The Hewlett-Packard spying scandal has produced its first shareholder suit, which was filed two months ago by noted plaintiffs' attorney William Lerach.

But the question remains whether the action should be interpreted as stemming from a unique and headline-friendly set of circumstances, or whether it is a product of a new atmosphere of boardroom turmoil, which should, in turn, have directors and officers liability insurers concerned about a new spate of claims.

The Lerach suit was filed in California Superior Court, Santa Clara County, in September, asserting that the Silicon Valley electronics pioneer breached its fiduciary duty through illegal spying and the use of false “pretexts” to obtain directors' phone records in order to discover the source of leaks to reports about confidential board business.

Separately, in October, California Attorney General Bill Lockyer filed felony charges against former Hewlett-Packard Chairwoman Patricia C. Dunn and four other defendants, alleging they committed criminal offenses related to the use of false pretenses to access individuals' phone records during the company's probe of boardroom leaks to the media.

Unlike the options timing scandal, which insurance executives feared could result in a rash of directors and officers suits, if it turns out other companies were engaged in spying practices similar to HP, the HP shareholders lawsuit does not appear to be the tip of any iceberg.

Peter Taffae, managing director for Los Angeles-based ExecutivePerils, sees the HP case as “unique.”

“It is a perfect storm. The stock is growing, the scandal breaks, the stock takes a hit and the market cap drops,” Mr. Taffae said. “Whenever there is a scandal, Lerach and his buddies are excited.”

Former HP Board Chairman Patricia Dunn and General Counsel Ann Baskins, who have already resigned, the suit alleges, should be forced to pay damages for their role in the scandal.

The suit is a so-called derivative action, which shareholders file on behalf of the corporation for damages incurred by the injurious actions of the parties named.

Mr. Taffae said what makes derivative lawsuits particularly dangerous to insurers is that there is no deductible, and for the parties at fault, there is the potential to be forced to pay out of their own pockets if the Worldcom and Enron suits are any guide.

The reason there is no retention, “with very few exceptions of certain states,” is that no corporation is permitted to indemnify for a derivative suit.

“The average derivative can be $25 million,” he said.

The scandal first became public in September, when news outlets reported Director Thomas Perkins' claims that he was pressured to say his resignation was for personal reasons rather than to protest the leak investigation.

According to the Lerach complaint, Boston-based contractor Ronald DeLia used pretext to access board members' phone records to find out who was leaking information to reporters.

Mr. Perkins and board member George Keyworth were among the targets of the leak probe in addition to nine journalists they were allegedly in contact with.

“As a result of the defendant's wrongful acts, HP is exposed to substantial criminal liability by Board members' illegal conduct and millions of dollars in potential criminal and legal penalties, as well as the enormous expenses of dealing with the crisis,” the suit alleges.

The suit tells of rivalries within the board, consisting for people loyal to Mr. Perkins, a longtime Silicon Valley pioneer, and those loyal to then Chairman Dunn, which are at the heart of the scandal.

HP investigators typically used the last four digits of directors' Social Security numbers to obtain phone records from the phone company, the suit claims.

While the HP case may be something of a “fluke,” Mr. Taffae asserted, what is interesting is the fact that the general counsel and the outside law firm got caught “red-handed.”

“Not only is HP a Fortune 500 company, but its law firm, Wilson Sonsini, has some very deep pockets,” Mr. Taffae said.

What students of such suits will be watching in the HP case is the dual role of Ann Baskins as both an officer of the company and its general counsel, he said.

“The directors and officers policy does not provide professional liability [coverage]. It does not cover legal malpractice and such,” he said.

Thus, the HP carrier could use this dual role to deny coverage. “This capacity has always been an issue,” Mr. Taffae said.

The issue has arisen most often in leveraged buyout instances, when officers buy the company from shareholders and therefore have a grave conflict, since they are supposed to represent their interests, he said.

“Only time will tell what is going to happen,” Mr. Taffae said. “But I think this is something that every general counsel is going to watch.”

And outside counsel will also more than likely take an interest.

The Lerach suit alleges that since Attorney Larry Sonsini was actively involved in the leak investigation that was at the heart of the scandal, the law firm's advice to the company not to pursue legal action or full investigation would seem suspect.

While pretexting and director-on-director spying may present unique circumstances, boardroom turmoil in general looks to a ready source of directors and officers suits in the coming years, said one expert.

Kevin LaCroix, an insurance broker for Oakbridge Insurance in Beachwood, Ohio, who is also author of the D&O Diary blog, citied recent chief executive ousters at Bristol Meyers Squibb and Pfizer, saying that such dismissals “involve not only the potential for board turmoil, distraction and adverse publicity, but increasingly also present the possibility of D&O litigation.”

The recent boardroom upheaval at the San Jose-based semi-conductor manufacturer Atmel illustrates the perils of the new era, according to Mr. LaCroix.

Five independent board members succeeded in firing Chief Executive George Perlogos, as well as three other executives on Aug. 5 for alleged misuse of corporate travel funds. Mr. Perlogos immediately filed suit asserting the firing would have a devastating impact on shareholder value.

Sarbanes-Oxley reforms have led to increased presence and activism of independent directors who are less likely beholden to company management, as evidenced by the Atmel board, according to Mr. LaCroix.

In addition, regulatory and investigative pressures have taken their toll, leading to the removal of the chief executive officers of both Bristol Meyers Squibb and American International Group in recent years.

“This atmosphere not only presents a challenge for corporate boards, but also represents an environment where allegations of wrongdoing can more easily arise,” Mr. LaCroix said.

A recent ruling in the U.S. Court of Appeals, Second Circuit may also help stoke future independent director fires under management. The court ruled in favor of a process allowing shareholders to wage director election contests when they are unhappy with slates of directors that corporations put up.

Almost as if on cue, three major public pension funds that are major HP investors in New York, Connecticut and North Carolina, filed a proposal seeking access to the Hewlett-Packard proxy.

“This is just one more element under the larger category of shareholder independence that we are seeing today,” Mr. LaCroix said.

Art caption: The first shareholder derivative lawsuit filed in the wake of the HP spying scandal alleges that former HP Board Chairwoman Patricia Dunn should be forced to pay damages for her role.

Recent CEO ousters not only highlight the potential for board turmoil, but increasingly also present the possibility of D&O litigation.

Kevin LaCroix, Oakbridge Insurance

“It is a perfect storm. The stock is growing, the scandal breaks, the stock takes a hit and the market cap drops. Whenever there is a scandal, [William] Lerach and his buddies are excited.”

Peter Taffae, Executive Perils

Special Reports /

HP Suit Highlights Boardroom Turmoil

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