There's no denying the momentum behind regulation D and the JOBS Act. But these regulations have also created some confusion when it comes to a company’s directors and officers insurance. Are securities exempt under crowdfunding regulations covered? Is an endorsement required? How does coverage react in the event that the fund raise is successful and we decide to file an IPO? Since D&O insurance policies are a primary source of defense when lawsuits arise, these are all important questions.
First it’s important to understand that all private company D&O insurance policies contain a public offering/securities exclusion. Without this the policy would also act as a “public company policy”. In order to maintain coverage for 1) claims related to exempt securities, and 2) potential future public offerings, carriers generally include wording that will carve back such coverage. However, not all wording is created equal. A sample exclusion may read accordingly:
The Company will not be liable for Loss for any Claim based upon or arising out of:
a. the public offer, sale, solicitation or distribution of securities issued by the Insured Organization; or b. the violation of any federal, state, local or provincial statute relating to securities, including the Securities Act of 1933 and the Securities and Exchange Act of 1934, or any rules or regulations promulgated thereunder.
provided that this exclusion will not apply to any offer, purchase or sale of securities, whether debt or equity, in a transaction that is exempt from registration under the Securities Act of 1933 (an “Exempt Transaction”).
In addition, if at least thirty (30) days prior to an offering of securities of the Insured Organization, other than pursuant to an Exempt Transaction, the Company receives notice of the proposed transaction and any additional information requested by the Company, the Insured Organization may request a proposal for coverage subject to any additional terms and conditions, and payment of any additional premium, described in such proposal.
When reviewing the offering/securities exclusion and any carve backs, there are a number of questions policyholders should ask:
- Has the insurer added any explicit crowdfunding exclusion to the policy? If so, what exactly is excluded? Does it apply to claims solely against the organization or may it extend to individual directors or officers? Companies engaged in crowdfunding should steer well clear of any such policy exclusions.
- Are exempt securities explicitly carved back? Some policies’ offering exclusions will contain carve backs for “roadshow wrongful acts” but fail to include “exempt securities” within that definition.
- How are exempt transactions/securities defined? Does it carve back all exempt securities or does it specify? While carving back coverage for “private offerings” some policies maintain a narrow definition. At least 2 policies we reviewed contained exemptions that were limited to “debt securities”. Strong carve-backs are sufficiently broad, carving back “any securities exempt from registration”. While this wording would arguably be broad enough, some insurers provide additional clarity by including wording confirming coverage for securities offered under “Regulation D” and “Regulation S”. Regulation A+ raises can however prove more challenging. Companies engaged in any crowdfunding raises (particularly those raised under A+) should work very carefully to review their policy’s “exempt securities” carve backs, in order to ensure their raises qualify.
- Does the carrier require an offering notification of exempt securities? Within how many days? Does that notice guarantee a proposal/indication or guarantee coverage? Will there be a premium associated? While some exemptions state that there will be no additional premium, they will proceed to require notice of particulars within 30 days of said offering. With crowdfunding being a demanding time for companies and their c-suite, such a requirement may be problematic for policyholders due to the potential of surpassing the window. Additionally many policyholders may be entirely unaware of said requirement which can threaten to compromise coverage. Policies that provide the broadest terms often contain no such notification requirement.
In situations where policy language is poor, a properly worded crowdfunding endorsement may help broaden policy language, provide additional clarity, or provide coverage where there was none. However, they can be potentially disadvantageous when the carve backs to the securities (public offering) exclusion are already sufficient, in which case its primary purpose is often to limit coverage for claims arising from such securities, by applying a sublimit of 250k or 500k on a larger limit.
Since crowdfunding rounds are often used as testing grounds and on ramps for IPOs, organizations should think one step ahead and review their policy’s transaction provisions regarding coverage for roadshows and IPOs. Policies should provide a guarantee for proposals for “public offerings”. Some policies simply state that the policyholder may request a quote but provide no language indicating that they will guarantee a proposal. However, even when policies do contain language guaranteeing said proposal - insurers disinterested in providing such coverage can still present an inflated premium which may deter purchase by the policyholder. That said, it is still advised for the policy to contain such a guarantee – this may also be particularly comforting for companies in higher risk industries that may have a difficult time locating alternative insurers. Lastly, as we already touched upon above, this provision should be limited solely to “public offerings”. Some policy forms were either silent on, or inclusive of “exempt securities” that would require private companies to present all particulars to the carrier within 30 days of offering “exempt securities” – this requirement may place undue burden on the policyholder. Companies considering future public offerings should ensure their policy provides coverage for “roadshow wrongful acts” and claims arising from the failure to undertake an IPO.
Lastly, we should note that recent developments in securities laws have also created some new capabilities for company's, which may also create some challenges for insurers when defining “exempt securities”. First the SEC extended private registrations to all new IPOs. While this is not an exemption, such registrations could challenge some insurers’ definitions of exempt securities (particularly insurers with poorly worded forms). This could implicate true public securities coverage under private D&O forms. ICO’s (initial coin offerings) have become another area of critique for the SEC, with the agency recently releasing a report indicating that ICOs may in fact be subject to federal securities laws, unless exempt. While it’s too early to offer any insight or speculate on the challenges this might pose, it will be undoubtedly be a topic of much interest/debate moving forward.