Litigation Trends

Predicting D&O Claims

Risk managers must be prepared for SEC regulators, cyber-related lawsuits and other new litigation trends. 
By: and | November 3, 2014

Publicly traded companies have never faced such a broad array of challenges to their integrity or threats to their existence.


Ironically, the pressure on the securities plaintiffs’ bar may be even higher. The past year revealed that familiar lawsuit trends such as Chinese reverse mergers and merger objection suits are often offset by countervailing market trends.

In fact, plaintiffs’ firms are desperately searching for the next big securities law trend. There are several potential candidates for this next wave — and ways that insureds can take steps now to prepare.

Shareholder Class Actions

In the last seven years, the securities plaintiffs’ bar has feasted on a smorgasbord of new litigation trends, which has sustained higher volumes of securities class actions even while the pool of public companies to target has steadily contracted.

For example, in 1997, there were nearly 8,900 public companies in the United States, but by 2007 that number had fallen to approximately 6,000, and continued to drop to around 5,000 by the end of 2013. Yet, the number of securities class action filings remained robust due to the emergence of certain novel litigation trends created by the credit crisis, Chinese reverse mergers, and merger objection lawsuits.

Mark Weintraub,  vice president, insurance and claims counsel, Lockton Cos.

Mark Weintraub, vice president, insurance and claims counsel, Lockton Cos.

Today, however, credit crisis-related lawsuits are precluded by statutes of limitation, Chinese reverse merger suits have largely run their course, and merger objection suits, while ubiquitous, are dependent on M&A activity, which was down in 2013.

In short, securities plaintiffs’ firms that relied on litigation trends to supplement their caseload over the last seven years will be facing unprecedented competition for cases at a time when there are fewer public companies to target.

The result is that today, a public company has a greater chance of facing a traditional securities class action than it has in the past. Plaintiffs’ firms brought more such class actions in 2013 (148) than were brought, on average, in the previous seven years (120).

Going forward, plaintiffs’ firms will most likely bring more “borderline” cases as they search for targets. Arguably making this situation more difficult, the securities defense bar won a small victory this past June.

Clarifying the Fraud-on-the-Market Presumption

In the closely watched Halliburton Co. vs. Erica P. John Fund Inc., the defendants asked the U.S. Supreme Court to overturn a ruling from 1988, Basic Inc. vs. Levinson, where the court established the “fraud-on-the-market” presumption — that markets are efficient and investors presumptively rely on material information disclosed by the company.

Because of the fraud-on-the-market presumption, reliance on alleged misleading disclosures is presumed and a class may be certified without having to prove that each and every stockholder relied on a specific disclosure.

The court declined to completely do away with the presumption, but clarified that defendants could rebut the presumption before a class is certified.  By facing an additional evidentiary challenge, class certification should be more challenging for plaintiffs to obtain.

While not a “death blow” to securities litigation, the Halliburton decision added to the current pressure on the securities plaintiffs’ bar to find a new litigation trend.


One likely source of inspiration for plaintiffs’ firms is the regulatory arena, where a seemingly re-energized Securities and Exchange Commission is poised to move on a number of fronts against corporate misdeeds and perceived abuses of power.

A More Aggressive SEC

Since Mary Jo White took the helm of the SEC, she has promised focused and rigorous enforcement. The SEC is coming off a record year — issuing $3.4 billion in penalties and disgorgements in 2013 — and appears to be in a more aggressive mode as formal investigations are up 20 percent year over year.
Pundits have spent considerable time parsing public statements to divine the future direction of SEC enforcement, and some key themes have emerged:

SEC• The SEC wants issuers of securities to be more accountable, and one way to achieve that is to require admissions of wrongdoing as a condition of a settlement.

White recently stated that “admissions can achieve a greater measure of public accountability — which can be important to the public’s confidence in the strength and credibility of law enforcement and the safety of our markets,” and she promised to “demand admissions in an expanded category of settlements.”

This should have a major impact on civil litigation, as any admission is seen as a red flag and an opportunity for the plaintiffs’ bar.

To counter this, in its settlement over the “London whale” trading, JP Morgan purposely crafted admissions that were short on detail and did not name responsible individuals, but the efficacy of this careful phrasing is sure to be tested in future civil matters and will not stop securities plaintiffs from trying to take advantage of such admissions.

• The SEC is already sitting on a large volume of whistleblower tips and recently awarded at least $30 million to a tipster for leading investigators to the source of the wrongdoing and assisting in the investigation.

Gatekeepers who capture the SEC’s attention are sure to also capture the attention of the securities plaintiffs’ bar.

This award, along with an earlier $14 million award, will encourage more would-be whistleblowers to come forward, and increase the number of inquiries, investigations and enforcement actions by the SEC. Plaintiffs’ firms have inserted themselves into the whistleblower process, and, to the extent they are able, will file related civil suits based on successful tips and alleged wrongdoing.

• The SEC will continue to focus on what it refers to as “gatekeepers” — those tasked at the company with protecting investors.

While some observers question the effectiveness of relying on gatekeepers to point out accounting inconsistencies and other improprieties, the SEC has stated it will remain “focused on holding accountable accountants, attorneys, and others who have special duties to ensure that the interests of investors are safeguarded.”

Gatekeepers who capture the SEC’s attention are sure to also capture the attention of the securities plaintiffs’ bar.

• The SEC does not want to act in a way that would further harm shareholders, so enforcement will be less about punitive action (e.g., imposing large fines) and more about deterrence and preventing further abuses.

To paraphrase Commissioner Daniel Gallagher Jr., the SEC’s job is to foster efficient and fair capital markets, and leave punishment to the Justice Department.


To employ more creative enforcement measures, the SEC announced the formation of two units: the Financial Audit and Reporting Task Force — to improve the way the SEC looks at financial reporting misconduct — and the Center for Risk and Quantitative Analytics — to focus on irregularities and abnormalities that could signal financial misreporting via a systematic analysis of data.

While these new regulatory weapons may not be considered punitive by the SEC, they will alert plaintiffs’ firms to potential wrongdoing and could serve as a basis for allegations for new civil suits.

According to White, 2014 “promises to be an incredibly active year in enforcement, as we continue to vigorously pursue wrongdoers and bring enforcement actions across the entire industry spectrum.”

Expect the securities plaintiffs’ bar to capitalize on this increased activity and bring more follow-on civil suits stemming from regulatory actions.

The Growing Cyber Risk Landscape

The specter of cyber risk is relatively new, but it is nevertheless casting a growing shadow over board rooms and could be the mother lode for future securities litigation.

The lawsuit dynamics surrounding the Target cyber breach can easily develop into a new litigation trend as the pattern can be replicated whenever a company suffers a significant cyber event.

The Target data breach is a perfect illustration; shareholders have filed two derivative suits against the company’s directors and officers asserting several causes of action, including breach of fiduciary duty and waste of corporate assets.

The plaintiffs allege that company leaders knew the cyber risks but failed to protect customer data, and seek to hold the board accountable for cyber breach costs and any damages awarded in the related consumer class action lawsuits that have been filed.

The lawsuit dynamics surrounding the Target cyber breach can easily develop into a new litigation trend as the pattern can be replicated whenever a company suffers a significant cyber event.

Moreover, data is rapidly becoming a company’s most valuable asset and, with the increase of mobile apps, digital processes are replacing more and more manual transactions.

Rodger Laurite, senior vice president, unit manager, Lockton Financial Services

Rodger Laurite, senior vice president, unit manager, Lockton Financial Services

In this environment, companies must revisit their processes, procedures and protocols for safeguarding data and abide by the SEC’s guidelines for cyber-related disclosures that have been in place since 2011. Those guidelines state that companies should:

• Describe aspects of operations that might give rise to material cyber security risks;

• Detail functions that are outsourced;

• Disclose past cyber incidents;

• Discuss risks that may remain undetected; and

• Describe relevant insurance coverage.

Failures to abide by these guidelines are another potential source for litigation. A common criticism has been that companies are withholding material information about cyber risks from investors.

Implications for D&O Insurance

Anticipating the next trend in securities litigation is more speculation than science; the same is true for anticipating how to address these new trends in a D&O insurance policy.

Fortunately, the best course of action is to sit tight for now. Existing policies often cover the latest developments in claims, and carriers require time to react to new trends. The burden to adjust policy wording — including increasing retentions and strengthening exclusions — will be on the carriers, and they rarely act prospectively, but instead wait until a trend develops.

That said, one carrier has responded to the Halliburton decision and introduced an endorsement that would facilitate payment for “event studies” used to rebut the fraud-on-the-market presumption.

Certain measures still can be taken now to anticipate the “next big thing” in securities litigation.

While public company D&O insurance will cover individuals for most claims, the entity itself is only covered for “securities claims,” which are typically limited to claims arising out of a purchase and sale, or offer to purchase and sell, securities.


The phrasing of that definition, however, can sometimes leave doubt as to coverage for claims and SEC enforcement actions concerning accounting violations.

In light of the SEC’s new tools to investigate accounting fraud, these types of enforcement actions and follow-on civil suits are more likely to emerge. Accordingly, insureds should seek a definition of “securities claim” that will capture such matters.

Likewise, insureds should avoid language that prospectively limits coverage for follow-on civil litigation that arises from ongoing SEC investigations.

Additionally, “written admissions” can trigger improper conduct exclusions that will preclude coverage for both enforcement actions and follow-on civil litigation relying on these admissions of wrongdoing.

Most carriers, however, remain flexible with “admission” language and some insureds even prefer such language as it often matches bylaw provisions that preclude indemnity and defense for a bad actor who has admitted to wrongdoing.

The SEC’s stockpile of whistleblower tips and deep pool of potential claims also should be addressed. Insureds should insist that whistleblowers are carved out of any “insured vs. insured” exclusion, so that claims arising from whistleblower tips are not denied.

Finally, potential cyber-related D&O claims can be mitigated by rigorous cyber security policies and cyber insurance that protects a public company’s balance sheet and increases the difficulty of alleging corporate waste.

As technology grows ever more present in daily living, the public will expect corporations to act responsibly, and any failure to mitigate cyber risk or to obtain cyber insurance may be grounds in and of itself for a breach of fiduciary duty action. As one SEC commissioner commented, “boards that chose to ignore or minimize the importance of cyber security responsibility do so at their own peril.”

Whether it is cyber risk, regulatory action or something unexpected thus far, the challenge for public companies is to anticipate any new litigation trend and prepare via their company’s D&O insurance policies as best they can.

Mark Weintraub is vice president, insurance and claims counsel at Lockton. Rodger Laurite is senior vice president, unit manager, Lockton Financial Services. They can be reached at [email protected]

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