By Steve Tuckey
An economy rebounding in fits and starts has produced something of an uptick in mergers and acquisition activity, and with it new ways for the plaintiff's bar to fill its coffers.
Evan Rosenberg, senior vice president of The Chubb Group of Insurance Companies, said federal legislation aimed at curbing frivolous, or what industry insiders term 'strike,' lawsuits over the past couple of decades has slowed the filing of suits against directors and officers in U.S. District Court.
But plaintiff's attorneys, he said, are now bringing them in state courts, objecting to virtually every announced merger transaction. The lawsuits are based on an alleged breach of fiduciary duty to shareholders, complaining that the terms of the merger are unfair.
"These lawsuits are unique in that they fall outside the protection of the federal legislation aimed at curbing strike lawsuits," Rosenberg said. Many attorneys prefer to fight their battles in state courts where more favorable rules of discovery and other issues prevail, he added.
In addition, attorneys are filing the suits in multiple states in an effort to gain leverage and drive up the cost of settlement.
Rosenberg will be one of several experts expounding on directors' and officers' coverage and other issues this month at the 25th Annual International Conference of the Professional Liability Underwriting Society.
The conference will be held in Chicago, Nov. 7-9.
"These merger cases have always occurred, but in small numbers. But now you are up to a couple of hundred of these lawsuits per year," he said. "If a company announces it is being acquired, you can almost predict it will be sued."
Rosenberg said that in virtually all instances no settlement funds go to shareholders, "and in most instances plaintiff lawyers collect fees in return for settling or dismissing the lawsuit."
"So you are not seeing a change in the price of the merger. Settlement terms are mostly prophylactic, changing some disclosures in the proxy statement. There have been some outliers where there have been some serious issues on the table, but the sheer number of these lawsuits has been causing carriers some indigestion because there are just so many of them," Rosenberg said.
Rosenberg said insureds don't have many options when it comes to preventing these actions. "Last time we had a strike suit problem it took two acts of Congress to deal with this issue," he said.
Just as the Internet boom was getting under way in the 1990s, Congress in 1995 passed the Private Securities Litigation Reform Act (PSLRA) that backers described as an attempt to curb frivolous securities class action lawsuits with new rules for discovery. Three years later, the lawmakers approved the Securities Litigation Uniform Standards Act, which prohibited plaintiff's attorneys from making an end run to state courts for their actions.
With this new fiduciary duty opening, Rosenberg does not hold out much hope for Congress taking any remedial action. "Absent any type of legislative change, we think this is the new normal," he said.
A rebounding economy will in all likelihood also produce a spate of initial public offerings and with them new challenges for directors and officers seeking to protect themselves from either the incompetence or venality of others.
The slumping post-IPO share price of Facebook has produced its share of headlines concerning technical glitches, undisclosed earnings forecast information and, of course, how Mark Zuckerberg is coping now that he is down to his last $9 billion.
The first securities-based lawsuit stemming from the May 18 Facebook IPO, naming among others, the directors and officers of the company, was filed four days later in California Superior Court in San Mateo.
Separate plaintiff's counsel filed suit the next day in U.S. District Court in New York, alleging many charges including the fact that only a handful of investors were made privy to reduced earnings forecasts prior to the IPO.
Prominent liability attorney Kevin LaCroix, writing in his D&O Diary, said that in this case SLUSA does not necessarily preclude concurring state and federal jurisdiction in these securities cases.
"The question of the existence of concurrent state court jurisdiction under the Securities Act of 1933 has been well ventilated in a variety of cases filed in connection with the subprime meltdown and the credit crisis," he wrote.
Based on the developments in the case of Luther v. Countrywide, "there would appear to be substantial grounds on which the plaintiffs in the recently filed action against Facebook might proceed in California state court," he wrote.
But outside the San Francisco-based 9th U.S. Circuit Court of Appeals, there would likely be less support for concurrent state court jurisdiction, he added.
The 9th Circuit has garnered notoriety over the years for its left-leaning decisions, particularly during last winter's GOP Republican presidential primary race when Newt Gingrich called for its abolition.
In an effort to produce more IPOs, President Barack Obama signed into law last April the Jumpstart Our Business Startups (JOBS) Act that loosened some of the rules governing private company shareholders.
Boston-based attorney Carl Metzger said that the action could also jumpstart D&O lawsuits if the expanded private company shareholder rosters include more investors who feel they get a raw deal for whatever reason.
"It will present more potential areas of liability for companies that take advantage of certain provisions of the act," he said.
For example, the law will allow a stockholder base for the emerging growth companies in their private company phase to expand from 500 to 2000.
"That is a good thing because it allows companies to grow their business," Metzger said. "But it also presents the possibility for more shareholder claims."
A new funding mechanism for companies looking to go public known as "crowd funding" also presents new liability claims potential, Metzger said. The process allows companies to use SEC-approved portals for solicitation of up to $1 million in shareholder funds.
"These private company investors used to be limited to what was known as 'sophisticated investors,' but as you open up this universe you will be getting , in theory, less savvy investors and thus the potential for more claims," he said.
Metzger said that directors and officers connected to companies that take advantage of JOBS activities should make sure their D&O policies actually cover these activities.
"Because, after all, when the policies were written they were not done so with the tools of the JOBS Act in mind," he said. "And I can tell you that under some private company D&O policies IPO exclusions may need to be reworked to allow companies to take advantage of all the JOBS Act opportunities."
While some companies have taken advantage of some JOBS measures, its true impact will not be seen for several years since some aspects of the legislation have yet to undergo the process of SEC rulemaking.
The financial and even existential threat of massive data breaches has hung over corporations for decades now and directors and officers are not immune, according to one leading expert in the field.
Richard Bortnick, a Philadelphia-based attorney with Cozen O'Connor, also writing in the D&O Diary, said that cybercoverage has become a necessity due to the increasing sophistication of hackers and the limitations of existing policies.
"Equally troublesome, our expanding online society has introduced new financial risks and exposures that may not be covered under general and professional liability insurance products, including standard directors' and officers' policies," Bortnick said.
In the event of a data breach or a catastrophic first party loss, Bortnick said it would not be surprising for shareholders' counsel to file securities fraud and derivative suits against a company's directors and officers, alleging failure to properly disclose and manage risks and or breach of fiduciary duty.
He added that "given the defense costs associated with such suits, even in the absence of liability exposure, it is essential to have a D&O policy that complements a cyberinsurance policy."
Rosenberg, LaCroix and Metzger are scheduled to speak at the PLUS International Conference, which will also feature speakers on employment practice liability threats, and on liability issues facing companies looking to expand globally.
STEVE TUCKEY has written on insurance issues for a decade for several national media outlets. He can be reached at firstname.lastname@example.org.
November 1, 2012
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