Insurers waiting for a definitive understanding of what kind of hit their directors and officers liability books will take from the subprime fallout will be disappointed to learn that the jury is still out.

In fact, it may be out for a while to come, experts say.

While bankers are still dealing with the fallout of a housing market in decline from decreased lending and foreclosures, the legal world has either been slow to respond, or is having trouble finding the legal basis to sue, attorneys believe.

Richard Bortnick, an attorney with the law firm Cozen O'Connor in West Conshohocken, Pa., said that few lawsuits have been filed related to the subprime crisis, and those suits that have been filed have not been granted class action status. Essentially, the battleground over subprime is still being drawn and how deep it will run remains a question.

“It's not as big as one thought it would be back in the summer,” Mr. Bortnick said. “It will still be significant for insurance companies, but it's way too early to put a dollar figure on it,” he said.

There have been a number of allegations made and securities lawsuits filed against publicly traded subprime mortgage lenders that could give rise to D&O insurance claims, he said. The general complaint is that the lenders failed to accurately reveal the scope of risk behind the subprime failure to their shareholders or failed to have adequate reserves for the true nature of failures.

On another front, subprime loans were repackaged and sold as investment portfolios to banks and other financial institutions around the world, said Mr. Bortnick. The chief executives who signed off on these deals are possibly subject to legal actions over accusations of misrepresentation of the quality of the investment packages.

While all of these allegations and conjectures are aimed at publicly held companies, there are other legal exposures for the lenders, Mr. Bortnick continued.

A case could be made by some attorneys that the homeowners were not fully advised of the nature of the adjustable rate loans and that in fact the mortgages are usurious, aimed at taking advantage of an individual's financial condition. While such allegations would typically mean claims against professional liability or E&O insurance policies of the lenders, if a case can be made that the chief executives of mortgage lending companies were aware or were a part of such a scheme, this could then involve their D&O coverage.

While D&O cases primarily involve publicly held companies, there are the privately held companies where allegations of fraud could be made, but he added, “These are fewer than investor suits.”

The bottom line for the investor legal actions, Mr. Bortnick said, is that “you the company did not disclose to me, the investor, the true quantitative and qualitative composition of your portfolio and you misrepresented the financials I reasonably relied upon to my detriment.”

“But until you get a class [action], you don't know how many shares are involved,” he continued, noting that damages are derived from the number of shares.

Kevin M. LaCroix, a director with the wholesale brokerage firm Oakbridge Insurance Services in Beachwood, Ohio, has kept a close eye on how the subprime meltdown could affect the D&O market.

Mr. LaCroix, who is also an attorney and writes a blog on this and other matters (dandodiary.blogspot.com), said that in one sense, the subprime meltdown can be compared to the stock options backdating scandal. In that case, the dates of issuance of stock awards to executives were changed to give the recipient a financial advantage.

Despite a lot of lawsuits being filed, “collectively, they were not an industry-turning event,” he noted.

At this point, there have been much fewer legal actions filed in the subprime case compared to the backdating scandal, but no one knows how many have invested in subprime securities or how much they have invested, he said, referring to individual investment firms that purchased portfolios with subprime exposure.

If the ripple effects from mortgage failures grow, it could produce scenarios of significant share price declines and much larger incidents of losses in the future, and subsequently produce shareholder suits.

He said there is more than $1 trillion in mortgage-backed securities disbursed around the world. Though some of the holders of these securities have been identified, a true accounting is unknown. If there proves to be large concentrations of the securities among a few institutional investors, the losses could prove to be tremendous.

It is the unknown that has a lot of insurers worried, he said, noting that if it turns out that there are a number of sudden investor write-downs, those actions could produce a significant number of D&O claims.

“This is harder to get your arms around because you don't know where to look,” said Mr. LaCroix. “The question is, are they [investing institutions] vulnerable to write-downs and selling the securities at distressed prices?”

With all of this, companies may be subject to increasing reserves or taking write-downs that affect earnings materially, pointed out Mr. LaCroix. This is what happened when Merrill Lynch, on Oct. 24, announced it was taking a $7.9 billion write-down, in part because of its exposure to the subprime market. He said that action has had an unsettling effect on a few in the industry.

Even the rating agencies have been caught up in this to some degree, he noted. Shareholders of Moody's and Standard & Poor's have sued contending that the company did not disclose how dependent the ratings were to the investment of the subprime securities, and this caused a loss in the share price for the rating agency's shareholders.

All these legal actions, noted Mr. Bortnick, have already resulted in claims to insurers as attorneys line up to defend the directors and officers who are accused of wrongdoing.

“When companies foresee storm warnings, they go out and get attorneys,” he said, adding that it will be up to the insurers to begin evaluating the coverage.

“How bad will this be? It is way too early to tell,” said Mr. LaCroix.

“This story has a long time to tell–months and months. There are $6 billion in subprime mortgages scheduled to reset in 2008. You can't assess how big this is now, or if it will get bigger than it is. No one knows how big this will get, but a lot of people in the industry are nervous.”

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Extent Of D&O Insurer Subprime Fallout For Remains A Question Mark

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