By DOUGLAS MCLEOD, a veteran insurance industry journalist
The pace of new credit-crisis suits against financial institutions has been falling since the middle of last year, as the overall rate of securities class-action filings declines, according to consulting firm Advisen Ltd. The same period, though, has seen a sharp rise in suits accusing corporate executives of breaching fiduciary duties, many of them filed by disgruntled shareholders opposing merger-and-acquisition deals.
The shift "changes the dynamics" of the directors' and officers' liability insurance (D&O) market, said David Bradford, an Advisen executive vice president in New York. While class actions generate a relative handful of big settlements, fiduciary suits result in smaller but much more frequent losses, putting more pressure on primary D&O insurers, he explained.
Meanwhile, federal regulators are widely expected to step up litigation this year against executives of many of the more than 340 banks that have failed since 2008. The suits are also likely to target accountants, lawyers and other professionals who did work for the banks, and in many cases they could trigger private litigation against the same defendants, experts say.
Overall, securities litigation edged up last year, with 1,196 suits filed in state and federal courts compared with 1,171 filed in 2009, according to Advisen. Continuing a five-year trend, new class-action filings dropped last year to 193, or 16 percent of all securities suits filed, from 233 the year before. The decline accelerated in the fourth quarter, with class actions accounting for only to 14 percent of filings. Securities fraud claims brought by regulators and law enforcement agencies likewise fell to 405, or 34 percent of the total last year from 479 in 2009, with a similar drop-off in the fourth quarter.
The declines reflect a winding-down of new cases related to the mortgage meltdown and financial crisis.
Boston-based Cornerstone Research Inc.--which tallies class actions differently from Advisen and counted 176 new federal filings last year--reported just 13 new credit-crisis suits in 2010, down from a peak of 100 in 2008. Financial firms and their executives were less frequent targets last year, with information technology and healthcare companies facing a growing share of securities litigation, both Cornerstone and Advisen reported.
FIGHT STILL ON
None of that means the battle is over for financial companies, though. In a review of 193 credit crisis class-actions filed between 2007 and 2009, Cornerstone found that 56 percent were still pending last year, with 34.2 percent dismissed and only 9.8 percent settled.
"Many of the really big ones are still out there and will be settled over the next year or 18 months," said Dan A. Bailey, a lawyer with Bailey & Cavalieri in Columbus, Ohio. Some will be "blockbusters," with settlements in the hundreds of millions of dollars, he said.
The backlog of pending cases will be "hanging over D&O insurers for some time," agreed Kevin M. LaCroix, a lawyer and executive vice president with OakBridge Insurance Services in Beachwood, Ohio.
In addition, the flow of new credit-crisis class actions, while slowing, won't stop completely. February 2011 saw the new year's first such suit, filed against Bank of America and some of its executives, charging that they failed to record mortgages and process foreclosures properly.
Still, D&O experts are shifting their attention to a faster-growing field in securities litigation: breach of fiduciary duty suits, including so-called "merger objection" suits. These suits, 80 percent of which are filed in state courts, typically charge that executives shortchanged shareholders in negotiating a sale or buyout of a company.
The number of M&A suits shot up to 335 last year, more than triple the rate of 200, and the pace could continue to climb with an expected increase in merger activity this year, experts say.
The median market capitalization of companies named in M&A suits has dropped from $1.1 billion in 2006 to $509 million last year, suggesting that smaller plaintiffs' law firms have moved into the field and are targeting smaller companies, according to a recent Advisen report.
Compared with sprawling class actions, individual M&A suits are inexpensive, settling quickly for small amounts and payment of plaintiffs' legal fees. Plaintiff lawyers collect an average of $500,000 per case, according to Advisen, and many companies are eager to settle so they can complete M&A deals.
"Generally, they get teed up and go away fairly quickly," Bailey observed.
Despite that, a rising volume of suits can create problems for companies' D&O programs, LaCroix warned.
"They're more a frequency risk than a severity risk," he said, and "more a concern for primary and first-attaching excess (D&O) insurers."
Frequent, low-level losses could exhaust executives' primary coverage, driving costs of any later D&O claims into higher excess layers, he said.
A single M&A deal can also spark several separate lawsuits, adding to the cost. Last year, some deals brought simultaneous suits in as many as six different jurisdictions, according to Advisen. The average contested deal in 2010 created suits in 1.57 jurisdictions, compared with an average of about 1.1 in 2007. And unlike large federal class actions, there is no way of consolidating M&A cases spread across state and federal courts, lawyers agree.
"They're becoming a much larger nuisance to deal with," Bradford said.
GOING AFTER FAILED BANKS
Failed banks, meanwhile, are another potential source of D&O losses this year. More than 340 banks have collapsed since 2008, including 157 last year and 22 so far this year.
The Federal Deposit Insurance Corp.'s board of directors has so far authorized D&O lawsuits against 130 individuals involved in bank failures, seeking $2.6 billion in damages; only four of the suits, naming 35 people, had actually been filed as of mid-January, according to the FDIC's website.
"The FDIC has been slow getting it going, but that train is going to leave the station," Bailey predicted.
Given the number of pending FDIC investigations and the similarity of the banks' problems to those of failed savings-and-loan institutions in the late 1980s and early 1990s, more D&O litigation is in the cards, according to a study by NERA Economic Consulting in New York. The agency is "likely to pursue professional liability claims as vigorously as they did following the S&L crisis," NERA predicted.
If it follows the pattern of its S&L litigation, the FDIC will go after not only bank directors and officers but also accountants, lawyers and other professionals involved in the banks' business, creating potential losses to professional liability and errors-and-omissions programs, experts added. The FDIC recovered $3.3 billion from S&L liability claims between 1990 and 1995, including in $1.3 billion in D&O proceeds, according to NERA.
Regulators' suits could also provide a roadmap for private plaintiffs' lawyers.
"FDIC suits will almost certainly spark private actions against the same directors and officers," the Advisen report predicted.
One reason for hope among D&O insurers, Bailey pointed out, however, is that most of the failed banks are small, local institutions.
"The amount of insurance money at risk on the D&O side is somewhat contained," he said.
If bank failures continue at the current rate for another two years, though, the FDIC's liability litigation claims "would approach S&L levels," NERA warned.
March 1, 2011
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