Corporate Scandals Impact E&O

"It has been going on for the past five years or so," she noted. "Frequency and severity are up. Carriers are afraid of taking significant hits from U.S. and foreign accounting fraud scandals. It would take 100 years of premiums to make up for such hits."

Accounting firms that do audit work are especially vulnerable to E&O-type claims, according to Clint Johnson, senior vice president in the New York office of ACE USA.

"Any time an accountant makes a representation to the public concerning a company, there is potential liability," he noted.

Other possible E&O traps for accountants, Mr. Johnson pointed out, involve consulting work that creates a conflict of interest, providing financial advice and work involving the sale of securities.

"Whenever a corporation has to make a restatement of earnings, there is potential liability that can trickle down to the accounting firm," Mr. Johnson said. "In an economic downturn, this class of business [accountants professional liability] gets stressed.

"Clients ask: Why did we lose our money?" Among the first places they look for answers is their accountants office, he indicated.

Even the smaller accounting firms are potential defendants, noted Mr. Johnson. And this is reflected in insurance premium increases on renewal that are averaging 20 percent and can go as high as 100 percent.

Joseph Flanagan, president and chief executive officer of Mack and Parker, a division of Chicago-based HUB International, pegs the average jump in accountants professional liability premium at 20 to 40 percent.

"Accountants that perform work for publicly-traded companies are the most at risk," according to Mr. Flanagan. "The big ones and the regionals are the most susceptible to E&O suits. It doesnt go too far below that. The mid-market firms have less exposure," he added, saying large firms that do audit work are where the significant claims are likely to be.

Financial companies, including broker/dealers and investment advisors/counselors are also experiencing fallout from the corporate governance failures.

"Forms and pricing for these classes have been tightened and the self-insured retentions have been increased," Ms. Longmore said. "A few years ago, mid-sized companies in this field carried limits of $5 million to $10 million. Now, those are their retentions."

Investment banks and money-center banks usually have retentions in the $50 million to $100 million range, she pointed out.

"Banks are at risk due to the diversified nature of their businesses," Ms. Longmore said. "For example, there could be an allegation that, because they extended credit for a certain transaction, they gave it the appearance of legitimacy. That theory hasnt been tested much in the United States, but it is common in other countries, such as France."

The main exposure for banking firms relates to allegations that certain transactions were "shams to take items off the balance sheet to pump up income," said Ms. Longmore. The banks have to pass the "fitness test;" they have to demonstrate that reasonable parties would deem the transaction to be legal and in the normal course of business.

Mr. Flanagan added that "the lack of confidence people have now in financial firms, such as investment banks, increases the claim activity."

Another issue rising from the current spate of corporate scandals, noted Ms. Longmore, is controversy over whether Securities and Exchange Commission fines against investment banking firms are covered under those firms E&O policies.

"The insurers have legitimate defenses," she said, "such as that there were settlements made without insurance company approval, or that the fines and penalties are specifically excluded under the policies."

Not surprisingly, lawyers have also become embroiled in these financial claims and have suffered some professional liability fallout.

"Attorneys write the contracts for these deals and they also may give opinions as to the tax ramifications of the transactions," Ms. Longmore said.

She compared the corporate governance crisis to a past savings and loan crisis when there was a spillover of financial-related E&O claims to attorneys.

According to George DeWalt, president of Newport Beach, Calif.-based Professional Practice Insurance Brokers Inc., a division of Richmond, Va.-based Hilb, Rogal & Hamilton, lawyers' professional liability renewals have risen 20 to 30 percent, and that can go to 40 percent or more for a big-city firm doing securities work.

"Exposures can be especially great for lawyers that provide legal opinions regarding tax and off-shore shelters," Mr. DeWalt noted.

Mr. DeWalt also pointed out that the recently enacted Sarbanes-Oxley Act gives lawyers the responsibility to be "whistleblowers" in certain situations involving financial disclosure, and there may be an E&O exposure if they fail to do so. However, fines for failure to disclose may not be covered because most professional liability policies exclude coverage, he added.

"Setting up corporate structures and tax-deferred transactions, and transactions that create phantom income can lead to substantial liability for lawyers," Mr. Flanagan said. Lawyers are the "trusted advisors" in these deals, and when that trust proves to have been misplaced, the claims can come, he noted.

ACEs Mr. Johnson noted that some "lawyers do consulting on tax structures of corporate transactions and may get involved in the issuing of securities." In those situations, "the amounts at stake are very large. So is the potential for professional liability claims," he said.

There are some strategies producers can advise their clients to employ to help mitigate claims, said Cathy Kelly, manager of the professional liability group at Hartford Financial Products in New York. She suggests that brokers advise their clients "to use standardized contracts for all engagements, and to have any contract modifications approved by the legal department or a key individual."

"Proper documentation and communication is key to minimizing the potential for E&O claims," she stressed.

Ms. Kelly recommended that if an error or omission does occur, the client should offer to reduce their charges for future services. Clients should also think long and hard before suing for fees because such actions are often met with countersuits claiming professional negligence, she warned.

Reproduced from National Underwriter Edition, May 19, 2003. Copyright 2003 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.