D&O trends in the US
The level of securities class actions filed in US state and federal courts combined reached record levels in 2018, which is in part driven by merger objection suits, “event driven” litigation, and traditional securities fraud claims. In light of these unprecedented numbers, we consider the 2018 filing trends, provide an analysis of recent US Supreme Court decisions that have the potential to impact the liability of directors’ and officers’ (D&O) and provide an overview of several of the key cases from 2018 addressing coverage under D&O insurance policies in the US.
Since 2012, litigation initiated against companies and their D&O insurance policies has increased steadily - and at times dramatically - year over year. In 2018, the heightened level of filings continued, due in part to the US Supreme Court’s decision in Cyan, Inc. v Beaver County Employees Retirement Fund, discussed further below. Additionally, the overall litigation rate (i.e., the number of securities actions compared to the number of public companies in the US) continues to increase. While this is partially due to the fact that the number of publicly traded companies in the US has declined due to a variety of factors, such as mergers and bankruptcies, it is a factor to be mindful of when considering the rate of filings.
Many of the securities actions filed over the past year involved merger objection lawsuits, as well as a number of traditional securities class actions. In addition, “event-driven” securities class actions (i.e., securities class actions filed against companies that experience some type of a significant event that has a negative impact on operations) are a continuing and concerning trend. Such litigation now commonly follows corporate announcements (and subsequent stock drops) in a variety of areas, including cyber-security breaches, allegations of corporate or director-based sexual harassment or discrimination, wildfire liability, drilling explosions, and even the filing of widespread product liability litigation.
Filings were greatest in New York, Delaware, and California federal courts (in that order), but there were also a sizeable number of filings in New Jersey. Given this backdrop, it is no surprise that D&O liability and the insurance coverage issues presented by litigation involving D&O policies were the subject of several judicial decisions at both the state and federal levels during 2018.
2018 US Supreme Court decisions impacting D&O liability
Two cases decided by the US Supreme Court in 2018 directly impact D&O liability, and as such deserve greater attention. The first of these cases is Cyan, Inc. v Beaver County Employees Retirement Fund (March 20, 2018). In this case, the Supreme Court decided the question of whether the Securities Litigation Uniform Reform Act of 1998 (SLUSA) stripped state courts of jurisdiction over securities class actions alleging solely violations of the Securities Act of 1933 (the ‘33 Act), and if not, whether SLUSA allows defendants to remove such actions to federal court.
In unanimously deciding this issue, the Supreme Court held that SLUSA does not pre-empt a state court’s jurisdiction (as provided for in the ‘33 Act) over cases solely alleging violations of the ‘33 Act. The Supreme Court also determined that removal to federal court was not allowed for actions filed in state courts that solely allege violations of ‘33 Act claims.
As a result of the Cyan decision, the Supreme Court has conclusively determined that without Congress taking action, defendants involved in securities actions filed in state court solely alleging violations of the ‘33 Act have no means by which to extricate themselves from that court to have their case heard by a federal court. This matters for several reasons:
- State court judges are often times less familiar, not only with securities cases generally, but also class actions brought under the ‘33 Act.
- The Cyan decision will likely result in defendants having to concurrently defend securities class actions brought in both federal and state courts.
- Defendants lose the protections the Private Securities Litigation Reform Act (SLRA) procedural reforms provided in federal court actions, which could result in costly merits discovery beginning earlier in the litigation.
The second important Supreme Court decision decided in 2018 resolves an issue not only relevant to securities class action, but one that will have an impact on all class actions going forward. In China Agritech, Inc. v Resh (June 11, 2018), the Supreme Court answered the question of whether the tolling (or pausing) of statute of limitations periods as set out in American Pipe & Construction Company v Utah (1974) applies not only to individual claims, but to successive class actions as well.
In American Pipe, the Supreme Court held that the timely filing of a class action tolls the applicable statute of limitations for all persons encompassed by the class complaint who may want to later file an individual action. What remained unclear to some after the American Pipe decision was whether the tolling extended to subsequently filed class actions where the original purported class action failed to obtain class certification.
In reviewing this issue in Resh, the Supreme Court held that American Pipe does not permit a putative class member to file a new class action beyond the time allowed by the applicable statute of limitations in the first instance (i.e., there is no tolling for such subsequent class actions).
The Resh decision should have a positive impact on the exposure presented by securities class actions going forward (as well as other types of class action litigation). While the decision may encourage multiple parties to initially file a class action to address the same wrong, only one action should ultimately be allowed to move forward to represent all class members.
One to watch
In its upcoming term, the Supreme Court is expected to render its decision in Francis v Lorenzo v Securities and Exchange Commission, which will decide whether a theory of “scheme liability” can be used to hold someone liable under the securities laws for the misrepresentations of another. Here, the Securities Exchange Commission (SEC) prosecuted an individual who sent out communications from his superior about certain investments, despite the lack of any evidence that the individual drafted or even read the communications he issued. Nonetheless, D.C. Circuit Court held that the individual’s actions violated certain securities laws. This represented a split amongst the Circuits, as the Second, Ninth and the Eighth Circuits have all held that something more than just a fraudulent statement is necessary to find liability uh.nder a theory of scheme liability. As such, depending on how the Supreme Court decides this question, it could lead to more claims being asserted against D&Os seeking to recover under a theory of fraudulent scheme liability.
Summary of 2018 D&O insurance cases
In 2018, there were several decisions in the US focusing on coverage issues raised in the context of D&O policies. A summary of some of the more interesting and relevant cases is provided below:
Security National Insurance Company v H.O.M.E., Inc. (May 18, 2018)
Applying North Dakota law, the United States District Court of North Dakota held there was no coverage under a D&O policy for an action brought against the President and Director of the insured company who was sued both in his insured capacity as a D&O of the company, as well as in his non-insured capacity as a lawyer, where the policy only provided coverage where the defendant was sued “solely” in their capacity as a “director, officer or . . . employee of the company”.
Goggin v National Union Fire Insurance Company (November 30, 2018)
Applying Delaware law, the court held there was no coverage for certain former directors where the allegations in the underlying complaint arose out of their involvement with uninsured entities where the D&O policy excluded coverage for claims “. . . arising out of, based upon or attributable to any actual or alleged act or omission of an Individual Insured serving in any capacity, other than as an Executive or Employee of a Company. . . .”.
Gleason v Markel American Insurance Company (January 24, 2018)
Applying Texas law in the context of a duty to defend D&O policy, the court held that the underlying complaint potentially triggered coverage where the allegations were not limited to the directors’ actions as sellers of shares of the insured entity, but that coverage was otherwise excluded by the policy’s broadly worded securities exclusion that precluded claims “based upon, arising out of, or in any way involving . . . the actual, alleged or attempted purchase or sale, or offer or solicitation of an offer to purchase or sell, any debt or equity securities”.
In Re TIAA-CRFF Insurance Appeals (2018)
Applying New York law, the court held that the insured could receive indemnification from its insurers for disgorgement claims made by investors in underlying class actions where, among other things, the insured denied wrongdoing in the underlying actions, and no court had found that the insured had obtained ill-gotten gains.
J.P. Morgan Securities, Inc. v Vigilant Insurance Company (September 20, 2018)
Applying New York law, the court held that a US$140 million “disgorgement” payment ordered by the SEC arising from alleged violations of securities laws constituted an uncovered “penalty” that did not constitute a covered “loss” within the definition of a primary professional liability policy in line with the US Supreme Court’s decision in Kokesh v Securities Exchange Commission, (2017) that “conclusively defined the nature of the SEC disgorgement remedy as a penalty, not a loss”.
Definition of claim
Astellas US Holdings, Inc. v Starr Indemnity and Liability Company (May 30, 2018)
Applying Illinois law, the court held that the definition of “Claim” under a D&O policy applied to a subpoena issued by the US Department of Justice where the definition of “Claim” included a written demand for non-monetary relief and the subpoena “demanded” information.
Millenium Labs v Allied World Assurance Company (March 7, 2018)
Applying California law, the court held that that the definition of “claim” under a D&O policy required reviewing various underlying matters and investigations as separate claims, some of which were excluded by the policy’s specific litigation and/or pending and prior litigation exclusions, while others were not.
Jalbert v Zurich Services Corporation (September 5, 2018)
Applying Massachusetts law, the court held that an SEC formal order of investigation constitutes a “claim” under the policy at issue where such definition included “a formal regulatory proceeding (civil, criminal or administrative) against or formal investigation of an Insured”.
Cushman & Wakefield, Inc. v Illinois National Insurance Company (April 20, 2018)
Applying New York law, the court applied the “sufficient factual nexus” test under certain professional liability policies and determined that that multiple claims brought against the insured over a period of three years were all related for purposes of determining which policy period was properly triggered.
Duty to defend
Woodspring Hotels LLC v National Union Fire Insurance Company of Pittsburgh (May 2, 2018)
Applying Delaware and Kansas law, the court held that the D&O carrier had a duty to defend both the insured entity and an individual D&O in connection with a lawsuit asserting the insureds had misappropriated confidential and competitively sensitive information from a competitor, as well as violation of trade secrets laws, tortious interference with contract and business expectancy, and violation of the federal computer fraud and abuse act.
The fraud exclusion
Arch Insurance Company v David H. Murdock (March 1, 2018)
Applying Delaware law, the court held that public policy does not “clearly prohibit” insurance companies from insuring fraud.
The professional services exclusion
Beazley Insurance Company, Inc. v ACE American Insurance Company (January 22, 2018)
Applying New York law, the court upheld the application of a professional services exclusion where the underlying plaintiffs could not have prevailed without establishing their injuries were caused by the types of trading services the insured exchange engaged in.
Hotchalk, Inc. v Scottsdale Insurance Company (June 4, 2018)
Applying California law, the Ninth Circuit upheld a D&O carrier’s denial of coverage under a professional services exclusion with regard to a qui tam action on the basis the insured’s liability derived from the fact that its professional services caused ineligible students and universities to submit financial aid claims to the federal government.
The prior acts exclusion
Certain Underwriters at Lloyd’s of London v The Federal Deposit Insurance Corporation (May 29, 2018)
Applying New York law, the court held because there were independent wrongful acts that occurred during the policy period, the D&O policy’s prior acts exclusion did not operate as a complete bar to coverage.
Specific/special event exclusion
Emmis Communications Corporation v Illinois National Insurance Company (March 21, 2018)
Applying Indiana law, the court held that a D&O carrier could not rely on allegations in the second amended complaint referring to the excluded events for purposes of denying coverage where the events referenced in complaint were mere “window dressing” rather than “operative facts” necessary to support the underlying legal claims.
Insured v insured exclusion
Security National Insurance Company v H.O.M.E., Inc. (May 18, 2018)
Applying North Dakota law, the court held that the Insured v Insured exclusion barred coverage for an action brought against a D&O of the insured company by his sister, who was a director of a subsidiary bank of the insured company, and thus an insured under the policy.
Contractual liability exclusion
Spec’s Family Limited. v Hanover Insurance Company (July 23, 2018)
Applying Texas law, the court held that it was premature to enter judgment on the pleadings based on the contractual liability exclusion of a D&O policy where, among other things, there were allegations of negligence that could be separate and apart from the alleged losses for breach contract.
Gleason v Markel American Insurance Company (January 24, 2018)
Applying Texas law in the context of a duty to defend D&O policy, the court held the D&O policy’s broadly worded securities exclusion applied to preclude coverage for the underlying complaint where the directors agreed to sell their interest in the insured entity to a separate company.