Risks Facing Directors and Officers

THIS ISSUE:

FEATURE The role of the board in crisis management www.financierworldwide.com

Issue 226 October 2021

SPECIAL REPORT Restructuring & insolvency ROUNDTABLE Risks facing directors & officers

Published by Financier Worldwide Ltd ©2021 Financier Worldwide Ltd. All rights reserved.

Cyber hygiene: identifying and defusing risks in M&A Knowing how to assess risks and take appropriate action is key.

ROUNDTABLE October 2021

RISKS FACING DIRECTORS & OFFICERS As the world continues its recovery from the ravages of coronavirus (COVID-19), directors & officers (D&Os) find themselves amid an increasingly volatile risk landscape. While ‘traditional’ risks, including securities claims and regulatory scrutiny, remain, others, such as cyber security threats and environmental, social and governance (ESG) pressures have emerged as key priorities from a D&O perspective. As companies face evolving risks and concerns in a ‘new normal’, the challenges facing D&Os appear set to escalate.

Permission to use this reprint has been granted by the publisher.

REPRINT Mergers & Acquisitions

THE PANELLISTS Laura Skaanild Managing Director, Professional & Executive Risk, Ed Broking LLP T: +44 (0)20 7204 4936 E: laura.skaanild@edbroking.com www.edbroking.com

Laura Skaanild is managing director of the professional & executive risk team at Ed Broking LLP, providing directors’ & officers’ liability, professional indemnity, cyber and related insurance solutions for a global client base. She is a solicitor with over 20 years of experience in the legal and insurance sectors and brings a relentless focus on client service, coupled with a strong consultative approach.

Howard S. Suskin Partner, Jenner & Block LLP T: +1 (312) 923 2604 E: hsuskin@jenner.com www.jenner.com

Howard S. Suskin is a partner in Jenner & Block’s litigation department and co-chair of the firm’s securities litigation practice and its class action practice. Mr Suskin has substantial first-chair experience representing individuals and business entities in civil and criminal securities matters, including class actions alleging securities fraud and misrepresentation claims, derivative actions claiming breach of fiduciary duty, contests for corporate control, insider trading investigations and broker-dealer issues.

Thomas M. Sheffield Managing Director, NFP T: +1 (212) 973 9259 E: thomas.sheffield@nfp.com www.nfp.com

Tom Sheffield co-leads NFP’s management and professional lines practice. He is responsible for all phases of NFP’s value proposition for corporate and financial lines insurance clients. He has more than 20 years of experience in the industry, and has personally handled major D&O and financial institutions claims and clients throughout the world. He was formerly a partner in a multinational law firm focused on insurance coverage with a particular emphasis on management and professional lines, as well as political risk, media liability and other coverages.

Steven Hadwin Director, Norton Rose Fulbright LLP T: +44 (0)20 7444 2290 E: steven.hadwin@nortonrosefulbright.com www.nortonrosefulbright.com

Steven Hadwin is a dispute resolution lawyer based in London. His practice is focused on cyber risk management and incident response. He frequently advises clients on the legal implications, including under the GDPR and the NIS Directive, of adverse cyber incidents, including data breaches, malware attacks and network interruptions. He is experienced in coordinating the legal response to cyber incidents across a range of jurisdictions and regions.

Brittany Rosen Vice President, Public Company Management Liability, QBE North America T: +1 (203) 858 6937 E: brittany.rosen@us.qbe.com www.qbefinancial.com

Brittany Rosen is vice president, public company management liability at QBE North America. Her responsibilities include the continuing development and execution of the go-to-market strategy in the Western Region. In addition, she manages the portfolio while growing and maintaining broker relationships in the region. She has nearly 10 years of industry experience in the public commercial and financial institutions markets.

Paul Rayner Head of Financial Lines, Tokio Marine HCC T: +44 (0)20 7648 1305 E: prayner@tmhcc.com www.tmhcc.com

Paul Rayner is head of financial lines at Tokio Marine HCC, overseeing all of the firm’s financial lines business in the EMEA region. Prior to joining the company in 2008, he worked at AIG in Paris where he was regional manager for commercial PI and management liability FIs, and before that at AIG UK in London as corporate manager of PI. Mr Rayner launched his career as a broker working for Aon.

www.financierworldwide.com

FINANCIER WORLDWIDE

OCTOBER 2021

REPRINT

REPRINT Mergers & Acquisitions

FW: In what ways have risks faced by D&Os changed over the past few years?

What major new risks have arisen?

Rosen: Two of the primary developments in the risks faced by directors & officers (D&Os) are the rise in event-driven and derivative litigation. With event-driven litigation, following the announcement of an event, be it weather-related, the impact of coronavirus (COVID-19) or a data breach, and a subsequent stock market ‘reaction’, class action litigation may quickly follow, which alleges that the risk of the event was concealed, under-disclosed or downplayed by the company. Companies with a lower risk of a more traditional accounting-based claim are not immune from this new, event-driven exposure.

Another material trend is a rise in derivative severity, as well as overall derivative activity. Since the Supreme Court’s decision in Marchand v. Barnhill, we have seen a rise in derivative claims following an event, alleging that the board failed to oversee a material risk. Historically, most derivative actions were brought as a tagalong suit to a securities class action and would settle for corporate therapeutics or governance changes. Recently, there have been several notably large settlements, along with many pending lawsuits, which could potentially exceed $100m.

Sheffield: There are some evolving classes and areas of risk that have arisen and evolved significantly over the last few years, including the cannabis industry and the rise and use of cryptocurrencies. However, for management liability, the risks have always reflected strategy, decision making and clarity around the management of business. Public company stock volatility, global expansion and facing new threats continue to be the risk story. Within that, however, the largest risk factors that have changed for D&Os have involved profound changes in the access and use of available information about companies and their decisions. The rise and use of social media and information from myriad sources are making increasing impacts within companies and the boardroom. The heightened attention to environmental,

social and governance (ESG) issues and the pressure on companies to do good in addition to doing well will be a theme for some time to come.

Skaanild: Cyber risk continues to be a key exposure for directors, with ransomware attacks increasingly prevalent and severe.

Boards will be subject to both shareholder and regulatory scrutiny as to how cyber risk has been approached and how systems and safeguards have been adapted. With a large proportion of workforces continuing to work from home to some extent due to the COVID-19 pandemic, operational risk continues to be a concern, with the potential for issues stemming from less in-person oversight and a possible dip in employee engagement after a prolonged period at home. As workforces return to the office, boards are working their way through a potential HR and health and safety minefield, with an increased potential for employment-related claims including how employee safety has been managed. We are yet to see the full impact of the phasing out of temporary support measures, meaning the true fallout of COVID-19 from an insolvency perspective is still to come – particularly in the travel, hospitality and retail sectors. ESG-related topics such as climate change, #MeToo, board diversity and Black Lives Matter have also contributed to the evolving risk profile for D&Os. Suskin: In the area of securities litigation, shareholder class actions against publiclyheld companies and D&Os continue to be filed at a high rate, arising from a wide range of circumstances, albeit at a lower level than in 2020. The lawsuits are both event – stock drop cases following a disclosure of adverse news – and litigation driven, following announcements of M&A activity, although M&A-related litigation has slowed somewhat as courts are less receptive to those types of claims. Among the trends reflecting key factors shaping the risk landscape are an increased number of shareholder lawsuits against special purpose acquisition companies (SPACs) and companies in the cryptocurrency and cannabis industries. Additionally, cases

www.financierworldwide.com

FINANCIER WORLDWIDE

continue to be filed against companies alleging misleading or inadequate disclosures relating to the companies’ responses to the COVID-19 pandemic, cyber security breaches, and alleged misrepresentations relating to companies’ ESG initiatives. Also, there is a widespread perception that the Securities and Exchange Commission (SEC), under the Biden administration and with its new chairman, will be more aggressive in pursuing enforcement actions against companies and their D&Os than the previous administration.

Rayner: The risks facing both D&Os and companies increase in complexity as their industry evolves. The ‘traditional’ risks, such as securities and regulatory claims, remain. However, their importance has changed as companies face new evolving risks and concerns. Of these, cyber attacks and data loss are probably the most significant for boards, owing to the speed and frequency of attacks, the faceless global nature of the attackers and the companies’ total reliance on IT infrastructure, among others. Global regulators are concerned about cyber attack consequences and require boards to act and to have oversight, so ensuring a strict cyber safety framework is in place to prevent attacks and associated data loss. ESG is another incredibly important risk area for boards to manage and the next potential insurance litigation trend, although we are already witnessing some claims now. Recent global events have meant that boards may not have been focusing sufficiently on this area.

Various stakeholders are actively engaged with boards to ensure ESG issues are being addressed or face the consequences.

While the pandemic has been a focal point for boards, save for certain sectors, the concern for insolvency is waning.

That said, there is still uncertainty in some industries regarding restructuring, job losses and insolvencies. Finally, it is becoming increasingly important to set policies encompassing the broader social movement, and failure to do so can create unwanted attention for boards such as litigation concerning diversity and cultural equality.

OCTOBER 2021

REPRINT

REPRINT Mergers & Acquisitions

Hadwin: As the world attempts to recover from the COVID-19 pandemic, D&Os find themselves in an increasingly challenging and volatile risk landscape. Cyber risk has emerged as a key priority from a D&O perspective. The recent spate of high profile cyber attacks – most notably ransomware and data theft extortions – highlight the fact that cyber risk is an area that D&Os need to understand and engage with.

Understanding these issues is a particular challenge in circumstances where many workforces have shifted to a remote model on a permanent or semi-permanent basis, meaning that traditional ways of thinking about cyber security and information governance need to be recast. Even before COVID-19, regulators emphasised a topdown approach was needed to manage cyber risk. This reflects the broader shift toward cyber risk management being something which has to be implemented at all levels of an organisation, starting with the board. In the US, we have seen a number of derivative actions brought against board members following high profile cyber incidents, and it remains to be seen whether liability issues of this nature will emerge in the UK and Europe.

FW: The focus around environmental, social and governance (ESG) issues has increased substantially and become more important to the investor community.

How has this impacted the risks faced by D&Os? Sheffield: Greater access to information through public sources enables much deeper advocacy on topics that have not previously entered the boardroom. Management remuneration, environmentally sustainable business strategies and the commitment to economic and social justice are now much higher on the board agenda and have introduced new levels of risk for D&Os. In the past, a generalised commitment to any social issues was laudable for companies, but not widely demanded – and normally not actionable.

Now, activists, equity and other financial stakeholders are adding significant pressure to the tangible decisions being made by companies. Likewise, those companies are increasingly expected to embrace social change and use their leverage in accordance with the values they assert. The victory by the ‘Engine No. 1’ hedge fund with Exxon – where it was joined by other large funds in adding social activists to the board during the annual meeting – likely begins the next chapter in risk for D&Os. Skaanild: Climate and ESG task forces have been created in various jurisdictions, recognising that climate and ESG risks are critical issues for investors. For example, the SEC’s Climate and ESG Task

‘‘

Force seeks to identify both ESG-related misconduct and material omissions or misstatements in disclosure of climate change risks under existing rules. The disclosures that the Taskforce for Climate Related Financial Disclosures (TCFD) in the UK currently recommend will be mandatory by 2025. It is therefore key that D&Os in the UK start to familiarise themselves with this, especially as listed companies will be expected to undertake some element of retrospective reporting.

ESG-related litigation by shareholders and other stakeholders is increasing, alleging failure to meet climate change and diversity targets, and focusing on execution of business strategy from an ESG perspective.

Boards should take the time to understand what ESG-related risks are covered under their D&O insurance policies and whether any exclusions, such as environmentalrelated provisions, should be reviewed to reflect the evolving exposure.

Suskin: Lawsuits alleging that companies and their D&Os misrepresented their ESG policies and practices when they made generic statements about their companies’ advancement of ESG issues are among the latest wave of litigation trends de jour. These lawsuits typically take the form of shareholder derivative actions and allege that D&Os have failed to adhere to their company’s stated ESG aspirations. The lawsuits can also take the form of shareholder class actions, if disclosure of a material risk of an ESG issue causes the company’s stock price to decline, giving shareholders the opening to argue that the disclosure should have been made sooner. Defending these actions has become somewhat more difficult in the wake of the US Supreme Court’s decision in June 2021, in the Arkansas Teacher Retirement System’s securities fraud case against Goldman Sachs Group, where the court allowed for the possibility that generic statements by the company about its integrity and customer practices could have artificially inflated the company’s stock price. Even if ESG-related cases do not survive a motion to dismiss, and many of them should not, because the statements complained about are often aspirational

’’

ALL STAKEHOLDERS, FROM INVESTORS AND REGULATORS TO ALL INTERESTED PARTIES, ARE ENGAGED WITH ESG ISSUES.

PAUL RAYNER

Tokio Marine HCC

www.financierworldwide.com

FINANCIER WORLDWIDE

OCTOBER 2021

REPRINT

REPRINT Mergers & Acquisitions

and are not alleged misrepresentations of historical fact, companies and D&Os who must defend such cases usually incur significant legal defence costs as well as the risk of reputational damage. These risks auger for careful review and vetting of any disclosures relating to ESG issues, and to include cautionary safe harbour language for any forward-looking statements.

Rayner: The significance of ESG issues hardly needs mentioning, with a recent Intergovernmental Panel on Climate Change (IPCC) report highlighting the catastrophe that could be avoided if the world acts, and acts fast. All stakeholders, from investors and regulators to all interested parties, are engaged with ESG issues. Regarding climate change, directors and the board are expected to put in place steps to mitigate and reduce to a carbon neutral position, as well as establish relevant disclosures and monitoring. We are already seeing claims brought against companies accused of contributing to global warming and environmental disasters on account of their inability to adapt to climate change, or for failing in their reporting requirements. Regulators in general are gearing up to put entities through climate stress tests and imposing target-driven expectations for CO2 reduction. Boards will need to have strict oversight to ensure that they can deliver these expectations or fall foul of regulators and global investor and social community pressure.

Hadwin: Investors are applying increasing pressure on their companies to act with ESG principles at the forefront of their strategy – and D&Os bear responsibility for putting this into practice. Beyond regulatory enforcement, D&Os must pay due regard to the reputational risks which are inherent to ESG issues and adapt their business models accordingly. Over the past year we have seen numerous shareholder rebellions in response to a perceived disregard for ESG issues by D&Os in the UK – and we have seen more than 50 large investors demand that companies disclose a plan to cut their greenhouse gases, make a board director responsible for those actions and allow investors to vote annually on

‘‘

’’

ONE TREND WITHIN THE LITIGATION LANDSCAPE IMPACTING BOTH SECURITIES CLASS ACTIONS AND DERIVATIVE LITIGATION FREQUENCY HAS BEEN ESG ACCOUNTABILITY, AS COMPANY STAKEHOLDERS DEMAND MORE.

BRITTANY ROSEN

QBE North America

progress on the plan. In the US, we have seen several lawsuits alleging breach of fiduciary duty filed by shareholders against the boards of major corporations for failing to live up to their diversity commitment disclosures. Again, this is something which we may well begin to see here in the UK and elsewhere in Europe.

Rosen: One trend within the litigation landscape impacting both securities class actions and derivative litigation frequency has been ESG accountability, as company stakeholders demand more. There has been an increase in suits filed against the board claiming a lack of diversity or failure to keep promises around their commitments to diversity and inclusion. While the initial wave of these suits surrounded #MeToo and gender diversity, particularly in 2020, we began to see a spotlight around racial diversity as well. Regulators have also been concentrating on corporate culture, particularly in California. Climate change is another key element of ESG risk. Although we have already seen several lawsuits in this area, as the focus on climate change continues to grow, we can expect to see a wave of D&O litigation. These lawsuits will likely be brought about by increased regulatory and societal scrutiny of the decisions of D&Os, as they try to mitigate these risks.

www.financierworldwide.com

FINANCIER WORLDWIDE

FW: Securities class action filings were down in 2020, and year to date filings suggest a similar outcome in 2021. What are your expectations for litigation rates – and what factors are shaping current trends?

Skaanild: With merger activity increasing in 2021 it remains to be seen whether this reduction in class actions will continue.

Additionally, there has been an increase in SPAC-related securities class action in 2021, which we expect to continue given the large increase in SPACs. It is also reasonable to expect an increase in COVID-19-related actions. Event-driven litigation will become even more prevalent, with shareholders being increasingly concerned with ESG-related issues, using their ownership to help drive change in the companies in which they invest. The marked increase in litigation funding continues to contribute to appetite for class actions, making such activity more accessible as it allows shareholders to bring claims without being required to contribute to the cost of them. This is a market which has seen significant growth in recent years, with securities class actions seen as a key area for investment.

The litigation environment in the UK has developed in recent years to encompass class actions and securities litigation.

This is a trend we expect to continue and

OCTOBER 2021

REPRINT

REPRINT Mergers & Acquisitions

one that will significantly contribute to the claims we routinely see under D&O policies, particularly in terms of defence and investigation costs.

Suskin: It is true that securities litigation filings are down so far in 2021, but they are not going away. According to the Cornerstone Research 2021 Midyear Assessment, 112 new class action securities cases were filed in federal and state courts in the first half of 2021, down 25 percent relative to the second half of 2020. That is still a significant volume of cases.

Cornerstone calculates that the likelihood of a filing against a US exchange-listed company is at an annualised rate of 4.2 percent. With the stock markets at record highs, it is not surprising that the number of securities class actions has tapered off.

If the market has a significant correction, one might expect that the plaintiffs’ bar will attempt to tie a company’s stock fall with some failure to disclose risk. Notably, there were twice as many securities lawsuit filings against SPACs in the first half of 2021 as there were in all of 2020. D&Os of SPACs are highly vulnerable to being sued, both on adequacy of disclosure issues and alleged conflict of interest issues, and that trend is expected to continue.

Rayner: Although we have seen filings decrease with a large reduction in M&A claims, they remain above the long-term

average and with increasing average settlement values. The concern regarding securities claims depends on size of entity, its location and industry. In general, we are seeing a rise in group claims assisted by the growth of litigation funders and in line with public policy. Associated with securities claims are rising defence costs.

Once normal economic activity returns and government support schemes are phased out, there are well-documented concerns that there may well be an uptick in corporate bankruptcies and, inevitably, D&O claims. We are seeing an increased tendency for derivative claims to accompany securities claims. These bring out a more complicated head of claim, escalating amounts paid, as well as legal fees. Therefore, the issue of indemnification becomes very relevant. One thing that is all too apparent is that claims inflation is making D&O claims more expensive to defend and settle. This trend is unlikely to be reversed.

Rosen: It is too early to tell whether securities class action activity over the past 18 months is a trend or an anomaly.

The broader stock market decline to March 2020 lows may have created a challenge for plaintiffs’ attorneys to prove ‘abnormal returns’ for an individual stock. Excluding more heavily impacted industries, many company valuations have

‘‘

recovered beyond pre-pandemic levels.

This creates a challenge to demonstrate shareholder damages, which are generally calculated based off market cap loss.

Moreover, it is worth acknowledging the high volume of securities class actions activity between 2017 and 2019, which may be straining resources for plaintiffs’ firms. There have also been delays in court opening dates and prolonged settlement negotiations due to COVID-19. Factors that are likely short-lived, but may have influenced 2020 numbers. With the stock market performance potentially stretching valuations and a rise in an increasingly retail-based investor base, we have seen a dramatically more volatile stock market in 2021. In time, we will see whether this volatility may lead to an increase in litigation activity.

Hadwin: The overall number of securities filings dropped considerably in the first half of 2021. This decline was largely driven by a substantial reduction in the number of M&A class actions and securities class actions against non-US based businesses.

Again though, the emergence of cyber risk as a key boardroom priority could have a significant impact on this trend.

While there were only two cyber-related securities filings made in the US before July, four were filed in July 2021 alone, which is likely a product of the high frequency of significant cyber attacks which have taken place in the last 18 months or so.

It remains to be seen whether economic conditions will lead to further securities class actions in the short to medium term.

This will likely depend on whether we see a post-pandemic economic recession, which would no doubt result in insolvencies of companies which may to date have been beneficiaries of financial support during the pandemic. A high volume of insolvencies would very likely lead to an uptick in securities class action filings.

’’

D&OS IN VARIOUS GEOGRAPHIES AND INDUSTRIES WOULD BE ADVISED TO CONSIDER SPAC-RELATED LITIGATION AS A RISK THAT THEY MAY SOON FACE.

STEVEN HADWIN

Norton Rose Fulbright LLP

www.financierworldwide.com

FINANCIER WORLDWIDE

Sheffield: In addition to company stock performance, historical swings in securities litigation sometimes also reflect changes in a variety of seemingly unrelated factors. For example, we have seen trends shifts with changes in the makeup of the plaintiffs bar,

OCTOBER 2021

REPRINT

REPRINT Mergers & Acquisitions

changes in large pension fund strategies and cyclical economic issues, such as the ‘Amazon’ effect creating competitive strain on retailers. That said, most commentors have suggested that the largest impact on securities litigation trends is a notable decrease in merger objection cases. This trend has continued through 2021 and we anticipate the litigation trend to remain the same through 2021. We are seeing increases in SPAC-related litigation and regulatory activity surrounding securities.

So, while securities class actions have trended down over the last year and a half, we do see continued activity by active regulators in this space. In all, we see continued scrutiny over representations made by D&Os about company valuation and this has not changed.

FW: Recently, there has been a surge in activity related to special purpose acquisition companies (SPACs). What insights would you offer on SPAC-related litigation, and the expected impact on D&O risks and liabilities?

Suskin: The surge in SPAC transactions has created a scarcity of high-quality companies to be acquired. As the quality of the transactions decreases, the risks of failures and resulting litigation is increasing. Additionally, the surge in SPAC transactions has been drawing increased regulatory attention, generating new guidance from the SEC about accounting treatments and exposure for forwardlooking statements. Of particular interest, a lawsuit was filed in August 2021 by a former commissioner of the SEC against a high-profile SPAC contending that the SPAC is not an operating company but rather is an investment company that should be regulated by the Investment Company Act of 1940. If that lawsuit prevails, it could dramatically expand the duties, risks and potential liabilities of D&Os for SPACs. Rayner: Although it is early to say, the fact that these ‘blank cheque companies’ have already become a magnet for a plethora of lawsuits illustrates their elevated risk profiles. It also reinforces certain investor

‘‘

’’

IN ALL, WE SEE CONTINUED SCRUTINY OVER REPRESENTATIONS MADE BY D&OS ABOUT COMPANY VALUATION AND THIS HAS NOT CHANGED.

THOMAS M. SHEFFIELD NFP

scepticism that they may end up falling short of their promises. Derivative and securities class actions are common to SPACs and the SPAC board, as well as the more established listed company. Either the entity has made material misstatements or omissions in its earlier public statements, or a suit is brough derivatively, bringing concerns about indemnification. This puts pressure on D&O insurance adequacy.

Generally speaking, it has been suggested that less sophisticated companies will select the de-SPAC route rather than the more traditional offerings, as they are unable to handle the more detailed IPO process. So, considering the relatively short period that SPACs have been reporting versus the large number of claims made in that period, it is not surprising that the insurance market is wary at best.

Hadwin: It is certainly true that there has been a surge in activity in this area. There had been 300 SPACs floated by August of 2021, compared to 248 during all of 2020. While in principle, SPACs raise many of the same litigation risks presented by traditional initial public offerings (IPOs) and M&A, there are some SPAC-specific risks to bear in mind. Not only do the directors of a SPAC itself need to be wary of claims of breached fiduciary duty or negligence, but so too do the directors of the sponsor company – the operative

www.financierworldwide.com

FINANCIER WORLDWIDE

company the SPAC is investing in – for their actions in the process of establishing, investing in and operating the SPAC. In other words, the existence and use of a SPAC is not something which will protect D&Os of investors from liability in all circumstances. Therefore, both SPAC sponsors and target companies should ensure a comprehensive plan is in place to address and guard against or mitigate these risks. While we have not seen any filings against a non-US issuer in 2021 so far, D&Os in various geographies and industries would be advised to consider SPAC-related litigation as a risk that they may soon face.

Sheffield: In general, much of the litigation facing SPAC deals now has largely involved the adequacy of disclosures to potential investors and possible conflicts of interest. More litigation may also be coming, given some guidance provided by the SEC on whether forward-looking projections are eligible for ‘safe harbour’ protections under securities laws. The SEC has suggested limitations, and as a result the plaintiffs’ bar may see that as a potential avenue for litigation. Ultimately, the attractiveness to investors in a SPAC transaction was largely about access to capital and the relative speedy access to public trading. As such, our long-term view is that transactions involving SPACs

OCTOBER 2021

REPRINT

REPRINT Mergers & Acquisitions

will resemble other securities litigation. If cases involving potential conflict of interest increase or find affirmation by courts, then we can anticipate this to be a developing risk for D&Os. Rosen: There are currently over 400 SPACs searching for a target, facing a finite universe of potential companies to take public. Given that competition, there has been far less due diligence performed than would normally be sufficient, which will likely result in issues being uncovered after the deal has closed. The accelerated pace with which a company goes public in a de-SPAC creates a substantial risk of accounting-related issues and insufficient controls around public disclosures.

Financing has become a challenge, as the private investment in public equity (PIPE) market has dried up and many SPACs have experienced increased redemptions, as their stocks trade below net asset value. This has forced companies to secure a greater level of financing at onerous terms, to get a deal across the finish line. The exponential rise in SPAC activity has spurred increased focus from the SEC and other regulatory and legislative bodies, particularly around the application of safe harbour provisions under the Private Securities Litigation Reform Act (PSLRA) to SPACs. Many companies have elected to go public via de-

SPAC vs. IPO so that they can ‘effectively narrate their story’ to the market. But the forward-looking projections made in reliance on the PSLRA safe harbour may create a substantially greater risk for their D&Os as the legal landscape evolves.

Skaanild: There are several exposures faced by the D&Os of the SPAC itself, the target company, and the public company that is borne of the process. The SPAC sponsor may also come under scrutiny.

Given the wide-ranging potential exposures, insurers are understandably hesitant regarding SPACs but there is some appetite in the London insurance market for those with a good risk profile listing in London or Europe. To get comfortable with providing D&O cover for a SPAC, insurers will want a good understanding of the experience of the D&Os in question, the sponsor, the due diligence process, the communications to investors, the size of the offering and the intended investment strategy. Insurers will also be keen to understand the level of investment by the founding partners as compared with external investors; are they invested to an appropriate extent?

FW: In terms of D&O insurance, what steps should companies take to ensure they offer their D&Os an appropriate level of coverage?

‘‘

Sheffield: First, companies should recognise that there are experts that have significant resources to assist in assessing or ‘validating’ the strength of their programme. Many companies will use peer benchmarking – which gives a view on what other similar companies may be buying – but a deeper review of contract terms and conditions, and the risks that they are meant to address, is absolutely essential. Brokers often provide the best resource for this assessment, and the review can be done in the context of other insurance and risk management strategies.

Brokers can also assist in modelling potential losses and ensuring that vendors, like law firms, are arranged to address claims that may arise. Most importantly, though, we recommend that clients evaluate and build strong partnerships with the carriers with whom they work.

Understanding their claims capabilities and philosophies, before a claim, is essential for a well-run insurance programme.

Rosen: The question of D&O insurance limits selection, as well as programme structure, will depend on the buyer ultimately, and the company’s tolerance for self-insuring risk to the balance sheet versus dedicating limits solely to the insured persons who cannot be indemnified by the company. Due to their heightened liability, D&Os should review their company’s risk management controls.

It is recommended to consult with a knowledgeable and experienced broker about the latest regulations and legal nuances. Consequently, it is incumbent upon directors and officers to compare previous D&O programmes to the renewal programme under discussion to ensure it provides optimal coverage. Enlisting the expertise of a broker is important in helping to inform this decision.

’’

PAY CLOSE ATTENTION TO KEY TERMS, EXCLUSIONS AND LIMITATIONS OF A POLICY AND HOW THE TOWERS INTERACT, PARTICULARLY IN A SITUATION WHERE A SETTLEMENT OCCURS BELOW ONE TOWER LEVEL, BUT EXPOSURE REMAINS FOR OTHER RELATED CASES.

HOWARD S. SUSKIN

Jenner & Block LLP www.financierworldwide.com

FINANCIER WORLDWIDE

Skaanild: Companies should undertake a risk mapping exercise to ascertain the risks to which their D&Os are exposed and the costs which may be involved in a claim.

When considering limit and retention, companies should reflect on the rationale for the insurance, their risk appetite and how the business would weather the costs

OCTOBER 2021

REPRINT

REPRINT Mergers & Acquisitions

of a claim. Once the limit and retention are determined, these should be kept under review at subsequent renewals to ensure they remain appropriate as both the company and the risk environment evolves. Arguably, more important than limit and retention is ensuring that the policy provides the appropriate breadth of protection and is structured in the right way, ideally drafted by a lawyer with insurance coverage litigation experience. A broad form policy with minimal exclusions operating as narrowly as possible is key, the investigation and pre-investigation costs element of the policy being a fundamental component which should be triggered as early as possible. Awareness of claims notification requirements is crucial. It is important to ensure that insurers are notified of issues at the appropriate stage to avoid potentially damaging late notification issues. It is also key to consider who the policy is intended to protect and whether a ringfenced additional limit should be provided for a certain class of D&Os. A regulatory investigation may start by including a broad spread of individuals, before narrowing in on more senior individuals in terms of core accountability.

In such cases, the policy limit may be depleted by the cost of responding to the initial wide-ranging investigation to such an extent that little remains for the key individuals involved. Side A difference in conditions (DIC) cover – which provides excess coverage and is solely available to the D&Os covered by the underlying policy – has been used increasingly in recent years to help ensure that there is sufficient cover for D&Os. Given the potential for the policy limit to be eroded by indemnifiable losses, Side A DIC is purchased by many publicly traded companies, allowing dedicated limits to be available for individuals.

Hadwin: Companies and their D&Os should work together to scope the liability risks that the D&Os face globally and should then cooperate to ensure that appropriate protections are in place to mitigate those risks. These protections will most likely take the form of a corporate indemnity and D&O insurance cover. It is

‘‘

’’

WHEN CONSIDERING LIMIT AND RETENTION, COMPANIES SHOULD REFLECT ON THE RATIONALE FOR THE INSURANCE, THEIR RISK APPETITE AND HOW THE BUSINESS WOULD WEATHER THE COSTS OF A CLAIM.

LAURA SKAANILD Ed Broking LLP

essential for companies to always analyse the scope of and limitations on D&O cover to ensure that it matches the risk profile faced by the D&Os. This should include an assessment of certain considerations.

Is the limit of indemnity sufficient? Is the definition of ‘insured person’ broad enough to include all relevant individuals in the appropriate contexts, such as individuals with particular regulatory responsibilities?

Companies should also ensure that triggers for cover are early enough. This is because in recent years regulators have increasingly made enquiries of D&Os in particular circumstances, in a way which falls short of being a full-blown investigation.

Ideally, D&O policies should cover any costs incurred in responding to those enquiries, notwithstanding that a formal ‘investigation’ – which was traditionally the trigger for investigation costs cover in many D&O policies – has not been commenced.

Companies must keep their position, in terms of both the liability risks and the appropriate means of protection, under constant review, bearing in mind that in the wake of the COVID-19 pandemic, the risk landscape is anything but static.

Suskin: Companies should take a holistic approach to ensuring they offer their D&Os an appropriate level of coverage.

This includes having the D&O insurance programme provide, in addition to Side-A only coverage, other coverage programmes

www.financierworldwide.com

FINANCIER WORLDWIDE

for errors and omissions, property, products, cyber and general liability.

Consulting with outside insurance coverage counsel and insurance brokers is important to making an accurate determination whether insurance coverage is adequate.

And, it is equally important that D&Os, before accepting their positions, investigate and ask questions to confirm that they are appropriately covered.

FW: How would you describe the current D&O insurance market? Could you outline some of the trends you are seeing with regard to pricing, terms, capacity, and so on?

Rayner: The D&O market has been soft for many years, with the occasional short term hard market event, for example the global financial crisis. The loose terms and conditions and the underpriced market provided by insurers never envisaged the strong growth in claims. This culminated in significant loss ratio deterioration in the latter half of the last decade for insurers for both commercial and financial institution markets. The enhanced litigation environment is set to continue, and the existence of open-legacy claims has been the catalyst for the unprecedented hardening of rates. The market expects entities to have more involvement in the programmes, with entity retentions

OCTOBER 2021

REPRINT

REPRINT Mergers & Acquisitions

increasing significantly and wordings amended to remove the undesirable broadening of terms that ensued in the soft market. In addition to significant rate increases, limits are being pared back to a more manageable level and a more prudent return to risk selection, where insurers hope to write to a more palatable combined ratio in the longer term, at the same time strengthening reserves for 2014 to 2017 legacy items and for the next wave of litigation. Long may this continue. Over the next two to three years, should these legacy claims settle unsatisfactorily for insurers, it will likely put a brake on the slowdown in rate increases, something that seems to be overlooked by a number of commentators.

Hadwin: The COVID-19 pandemic has only reinforced the trend of an already hardening D&O market and we are aware of significant premium increases in the UK and US markets, with Marsh having reported increases of almost 50 percent and 60 percent respectively. In parallel, terms are tightening, with increasing exclusions in particular for cyber incidents and data privacy losses. On a more optimistic note, we would hope that the resilience of capacity in the D&O markets will mitigate the pace of these trends.

Skaanild: Over the last two years, the D&O market has undergone a marked shift, with key participants withdrawing from the sector, overall available capacity reducing significantly and insurers’ appetite for D&O insurance contracting, particularly for new business. While recent new entrants to the market have been helpful from a capacity perspective, insurers continue to focus on the breadth of the cover they provide, in some cases looking to remove or narrow cover, or apply an additional premium to reflect perceived increased risk. It is therefore key for insureds to work closely with their broker to understand the cover from which they benefit and to ensure that optimum insurance arrangements are in place. For example, the increase in UK class actions means that Side C cover regarding securities litigation has come under review, together with shareholder derivative action cover. We have also

seen increased application of insolvency exclusions, particularly in scenarios where a company is encountering financial difficulties. Further, insurers may look to ensure that risks which may be covered under another type of insurance – for example employment practices-related liabilities of individuals – are not covered under the D&O policy. If firms consider reducing the limit purchased and accepting higher retentions, careful consideration should be given to the potential impact on the directors in the event of a claim.

Rosen: The D&O market continues to evolve. After 15-plus years of a soft market, over the past two years, many underwriters have begun to digest prior losses and determine that historical rates were inadequate given the litigation environment. While most programmes continue to see increases year-over-year, on average those changes have been less material than in 2020. However, the market may be different depending on the class of business, as many carriers look to avoid riskier classes of business, new and emerging industries – such as cryptocurrencies and cannabis – and SPACs and de-SPACs. Several new markets have recently entered the space, attracted by current rates. As carriers look to manage their capacity, many insureds have been able to maintain expiring programme limits with newer markets. There is currently a backlog of securities class actions from the 2017-2020 accident years where the outcomes are still pending. Absent an increase in dismissal rates from historical averages, we can anticipate relatively high settlement levels in the upcoming years in terms of both count and dollar value. The impact that these claims may have on the D&O marketplace remains to be seen. If securities class actions activity returns to the levels seen between 2017 and 2019, the current deceleration in rates could reverse.

Excess rates would likely also appear challenged given the heightened damages that would accompany this activity, with market caps currently at all-time highs across most sectors.

www.financierworldwide.com

FINANCIER WORLDWIDE

Suskin: D&O underwriting has become more restrictive, coverages have been limited, and premiums have increased substantially. There have been many causes for these changes, including continuing relatively high levels of securities class actions and derivative actions, new areas of liability arising out of ESG-related claims, and elevated concern about exposure arising from cyber security breaches.

Sheffield: Global economic pressures and conditions surrounding COVID-19 still persist and impact D&O insurance products in particular. Q2 saw the start of slight easing of the firm insurance market for some management and professional lines of business, including, notably, D&O insurance. The trend is still an increase in rates year-over-year, but not as sharp as it has been over the last two years. Likewise, we have seen carriers remain firm with increased premiums and retentions, along with disciplined capital deployment. Terms, conditions, limits and retentions are all more constricted than they have been.

Additionally, profound increases in criminal cyber attacks and ransomware, event-driven litigation, as well as the increasing shift in corporate governance scrutiny, adds more pressure for businesses and leaders to address climate, social and political instability in the world.

FW: What advice would you offer to both companies and D&Os on assessing their D&O insurance towers? Which elements are of paramount importance?

Skaanild: Companies must regularly review with their advisers whether the cover provided by their policy reflects the nature of the company. As companies grow and evolve, so too should their insurance programme. For example, what is termed as ‘Side C’ cover is particularly for listed companies but is sometimes overlooked by companies that have moved from being private to public over the years. Exclusions within a policy should also be kept under review. It is not unusual for there to be some form of US exclusion on a D&O policy. However, where a company has recently expanded the territories in which it

OCTOBER 2021

REPRINT

REPRINT Mergers & Acquisitions

operates or services it provides, the impact of any exclusions should be discussed with insurers to determine whether they can be narrowed or removed, ensuring that the company and its directors benefit from appropriate cover. The cover provided by a policy is crucial but so is drafting the policy correctly, ideally by a lawyer with insurance litigation experience. Insureds need to be confident that, should a claim arise, the cover operates in the right way and that the policy will respond. An additional consideration is ensuring that the insurers on the programme have a robust claims offering, a good record of paying claims and a pragmatic and collaborative claims handling philosophy. It is also key to include features such as provision for separate legal representation of individuals, rather than appointment of one law firm which can be problematic where a claim involves several individuals and the company with conflicting interests, and priority of payments, entitling D&Os to payment of losses prior to the company in a claim involving both.

Rosen: Particularly due to the evolving litigation environment, programme structure and carrier partner selection are increasingly important when assessing D&O insurance towers. Although price is a key part of most buying decisions, determining the value of the product being purchased is even more so. Particularly important is the carrier’s claims reputation, especially for those providers in the primary, lower excess and lead Side A positions. The value in partnering with carriers that understand your current risk, and how that risk might be expected to evolve in the coming years, cannot be understated.

Suskin: It is important to pay close attention to key terms, exclusions and limitations of a policy and how the towers interact, particularly in a situation where a settlement occurs below one tower level, but exposure remains for other related cases. One aspect that is also particularly important, and often overlooked, is regarding insurer control over selection of counsel. D&Os normally prefer to be

defended by counsel with whom they are familiar. But D&O policies often give the insurer significant influence or control over selection of counsel, frequently in connection with the insurer having negotiated significant rate discounts with select panel counsel. D&Os should examine whether their regular outside counsel will be on the insurer’s approved list and, if they are not, negotiate their inclusion at the policy inception. It is usually difficult to get counsel approved later, and approval may be tied to significant concessions on rate discounts that the counsel may be unable or unwilling to accept. It is also important to make sure that policies include coverage for investigations. Not all policies do, and some that do have limitations that unrealistically underestimate the costs of conducting such investigations. Additionally, many policies do not cover responding to government subpoenas, including as non-party witnesses, but such responses can entail exceptionally high costs, particularly where identification, recovery and production of electronically stored information is involved.

Sheffield: Some advisers will begin with a discussion about which contract provisions, sub-limits and extensions of cover are best to seek and obtain. However, I believe the best advice is to consider, above all else, carrier partnerships and relationships. The partnership between insurer and policyholder is the single largest factor in building a successful programme and result in the event of a claim. Counterparty strength and insurer credit rating are undoubtedly important, however more practical considerations like claims team leadership and alignment between underwriting, claims and legal and technical leadership is very important.

Understanding the experience level of the underwriters assessing the risk and having a stewardship approach that fosters engagement throughout the policy year, not just the renewal, is really important.

Many policies feature ancillary services, for example hotline numbers for employment practices and assessment vendors for cyber. Using those services fully allows the

www.financierworldwide.com

FINANCIER WORLDWIDE

policyholder to understand the carrier more fully and should be used more.

Hadwin: It is important to carefully review the wordings of each excess layer and ensure they dovetail appropriately with a company’s primary D&O cover.

For example, each layer should contain consistent aggregation language setting out the circumstances in which matters should be considered to be a single claim.

Inconsistency in this regard can cause significant uncertainty as to how a large loss should be handled across a D&O tower, which, in worst-case scenarios, could require litigation to resolve.

FW: How might risks facing D&Os evolve in the months and years to come?

To what extent are they becoming more complex, international and unpredictable in scope?

Sheffield: One thing is predictable: business leaders will always be secondguessed by others being impacted by their decisions. Because of that, litigation, regulation and scrutiny on those decisions will undoubtedly continue, and continue to present complexity for D&Os. Additionally, because the economy is becoming more global, risk and opportunities are both becoming more global in scale. We are continuing to see business success as the result of an aggregation of services, supplies and products. For example, right now, automobile manufacturing is dramatically slowed due to the impact of chip manufacturing essential to the industry.

As a result, and this will continue into the future, business decisions will continue to occur within the context of a more complex world. D&O policy is designed to keep up with that pace of change and to broadly cover risks faced by businesses and their leaders in this environment as well.

Suskin: It is challenging to try to anticipate what new and unexpected risks might confront D&Os in the years ahead, as the risks facing D&Os continue to be more complex, international and unpredictable in scope. Very few, if any, predicted a couple years ago the

OCTOBER 2021

REPRINT

REPRINT Mergers & Acquisitions

explosion in #MeToo investigations and claims that are now being lodged with increased frequency against D&Os and their companies for having failed to prevent the alleged misconduct. Likewise, in the securities litigation arena, efforts at bringing shareholder class actions in foreign jurisdictions are getting more traction. Additionally, shareholder activist campaigns, including demands for books and records under Delaware’s General Corporation Law Section 220 and analogous statutes in other states, shareholder derivative demands and shareholder derivative lawsuits continue to evolve as new types of controversies unfold.

The subject matters of the campaigns have been wide ranging, including issues concerning accounting internal controls, internal controls related to cyber breaches, representations about ESG, Foreign Corrupt Practices Act (FCPA) violations, and allegedly excessive compensation of D&Os. All of this elevated risk of liability has been exacerbated by the trend of having shareholder activism supported by litigation funding firms. The consequence is that the opposition can afford to be more aggressive and has considerable added staying power to remain in the fight. All of which augers for the importance of confirming that D&Os have robust insurance coverage.

Hadwin: Heightened regulatory scrutiny and higher shareholder expectations are not new developments in and of themselves, but no doubt will continue to evolve. The emergence of shareholder class actions following cyber attacks is likely to be a new development that will cause significant concern for D&Os. More broadly, as COVID-19 has changed the way many companies work, D&Os

will need to consider how their potential liability exposures will change as a result.

People risk, cyber security risk and ESG are just three examples which have evolved significantly as a result of the pandemic and which D&Os will need to consider with their obligations in mind – be those statutory, fiduciary or otherwise.

of internal control effectiveness and new disclosures, together with a directors’ statement regarding the legality of proposed dividends and impact on the future solvency of the company. Cyber exposures and ESG-related claims will continue to evolve, as will merger objection litigation and investigations.

Rosen: There are a number of newer risks to watch as they evolve over the coming years. The rise in social media’s influence on investment decisions, as well as D&O use of social media, will likely present an increasing risk in the future. The number of newfound and emerging industries, including digital assets, cannabis and electric vehicles, may prove to provide fertile grounds for plaintiff’s firms. There are also likely to be changes at the SEC, including how it approaches emerging areas like SPACs and cryptocurrencies, disclosure requirements and scrutiny of insider trading plans.

Rayner: The increasing claims environment stems from the growing and varied scrutiny that D&Os and entities now face. Individual and corporate oversight has never been greater as more stakeholders – shareholders, regulators, D&Os and wider cultural influences – are now actively engaged with boards to ensure compliance. Entities are no longer parochial, they are globally influential with local culture, economics and legislative fundamentalism. They are interconnected with the local networks and, as such, need to be conscious of this. Therefore, the risks facing the board become more complex and evolve as the global trade environment evolves. The ‘traditional’ conduit for risks and claims remains, but the claims triggers change in priority with the increasing and changing impact of social and geographic influences. Social media can be used very effectively to channel opposition to any controversial course of action proposed by a company. The board arguably did not face such pressures a decade ago, underscoring the speed at which the social media phenomenon is forcing D&Os to rethink how they engage with all their stakeholders, rather than just investors. Increasingly, it is important for boards to set policies that encompass the broader social impact of a company as a whole, as it is no longer enough to purely focus on maximising traditional shareholder returns.

Skaanild: In recent years, we have seen several high-profile corporate collapses, meaning increased oversight of directors and execution of their duties has been viewed by many as desirable. In the UK, there will be new considerations for D&Os due to audit reform and corporate governance proposals aimed at improving the framework for audit, corporate reporting and corporate governance systems, with a focus on strengthening internal company controls.

Under the proposals, directors will be required to provide a statement noting their responsibility for establishing and maintaining adequate internal controls and procedures for financial reporting. The proposals also include an annual review

This article first appeared in the October 2021 issue of Financier Worldwide magazine. Permission to use this reprint has been granted by the publisher. © 2021 Financier Worldwide Limited.

www.financierworldwide.com

FINANCIER WORLDWIDE

OCTOBER 2021

REPRINT