The stock options timing scandal could present new risks for directors and officers insurance writers, according to industry experts.
Options timing involves the practice of granting so-called "in the money" stock options to executives as compensation, without putting them at risk of having them turn out to be worthless. The Securities and Exchange Commission and other federal and state prosecutors are investigating the activity.
Their inquiries commenced in March after The Wall Street Journal reported executives were receiving option grants at times when share prices hit lows leading to suspicions the options were backdated to ensure the executive was able to make money by executing them.
Options are the right to buy a stock at the so-called strike price, which for executives is supposed to be the day they are granted. If the price rises they make money and if it falls they are worthless.
Professional liability attorney Kevin LaCroix said that one particularly "ominous" development for insurers offering D&O protection has been the creation of a special "Independent Options Pricing Investigation Division" at a prominent New Orleans law firm.
Last week, American Tower Corporation became the fourth company named in a class action suit in connection with the options timing issue.
Lewis Kahn, partner in the firm of Kahn Gauthier Swick, which started the options pricing unit, said the issue has "serious implications" for directors and officers liability writers.
Morgan Stanley securities analyst William Wilt said the fact that options are not a particularly important part of insurance executive compensation was good for the industry. So far, only UnitedHealth Corp. has been the target of class action suits over option timing.
"At this point, we are not expecting the issue to result in a major pandemic for professional liability underwriters," he wrote.
Mr. Wilt said that coverage will depend on several unique issues.
For example, if the practice caused a sustained price drop, and if there was proven fraud, perhaps there could be exposure. But relevant exclusions could apply, he said.
But even if coverage is not applicable, D&O writers will still be faced with providing defense costs, which Mr. Wilt said could be nearly half of professional liability claims payments.
"Discovery efforts are usually a significant component of legal costs but should be manageable, we think, considering the investigations will probably focus on communications between a small group of executives and the board," Mr. Wilt said.
He added that on the positive side, D&O writers will now probably start asking some questions about the practice, and can use this new risk to help sustain disciplined market conditions.
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