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Law360 (September 2, 2020, 5:58 PM EDT )
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| Priya Huskins |
Since 2016, each year has set a decade record for the number of securities class actions filed in a year. Last year set another new record with 268 securities class actions filed against issuers of stock traded on U.S. exchanges, according to data collected by my firm.
Notwithstanding the increases in litigation, D&O insurance prices were still fairly moderated for most public companies until recently. Starting in 2018, the situation changed for initial price offering companies for reasons discussed below. Now in 2020, we are seeing enormous increases in the cost of D&O insurance for all public companies.
However, from January to June 2020, securities class action filings were down 66% compared to the same period in 2019. It is not clear why the number of suits is down. One possibility is COVID-19 slowing the plaintiffs bar along with the rest of the global economy.
One would think D&O insurance rates might go down as a result. Unfortunately, that's not the case. Notwithstanding the recent drop in securities class action filings, a challenging litigation environment still exists.
New Risks
The pandemic itself is a cause of new risks leading to new litigation and economic uncertainties. We're already seen more than a dozen COVID-19-specific cases filed against public companies through June.
These suits include brand names like Norwegian Cruise Line Holdings Ltd.[1] and Zoom Video Communications Inc.[2] as well as some life sciences companies such as Inovio Pharmaceuticals Inc.[3] and Sorrento Therapeutics Inc.[4]
This summer's social unrest has also fueled new litigation around corporate commitments to diversity and the disclosures about them at major companies, including Facebook Inc.,[5] Oracle Corp.,[6] Qualcomm Inc.[7] and NortonLifeLock Inc.[8]
IPO Risks
These new risks are piling on top of the litigation that kickstarted the hard D&O insurance market, IPO-related litigation.
The 2018 landmark U.S. Supreme Court decision in Cyan Inc. v. Beaver County Employees Retirement Fund[9] allowed Section 11 suits to be brought in both federal and state courts. This fueled a slew of frivolous IPO registration statement-related litigation in state courts.
State court securities class actions are generally more expensive than if the same cases were brought in federal court. This is because state courts have a lower standard to bring a claim, and so more claims survive the state court equivalent of a motion to dismiss. In addition, defendants have to endure the costs of discovery because, unlike in federal court, discovery is not initially stayed.
As a result of the Cyan decision, we saw Section 11 suits rise 178%[10] in just two years, according to my firm's proprietary research. Also, there were 40 parallel filings in 2019 in which a company faced the same set of allegations in both state and federal court.
Open Cases
The big issue for D&O insurance carriers is the sheer number of open cases that have not yet been settled.
In addition to the problem of numerosity (about 600), cases that are open longer tend to settle for higher amounts. Also, the longer a case is open, the higher the defense costs.
Numerosity and longer duration cases are, of course, bad for D&O insurance carriers, making it difficult for them to be profitable even with the recent dramatic increase in D&O insurance rates.
High Settlements
Of course, some cases are settling, but unfortunately some of the settlements being paid by insurers are very large.
In the first half of 2020, we saw 36 securities class action settlements that totaled $1.4 billion in payouts. One notable example is Signet Jewelers Ltd., a sexual harassment case involving senior executives, which topped $240 million[11] in settlements. D&O insurance funded $205 million of that settlement.
Fifteen of the 36 cases that settled in the first half of 2020 were for $20 million or more. Of those 15 cases, six of them had been in litigation for more than five years. This exceeds the average time to settle, which is about three years. As mentioned, longer litigation means more defense costs.
Derivative Suits
A common byproduct of a securities class action is a derivative suit brought against the company's directors and officers on behalf of the company for alleged breach of fiduciary duties. These types of suits also seem to be getting more expensive to settle.
In the first half of 2020, we saw a record-breaking settlement of nearly $287 million involving American Realty.[12] But there have already been other notable settlements already this year, too: McKesson Corp. at $175 million,[13] Tesla Inc. at $60 million[14] and Equifax Inc. at $33 million.[15]
These settlement dollars have insurers on guard for what may be coming. There are more than 20 companies with difficult pending derivative lawsuits. These suits include cases against Alphabet Inc. board members[16] (Google Inc.'s parent company) for sexual misconduct claims, The Boeing Co. board members[17] for the safety of its 737 MAX airplanes, and Marriott International Inc. directors and officers[18] for its massive data breach.
Some companies have multiple derivative suits pending against them. Facebook is one example and claims range from insider trading and board diversity to data privacy.
A Potential Source of Light in the Darkeness
On a positive note, an important decision coming from the Delaware Supreme Court in March 2020 in Sciabacucchi v. Salzberg[19] may deter frivolous Section 11 litigation.
In that decision, the Delaware Supreme Court said Delaware corporations could adopt federal choice of forum provisions that mandate Section 11 suits only be brought by shareholders in federal courts.
Experience shows that non-Delaware courts have honored state choice of forum provisions adopted by Delaware companies by declining to hear derivative cases brought against Delaware-incorporated companies. The hope is that state courts will be equally respectful of federal choice of forum provisions adopted by Delaware-incorporated companies.
However, we have yet to see the impact of this decision; that is no surprise with state courts largely shut down for civil matters due to COVID-19. Sooner than later, we hope to see a company facing state court litigation win a motion to dismiss the case because of federal choice of forum provisions.
When this happens, it will be a game changer when it comes to the rate of suits filed against IPO companies, not to mention the costs associated with these types of claims.
Priya Huskins is a senior vice president at Woodruff-Sawyer & Co.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
[1] http://securities.stanford.edu/filings-documents/1073/NCL00_01/2020312_f01c_20CV21107.pdf.
[2] https://www.law360.com/articles/1300333/zoom-deceived-users-about-privacy-protections-suit-claims.
[3] http://securities.stanford.edu/filings-documents/1073/IPI1200_12/2020312_f01c_20CV01402.pdf.
[4] https://www.law360.com/articles/1300741/sorrento-investors-fight-to-lead-covid-19-cure-suit.
[5] https://www.dandodiary.com/wp-content/uploads/sites/893/2020/07/Facbook-complaint-board-diversity.pdf.
[6] https://www.dandodiary.com/wp-content/uploads/sites/893/2020/07/Oracle-complaint.pdf.
[7] https://www.dandodiary.com/wp-content/uploads/sites/893/2020/07/qualcomm-complaint.pdf.
[8] https://www.law360.com/california/articles/1298820/nortonlifelock-investor-sues-over-lack-of-board-diversity.
[9] https://www.supremecourt.gov/opinions/17pdf/15-1439_8njq.pdf.
[10] https://woodruffsawyer.com/do-notebook/2019-securities-class-action-review/.
[11] https://www.reuters.com/article/us-signet-results/signet-jewelers-in-240-million-settlement-over-sexual-harassment-loan-portfolio-idUSKBN21D2WB.
[12] https://www.law360.com/articles/1236771.
[13] https://www.law360.com/articles/1266395/mckesson-settles-derivative-suit-over-doj-fine-for-175m.
[14] https://news.bloomberglaw.com/environment-and-energy/minus-musk-tesla-board-gets-court-nod-for-solarcity-settlement.
[15] https://www.law360.com/articles/1247297/equifax-investor-suits-get-early-oks-for-149m-33m-deals.
[16] https://www.dandodiary.com/2019/01/articles/director-and-officer-liability/alphabet-board-hit-derivative-suits-alleged-sexual-misconduct-google/.
[17] https://www.nasdaq.com/articles/lawsuit-against-boeing-seeks-to-hold-board-liable-for-737-max-problems-2019-11-18.
[18] https://news.bloomberglaw.com/securities-law/marriott-hit-with-derivative-suit-over-massive-data-breach-1.
[19] https://law.justia.com/cases/delaware/supreme-court/2020/346-2019.html.
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