The Chinese have a saying, “May you live in interesting times,” that is more of a curse as it signifies a period of disharmony and chaos. Safe to say that 2019 was an interesting time in the public D&O space. We saw, for the first time in a very long time, real firming of conditions that impacted premiums and retentions, as well as all layers - primary, excess and Side A of difference in conditions (DIC) to varying degrees. The impact differed depending on a number of factors, but suffice to say that it was felt by everyone. Given the new reality, it is always helpful to look back and see how we got here, which in turn better allows us to understand and protect our clients’ interests.
Securities Litigation Activity Continues at Historically High Numbers
While we can quibble about whether the severity of the firming is justified, the simple reality is it has not been easy being a public D&O carrier. 2019 saw yet again a historically high number of securities class action filings, with 404 total cases, up slightly from 402 in 2018 and down slightly from the high in 2017 of 412.
Admittedly, a significant portion of the bump in the past 3 years are merger objection suits, perhaps the most frivolous (generally speaking) type of securities litigation today, which are now being filed in federal court at higher numbers due to new barriers to settling such suits in state courts. Even so, there were about 250 “traditional” class actions filed in 2019, which is still meaningfully above a historical average of ~ 200 filings a year.
Even worse is the litigation rate, which is the probability of a public company being hit with a securities class action. Historically, the rate has been under 3%, but we have far fewer public companies today while filings are skyrocketing. The rate was 8.4% in 2017 and 2018 and 8.66% last year, all historically high numbers.
Even normalizing by removing merger objection suits, you are still left with a litigation rate over 5%. These are meaningful increases, and while the chance of a dismissal remains high for many cases, the reality is it is still costing carriers and clients’ real money to get out of these cases.
The IPO Market is Bonkers
If life can be tough for mature public companies, forget about IPOs. 2019 saw a market correction the likes of which I have never seen in close to two decades in public D&O. In late 2018/early 2019, you could find $10M primary options for $250,000 to $350,000 with $1M to $1.5M securities claim retentions.
By the end of 2019, primary $5M (and sometimes $2.5M for the more difficult risks) were pricing at $800,000 to $1,000,000 with $10M to $20M retentions. Yes, $10M to $20M retentions. $40M limit programs that costs ~ $500K to $600K a few years ago could now easily exceed $2.5M to $3M. Results of course vary by industry, risk profile, etc., but the scary thing is that I think this change was not only warranted but two years overdue.
The Impact of Section 11 Cases
Why the IPO market has gotten so bad could fill a blog post of its own, but the quick story is that a few years ago some enterprising plaintiffs firms started filing these cases in state courts, with a focus on California state courts and even more specifically certain courts in Northern California. They are referred to as Section 11 cases, which is a reference to the provision in the Securities Act of 1933 that governs liability arising from the registration filing.
The negative impact this had cannot be overstated, and I speak from experience as I had a number of clients sued in the local NorCal state court that was the epicenter. Cases that should have been dismissed (and in one situation actually had their sister federal suit dismissed with prejudice on the first round, which rarely happens) ended up settling for $8.5M and $32M respectively, and that does not include multi-million dollar defense bills.
The jurisdictional issue even made it to the U.S. Supreme Court, but unfortunately the Court punted and pushed it to Congress to fix, which in today’s environment means we should not expect things to change anytime soon. But, on a more positive development, the Delaware Supreme Court last week upheld the facial validity of provisions requiring that ’33 Act cases be brought in federal court (aka forum selection provisions), which offers hope that maybe we have turned a corner. For those curious, the Section 11 case was Cyan, Inc. v Beaver County Employees Retirement Fund and the forum selection case was Salzberg v. Sciabacucchi.
Are Boards at Greater Risk Today?
As riveting as discussions about insurance market conditions can be, the ultimate question is if boards are at greater risk today than before. The honest answer is yes and no.
Yes, there are historically high numbers of filings and a great likelihood of being sued and there is no indication that is going to slow down and indeed, we’ve seen plaintiffs’ firms more aggressively pushing the boundaries Section 11 cases beyond IPOs post Cyan. The reality, however, is more nuanced, as “normal” class actions still have a high probability of being dismissed or settling within the historical median that is below $10M.
A case in point is a 2019 decision in a derivative case involving Clovis Oncology that was making the Directors education conference circuit last year. That case involved a denial of a motion to dismiss under what is known as the Caremark standard, which is Delaware Supreme Court precedent that governs board liability for lack of oversight.
This followed a similar case called Marchand, in which a Caremark case was also allowed to proceed. Caremark cases are extraordinarily difficult for plaintiffs to win, so the fact that we have had two such cases in a relatively short period of time is concerning.
But, we have to keep things in context. These were notable to some degree because these cases are so hard to bring. Further, there were unique facts in both cases (deaths from a listeria outbreak in Marchand and a nine figure securities settlement and SEC fines in Clovis, among others) that likely influenced the courts’ decision to allow the cases to proceed.
If anything, they are important reminders for boards to develop proper internal controls, but also remain engaged in their oversight throughout the year – things that they are already doing as responsible board members.
What to Expect in 2020?
I started drafting this post before our world got turned upside down by COVID-19 and not surprisingly have been getting a number of questions from clients and others about the D&O impact. Public companies, particularly those with unique sensitively to the impact of the virus, were hopefully ahead on their public disclosures, and I imagine they were, but it is an issue for all public companies and simply a matter of good governance. I fully expect this will be yet another example of the “event” driven securities litigation that we’ve seen the past few years and while proper disclosures and controls are not a barrier to being sued, they are important facts to help get the suit dismissed.
Of more pressing concern is the sheer scope of the economic and market dislocation that is likely to only get worse. Depressed share prices are one thing, but I worry just as much (if not more) about our mutual private company clients who are more at risk of shutting down, either voluntarily or involuntarily. This has risk implications in many areas, such as D&O, EPL and others, and it is important that we provide you, our retail partners, the information you need to properly advise your clients.
A discussion on the insurance implications could also fill a blog post, but I will admit that I don’t worry so much about coverage at this point. A properly structured D&O policy should be there in the event a Director or Officer is sued in their capacity as such arising from COVID-19. The most obvious coverage issue is the bodily injury exclusion, but there is language that candidly should already be in place to ensure that the exclusion is sufficiently narrow to potentially cover a follow-on D&O suit and this is particularly true for public companies.
The Larger Impact
What larger impact will this have on the public D&O market? The honest answer is we will see. Conditions were tough before, especially on the primary, and this will certainly not make it any better. In the end, all we can focus on is what we can control and that is the services we provide to clients. We should never lose sight that D&O at its core is a very personal insurance protecting real assets of real people. These difficult times, probably a first for many clients (let alone the impact of COVID-19 on all of us), require reasoned counsel, creativity and guidance more than ever. More importantly, we at RPS hope that all our clients, partners, colleagues, and their loved ones, stay healthy and safe. We will get through this together! Now go wash your hands.