As the Scandals Mount…What Is the Right Approach For Protecting My Private Directors and Officers?

by

Harry C. Wallace

Managing Director

Executive Risk Management

Mazonson, LLC

 

The unprecedented events being played out concerning wrongdoing in corporate America cannot be avoided. Plaintiff lawyers are active and juries or potential jurors are developing opinions about all corporations, public or private.

 

This is especially true in the current U.S. litigation climate as it pertains to corporate Directors & Officers exposures. What follows are our thoughts on the three key coverages every company should consider who enters the U.S. marketplace: Directors & Officers Liability, Fiduciary Liability and Employment Practices Liability.

 

Directors & Officers Exposure:

 

Recent developments in the U.S. regarding corporate scandals and management impropriety have placed an enormous amount of scrutiny and negative spotlight on many publicly traded companies. New laws and regulations taking effect are making board membership much more than a spectator sport.

 

While most of the attention has been toward publicly traded companies, private companies in the U.S. are under increased pressures as well. Plaintiff attorneys, emboldened by their success in the publicly traded arena, are now looking more closely for opportunities to bring actions against mid size to large private firms.

 

In a recent article in the Wall Street Journal entitled “Lawyers Find Jury Pools Polluted by Anti - business Biases” (8/12/2002), a lawyer was quoted as saying:

 

“Right now is a very dangerous time. You start out with some substantial number of people in the jury pool who are going to give less credence to testimony of corporate executives just because they’re corporate executives.”

 

Accounting irregularities, such as revenue recognition, the source of many of the problems in the public world, also create exposures for private firms.

 

Also, representations made by owners or CEO’s of private companies to potential shareholders or customers, if not realized, quite likely could result in a damaging lawsuit.  Take for instance this example from a southern-based company with 145 employees and $37 million in annual revenue:

 

An officer of the company held a conversation with a potential investor in which they discussed the future plans for the company, including the launch of new products over the coming six months. Based on these representations, the investor committed over $500,000.

 

After a year, the products that were anticipated did not appear in the marketplace. During this time, the value of the original investment declined. The investor sued the company and the directors and officers for misrepresentation in state court, seeking over $10 million in damages. After two years of litigation and $250,000 in defense costs, the case was settled for $335,000.

 

This scenario is not unique and is just one example of the exposures private directors and officers face. Loss scenarios such as this are generally not covered under standard General Liability or Excess Liability insurance policies.

 

The general legal standards for directors and officers of private as well as public companies include:

 

 

Rarely in U.S. corporate history have these duties been as demanded of corporate leaders as now. An alleged breach of these duties in the form of a lawsuit could bring substantial expense to the company in the form of defense costs as well as becoming a great distraction to leadership, who should otherwise be focused on producing business results.

 

Directors and Officers insurance covers the D’s & O’s (and the company to the extent it indemnifies the D’s & O’s) for defense costs within the policy limits, settlements and judgments on account of claims by shareholders, employees, creditors, customers, competitors, regulators and other third parties for a broad range of allegations such as:

 

 

There are many insurance companies who write coverage for D&O exposures in the U.S. However, a good broker will make sure that the coverage is a broad as possible. Some of the things you should look for in a D&O policy include:

 

 

 

Fiduciary Liability:

 

This is another significant exposure faced by U.S. employers and their employees who serve as trustees of, or who have discretionary authority with respect to, or who assist in the administration of any retirement plan or other employee benefit program (such as medical, accident or group life plan) including 401k’s.

 

As “fiduciaries” these people must comply with detailed, complex and stringent legal requirements, act with the utmost care, and avoid even the appearance of certain conflicts of interest.  If a wrongdoing - albeit inadvertent - occurs, potential damages can be enormous in light of the large amount of money controlled by or owing under employee benefit programs.

 

Since the passage of the Federal Employee Retirement Income Security Act of 1974 (ERISA), numerous additional state and federal government laws have been enacted and court decisions have broadly interpreted the statutory provisions to create an escalating liability environment.  Potential plaintiffs in this type of litigation include plan participants and beneficiaries, other fiduciaries or third-party administrators, the Department of Labor (DOL) and the Pension Benefit Guaranty Corporation (PBGC).

 

A Fiduciary Liability policy is meant to provide coverage for both defense costs as well as loss payment for these exposures.

 

As with D&O coverage, there are many different kinds. However, at a minimum a policy should provide coverage for a broad range of alleged ERISA or state imposed fiduciary breaches including:

 

·        Improper disclosures to plan participants

·        Imprudent investment or lack of investment diversity

·        Imprudent choice of insurance company, mutual fund, or third-party service provider (investment manager, actuary)

·        Improper advice or counsel

·        Failure to adequately fund a plan

·        Administrative error

·        Improper amendments to the plan document

 

Most if not all of these allegations are not covered under a General Liability or Excess Liability policy.

 

Policies can vary from company to company. Some important policy features we look for include:

 

 

 

Employment Practices Liability:

 

Employee related litigation continues to preoccupy thousands of owners and chief executives of private companies. No company, no matter the make up or composition is immune.

 

A few alarming facts about U.S. employment exposures are:

 

 

·    41% Of EPL claims arise from employers with 15 to 100 employees; 38% from employers with 500 to 700 employees.

 

·    USA Today estimates wrongful employment practices complaints filed at state agencies and the EEOC at more than 150,000.

 

·    A recent article in CFO Magazine cited estimates that corporate America may spend more than $1 billion per year to defend and settle sexual harassment claims.

 

·    Statistics show that employers are only winning 1/3 of employment related claims, and punitive damages are awarded 97% of the time.

 

 

And it is no longer just about sexual harassment. Consider this claim example from a Northeast U.S. company with 40 employees and $3.7 million in annual revenue :

 

A mid level supervisor with a long history of documented performance issues was terminated for smoking in a restricted area where flammable chemicals were stored. The terminated, 54 year old employee responded by suing the company for wrongful termination.

 

He alleged age discrimination on the basis of comments made by his boss, such as, “You are too old…” and disability discrimination because the company refused to make accommodations for his high blood pressure. He also alleged he could only be terminated for good cause.

 

The plaintiff sought back pay, front pay, special damages and attorney fees totaling $275,000 as well as punitive damages.

 

The company settled with the former employee, paying $350,000, but not before it had paid $130,000 in defense costs as well as a significant amount of undocumented expense caused by distraction of the management team from the business plan.

 

 

There are many different policy forms that exist in the marketplace. However, before buying, make sure that they provide coverage for:

 

·        Wrongful termination

·        Workplace and sexual harassment

·        Breach of employment contract

·        Discrimination, including marital, sexual orientation, veteran status, and bankruptcy

·        Retaliatory discharge

·        Failure to employ or promote

·        Deprivation of career opportunity

·        Negligent evaluation and employment-related misrepresentation

·        Defamation or wrongful infliction of emotional distress

 

Key enhancements that can be added are:

 

·        Coverage for intentional acts or purposeful violations.

·        Coverage for mental anguish and emotional distress.

·        No exclusion for prior acts.

·        Coverage (where allowed) for punitive damages.

·        100% defense costs coverage.

 

In addition, some insurance carriers offer loss prevention assistance or premium discounts for services you pay to reduce your exposure. These can include costs to update your employee handbook or provide harassment training to your management staff.

 

Summary:

 

Protecting your interests from these exposures does not have to be complicated. For instance, many of these coverages can be combined in a package format. We generally recommend this approach for ease of handling and the efficient use of limits and deductibles.

 

When considering your individual risk, it is often best to enlist the help of a broker who specializes in these lines of insurance; someone who will work to understand your business and recommend the appropriate program to match your particular exposures.

 

 

 

Harry Wallace is Managing Director of Executive Risk Management for Mazonson, LLC, a Boston based insurance brokerage firm. His experience is both as a broker and a D&O claims and litigation specialist. He can be reached at 617-482-4575 or at hwallace@mazonson.com