Insurers may find it impossible to rescind their directors and officers contracts with policyholders accused of backdating stock options because the threshold to prove fraud may be too steep, legal experts said yesterday.
Their comments came as LexisNexis Mealey's services presented a panel of four lawyers discussing "Securities Litigation and Stock Option Grants–Directors & Officers Liability Insurance."
The attorneys, Kevin M. Mattessich, of Cozen O'Connor in New York; Jerry Oshinsky with Dickstein Shapiro LLP; Jonathan M. Cohen with Gilbert Heintz & Randolph LLP; and Gary Seligman with Wiley Rein & Fielding, all three in Washington, D.C.
The group discussed a wide range of issues regarding directors and officers policies, and emphasized that insureds' attorneys should read and understand the insurance contract.
They emphasized that policyholders need to understand the extent of the coverage they are buying and to be sure it is what they envision the coverage to be.
On the issue of recission, Mr. Mattessich said insurers have the right to rescind the policy when there is clear fraud. He said insurers would have grounds for rescinding the policies because of a misrepresentation, in this case the backdating of stock options, by the policyholder that could have substantial effect on the company's reported financial statement.
The issue of backdating concerns the dating of stock options issued to an individual for compensation. Backdating occurs when they are issued with a date going back to a time when the price would be more advantageous to the stockholder, and not on the date the individual actually cashed them.
Issuing of options improperly should be revealed to the insurers and if not revealed, the insurer should have the right to rescind, according to Mr. Mattessich.
However, Mr. Cohen said most courts see recission "as a draconian remedy" and look very closely at what the representation was.
Insurers, he said, must look closely at the misrepresentation in the process of the application and cannot unilaterally abandon the policyholder.
Mr. Cohen advised that insurers need to prove that they relied upon what was misrepresented as part of the underwriting of the policy. Only the decision of a court can rescind a policy, and a settlement may "render the recission defense not particularly useful to the insurer." If the insurer is successful, the money can be returned, he added.
Mr. Cohen noted that severability actions, again dependent upon the language of the policy, may mean that insurers must provide the cost of defense for an innocent executive, but can rescind the policy against the guilty. There are also issues of whether the backdating action was a clerical error or a conscious decision to commit a crime.
Mr. Oshinsky said recission cases are a recent invention. Underwriters have to prove fraud and must prove that the fraud was integral to granting the policy, a very high level of proof the underwriter must meet, he said.
If there is a binding arbitration clause in the policy, and the carrier attempts to rescind the contract, in Mr. Oshinsky's opinion, the carrier would have to seek arbitration of the recission.
"It's a very interesting ground for debate," Mr. Oshinsky concluded.
© Arc, All Rights Reserved. Request academic re-use from www.copyright.com. All other uses, submit a request to TMSalesOperations@arc-network.com. For more information visit Asset & Logo Licensing.