Supreme Court Ruling Is Relief To D&O Insurers

WASHINGTON--The Supreme Court yesterday issued a decision that places restrictions on securities lawsuits, an action welcomed by insurers who provide directors and officers liability coverage.

In Stoneridge Inv. Partners, LLC vs. Scientific-Atlanta Inc., No. 06-43, the court in a 5-3 decision threw out a lawsuit by Charter Communications Inc. shareholders against two of the companies' suppliers, Motorola Inc. and Scientific-Atlanta Inc.

The plaintiffs in the case had sued Motorola and Scientific-Atlanta, two cable television equipment suppliers involved in a deceptive transaction that helped Charter, a cable television company, inflate its earnings and hide its failure to achieve its financial goals.

The majority opinion upheld a federal district court in Missouri, which had dismissed the suit, and the 8th U. S. Circuit Court of Appeals, which had upheld the dismissal.

Kevin M. LaCroix, of Beachwood, Ohio, an attorney and a director of OakBridge Insurance Services, a brokerage which specializes in directors' and officers' liability insurance, reacted by saying: "The position that the investors urged, if successful, would have had a dramatic impact on the cost of liability insurance."

The decision was controversial, with Democrats in Congress criticizing it. Sen. Chris Dodd, D-Conn., chairman of the Senate Banking Committee, said, "As the author of the Private Securities Litigation Reform Act, I stand second to none in my commitment to protect American businesses from frivolous litigation.

"But today's decision goes beyond that common-sense law," he said. "Instead of protecting innocent businesses, it would protect wrongdoers from the consequences of their actions. Such a misguided standard will do nothing to strengthen the competitive position of America's businesses and capital markets."

Earlier, Sen. Dodd and other Democrats in Congress had urged the Bush administration, including President Bush and Solicitor General Paul Clement, to voice disappointment that the Solicitor General chose not to file a brief with the Supreme Court expressing the views recommended by the U.S. Securities and Exchange Commission (SEC) in the case.

Sen. Dodd wrote to SEC Chairman Christopher Cox in May of last year to inquire whether the SEC would continue its support of "scheme liability" in the case and to voice his endorsement of the SEC's position.

In its decision, the majority said the shareholders didn't show that they relied on the alleged deception by the suppliers in making investment decisions.

The cable company arranged with the two suppliers to inflate their prices on cable boxes and then use the excess cash to advertise on the cable system. The inflated prices were listed as a capital expense and the advertising was added to revenues helping the company meet securities analysts' expectations.

The term of art involved in the case was "scheme liability," according to lawyers active in the business of insurance against directors' and officers' liability.

That is the idea that third parties could be held liable for securities fraud committed by companies with whom they do business. This would have made investment bankers, accountants, law firms and suppliers liable for fraud committed by their public company clients.

The directors' and officers' liability insurance industry had been awaiting the decision with bated breath.

Mr. LaCroix said a critical part of the majority opinion was that if investors' position were recognized, "then companies would seek to protect against the threats, which would raise the cost of doing business."

Further, he said, if companies had been forced to get insurance to protect against not only the securities liability arising from their own conduct but also with respect to every company to whom they are a customer or vendor, "the cost of liability insurance would have soared."

Moreover, he continued in comments on his blog, "the burden of trying to underwrite this exposure would have been enormous as well, not to mention extremely challenging."

Mr. LaCroix noted, "These same points could also be made with respect to liability insurance for third-party professionals as well."

He added that "these practical considerations support the view that the Stoneridge case is a defense victory and represents a rejection of an expanded reading of Section 10(b) of the Securities Act.

"But the more expansive possibilities may never really have been in the cards, given the lineup of the court," he said.

"Yes, the decision could have changed things, but in the end, it did not," he said. "In effect, Stoneridge represents a 5-3 vote for the status quo. So while a decision for the investors could have increased the cost of insurance, the actual outcome on behalf of the vendors is unlikely to impact the cost of insurance."

American International Group, whose National Union Fire Insurance Company of Pittsburgh, based in New York, is a major player in the D&O market, agreed.

"While this is an important decision thwarting an attempt to broaden management liability, it's unlikely to have any impact on D&O claims trends," said Chris Winans, a company spokesman. "At AIG, our underwriting already assumed that the case would be decided this way, so it doesn't affect our book of business."