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D&O risks remain high for public and private firms

Directors and officers (D&Os) of public companies and private/nonprofit organizations, alike, face significant risks of liability.  These risks include shareholder derivative actions, regulatory enforcement activity by increasingly active regulators, and personal liability arising out of bankruptcy-related claims.  The significant risk environment in which public and private/nonprofit D&Os operate underscores the need for D&Os and their respective organizations to implement strong risk management strategies, including the procurement of robust D&O insurance programs with personal asset protection for D&Os in the event of non-indemnifiable loss (i.e., “Side A” D&O insurance coverage).

Shareholder Derivative Actions

Regardless of whether a company is public or private, its D&Os are fiduciaries of the company who are required to act in the company’s best interests.  Although directors—and, more recently, officers—may be exculpated from monetary liability to their respective companies for certain misconduct, such D&O exculpation generally is forbidden with respect to serious misconduct, such as D&Os breaching their fiduciary duties of loyalty to the company, acting in bad faith, or knowingly violating the law.

Subject to various procedural requirements, when D&Os engage in such misconduct and thereby allegedly harm their companies, the law generally permits shareholders of companies to police the misconduct by stepping into the company’s shoes and suing the D&Os on the company’s behalf in what is called a shareholder derivative action.  Particularly in recent years, the plaintiffs’ bar has had success in shareholder derivative actions, as reflected by the facts that many such lawsuits have survived early motions to dismiss and the monetary amounts of derivative lawsuit settlements have grown exponentially over the past two decades.

Notably, because the companies in derivative lawsuits are the alleged victims and the settlement payments are thus made to the companies, the law generally forbids companies from indemnifying derivative lawsuit settlements.  This is one of the key reasons why Side A D&O insurance is so important:  without it, D&Os settling derivative claims would have to reach into their own pockets.  And maintaining dedicated excess Side A insurance that can “drop down” to pay upon differences in conditions even when other underlying insurance fails to pay has become a critical tool for companies—public and private—to protect their D&Os from having to use their own personal assets to fund non-indemnifiable derivative settlements.

Regulatory Environment

Companies and their D&Os face significant regulatory risks.  Underscoring the point is the fact that the Division of Enforcement of the U.S. Securities and Exchange Commission (SEC) recovered more in financial remedies in fiscal years 2022 and 2023 than in any other years in the Commission’s history.  Moreover, regulators have eagerly demonstrated their commitment to policing misconduct arising out of novel technologies.  Artificial intelligence (AI) is just one example.  The U.S. Department of Justice (DOJ) has prioritized AI, as evidenced from the Department’s recently updated Evaluation of Corporate Compliance Programs to scrutinize companies’ risk assessments of the AI technologies they use.  In a similar vein, the Federal Trade Commission recently announced five new enforcement actions involving AI-related deceptive and unfair conduct, part of the FTC’s new AI enforcement initiative, Operation AI Comply.

For public companies, D&O insurance can be a valuable tool in mitigating the impact of a regulatory investigation and/or enforcement action.  Public company D&O forms generally will include some amount of coverage for costs incurred by D&Os in responding to investigations (including coverage for the company reimbursing D&Os), coverage for defense costs in an enforcement action, and potentially even coverage for certain fines and penalties.  Although public D&O forms (unlike private company D&O forms) usually limit the company’s coverage for loss incurred in the company’s own right to only securities claim-related loss, more insurers are becoming receptive to extending coverage to the company for loss incurred in securities-related investigations, as well.  And as recent cyber-related enforcement activity involving corporate cyber officers has revealed, insurers also are generally receptive to adding specific roles to the definition of “Insured Person,” which, in a public company D&O form and in stark contrast to private company D&O forms, generally is somewhat circumscribed and does not include all employees of a company for all claims.

Private company D&O policies provide broad coverage for the Organization and claims can be brought by shareholders, creditors, customers, vendors and regulators. The coverage extends more broadly to directors, officers, and employees, and may also include indemnified independent contractors as insured persons. Although private companies and their insured persons may not have quite the same exposure to the SEC that their public counterparts have, they nonetheless face regulatory risks.

Regulatory matters, which include proceedings brought by or on behalf of a government entity, such as the DOJ, SEC, State Attorneys General, or Qui Tam actions, are on the rise amid a heightened regulatory environment. These claims, while not frequent, are often the most severe and costly claims. AIG’s Claims Intelligence Series, North America Financial Lines: Private Company D&O Liability, categorized claims into five categories based upon the largest driver of each claim. Regulatory claims accounted for 20% of claim count and 15% of total paid loss. Antitrust claims typically brought by regulatory bodies such as the DOJ or Federal Trade Commission, account for 13% of claim count but the total percentage of paid loss is 25%, indicative of the severity of these matters.[1] And, the exposure for antitrust claims is not limited to large private companies; in fact, there have been numerous antitrust suits brought in the not-for-profit space over the past few years. Antitrust claims are typically brought against the organization and not the insured persons, and some private company D&O policies contain organization antitrust exclusions. Insurers are carefully evaluating the extension of antitrust coverage, and in some sectors such as higher education, antitrust coverage for the organization is very limited. In other sectors the coverage is more readily available in this marketplace, but higher retentions and/or sublimits may apply. As private companies evaluate their D&O program, careful evaluation of antitrust limits and coverage is required, as there is opportunity to build higher limits and to appropriately craft antitrust coverage to remove limitations relating to tortious interference within antitrust exclusions, if applicable.  

Bankruptcy

Inflation and other economic challenges continue to pressure public and private company balance sheets.  For example, the number of large corporate entities filing for bankruptcy protection so far in 2024 has increased. Cornerstone Research reports that, during the first half of 2024, the number of public and private companies with assets exceeding $100 million that made either Chapter 7 or Chapter 11 bankruptcy filings was 60—150% of the average (40) of first-half bankruptcy filings between 2005 and 2023. 

Much like the prevalence of derivative lawsuits, discussed above, bankruptcy risk underscores the importance of dedicated Side A insurance.  Simply put, an insolvent company in bankruptcy is unable to indemnify its D&Os, and D&Os of such a company thus will rely on Side A coverage to respond in the event that D&Os are sued.

Working with experienced risk advisors is essential to create strong D&O liability risk management programs. For more information about D&O risks and solutions, visit Directors’ and Officers’ (D&O) Liability Insurance | Aon.

  

Catherine Padalino is Private and Nonprofit Practice Leader in Aon’s Financial Services Group. Nick Reider is Deputy D&O Product Leader in Aon’s Financial Services Group.

This document is not intended to address any specific situation or to provide legal, regulatory, financial, or other advice. While care has been taken in the production of this document, Aon does not warrant, represent or guarantee the accuracy, adequacy, completeness or fitness for any purpose of the document or any part of it and can accept no liability for any loss incurred in any way by any person who may rely on it. Any recipient shall be responsible for the use to which it puts this document. This document has been compiled using information available to us up to its date of publication and is subject to any qualifications made in the document.

All descriptions, summaries or highlights of coverage are for general informational purposes only and do not amend, alter or modify the actual terms or conditions of any insurance policy. Coverage is governed only by the terms and conditions of the relevant policy.

¹ North American Financial Lines: Private Company D&O Liability