One of my “5 Wishes for Securities Litigation Defense” last month was for greater D&O insurer involvement in securities class action defense.
This simple step would have extensive benefits for public companies and their directors and officers. D&O insurers are repeat players in securities litigation, and they have the greatest economic interest in the outcome – both in particular cases, and overall. They want the defendants – their insureds – to win. They employ highly experienced claims professionals, many of whom have been involved in exponentially more securities class actions than even the most experienced defense lawyers.
Given insurers’ stake and expertise, defendants should involve them in key strategic decisions – working with them to help find the right defense counsel for the particular case, to help shape the overall defense strategy at the inception of the case, and to help make good decisions about the use of policy proceeds. With such an approach, I have no doubt that directors and officers would make it through securities cases more successfully, efficiently, and comfortably.
Yet in most cases, insurers are shut out of meaningful involvement in the defense, with many defense lawyers treating them almost like adverse parties, and other defense lawyers merely humoring them as they would a rich relative. Although this dysfunction is rooted in a complex set of factors, it could easily be fixed.
Why Are D&O Insurers Alienated?
When the general public thinks about insurance, they usually think of auto insurance or other duty-to-defend insurance, under which the insurer assumes the defense of the claim for the insureds. In contrast to duty-to-defend insurance, public company D&O insurance is indemnity insurance, under which the insurer is obligated to reimburse the company and its directors and officers for reasonable and necessary defense costs and settlement payments, up to the policy’s limit of liability.
Indemnity insurance gives the defendants control over the litigation, including counsel selection and strategic approach, with the insurer retaining limited rights to participate in key decisions. Although those rights give insurers a foot in the door, competitive pressures among primary D&O insurers work to minimize insurers’ involvement. For example, an insurer faced with unreasonably high defense costs must decide whether to pay them in full to avoid conflict, or to pay only the “reasonable and necessary” amounts, as the policy specifies – an approach that maximizes the policy proceeds for the insureds by not squandering policy limits on excessive legal fees. But if the insurer pays only reasonable and necessary amounts, it may be criticized in the marketplace by the broker or other insurers as being stingy with claims handling – and the insureds may be left holding the bill for the unreasonable excess fees.
In general, insurers take a relatively hands-off approach to D&O claims because they assume that their customers want them to stay out of the defense of the claim. But in my experience, this is a misconception. The priority for most companies and their directors and officers is simply the greatest protection possible, including assurances that they will not be left to pay any uncovered legal fees or settlement payments. In fact, not only do most insureds not want to be stuck paying their lawyers for short-pays, they don’t even want to write any checks at all after satisfying the deductible – instead preferring the insurer to take charge of the bills and pay the lawyers and vendors directly.
In other words, most public companies actually want their D&O insurance to respond more like duty-to-defend insurance. And if given a choice between having the freedom to choose any defense counsel and having total control over the defense, and saving on their premium and giving the insurers greater rights to be involved, I’m confident most public companies would choose to save on the premium, as long as they are confident that they will still be well-defended. This is especially so for smaller public companies, for whom the cost of D&O insurance can be a hardship, and against whom the plaintiffs’ bar is bringing more and more securities class actions. And few companies, large or small, would knowingly spend more on their premiums just to subsidize skyrocketing biglaw partner compensation – the D&O insurance elephant in the corner of the room.
Why do insurers have this misconception? To be sure, after a claim is filed, the insurer often gets an earful from the insureds’ lawyers and broker about the insureds’ indemnity-insurance freedoms. But these aggressive positions are typically not the positions of the insureds themselves. Instead, these positions are driven by defense counsel, usually for self-interested reasons: to get hired, to justify excessive billing, or to settle a case for a bloated amount because the defense is compromised by mounting defense costs or the defense lawyer’s inability to take the case to trial.
Frequently, defense lawyers will set the stage for their clients to have a strained relationship with their insurers by feeding them a number of stock lines:
- This is a bet-the-company case that requires all-out effort by us to defend you, so we have to pull out all the stops and do whatever is necessary, no matter what the insurer has to say.
- The insurer may ask you to interview several defense firms before choosing your lawyers. Don’t do that. They’ll just want to get some inferior, cut-rate firm that will save them money. But you’ll get what you pay for – we’re expensive for a reason! (And don’t forget that we have stood by you, through thick and thin, since before your IPO, back when you were a partner here. Plus, we gave you advice on your disclosures and stock sales, so we’re in this together.)
- The business of any insurance company is to try to avoid paying on claims, so the insurer may try to curtail our level of effort, and may even refuse to pay for some of our work. But trust us to do what we need to do for you. You might need to make up the difference between our bills and what the insurer pays, but we can go after the insurer later to try to get them to pay you back for those amounts.
- The insurer will ask us for information about the case. They’ll say they want to help us, but they’re really just trying to find a way to deny coverage.
- We’ll tell you when we think the time is right to settle the case, and for how much. The insurer will try to avoid paying very much for settlement. But if we say the settlement is reasonable, they won’t have a leg to stand on.
- We’ll need you to support us in these insurance disputes. You don’t need to get involved directly – we can work with the insurer and broker directly if you agree. Agree? Good.
In this way, defense lawyers set the insurer up as an adversary. But these self-serving talking points get myriad things wrong.
First, and most importantly, D&O insurers are not the insured’s adversaries in the defense of a securities class action. To the contrary, insurers’ economic interests are aligned with those of the insureds. Insurers want to help minimize the risk of liability, through good strategic decisions. Although keeping defense costs to a reasonable level certainly benefits the insurer, it also benefits the insureds by preserving policy proceeds for related or additional claims on the policy, so that the insureds will not need to pay any defense or settlement costs out-of-pocket, and will avoid a significant premium increase upon renewal. And insurers want their insureds to have superior lawyers – inferior lawyers would increase their exposure. Their interest in counsel selection is to help their insureds choose the defense counsel that is right for the particular case. The key to defense-counsel selection in securities class actions, for insureds and insurers alike, is to find the right combination of expertise and economics for the particular case – in other words, to find good value.
A D&O insurer’s business is not to avoid paying claims. D&O insurance is decidedly insured-friendly – which isn’t surprising given its importance to a company’s directors and officers. D&O insurers pay billions of dollars in claims each year, and there is very little D&O insurance coverage litigation. Although D&O insurance excludes coverage for fraud, the fraud exclusion requires a final adjudication – it does not even come into play when the claim is settled, and even if the case went to trial and there was a verdict for the plaintiffs, it would only be triggered under limited circumstances. Indeed, if they are utilized correctly, D&O insurers can be highly valuable colleagues in securities class action defense. Because they are repeat players in securities class actions, they are able to offer valuable insights in defense-counsel selection, motion-to-dismiss strategy, and overall defense strategy. They have the most experience with securities class action mediators and plaintiffs’ counsel, and often have key strategic thoughts about how to approach settlement. The top outside lawyers and senior claims professionals for the major insurers have collectively handled many thousands of securities class actions. Although their role is different than that of defense counsel, these professionals are more sophisticated about securities litigation practice than the vast majority of defense lawyers.
I have achieved superior results for many clients by working collegially with insurers – from helping shape motion-to-dismiss arguments, to learning insights about particular plaintiffs’ lawyers and their latest tricks, to selecting the right mediator for a particular case, to achieving favorable settlements that don’t leave the impression of guilt. Treating insurers as adversaries robs defendants of this type of valuable guidance.
How Can We Achieve Greater Insurer Involvement?
D&O insurers should set aside their preconceived notions about what the insureds really care about and want. Insurers need to appreciate that their insureds often welcome their expertise and experience – especially at smaller public companies that have less familiarity with securities class actions, and a more pressing need to control their costs. Not only is there an opportunity for greater involvement within the current D&O insurance product, but there is a market for new terms and products that allow greater insurer involvement, with corresponding premium or coverage advantages to the insureds.
Many insurers correctly address their claim-handling capabilities as part of the underwriting process. As part of this discussion, insurers should set the expectation that the insureds will consult with the insurer about the defense-counsel selection process before the defendants select counsel. Insurers have a unique perspective on the pros and cons of particular defense counsel, since they know the capabilities and economics of the relatively small bar of securities class action defense counsel very well. They can help the insureds identify several defense firms that would be a good match for the substantive characteristics of the case. For example, they might know that a particular firm has helpful experience in cases involving a particular industry or type of allegation, or has a good or bad track record with the assigned judge. Insurers can also help match the economics of the litigation with particular firms. They would know whether or not a particular firm is able to effectively defend a case within the limits of the D&O insurance, and conversely, they would know whether a firm has enough resources to effectively handle a large claim.
Although I am not an insurance lawyer, I believe this type of discussion is perfectly appropriate within the terms of existing insurance contracts. But if there is any doubt, existing policy forms could be tweaked to explicitly include greater insurer involvement. For example, the insurance contract could require the insureds to consult with the insurer about the defense-counsel process before engaging defense counsel, such as with a provision similar to the explicit requirement in D&O policies that insureds speak with the insurer before engaging in any settlement discussions.
Last, but certainly not least, I strongly believe that a public company duty-to-defend product for a “Securities Claim” would be highly attractive to many public companies, especially smaller companies. Many companies would gladly pay somewhat less for their D&O insurance in exchange for giving insurers somewhat greater control, as long as they know that they will be defended well. Such a policy would eliminate the risk that clients will have to make up for insurance short-pays, as they are often asked to do under indemnity insurance, while allowing the insurers to manage defense costs to help ensure that the policy proceeds will adequately cover the cost of defending and settling the litigation, and will not be needlessly expended. As the cost of securities class action defense continues to skyrocket, even as the size of the typical securities case continues to decline, it is time for the D&O insurance industry to consider introducing a product that will provide excellent coverage at a fair price that is affordable to smaller companies.