After an unexpected second-quarter dip, securities lawsuitfilings shot back up in the third quarter. But the reversal, whichcould trigger more future directors and officers liabilityinsurance payouts, had little pricing impact, experts say.

In a quarterly report published late in October, New York-basedAdvisen tallied 169 filings in a database that the firm refers toas the Master Significant Case and Action Database (MSCAd).Although the third-quarter figure represented an increase of 11percent from 152 filings for second-quarter 2009, both the second-and third-quarter counts were significantly lower than arecord-setting 249-suit first quarter.

In fact, the first-quarter filing pace was so active thatAdvisen couldn't even capture an accurate total in an initialreport on that quarter's suit statistics published in May of thisyear. That report had indicated just 169 filings for the firstquarter–80 suits below the first-quarter total as it standstoday.

"There were quite a few late-reported events," according toDavid Bradford, co-founder and executive vice president of Advisen.(For details about the initial report, see NU OnlineNews Service, May 25, "First-Quarter Securities Lawsuits Total169, Advisen Says," at http://bit.ly/LnBDY).

Mr. Bradford noted that the first-quarter numbers "were drivenpretty substantially by cases related to Madoff," referring to thelitigation fallout from an alleged Ponzi scheme orchestrated byBernard Madoff. "On the heels of the Dec. 11 arrest, there was justa whole flurry of suits," he said.

Advisen's third-quarter report reveals that Madoff-relatedfilings "fell off a cliff" in the second and third quarters,plummeting from 54 tallied in the first quarter to 17 in thesecond, and just six in the third.

Also pulling down the overall suit totals was a drop incredit-crisis related suits, Mr. Bradford said. These suitsnumbered 46 in first-quarter 2009, falling to 24 in the secondquarter and just nine in the third.

"It may be too early to call an end to the litigation activitythere, but certainly we see some downward activity and may belooking at the end of this [credit-crisis activity] in the comingquarters," Mr. Bradford noted.

Turning to the overall numbers, Mr. Bradford said it isdifficult to pick out one quarter as being reflective of theoverall trend for the year.

"What's the more representative, the second quarter or the thirdquarter? It's hard to say. But I think there was probably just alittle bit of taking a breath after that frenetic first quarter,"he said, explaining the lull suggested by the low second-quartertotal.

Annualizing the third-quarter total with a simple extrapolationtechnique (multiplying the quarterly total by four) produces a 676suit total for the year–a 3 percent drop from the record-setting2008 total of 697 securities suits, but higher than any previousyear since 2001, when 684 cases were filed in the wake of corporatemeltdowns at Enron and other firms.

Annualizing the total for the first three quarters instead, thefirst-quarter activity drives a higher estimate of 760 suits forthe full year.

No matter which extrapolation ends up to be closer to the actualtotal when the year winds down, Mr. Bradford said one key trendthat leaps off the pages of Advisen's analyses for all threequarters is the fact that securities class-action filings–filed byprivate plaintiffs alleging violations of federal securitieslaws–did not account for the bulk of securities suit filings thisyear.

That distinction instead goes to securities fraud suits filed byregulators and law enforcement agencies, Mr. Bradford said.

According to the report, the overall suit filing breakdown forthe third-quarter is:

o 70 securities fraud suits, accounting for about 41 percent ofthe total 169 securities suit fillings.

o 55 traditional securities class-action suits, accounting for33 percent.

o 27 breach-of-fiduciary suits–16 percent of the total–which mayallege some breach on the part of the board of directors, but couldname someone else, such as a fund manager, for example, Mr.Bradford said.

(Editor's Note: The inclusion of suit categories other thanclass actions explains why Advisen's 2008 total of 697 appears outof line with more typical figures reported by other researchorganizations, which put out numbers in the 210-to-225 range.Advisen reported 230 securities class actions as just one part ofits 697-case total for last year.)

Referring to the level of regulatory actions, which has outpacedprivate class actions for three straight quarters, Mr. Bradfordsaid "the Securities and Exchange Commission, under the Obamaadministration, is being more fully staffed and has a much moreaggressive mandate for enforcement."

Coverage for regulatory enforcement actions has been a hot topicin recent years at the Professional Liability UnderwritingSociety's symposiums, and Mr. Bradford echoed the beliefscommunicated by broker experts speaking at those seminars–thatwhile fines and penalties are typically not covered, defense costscan be covered.

What about costs incurred before a regulator files a suit–duringthe course of an investigation?

"If you're racking up costs for outside attorneys associatedwith regulatory action, then that could very well be covered underthe policy," he said.

Asked if he thought underwriters might be less inclined to coversuch costs going forward, as the securities fraud suit numberscontinue to climb, Mr. Bradford agreed that possibilityexists–"except at this point in the market cycle, it's still apretty competitive market outside of the financial institutionssector. Underwriters may be taking a harder look at it, but I'm notsure the leverage is available to them at this point in time to doanything about it," he concluded.

Giving a broker's perspective, Chris DiLullo, senior vicepresident in the Washington, D.C. office of Lockton, said coveragecan hinge on the question of whether the insured is the target ofan investigation or is just an involved party in an investigationwhere a regulator is targeting someone else.

"That fact doesn't change the seriousness and expenses that anorganization will incur to comply with the investigation, but itdoes raise coverage questions as to whether or not their D&Oinsurance policy gets triggered," he said, noting that not allpolicies respond.

Asked whether insurers are taking any actions to broaden thecoverage or clarify the wording, Mr. DiLullo said that carrierswere more likely to broaden A-side contracts than traditional A-B-Cpolicies.

(Generally, A-side coverage responds to non-indemnifiablelosses, where a corporation can't indemnify directors because ofstatutory prohibitions in a state, because the corporation isfinancially impaired, or for some other reason.)

"Broad-form A-side coverage is the most competitive sector ofthe D&O industry right now," Mr. DiLullo believes. (For more onSide-A market conditions and buyer interest, see related article inthe upcoming Nov. 30 edition of NU's e-newsletterE&S/Specialty Lines Extra to be available at www.property-casualty.com.)

SOFTER PRICING AHEAD?

While experts speaking to NU last year at this timewere confident the D&O market would harden in 2009, and whilesurges in suit statistics early this year might have suggested aturn to higher premiums was imminent, Mr. DiLullo and Mr. Bradfordconfirm that soft market conditions prevail in the thirdquarter.

What level of securities suits will it take to change thedirection of the market?

"Despite all of the other issues, the power of supply and demandseems to be the X-factor," according to Mr. DiLullo. "It seems tobe the most persuasive element driving the market from a pricingperspective," he added, overwhelming the combined impact ofregulatory actions, Ponzi schemes, the overhang of thesubprime/credit crisis, and increasing numbers of bank failures andcorporate bankruptcy filings.

With the stock market improving and the prospect that suitstatistics for 2010 will come in lower than 2009, is the oppositeprospect a possibility now? Will the D&O market become evenmore competitive?

Mr. Bradford responded that "claims definitely have an impact,but the bigger impact is the amount of capacity in the market–andright now there is just a tremendous amount of D&O capacitychasing after a finite amount of premium."

Both experts said commercial firms outside the financialinstitutions segment are seeing stable or declining D&Oinsurance prices–with one exception, that being highly leveragedcommercial organizations.

"I think it started a year ago, [when] the inability torefinance debt because of the freeze in the credit markets causedunderwriters to look closely at [insureds'] schedules for debtmaturities, their access to capital, and their liquidity or abilityto service existing debt," Mr. DiLullo said.

In a market update briefing on Lockton's Web site, he explainedthe trend further. "With equity valuations impaired across mostindustries, traditional measurements of risk, such as stockvolatility, are currently out of favor," he wrote.

"Companies with liquidity or debt issues can expect to facerenewal challenges marked by reduction in capacity, higher premiumsand increase[d] retention levels," he wrote, adding that "attemptsat coverage restrictions, particularly connected to creditorclaims, can be averted through focused and skillednegotiating."

He told NU that factors such as insider ownership ofequity can "begin to diffuse underwriter concerns" about potentialloss severity. "We are finding that underwriters are stilldifferentiating risk," he said, noting even leveraged firms withgood risk profiles can still enjoy flat-to-down pricing.

Asked to give a sense of price decreases possible in the currentmarket for the best non-FI risks with no issues, Mr. DiLullo saidhe'd seen program decreases in the 10 percent range. "I don't wantto mischaracterize that, though. It's not as if everyone's gettinga 10 percent decrease," he cautioned.

Still "there is a lot of competition for good business, and anoversupply of capacity to meet current demand," he added,attributing the oversupply to three sources:

o Companies that want to get into the D&O business and havedone so.

o Companies that have been in the D&O business, but want toget closer to the risk and get more premiums.

o Companies that have repositioned themselves with strongerappetites.

"There was a movement early this year by some market leaders tofirm up the pricing. I think while they tried and were initiallyprepared to walk away from some business, now that sentiment haschanged.

"Those carriers now are motivated to keep what they have andthey're willing to negotiate on rate a little more," he said,declining to identify the insurers beyond describing them as "twoor three historic leading carriers."

In addition to these "recommitted" markets, some insurers thathad traditionally been excess markets now want to compete forprimary business, Mr. DiLullo noted.

"There's been some shifting in the underwriting community," hesaid. "Groups of underwriters have left the companies they werewith [previously] to start up [new] facilities [and to join]facilities that were in the business but weren't necessarily knownfor writing a lot of primary," he said.