Placing public company D&O insurance is often a fairly straight forward exercise, assuming the corporation has realistic premium expectations and a risk profile that’s not overly challenging. However when it comes to OTC and micro-cap companies, that risk profile often challenges their expectations. Many companies assume their smaller stature and filing class will yield lower premiums, and while that may be the case sometimes, more often than not, they will find the cards stacked against them from the onset. The pool of companies willing to insure OTC companies is already small. Combine that with a difficult industry, distressed financials, or a steadily declining stock…and with each challenge that pool of insurers becomes even smaller.

For many micro caps simply securing coverage can be challenging. Underwriters concerns revolve around capital adequacy, stock volatility, director inexperience, board independence, lax governance/reporting requirements, and the potential for fraud which is perceived as a high risk among OTC companies. A prior study by the SEC highlights the most common fraud allegations. Leading the list are: shell company accusations, market manipulation accusations and securities fraud allegations. A closer look at a more recent investor alert demonstrates some of the methods of perpetration which include (among others) spam email marketing, cold calling, questionable releases and modified pump and dump schemes.

This can create some high hurdles. Many smaller public companies, when seeking financing or attempting to attract more experienced directors will almost always need to address a requirement for D&O insurance. While both of these activities serve as standard triggers for the placement of D&O, the importance of obtaining coverage can be considerably greater for these companies. An inability to obtain such insurance (or cost efficient coverage) may hamper their growth ability. While minimum premiums for a 1 Mill policy being at 20k per million it’s not uncommon to receive broad ranges, from 30k – 70k or more. These high premiums can also often arrive with aggressive exclusions such as bankruptcy carve outs, regulatory exclusions, or low-threshold majority shareholder exclusions (among others). This lack of competition also often results in coverage being dictated through difficult coverage negotiations - when carriers understand they are the only insurer providing terms, their willingness to broaden policy language is generally minimal at best. Limits relative to premium pose additional challenges. OTC companies with limited funds also have understandably lower budgets for D&O insurance. This often results in the organization purchasing low, and potentially inadequate limits. In more severe cases it results in the organization bypassing D&O insurance altogether.

Due to the critical importance of such insurance for micro cap companies, and due to the fact that they are often placed under a microscope when being underwritten, the c-suite should do everything they can to maximize their options in the marketplace. This will help achieve both competitive premiums as well as more favorable terms during coverage negotiation. The more concerns the company can proactively address the better. Considerations should include:

  • TIMING: Start the process early – preferably while still private. Or, if already public, applying for coverage while financials are strong and stocks are performing well is likely an opportune time.
  • GOVERNANCE: The company should also do everything it can to aggressively alleviate any underwriting concerns. This may include; strengthening bylaws, implementing a healthy balance of independent directors and strengthening any governance and reporting.
  • DILIGENCE: For reporting companies, acting with extra due diligence can be helpful in order to avoid any need for changes of auditors or financials restatements.
  • FINANCIAL CONCERNS: In order to alleviate financial concerns, the company should pro-actively address any distressed financials, mentioning any future funding in as much detail as possible, carefully addressing how financial obligations and capital requirements will be met over the next few years.
  • DIRECTION: Appearing disinterested or unprepared to the underwriters will raise red flags and result in declinations. If insurers are willing to engage in a conference call to learn more about the company’s direction, it’s critical that the CEO and CFO can articulate a clear financial strategy to the underwriters.

Crafting coverage poses yet its own set of challenges. Companies operating in the OTC space, may be subject to increased accusations of fraud and a greater potential for insolvency. For this reason, the directors/officers should perform a particularly careful assessment of the 1) fraud exclusions 2) application and exclusion severability, 3) bankruptcy terms & conditions and 4) language pertaining to change of control events (which may be triggered by the assignment of a bankruptcy trustee or following a merger/acquisition). Directors that are particularly concerned about insolvency should consider including a layer of Side A DIC (difference in condition) coverage to sit on top of the underlying policy. Side A DIC insurance provides a number of benefits. Most importantly, it provides drop down coverage to fill some of the coverage gaps in the underlying program. Secondly, it ensures coverage will be available in the event of a bankruptcy. Being that bankruptcy courts can sometimes deem D&O an asset of the bankruptcy estate, side A policies are able to avoid this due to their lack of entity coverage. Lastly, stand-alone side A policies may also serve as an alternative option for companies that do not have the assets for a full side program. Where a full side D&O policy may hypothetically price at 60k, a side A only may price at roughly 30k to 40k depending on the financials of the company. It is critical however that the entity fully understand the implications of such an approach, namely waiving any coverage for its balance sheet which can ultimately result in bankruptcy (following a claim) which may attract additional claimants.

There may also be registration changes along the way with the micro cap company deciding to de-list or go private. Converting to a private form for the benefit of broader entity coverage and lower retentions (among others) needs to be handled appropriately. With private conversion endorsements applying a securities exclusion for security related wrongful acts asserted after the conversion date, failure to handle this conversion properly can result in coverage being severely comprised. Many companies immediately equate such a conversion to a premium reduction which is most often not the case – at least for the first few years while potential securities claims are still within the statutes of limitations. Further complicating matters, reporting obligations may later be re-triggered which also needs to be considered. Solutions often include overlapping coverage through a combination of public form “tails” and separate private-policies, or private conversion endorsements. Lastly, public companies that do choose to go private will often pursue future equity/fund raises under crowdfunding regulations. With some insurers applying a crowdfunding exclusion to their private forms, it’s important to understand the scope of coverage for crowdfunding related claims under any policy. Companies that have any future plans of equity raise are best off addressing any crowdfunding exclusions at the time of the conversion application. Attempting to carve back crowdfunding coverage mid-term and/or prior to launch can prove to be more difficult.

While the above article outlines some of the most common hurdles faced by smaller public companies when seeking D&O, there are still many others. Partnering with an experienced securities/D&O attorney and qualified insurance broker is not only critical from a coverage perspective but can also help ease the purchase process.