds to "market time" its mutual funds, that is, to make in and out trades to secure higher profits, activities Bear Stearns purported to disallow. The D&O carrier made two principal arguments against indemnifying the settlement costs. First, the carrier argued that the violations were intentional, and insurance does not cover intentional wrongs. The Court rejected this argument, holding that while the violations of securities laws were willful and intentional, there was no conclusive evidence that Bear Stearns intended to cause injury or harm. Both intentional violation and intent to cause harm are necessary to preclude coverage. Second, the carrier argued that $160 million of the settlement was for disgorgement, and disgorgement is not covered and/or excluded. The Court held, however, that the disgorgement in this case was not for profits to Bear Stearns, but rather based on the profits of the hedge funds. The Court held that there is no bar to coverage for disgorgement of profits to third parties -- rather than disgorgement of profits made by the insureds. This decision may provide some additional arguments to obtain indemnification from D&O carriers in the context of SEC and other government settlements.