It’s a truism, but you really can insure everything from a surgeon’s hands to a half-time full-court shot promotion that pays out $1 million.
One type of insurance that’s common but not well-known is “directors and officers insurance,” which is taken out to protect a company and its executives from getting sued due to their actions running the company.
There’s been controversy around many executives lately, including sexual assault allegations against now-former chairman and CEO Les Moonves and Telsa CEO Elon Musk’s tweet about taking the company private and generally questionable behavior.
Because executives leading companies have fiduciary duties to their shareholders, giving false information, failing to respond adequately to a data breach, scandal, or other misconduct can be actionable, especially if it results in a stock drop, a fine, or other financial damages. The liability exists similarly for a board, whose job it is to supervise a CEO.
Most companies have D&O insurance. For example, a source with knowledge of CBS’s inner workings, which are not disclosed, told Yahoo Finance that it would be customary for the company to have it.
For large companies, D&O insurance is often too risky for one insurer to handle on its own. To keep losses to a certain level, an insurer will limit its exposure, requiring a company to find other insurers to join in. All these policies are stacked in a tower. The first few million, for example, could be covered by one company, but any further liabilities would be passed off to the next policy — which might have a higher limit, because it’s not first in line to pay up.
According to Mike O’Malley, SVP for public policy at the American Insurance Association, lawsuits usually occur after a massive stock drop or around mergers and acquisitions on either side.
“In almost all M&As, there’s an attempt to allege the selling company should have gotten a higher price or the purchaser should have gotten a lower price,” said O’Malley. Generally, he said, D&O coverage excludes lawsuit coverage from deliberate criminal acts, but if the board of directors’ actions did result in a stock drop, the coverage could apply.
While stock drops are the main instance in which D&O insurance comes in handy, there are occasionally other trends in the business world that precipitates a spike.
“Around 10 years ago there was an issue with CEOs having their stock options repriced so they had value,” said O’Malley. (Stock repricing means lowering the exercise price of stock options, which effectively sweetens CEO compensation because she or he would pay less for it.) “A lot of shareholders sued at the time. Sometimes something new comes to light [like stock repricing] and a new trend starts.”
According to Shanda Davis, D&O product manager at Travelers, we could be entering into a new trend – 2017 marked a 20-year high for class action lawsuits by shareholders against companies.
“Historically, you’d really see a lot of the securities claims filed around financial disclosures,” she said. “One thing we’ve seen is an uptick in what we call event-driven claims — claims stemming from things other than financial performance.”
These events can range from cybersecurity incidents, environmental impacts, fines from regulatory authorities, to some of the #MeToo headlines that has resulted in terminations, Davis said.
One reason for the increase in claims stemming from non-traditional suits may be because of the financial crisis finally burying the last of its litigation, she said. The industry of lawyers bringing suits is active, and now that many of the old claims from that era are done, there is bandwidth to pursue a new field of alleged mismanagement.
This could increase, Davis said. A Supreme Court decision from March 2018 (Cyan v. Beaver County Employees Retirement Fund) established that claims for errors or liability in a stock prospectus brought in state court are not removable to federal court.
“Basically what that said was if you’re bringing a claim [based on liability from an investing prospectus] it can be brought in state court,” said Davis.
This means the number of claims could skyrocket, as more state courts can get involved in cases, not just federal trial venues.
“You might have one [IPO] with one fundamental issue that results in claims in multiple states,” said Davis.
For now, the industry is watching this closely. But since corporate policies are generally made annually, parties can react quickly if prices, payouts, and lawsuits change.