Time Is Right For ClaimMadeSettlements In Securities Fraud Class Actions

Industry commentators share little doubt that we are in an ever-hardening directors & officers insurance market, a phenomenon that began earlier this year with fairly regular and sustained premium increases on renewals of expiring policies.

Concurrently, there has been an increase in the cost of reinsurance and a shrinkage of reinsurance capacity, as well as restrictions in the scope of coverage under the policies through more broadly-worded exclusions and introduction of significant coinsurance and/or pre-determined allocation factors.

While many of these factors were present in the last sustained hard market in the 1980s and seemingly will enable prudent insurers to write more D&O business, there is another compelling factor that should not be overlooked if either insurers or their policyholders are seeking to level the playing field with plaintiffs shareholders interests.

Specifically, the insurers and the defendants should be striving to stem the ever-increasing settlement values and defense costs in securities class action litigation.

As of 1999, the average settlement was approaching $15 million–and perhaps as high as $29 million if you include Cendant and other aberrational settlements.

This contrasts with average settlements of no more than $5-6 million in the years before the Private Securities Litigation Reform Act was enacted in late 1995. Defense costs in the litigation often swell the insurers exposure by an additional seven-figures or more.

While some observers may still foresee some downturn in securities litigation as a result of the events of the Sept. 11 tragedy, recent developments may belie that premise. For example, after a hiatus of several weeks, new securities class action lawsuit filings appears to have significantly resumed.

A slight downturn in the frequency of ubiquitous IPO laddering cases, in which IPO securities underwriters were charged with offering allocated IPO shares to institutional investors not scheduled to receive them, began in August and is, thus, unrelated to Sept. 11.

Finally, recent settlement values suggest that the expectation that securities fraud defendants will benefit from positive public sentiment in the wake of the impact of Sept. 11 on Wall Street may be unfounded. Witness the $92.5 million settlement of securities litigation against The Boeing Company within two weeks after the World Trade Center bombing and the even more recent $457 million settlement involving Waste Management.

There is a strategy, however, that has been used successfully, albeit with limited frequency, in the past to hold down the value of these class action settlements. That is the device known commonly as the “claim-made settlement.”

Although there can be slight variations, the essence of a claim-made settlement lies first in the agreement of a maximum settlement value for the class. This figure is derived by determining a dollar-per-share amount for damages and then multiplying that by the expected number of shares to come forward by way for claiming shareholders.

At this point, there is little that differs from the more traditional monetary settlements in this area.

However, the key to a claim-made settlement is what happens to the unclaimed portion of the maximum settlement pot.

In order to create the proper incentive for the defense interests to settle, the claim-made settlement will provide for a return of the “reverter” or unclaimed portion to the defendants.

Logically, if the settlement has been funded entirely with insurance proceeds, the reverter should go wholly to the insurers who funded the settlement. If there has been some contribution from the insureds, the reverter should be shared on a pro-rata basis.

This seems fair enough from the plaintiffs perspective, since the shareholders who care enough to come forward with their claim receive no less than if the entire class came forward. What then are some of the objections from other parties, and how can the defendants and their insurers best address them?

First and foremost are the mercenary concerns of plaintiffs counsel. Simply put, their fear is that the smaller the ultimate settlement pot, the smaller their fee award will be. There is a concern that the court will not look at the maximum settlement amount in determining an award, but rather only consider the ultimate payment to claiming shareholders.

This, however, is a weak argument because there has been little in the way of a track record for claim-made settlements in recent years and, in any event, courts have broad discretion in awarding plaintiff fees and costs.

Although most defendants and insurers are primarily focused on the amount of a settlement fund actually paid over to shareholders, the defendants can agree to support some floor level fee award to the plaintiffs lawyers on a percentage based on the maximum settlement fund. This type of agreement could be used to gain the plaintiffs counsels support for a claim-made settlement.

Second, some courts may view these type settlements as creating a potential windfall for the defense interests.

This is high speculation at best because the settlement amounts are typically only a relatively small percentage of the total class damages at issue.

Further, there are many advocates of the interests of individual and institutional investors alike, who would now have even more reason to “beat the drums” so that all potential claimants are aware of and actively present their claims against the settlement fund.

A final argument from the plaintiffs is that if there is to be any reverter it should go to the plaintiffs counsel to be donated to a charitable interest of their choice.

While there are many worthy charitable causes, and lawyers, corporations and others should all do their part to give freely and generously to the charity of their choice, it is respectfully suggested that there are better means and sources of funds to accomplish this.

Advocacy of claim-made settlements is just one tool that D&O insurers and their insureds must employ in bringing settlement values down to more fair and realistic levels. These efforts need to be coupled with other defense initiatives such as more vigorous challenges to class certification and with challenges to plaintiffs damages expert theories on Daubert standards where the judge acts as gatekeeper for determining what is admissable evidence.

There also needs to be a greater willingness to try more of these cases where the liability and causation defenses are notably strong.

Unlike premium increases, coinsurance and restrictions on the scope of coverage, which unfortunately drive a wedge between the interests of the insurer and the policyholder, all of the initiatives discussed above are ones where the interests of the insurer and insured converge.

Indeed, with the continuing emergence of higher retention levels, significant coinsurance percentages and potential settlement values that far exceed the total available limits of insurance, insureds are faced with an even greater financial stake in the outcome of this class action litigation. As a result, they should be more amenable to a workable partnership with their insurers in vigorous defense and settlement initiatives.

Joseph P. Monteleone is Vice President and Claims Counsel at Hartford Financial Products in New York City.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, December 3, 2001. Copyright 2001 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.

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Time Is Right For ClaimMade Settlements In Securities Fraud Class Actions

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