Zealous Institutions Drive D&O Settlement Skyward

With the noise of IPO laddering claims figuring into this year's statistics, there isn't total agreement about whether the level of more traditional securities cases in 2001 will be slightly up or slightly down from last year. But the dismissal rate of such cases is no longer rising and settlement values are ballooning, according to a plaintiffs' attorney.

“I believe the trends are positive for plaintiffs' securities class action litigation–and, conversely, negative for your industry,” Sherrie Savett, managing principal for Berger & Montague in Philadelphia, told insurers and brokers gathered at the annual meeting of the Professional Liability Underwriting Society in November.

“When the year is out, I think you'll see approximately the same number of cases” as last year, excluding laddering cases, she said, putting the range for the last few years at somewhere between 225 and 265 per year.

A 2001 phenomenon, laddering cases by themselves might also swell from 180 to 250, defense attorney Tower Snow Jr., of Brobeck, Phleger & Harrison in San Francisco, reported at the same PLUS session.

Laddering cases have been filed against securities underwriters of initial public offerings, the companies that had offerings, and their directors and officers. Such cases allege that allocations of IPO shares were made in exchange for excessive commission payouts to securities underwriters or in connection with undisclosed agreements to buy more shares in the exchange trading market.

(For a comprehensive look at laddering cases, see NU, Nov. 12, page 10.)

Speaking about more traditional, non-laddering cases, Ms. Savett said the dismissal rate has remained steady this year. Indicating that dismissals are now between 25 and 30 percent nationally, she said that the percentage of dismissals had been growing for a number of years as pleading standards of the Private Securities Litigation Reform Act of 1995 “were vetted out” by the courts.

With the Reform Act, Congress intended to end the “race to the courthouse” in which “frivolous” lawsuits were brought as soon as stock prices fell, by raising procedural hurdles for federal securities class-action filings. Among the hurdles introduced were higher pleading standards, which have now been interpreted by all U.S. district courts, Ms. Savett said.

While dismissal rates are constant, “the cases that remain after undergoing the strong scrutiny of the pleading motion are stronger cases. That's why we're seeing the mega-settlements,” she said.

Before the Reform Act, she said, there were less than five cases over $100 million–”and even just a handful over $50 million”–going on to list eight settlements ranging from a low of $95.2 million to a high of more than $3 billion in recent years. (See chart, page 23.)

Ms. Savett also reasoned that tougher economic conditions will lead to more accounting impropriety, fueling additional multimillion-dollar cases.

“Another trend is that the securities class action bar is consolidating. There are fewer firms willing to do this type of work,” she said. “It has become a winner-take-all mentality because of the provisions of the PSLRA which allow the plaintiff with the largest loss to control the entire case,” she said, noting that more institutional investors are emerging as lead plaintiffs.

“For a lot of the smaller plaintiffs' class action firms, there's very little opportunity to really participate in these cases,” she said, noting that institutions tend to hire large firms with more resources. As a result, she said, the smaller firms that used to work in the securities class action arena are looking for other avenues, such as consumer class actions, employment discrimination cases, and ERISA cases, suggesting that the trend creates “a double-barrel problem” for the insurance industry

“I don't think you can underestimate just how important the participation of large institutions is,” she added. “Many of them are state pension funds–teachers funds, employee funds–and they view themselves as having fiduciary duties for their constituents.”

“They're zealots and when they get involved in a case, theycan't conceive of getting 50 percent of the damages. We lawyers might think that's a good result because we see all the risks. But they're going for very big, complete recoveries,” she said.

Informing the D&O insurers and brokers that the lawyers inside the institutions “are of the most sophisticated nature,” she said, “these cases will not settle as easily as they may have at another time.” They are very involved “and that is a big threat to your coverage,” she said.

While Mr. Snow said he believed that the number of non-laddering cases had fallen to about 200 in 2001, he nonetheless agreed that the number would jump right back up in 2002, along with a continued increase in mega-payouts.

(According to statistics compiled by PricewaterhouseCoopers as of Nov. 19, 397 securities cases have been filed in 2001, including 210 laddering cases. For the same date, the Stanford Law School Securities Class Action Clearinghouse Web site indicates there are 385 suits, with 225 including laddering allegations.)

“Over $10 billion was paid out in settlements in the 1990s,” he said, adding that with 700 cases outstanding, “theres probably another $10 billion that's going to be paid.”

Don Bailey, managing director of Aon Financial Services suggested that “one of the takeaways” from the discussion of the rising severity of securities claims for D&O insurers is the need to “revisit program structure.”

“We've got to stop selling Fortune 100 companies $50 million in limits and $100,000 retentions,” he said. “There is volatility existing today where it never existed before. [So] we've got to sit down with our clients and talk about this as a catastrophic type of cover and not a working layer type of cover. We should be sitting down and talking to these companies about $5, $10, and $15 million retentions and selling them $500-to-$800 million policies,” he said.

Kim Hogrege, senior vice president of Chubb & Son in Warren, N.J., added that “an aggressive defense in these casesis worth thinking about,” suggesting, in particular, that defense and insurer counsel join forces to attack the soundness of plaintiffs damage theories.

“And God forbid I mention the word, but we might want to 'try' some of these cases–put some of these cases in front of a jury and see what a jury would do.”

“We don't know what the jury value of these cases is because so few of them are tried,” he said, noting that the few that have gone to trial resulted in favorable decisions for defendants and insurers. When institutional investors start losing some cases, then “some sense of normalcy will come back,” he said.

Ms. Savett responded. “Some of you feel that more cases ought to be tried. We feel that way too,” she said. “We don't get to try the good cases because they settle, because there's too much risk,” she asserted.

“I would welcome the defense to put forth all their technical experts on how we count their damage when there's a revelation of a restatement or some awful economic condition that causes the price of a stock to decline 30 percent in one day,” she added.

“You have five economic experts saying, based on their negative regression analysis, that the 30 percent decline that took place upon the announcement was not caused by fraud or the things alleged, but by every other conceivable factor in the market,” she told the D&O insurers. “I think jurors are people of good common sense. They will see the relationship between that loss and what wasn't disclosed before.”

As for the other topic of the session, the IPO laddering cases, both Ms. Savett and Mr. Snow agreed that issuers and directors and officers likely have a lot less liability than securities underwriters in these cases and, in fact, may have been the victims of an alleged wrongdoing.

“Theres even a securities class action filed on behalf of the issuers asserting exactly the theory that [issuers] were undercompensated in the offerings because of practices they did not know about,” Ms. Savett said, referring to a case brought in Florida, MDCM Holdings Inc. v. Credit Suisse First Boston Corp.

Mr. Snow, who noted that plaintiffs attorneys in the laddering cases have proposed a plan to put cases against the the directorss and officers on the back burner, still said he had one nagging concern about the laddering cases.

“As discovery goes downstream, facts [may] surface which would suggest that there might be cases for a traditional garden variety class action in conjunction with the offering–and some of these cases may morph into traditional class actions,” he said. “Maybe that's an unfounded fear, but it's in the back of my mind. I just figure that the more facts the plaintiffs look at, the more opportunity” there is to find something, he added.

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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Zealous Institutions Drive D&O Settlement Skyward

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