Opinion

Alison Frankel

In securities suits, is D&O coverage pot of gold – or brick wall?

By Alison Frankel
May 9, 2012

In an ideal world, the value of a shareholder securities claim rests entirely on its merits. And now that you’ve stopped snickering, let’s talk about the real world, where two disputed settlements test the de facto assumption that securities claims are worth what a company’s directors and officers insurance carriers are willing to pay to resolve them.

In Bank of America’s proposed $20 million settlement in Manhattan federal court of a derivative suit based on its 2008 acquisition of Merrill Lynch, a group of plaintiffs’ firms with a parallel case in Delaware Chancery Court argue that the settlement is insufficient because $20 million is only a tiny fraction of BofA’s $500 million in D&O coverage. Last week Delaware Chancellor Leo Strine refused to enjoin the New York deal, leaving it up to U.S. District Judge P. Kevin Castel to decide whether the derivative shareholders are getting enough money. That’s a sensible result: Castel, after all, is overseeing consolidated Merrill-related securities litigation against BofA, so he’ll evaluate the proposed derivative settlement with the understanding that there are lots of other claimants waiting in line for a chunk of that $500 million in D&O insurance, even as it’s whittled down by defense fees.

Meanwhile, Castel’s Manhattan federal court colleague, U.S. District Judge Lewis Kaplan, last week expressed reservations about a $90 million settlement of securities class action claims against Lehman’s former officers and directors, including former CEO Richard Fuld. Kaplan said in a May 3 order that he understood $90 million was all that remained of Lehman’s $250 million D&O policy, but wanted to satisfy himself that shareholders wouldn’t be better off if their counsel at Bernstein Litowitz Berger & Grossmann pressed on and obtained judgments against individual defendants. To that end, he ordered five former Lehman officers to turn over to him the financial records they’d already produced to a settlement magistrate, retired U.S. District Judge John Martin.

Kevin LaCroix, who writes the indispensable D&O Diary blog in connection with his day job as executive vice-president at OakBridge Insurance, said it’s all too often the case that securities settlements have more to do with coverage limits than the merits of a claim. “There’s an adage in the insurance business: Limits drive losses,” LaCroix said. “One of the things that gets talked about is, ‘If we buy significant insurance, will it invite claims?’ There’s not a single right answer to that question.”

LaCroix told me policy limits ought to be one of the considerations in settlement negotiations, but shouldn’t dictate the ultimate settlement amount. But Steven Toll of Cohen Milstein Sellers & Toll said that not only do coverage limits drive negotiations, but insurance representatives, who typically square off against shareholder lawyers at mediation sessions, have enormous leverage to determine settlement terms.

The problem, Toll told me, is that over the last decade insurers have splintered D&O coverage into multiple layers. So instead of negotiating with one insurer that wrote a $50 million policy, plaintiffs’ lawyers find themselves across the table from 10 insurers, each controlling $5 million layers of coverage. Often, Toll said, junior layers don’t even show up at mediations, sending a clear signal that their money is not in play because all of the higher tranches won’t commit to exhausting policy limits. “At every step, each carrier puts up a roadblock,” he said. “That dramatically affects the resolution of these cases. In almost every one, it’s the same fight.”

Toll said that even when the first couple of layers of insurance – which know their coverage will be exhausted through a settlement or litigation costs – agree to a settlement, there isn’t a deal if the next layers don’t sign on. A refusal by any one layer to pay its entire policy can preclude a settlement. By way of example, Toll pointed back to a 2005 case, the Globalstar Securities Litigation, in which Cohen Milstein ended up in a trial against Globalstar CEO Bernard Schwartz when his D&O insurers balked. Schwartz ultimately agreed to put up $20 million of his own money to settle the case, then turned around and sued his primary and three excess insurance carriers to recover his contribution. Toll was a witness at Schwartz’s bench trial against the two insurers that refused to settle with him. (They were found liable.)

“D&O insurance is a huge, huge deal in this business,” Toll said. “It’s a real practical dilemma, and plaintiffs’ lawyers have to confront it every day.”

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