Jimi Hendrix famously sang in All Along the Watchtower: “There'stoo much confusion, I can't get no relief.” If you have beenwatching the directors and officers (D&O) landscape, the lastyear has been a confusing haze of activity. If we take a closerlook, some patterns emerge that are understandable. Otherdevelopments are so new that we don't know if they are patterns,trends or idiosyncratic currents.

For carriers struggling with the continuation of soft D&Omarkets, there is little at the outset of 2018 to offer assuranceof direction. The thin mix of possible market advantageousdevelopments juxtaposed with market softening trends leaves manycarriers with early conclusions that 2018 will be another year inwhich they “can't get no relief.” In addition, the D&O marketis evolving as headline losses and technology present new risks.However, let's explore what we know, where we are, and why 2018portends continued uncertainty.

Crossing the Delaware (state court line) into FederalCourts

It shouldn't be news that the biggest trend of 2016 and 2017 wasthe bomb cyclone of securities class action filings. Spikingsecurities class action filings was perhaps the biggest buzz of thelast 24 months. If you missed the news, here is the data: In 2017,approximately 400 securities class actions were filed.

Close to 300 actions were filed in 2016. These filings outnumberall filings for the prior 20 years with the exception of a singleyear, 2001, when IPO laddering cases ballooned to nearly 500. Inearly 2016, everyone stayed riveted to the quarterly statistics tosee if filings would remain high. Then, as 2016 closed, thequestion was whether the filing frenzy would continue. It did.

However, 2017 dwarfed the 2016 figures that first raised alarmbells that “the sky [was] falling.” Taking a page from Henny Penny,a closer look revealed that some of this activity was fall-out froma rush of merger objection suits, which flowed out of Delawarestate courts into federal courts.

Why? In early January 2016, a Delaware state court issued theTrulia decision [Trulia, Inc. Stockholder Litigation, C.A. No.10020-CB (Del. Ch. Jan. 22, 2016)], which put a boot on Delawarestate court friendliness to 'disclosure only' settlements. Truliahas been described as representing the “court's intent to . . .reject settlements of stockholder class actions when the settlementconsideration does not include any monetary recovery for theclass.”

The wave

Following Trulia, the migration of securities class actions tothe possibly friendlier halls of federal courts was significant,but did not wholly explain the storm of filings. Nor did it exactlyassure that federal courts would wave open the slamming door ofDelaware state courts.

The epidemic of securities filings led to industry-wideexamination of additional causes. Other contributing causes havebeen debated, discussed and notionally agreed, providing insightsregarding some prominent shifts underway. First, the plaintiffs'bar goes where the oxygen is. There is considerable agreement thatas financial crisis claims were resolving, pursuit of D&Oclaims represented a new artery of income for firms. DouglasGreene, of D&O Discourse, thinks smaller firms want a piece ofthe action, and are whetted to pounce on companies making classicred-flag announcements — such as auditor resignations.

Other theories include the continuation of IPO-relatedlitigation, increased regulatory enthusiasm for SEC whistleblowertips and enforcement actions, and emerging headline and tech losseswhere they can be tethered to D&O responsibilities.

Cyber breaches are one of the key drivers behind thedeveloping risks for D&O insurers. (Photo:Shutterstock)

Watching the current

Water follows the path of environmental opportunity and so didthe D&O claims of 2017. However, what happened in 2017 won'tstay in 2017. Brand new technology and headline events demonstratethat these are the fluxes that will drive new D&O claims. Keyexamples include cyber breaches, new technology and sexualharassment issues.

Cyber breach may be the most prominent developing risk forD&O carriers and their insureds. It is a risk in a state ofrapid change, making it profoundly more difficult for directors andofficers to identify, clarify and comply. Corporate cyberresponsibility is even more challenging because it will be anevolving standard for years to come.

Cyber and data breach issues have not yet been the D&Oalbatross that we expected, but 2018 may change that. Two key typesof claims could prove bothersome in cyber parlance: First-party andthird-party claims. A securities class action filed because of acyber breach constitutes a third-party case. Third-party cases havenot set strong hooks in the D&O world – yet. This is becauseexisting cyber breaches have not resulted in stock dropssufficiently significant to support a classic securities claim.

No one thinks that third-party cyber breach cases will go away;it seems only a matter of time before a stock drop rings the bellfor a successful case. Juggling moving targets of state-imposed,SEC-based and court-developed standards for cyber responsibilitywill potentially lay the groundwork for more successful claimsagainst directors and officers.

More distracting for D&O carriers and their insureds, arefirst-party claims for breach damages to the corporation itself. Ascyber breaches have become daily news, some states, such as NewYork, have already attempted to define D&O standards of carefor cyber security. These standards, however, are somewhat lessstandard than they are brand new, and will likely change over time.The mutability of early standards will make it difficult fordirectors and officers to ensure their own compliance – thusbuffering themselves from D&O claims. The New York standardspointedly require senior officers to approve cyber policies andcertify compliance with the regulations. The SEC is also chiming inby warning public companies that it intends to investigate cyberpractices with more interest.

In like fashion, headline news events, such as “The WeinsteinEffect,” are eddying into the D&O landscape. The Weinstein caseand related matters span across a constellation of industries andpresent a universalizing doublet of a problem at once old and new.The concept of sexual harassment exposure is a familiar liabilityissue, but it has detonated with a mass of public announcements.Early disclosures began a domino effect across many businesses. Aheadline issue can cause a chain reaction that percolates intodiscrete allegations of D&O misconduct.

The 20th Century Fox harassment settlement of 2017, was ashareholders derivative case asserting that actions of managementcaused financial harm to the company. The sexual harassment issuepresents a unique supplemental exposure for D&O carriersoffering employment liability coverage as part of a D&Opackage. Broad management liability policies are acutely exposedbecause of the prolific media attention that has made the sexualharassment issue a focus for companies of all sizes. The WeinsteinEffect demonstrates a particularly difficult dilemma for D&Ocarriers: How to price for unpredictable volatile headline eventsthat inevitably culminate in D&O claims with serialfollow-ons.

There is a growing tendency to view D&O policies as atool to pay litigation to go away. (Photo: Shutterstock)

What lurks below for insurance carriers?

Beyond news and statistics, there are other surprises hidden inthe deep. Even matters that do not hit headlines can pervade theD&O market when attacked with high concentration in a specificarea. An example of this is the popularity of specialized scrutinyof ERISA funding, investment and management.

Attorney Jerome Lechter has made a name for himself in this areaand many carriers have seen a proliferation of doppelganger cases.The D&O industry is expected to see more of these claims thathave not fully washed through the market.

At a policy level, the view of D&O coverage as a commodityis becoming more problematic. D&O insureds are typicallysophisticated buyers, particularly public D&O buyers, and theseinsureds are more frequently viewing their D&O coverage as acash vault. There is a growing tendency to view the policy as atool to pay litigation to go away; this is a departure from pastyears where insurance was perceived as a vehicle to advance andsupport vigorous liability and damages defenses. D&O insuredsare increasingly prioritizing early settlements to avoid publicityand reputational damage.

A recent Deloitte report has concluded that reputational damagemay be a key threat for large companies, and one that directors andofficers will feel increasing pressure to guard against.

Another less obvious trend is the increasing complexity of 'hatwearing.' D&O insureds (often within broader managementliability policies), may hold officerships for multiple entities.Piecing apart titles, entities and coverage allocation is an areaof more frequent scrutiny and increased cost.

On the topic of costs, many carriers agree that the defense burnrate seems to be increasing with, for example, a $10M primary limitno longer representing a strong buffer from defense expense forcarriers participating above the primary.

Shareholder activism is also a newly popular discussion amongstD&O carriers. The World Economic Forum recently addressed thistopic, stating, “an impressively influential shareholder underdoghas appeared: the shareholder activist.” Shareholder activism isexpected to gain momentum and may result in claims againstdirectors and officers based on clashes between attention toshort-term and long-term duties and responsibilities.

A possible break from “no relief”

While these forces are in play, other developments may act as aballast to a difficult market. In its first year, the Trumpadministration has invested headlong energy into judicialappointments and confirmations. These confirmations are expected tohave a long-term effect of stacking a judicially conservative deck– possibly advantageous to D&O insurers.

While this reshaping will be felt over a much longer period,there is vigorous discussion concerning whether the new Chairman ofthe SEC, Jay Clayton, will push for and support reducedregulation.

Perhaps regulatory reductions are already underway. A GeorgetownUniversity study confirms that the SEC filed 612 enforcement casesin 2017, which is the fewest cases in the last four years.According to the study, the reduction may confirm the expectationthat President Trump intends to allow the SEC to steer morefavorably toward corporate, commercial and/or insurer interests.The concomitant drop in fines and penalties collected by the SECmay also signal lighter treatment. Consistent with this change oftide, Clayton has been widely quoted as stating that enforcementactions on large corporations hurt shareholders.

With an increasingly competitive D&O marketplace, carriersare smart to keep a close eye on the evolution of cyber D&Ostandards, exposures presented by new technology and headlinestories, as well as regulatory and judicial trends.

And, as the plaintiffs' bar has capacity and motivation topursue D&O cases against smaller companies, this willcontribute to intense pressure on the D&O market toappropriately predict and competitively price risks, especially asD&O cases continue to command premium defense rates.

The irons are hot for the plaintiffs' bar to accelerate thefrequency of D&O litigation. It remains to be seen ifadministrative actions will act as a counter wind. D&O carriersmust stay vigilant from the watchtower.

Jane Mandigo ([email protected]) isa senior vice president and senior claims expert with SwissReinsurance, specializing in professional lines matters.