The environment for D&O insurance has grown more contentious, given the increase in regulatory action and litigation. Directors and executive officers are faced with more lawsuits and, as a result, an increase in personal liability. NACD Directorship, in conjunction with Chartis, convened a group of experts at The Lotos Club in New York to discuss D&O liability and the future challenges directors face as they manage risk.
In the aftermath of the economic crisis and subsequent losses in shareholder value, Louis Lucullo, executive vice president of the Executive Liability Division of Chartis, pointed out that directors need to understand the intricacies of their policies. For example, when is director coverage triggered? At the start of even an informal investigation, directors are often asked for documents and other information, but coverage doesn’t start at that point in the process—often to the surprise of directors and officers.
Lucullo explained that current policies in the marketplace do not provide coverage until either an actual subpoena is issued or even later, such as receipt of a notice that charges may be brought. New policies seek to be more transparent and take effect earlier, such as “when you appear in an interview,” Lucullo said. Directors should ask: “To what extent is the coverage available?” he adds.
“When you look at your D&O policy, you should know the extent to which you are indemnified—and how the policy works in providing that indemnification,” Lucullo said. “The worst part for you as a director is that you’re often left out in the cold while the process is going on—there’s no need for that.” Your D&O policy must have a feature by which it will advance payments for any reason should the company fail or refuse to indemnify, he cautioned.
In addition to the unfavorable litigation climate, directors are often faced with scrutiny because the company is unsure whether or not a particular director has acted fraudulently. “The last thing you want is to have a company fear that you acted fraudulently, when in fact, you haven’t,” Lucullo added. “Broad D&O contracts have conduct exclusions—but we rarely use them.” Conduct exclusions are rarely utilized because very few securities litigation cases have gone to trial: “Fewer than 25 since 1995,” Lucullo noted.
As a director, Stuart R. Levine advises his peers to reinforce confidence in capitalism and the economic system by supporting common sense governance practices. “There are two things that work [when dealing with risk issues]…understanding reputational and financial risk for directors as well as for the corporations they serve,” Levine said. “Those two issues help to define our service.”
The desire to be adequately covered by a proper D&O policy could lead to “too much D&O.” According to John F. Levy, a member of three public company boards, “If you have too much D&O, you become a target for unscrupulous attorneys and their clients, but you want enough so you’re protected.” Levy recalled one experience where the company financed the D&O insurance and had an agent handle the process. The firm “paid the premium to the agent and the funny thing—the agent absconded with the funds.” Levy encourages directors and officers to “not just say ‘Oh, you’re taking care of it, so it’s taken care of,’ but to really make sure that it’s there and you understand it.” He urged directors to stay updated on what insurance plans are in place and to be aware of when policies are up for renewal.
D&O policies should also be reviewed after a merger or purchase by another company. “I was involved in a potential sale where a company didn’t have D&O insurance,” Edward J. Smith, president of Barnegat Bay Capital and director at ATS and Cognex, told the panel. “In the context of the sale, we went out and bought [D&O insurance] at arm’s length from the market…And remember: every word in the D&O policy is negotiable.”
The increase in regulatory action also raises new concerns. “Unfortunately, the cost of responding to regulatory inquiries and the cost of litigating has gone through the roof, because the volume of e-mails, documents and other information that gets produced on a daily basis has exploded,” said Michael B. de Leeuw, partner at Fried, Frank, Harris, Shriver & Jacobson. “One of the areas I think companies have to come to grips with at some point is how long are we going to allow employees to use the company e-mail system for every single thought that comes to mind.”
Corporate culture has forever changed as e-mail and other forms of “texting” have increasingly become the go-to method of communication for all employees. “When you get to the point where you have to review a mountain of e-mails and another mountain of documents to satisfy a regulator or comply with a litigation demand, you learn fast that it is far more expensive than it used to be,” added de Leeuw.
The discussion of sensitive company information being electronically transmitted segued into the issue of data and privacy. Eisner’s John Fodera emphasized how important it is for directors to understand privacy compliance as it relates to corporate policy on employee e-mail and the use of social media sites such as Twitter and Facebook. Some commercial statutes mandate the posting of privacy policies depending on where employees, customers and vendors reside. Fodera noted that 47 states now have breach notification and privacy laws and stressed the importance of boards monitoring compliance programs to include adequate risk management processes.
Carlos C. Campbell compares his experience as an aviator to being a director. “Flight training is an excellent example of risk management. A sign in the squadron’s ready room stated: ‘What you do not know will not hurt you, it will kill you.’
“As directors, it is essential to supplement our business experience and embrace the training we receive through seminars and various NACD publications,” Campbell advised. “We must process critical information, anticipate and be prepared to mitigate risks. Complacency and incompetence will certainly cause an unwarranted erosion in shareholder value.”