forum for financial institution directors: how do directors prepare for the worst?

Forum for Financial Institution Directors

How Do Directors Prepare for the Worst?

April 8, 2016

Christine Edwards, Winston & Strawn LLP Robb Adkins, Winston & Strawn LLP

John Schreiber, Winston & Strawn LLP Yelitza Dunham, Winston & Strawn LLP

Jerry Loeser, Winston & Strawn LLP

• Winston & Strawn conducts an annual webinar series to assist Financial Institution directors in understanding issues, regulatory requirements, investor priorities and market realities.

• This series complements our weekly Financial Services Update which is designed to provide quick, readable, and ongoing information about what Congress, regulators, courts and competitors are doing.

• If you wish to sign up to receive the Update, please visit winston.com/subscribe


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• This is the third in a series of four Director Training Sessions. • The first addressed regulatory expectations. • The second highlighted issues with the upcoming 2016 proxy season. • Please click here for a copy of the presentations and a link to the audio recordings from

the prior presentations.

• This session addresses how directors prepare for the worst: • Securities class actions and derivative litigation, • Criminal enforcement, and • D&O liability insurance.

• The fourth session will address the Directors’ Perspective. • Mark your calendars for April 29. Guest speakers to include:

• William S. Haraf, Director of Charles Schwab Corporation and former Commissioner of the California Department of Financial Institutions

• Cynthia A. Glassman, Director of Discover Financial Services and former Commissioner of the Securities and Exchange Commission

• Eileen Kamerick, Principal, The Governance Partners, LLC and Director of Associated Banc-Corp. and Legg Mason Closed End Mutual Funds


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http://www.winston.com/en/site-search.html?t=5273&t_name=Forum for Financial Institution Directors

Christine Edwards • Chair of Winston & Strawn’s bank regulatory practice • Nationally recognized expert on corporate governance • Over 30 years of experience, including as Former EVP and Chief Legal

Officer, of Bank One and of Morgan Stanley

Robb Adkins • Co-Chair of Winston & Strawn’s white collar, regulatory defense, and

investigations practice • Nationally recognized trial attorney • Former Executive Director of the federal government’s Financial Fraud

Enforcement Task Force


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John Schreiber • Partner Winston & Strawn’s securities litigation practice group • Nationally recognized by publications as a “Rising Star” in the area of

securities litigation

Yelitza V. Dunham • Partner in Winston & Strawn’s insurance recovery practice

Julius L. (“Jerry”) Loeser

• Of Counsel in Winston & Strawn’s bank regulatory practice • 45 years of bank regulatory experience • Former Federal Reserve Board lawyer, chief regulatory counsel at Wells Fargo

& Co., and Deputy General Counsel at Comerica Bank


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Today’s Presenters

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Robb Adkins Co-Chair

White Collar, Regulatory Defense, and Investigations

Practice San Francisco

[email protected]

Jerry Loeser Bank Regulatory Practice

Chicago

[email protected]

John Schreiber Securities Litigation

Practice Group New York/Los Angeles

[email protected]

Yelitza Dunham Insurance Recovery


[email protected]

Christine A. Edwards Chair

Bank Regulatory Practice Chicago

[email protected]

• The FDIC’s policy of pursuing individual officers and directors of failed institutions. • FDIC Office of Inspector General investigates the causes of each bank failure

and issues a report attributing responsibility for the failure.

• Politicians and even Federal judges argue for punishment of individuals engaged in wrongdoing. • In a January 2016 report entitled “Rigged Justice,” U. S. Senator Elizabeth

Warren criticized the effectiveness of SEC and DoJ enforcement efforts.

• U. S. District Court Judge Jed Rakoff (S.D.N.Y.) New York Review of Books article

• No individual executive has been successfully prosecuted in connection with the financial crisis; however there have been many settlements.

• This environment creates a threat to individual officers and directors.


Political Pressure to Pursue Individuals

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• SEC Chair Mary Jo White: • Enforcement will be a top priority, and we will pursue “all wrongdoers –

individual and institutional, of whatever position or size” (emphasis added) (at 2013 confirmation hearing).

• “Service as a director is not for the faint of heart” (2014 address at Stanford Directors’ College).

• Since 2000, the SEC has pursued individuals in 93% of its fraud and financial reporting cases. • Only a small number of directors have been charged though.

• Criminal securities law prosecution of director is quite rare.


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• September 9, 2015 U. S. Department of Justice Memorandum from Deputy Attorney-General Sally Yates • First major policy announcement by the Department of Justice since Attorney-

General Loretta Lynch took office in April 2015.

• Entitled “Individual Accountability for Corporate Wrongdoing”

• To federal prosecutors nationwide

• Intent: increase prosecutions against individuals • Focus on individual wrongdoing from beginning of investigation

• To qualify for credit for cooperation, a company shall identify all individuals responsible for wrongdoing regardless of position, status, or seniority.

Forum for Financial Institution Directors (con’t)

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• Financial Institution Regulators are incorporating more “directives” requiring Board involvement in policies, procedures and actions of financial institutions • For example, we estimate that, if a Board devoted 15 meeting minutes to

perform each of the new reviews and approvals mandated by regulators in the last two years, it would add 2 hours and 45 minutes to the time of their meeting every year.

• This creates a larger set of Federal mandates for Boards that must be followed • Delaware cases focus on the extent of Board and Director inquiries and

staying advised on issues • Important to understand the environment and what the potential impact may

be on your institution. • Ask Questions • Benchmark Practices • Set the timeframe for management follow up • Stay advised of litigation trends.


Director/Board Concerns and Issues for Today

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Robb Adkins: Financial Enforcement against Financial Institutions and Boards of Directors

• New enforcement leadership • Greater parallel enforcement • Increased emphasis on civil enforcement with potential large monetary

penalties or recoveries • FIRREA

• Emphasis on holding individuals and gatekeepers responsible


What is on the Horizon in Financial Enforcement and How Does it Impact Directors?

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New Leadership - DOJ Criminal Division

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Loretta Lynch, AG

Sally Yates, DAG

U.S. Attorney’s Offices (94 districts)

Leslie Caldwell AAG,Criminal Division Andrew Weissmann Chief, Fraud Section

• Department of Justice (DOJ) • Antitrust, Civil, Civil Rights, Criminal, U.S. Attorney’s Offices, FBI, ATF, DEA,

Bankruptcy Trustees

• Securities and Exchange Commission (SEC) – Enforcement Division • Other federal investigators/regulators

• CFTC, FTC, IRS, Secret Service, Postal Inspector, ICE, DOL, FDA, OCC, FDIC, FRB, NCUA, SIGTARP, FinCEN, CFPB

• Inspectors General • State Attorneys General and local District Attorneys • Other State Regulators


Increased Parallel Enforcement

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• Executive Order signed by President Obama • More than 25 Federal Agencies

• Local and State Partners

• Criminal, Civil, and Administrative Remedies

• Broad scope of FFETF • Equally broad mandate


Financial Fraud Enforcement Task Force

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ENFORCEMENT COMMITTEE

FINANCIAL FRAUD ENFORCEMENT TASK FORCE

TRAINING AND INFORMATION

SHARING COMMITTEE

STEERING COMMITTEE

VICTIMS’ RIGHTS COMMITTEE

MORTGAGE

FRAUD

SECURITIES AND

COMMODITIES FRAUD

RECOVERY ACT

FRAUD

TARP FRAUD

DISCRIM.

RMBS “Financial

Crisis”

• The government has been criticized for failing to bring criminal charges relating to the recent financial crisis

• Stung by that criticism, DOJ has resorted to filing civil fraud charges utilizing statutes with the potential for large fines and recoveries, including the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA)

• Benefits to a civil lawsuit approach include: • Lower “preponderance” burden of proof

• Longer statutes of limitations

• No “Arthur Andersen issue”


DOJ Approach Since the Financial Crisis

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• Passed in 1989 in response to the S&L crisis and the strain on federal deposit insurance programs associated with the failure of such institutions • Imposed regulatory requirements on covered institutions

• Set stricter capital maintenance requirements

• Created harsh civil penalties for violating certain federal criminal statutes, including: mail fraud, wire fraud, bank fraud or concealment of assets and other frauds against a federally insured banking institution, and violations of § 16(a) of the Small Business Act


Background of FIRREA

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• Many believe FIRREA was initially intended to protect financial institutions from fraud

• According to the legislative history, one of “[t]he primary purposes of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 [was to] enhance the regulatory enforcement powers of the depository institution regulatory agencies to protect against fraud, waste and insider abuse.” • In Wells Fargo, Judge Furman acknowledged that the “legislative history is

ambiguous at best.”


Purpose of FIRREA

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• FIRREA offers the government advantages as a tool for civil enforcement actions • Longer statute of limitations (10 years after cause of action accrues)

• Lower burden of proof (preponderance of the evidence)

• Significant monetary penalties (up to $1.1 million per violation or $5.5 million for a continuing violation or up to the amount of the violator’s pecuniary gain or loss caused by violator)

• Administrative subpoena process (can conduct investigation in advance of filing lawsuit)


Advantages of FIRREA

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• FIRREA claims may be brought only by DOJ • No private cause of action, no claims by securities regulators and state

attorney generals

• Many states plan to join under state unfair competition laws

• Statute allows whistleblowers to recover a percent of the award if DOJ acts on their information or bring their own suit if the DOJ fails to act within one year • While potential awards under FIRREA pale in comparison to those under the

False Claims Act, whistleblowers can bring claims under both statutes to increase their chance of recovery


Who Can Bring a Claim

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• In 1990, Congress created the Financial Institutions Anti-Fraud Enforcement Act (“FIAFEA”) to allow whistleblowers to bring confidential declarations to DOJ regarding potential FIRREA violations.

• Incentives include the confidential nature of the declarations, monetary awards, and anti-retaliation protection.

• If DOJ does not act on a declaration within one year, the whistleblower is entitled to a contract to privately pursue the case.


Whistleblower Benefits and Protections

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• FIRREA was rarely used until DOJ dusted off the statute and brought cases against banks and rating agencies in connection with the recent financial crisis

• The use of FIRREA against banks and financial institutions was largely the brainchild of Lee Weidman, a career civil prosecutor in the Los Angeles US Attorney’s office

• This new application of FIRREA has provoked criticism by defense lawyers who argue that it is inappropriate to use a statute intended to protect banks against those very institutions


Old Wine in New Bottles

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• Recent cases have determined that a bank can violate FIRREA by engaging in fraudulent activity and harming itself in the process.

• The relevant provision requires the defendant to have “affected” an

institution under the statute. The court now says an institution can “affect” itself.


“Affecting” a Financial Institution

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• The Whistleblower Program was created as part of the Dodd-Frank Act to provide monetary incentives for individuals to come forward and report possible violations of the federal securities laws to the SEC.

• In the wake of the SEC’s embarrassing failure to investigate the Madoff Ponzi scheme, Dodd-Frank required the SEC to establish a whistle-blower office, which was inaugurated in August 2011.


SEC: Office of the Whistleblower

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• Tipsters can receive up to 30 percent of the money the SEC collects when fining a company or its executives • Eligible Whistleblower: An individual who voluntarily provides the SEC with

original information about a possible violation of the federal securities laws that has occurred, is ongoing, or is about to occur.

• The information provided must lead to a successful SEC action resulting in an order of monetary sanctions exceeding $1 million. • But if that threshold is met, the minimum award is 10%.


SEC’s Monetary Incentives

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• To receive an award a whistleblower must • (1) voluntarily provide the Commission

• (2) with original information

• (3) that leads to the successful enforcement by the Commission of a federal court or administrative action

• (4) in which the Commission obtains monetary sanctions totaling more than $1 million.


Eligibility for Whistleblower Awards

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• SEC agreed to consider providing highest possible awards to employees who report fraud at work prior to turning to the government • More than 80% of aspiring whistleblowers have reported internally first

• Some companies now require employees to attest annually that they have never witnessed any fraud


Whistleblower Program in Corporate America

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• Pressure to hire independent counsel for internal investigations has increased. It will be more difficult for counsel to conduct the investigation for the audit committee or special committee and then also represent the company in a regulator’s inquiry.

• Outside counsel’s ability to jointly represent directors, individuals, and the company in a regulatory investigation may be reduced because the possibility of conflicts caused by whistleblower considerations.


Effects and Consequences of the Whistleblower Rules

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• Lesser requirements apply for a whistleblower to be protected by the anti-retaliation protections of Dodd-Frank

• Anyone who has a “reasonable belief that the information [they] are providing relates to a possible securities law violation,” regardless of whether the information in fact relates to a violation and regardless of whether the individual is eligible for an award. [SEC Rule 21F-2] • Creates strong incentives for employees who think their jobs may be in

jeopardy to seek whistleblower status and protection.


Anti-Retaliation Protection

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• Emergence of a Plaintiffs’ Bar • Plaintiffs’ Bar views the whistleblower program as a growth opportunity

• SEC is enlisting the help of companies to conduct investigation of whistleblower tips • SEC investigates the “juiciest” tips and filters out baseless tips

• For all other tips, the SEC may contact the company and request the company to conduct an independent investigation and report back on its findings


Future of Whistleblower Program Uncertain

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John Schreiber: Shareholder Litigation Targeting Directors: Derivative Suits & Class Actions

• Securities class action lawsuit filings in 2015 were at the highest level since 2008 (NERA and Cornerstone) • Not only has the number of lawsuits filed increased, but the rate of filings

relative to the number of publicly-traded companies is also up (fewer publicly-traded companies)

• Only 17 financial firms were sued in 2015, down from 26 in 2014 and well below the average of 35 between 1997-2014 (Cornerstone)


By the Numbers: Bad news/Good news

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• Average settlement value ($52 million) was up 46% due, in significant part, to a handful of large financial sector settlements stemming from the financial crisis • Median settlement value ($7.3 million) was up only slightly over 2014

• 58% of settlements were for amounts less than $10 million

• 13% of settlements were for amounts greater than $100 million

• Increase in the number of cases alleging violations of Section 11 of the Securities Act of 1933, primarily in IPO context • Supreme Court decision in Omnicare (discussed infra)


By the Numbers: Bad news/Good news (con’t)

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• The Board in the Crosshairs: • Section 11 Claims

• Directors face strict liability for material misstatements or omissions in a registration statement issued in connection with a public offering

• Shareholder Derivative Suits • “Oversight”/”Duty to Monitor Business Risk” claims

• Allegations, typically precipitated by some “corporate trauma,” that the Board failed to recognize or take action in the face of “red flags”

• Other Shareholder Class Actions • Merger challenges


The Threat

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• Heavily-regulated industries like the financial sector continue to be primary targets of securities litigation

• Private shareholder “piggyback” lawsuits now follow almost inevitably on the public disclosure of governmental/regulatory inquiries, investigations and enforcement actions, whistleblower suits, settlements and the imposition of fines or penalties -- even where there has been no determination or admission of wrongdoing • “Alphabet Soup”: SEC, DOJ, USAO, FDIC, CFTC, State AGs, foreign regulators, etc.

• Most common: • Federal securities class actions

• Generally, the defendants in a 10b-5 class action are the Company, the CEO and the CFO • In a Section 11 class action, however, members of the issuer’s Board of Directors are strictly

liable for material misstatements or omissions in a registration statement issued in connection with a public offering

• Shareholder derivative suits alleging breaches of fiduciary duty • Primary defendants are the members of the Board of Directors


The Climate

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• The Hook: Public disclosure of government inquiry, investigation, whistleblower lawsuit or settlement involving possible corporate misconduct

• The Theory: Development renders company’s prior public statements materially false and misleading • “Legal compliance” opinions


“Piggyback” Federal Securities Litigation

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• Section 11 imposes strict liability for any untrue statement of a material fact in a registration statement or any omission of any material fact required to be stated in a registration statement or necessary to make the statements therein not misleading

• Persons liable include: • The issuer

• The directors of the issuer

• Persons named, by their consent, in the registration statement as about to become directors of the issuer

• Every person who signs the registration statement

• Every expert (e.g., accountant, engineer, appraiser) who is named by consent as having certified or prepared any part of the registration statement

• Every underwriter of the relevant security


Section 11 Liability under Omnicare

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• Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund, 135 S.Ct. 1318 (2015) • Addressed whether and under what circumstances statements of opinion or

belief can give rise to Section 11 liability

• Rejected the notion that a statement of opinion or belief that is ultimately found to be incorrect – even if it was genuinely believed at the time it was made – is actionable as an untrue statement of material fact under Section 11

• Held that such statements could give rise to Section 11 liability on an omissions theory, however, if the registration statement – read as a whole by a reasonable investor – implied some fact about how the speaker formed its belief or opinion, when the true facts were otherwise


Section 11 Liability under Omnicare (con’t)

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• With respect to “legal compliance opinions” • Court held that plaintiffs must be “specific” and identify particular instances of

attorney warnings, contrary advice or the like that were omitted from registration statement.

• Even where a plaintiff can identify any such omission, district court must then determine whether: • “the omitted fact would have been material to a reasonable investor,” and

• in light of the overall circumstances and factoring in the other information the issuer “did provide about legal compliance, as well as any other hedges, disclaimers, or qualifiers it included in its registration statement,” the “alleged omission rendered [the] legal compliance opinions misleading.”


Section 11 Liability under Omnicare (con’t)

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• Tongue v. Sanofi, Nos. 15-588-cv, 15-623-cv, 2016 WL 851797 (2d Cir. Mar. 4, 2016) • The Second Circuit cautioned that Omnicare should not be interpreted

“expansively,” emphasizing that “Omnicare does not impose liability merely because an issuer failed to disclose information that ran counter to an opinion expressed in a registration statement.”

• “Issuers must be forthright with their investors, but securities law does not impose on them an obligation to disclose every piece of information in their possession. As Omnicare instructs, issuers need not disclose a piece of information merely because it cuts against [an opinion expressed in a registration statement].”

• Court affirmed dismissal of Section 11 claim premised on statements of opinion where, even though the government “disagreed” with the company’s interpretation of the facts on which the opinion was based, the company’s interpretation was not “irrational or unreasonable.”


Second Circuit interprets Omnicare

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• Focus on context/qualifying/caveat language • Materiality • Affirmative defense of “loss causation” where underlying

investigation/lawsuit has not led to a finding or admission of wrongdoing


Strategies for defending Omnicare claim

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• The Hook: Public disclosure of government inquiry, investigation, whistleblower lawsuit or settlement involving possible corporate misconduct

• The Theory: Company’s board breached its fiduciary duties by failing to exercise proper oversight to detect and prevent the alleged legal violations • Alleged harm/potential damages include the amount that the Company has

had (or will have) to pay in fines, penalties, settlements and legal fees because of alleged legal violations


“Piggyback” Shareholder Derivative Litigation

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• The Demand Requirement • In most jurisdictions, in order to sue derivatively, a shareholder plaintiff must

either first make a demand on company’s board or establish that such demand would have been futile

• To establish “demand futility,” a shareholder plaintiff must plead and prove that a majority of directors on the board at the time complaint was filed was not disinterested and independent

• Fact that a director is named as defendant is not sufficient; must show that the director faces a “substantial likelihood” of liability based on the claims asserted


Overarching Issues in Defending “Piggyback” Derivative Litigation

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• The Caremark Standard • To succeed on a “duty of oversight” (or so-called Caremark) claim, a

shareholder plaintiff must show that the directors knew, or ignored obvious “red flags” indicating, that violations of law were occurring and took no steps in good faith to prevent or remedy the situation

• Shareholder plaintiff must show that: a) the directors utterly failed to implement any reporting or information system or

controls; or

b) having implemented such a system or controls, consciously failed to monitor or oversee its operation, thus disabling themselves from being informed of risks or problems requiring their attention.

• Test is rooted in concepts of bad faith (note D&O coverage implications)

• Described by Delaware courts as “possibly the most difficult theory in corporate law upon which a plaintiff might hope to win a judgment”


Overarching Issues in Defending “Piggyback” Derivative Litigation (con’t)

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• What is the scope of a director’s duty to monitor “business risk”?

• The Goal Posts • In re Citigroup Shareholder Derivative Litigation, 964 A.2d 106 (Del. Ch.

2009) (Chandler, Ch.)

VS.

• American International Group, Inc. Consolidated Derivative Litigation; AIG, Inc. v. Greenberg, 965 A.2d 763 (Del. Ch. 2009)(Strine, VC) (“AIG”)


“Oversight” Claims Against Financial Institution Directors

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• Reaffirms business judgment rule protection for directors in the face of an allegedly negligent failure to monitor business risk • Claim that directors ignored “brewing” risk in the real estate and credit markets

prior to the financial crisis

• HELD: No liability for “bad business decision”


In re Citigroup

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• “Extremely high” bar • Courts should not second-guess directors’ business decisions,

especially where doing so leads to personal liability, just because they failed accurately to “predict the future” • No personal liability for mere breach of the duty of care (negligence) in failing

to monitor business risk, even where various directors were alleged to have been through the Enron crisis and qualify as “financial experts”

• “102(b)(7)” protection under the corporate charter/indemnification/D&O coverage


In re Citigroup (con’t)

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• Liability requires a showing that the directors “knew that they were not discharging their fiduciary obligations or that the directors demonstrated a conscious disregard for their responsibilities such as failing to act in the face of a known duty to act” • A “red flag” isn’t just bad news

• In addition, “a showing of bad faith is a necessary condition to director oversight liability”

• Note overlap with standard coverage/exclusions from D&O policies

• NOTE: A claim for corporate waste with respect to the CEO’s comp package permitted to proceed.


In re Citigroup (con’t)

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• Citigroup lays down an extremely forgiving standard, BUT: • Where there is evidence of directors’ actual knowledge of potential criminal

conduct, look out.

• In AIG, then Vice Chancellor Strine determined that plaintiffs’ allegations

supported the inference that the defendants – who were, significantly, inside directors – were running what the Court termed a “criminal organization” • In Citigroup, Chancellor Chandler expressly distinguished AIG on this basis

• “Many of the worst acts of fiduciary misconduct have involved frauds that personally benefitted insiders as an indirect effect of directly inflating the company’s stock price by the artificial means of cooking the books.”


AIG

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• Complaint sufficiently alleged breach of duty of loyalty against directors for “knowingly tolerating inadequate internal controls and knowingly failing to monitor their subordinates’ compliance with legal duties”

• The required degree of knowledge/intent on the directors’ part is satisfied by allegations that support an inference that the directors were “conscious of the fact that they were not doing their jobs”

• Where internal controls exists, but are known to be broken, failure to fix them can result in liability

• While it should go without saying, directors who trade in the Company’s stock based on material nonpublic information breach their duty of loyalty to stockholders


AIG (con’t)

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• In re Goldman Sachs Group Shareholder Litigation, C.A. No. 5215-VCG (Del. Ch. Oct. 12, 2011) • Citigroup is the guiding light

• Caremark claims asserted against Goldman’s directors based on theory that Goldman’s compensation structure created an environment of highly risky decision-making

• Court dismissed claims, finding that complaint did not adequately allege that directors failed to satisfy “their oversight responsibilities in regards to Goldman’s business risk” because they did not “consciously disregard” them, nor did they act in “bad faith”


“Progeny”

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• The logic central to Goldman Sachs has been reiterated in recent Delaware cases

• Asbestos Workers Local 42Pension Fund v. Bammann, No. CV 9772-VCG, 2015 WL 2455469, at *15 (Del. Ch. May 21, 2015) • “Assuming failure to oversee business risk can support a Caremark-style

action . . . a stockholder derivative plaintiff would have to plead with particularity that “the board consciously failed to implement any sort of risk monitoring system or, having implemented such a system, consciously disregarded red flags signaling that the company's employees were taking facially improper, and not just ex-post ill-advised or even bone-headed, business risks.”

• In re General Motors Company Derivative Litigation, C.A. 9627-VCG (June 26, 2015)


“Progeny” (con’t)

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• Ripeness/No Damages • Where underlying government inquiry or whistleblower lawsuit has not (yet

anyway) resulted in any fine, penalty, judgment, settlement or other determination, has the company suffered cognizable harm? Legal fees?


Additional Strategies for Defending Piggyback Derivative Suits

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• The Special Litigation Committee or “SLC” • Displacing the shareholder plaintiff through formation of special litigation

committee to investigate the claims asserted • An option at any stage of litigation, but most commonly employed following denial of a

motion to dismiss

• Requires at least one independent director

• Probably requires hiring a new, independent law firm

• Derivative litigation is generally stayed pending completion of SLC’s investigation

• SLC, following investigation, can seek dismissal or to take over the litigation from shareholder plaintiff • Where it “takes no position,” that’s tantamount to allowing the derivative suit to proceed and

supports demand excusal. (AIG)

• Considerations: cost; D&O coverage; distraction


Additional Strategies for Defending “Piggyback” Derivative Suits (con’t)

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• Delaware Court of Chancery (Laster) rejects contention that allegedly colorable disclosure claims brought by stockholder plaintiffs challenging mergers risked irreparable harm sufficient to warrant expedited injunction proceedings • Johnson v. Driscoll, C.A. No. 11721-VCL (Del. Ch. Feb. 3, 2016) (TRANSCRIPT) • Chester County Retirement System v. Collins, C.A. No. 12072-VCL (Mar. 14, 2016)

(TRANSCRIPT)

• In these rulings, Vice Chancellor Laster: • Holds that certain, allegedly material omissions in pre-merger disclosures did not

warrant pre-closing expedited proceedings because the disclosure claims raised purely legal issues that could be resolved after closing;

• Notes his distaste for “creat[ing] a system where we substitute ritualized litigation leading to disclosure-only settlements and replace that with ritualized litigation leading to mootness fee buy-offs.”

• Departure from long-standing Delaware precedent • Implications


Developments with Respect to Shareholder Merger Challenges

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Yelitza Dunham: Getting The Most Out Of Directors and Officers Coverage

• What does Directors and Officers Insurance cover? • How much coverage is enough? • Is dedicated coverage available just for the directors and officers? • Exclusions and Conditions to watch out for


Overview of Coverage Issues

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Scope of Coverage

• “Loss” arising out of a “claim” made against the insured based on any “wrongful act” by an insured officer or director acting in their respective capacities.


What is Insured?

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• Individual Directors and Officers - Side A • May cover shareholder derivative suits for breach of fiduciary duty (e.g., wasting

corporate assets, usurping corporate opportunity). • Only applicable if corporate entity unable to indemnify (by insolvency or operation of law

such as shareholder derivative action). • Additional Side A coverage can be purchased.

• Corporation for reimbursement of indemnity paid on behalf of officers and directors - Side B • Insures corporate indemnification obligation for directors and officers.

• Entity Coverage - Side C • Created because courts had required insurer to bear full expense where claims made

against individuals and corporate entity. • Covers corporation for claims, typically only securities claims.


Who is Insured?

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• Appropriate amount of coverage varies by company. Broker will benchmark

• Premiums tend to decrease as layer of coverage being purchased increases. In other words the first $5 million in coverage is more expensive than for $5 million excess of $10 million

• Separate Side A only Coverage may be desirable • Typically no retention for claims against individuals


Amount of Coverage and Retentions

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• Defined to include damages, judgments, settlements, and defense costs. • Insurers may argue that disgorgement is not a covered “loss.” See Ryerson

Inc. v. Federal Ins. Co., 676 F.3d 610 (7th Cir. 2012); Bank of the West v. Sup.Ct., 2 Cal.4th 1254 (1992). • Policyholder response: Not seeking restitution or value at time of purchase, or

amounts that insured wrongfully acquired from plaintiff; instead, seeking damages in form of difference between value at time purchased and time of trial. See J.P. Morgan Securities Inc. v. Vigilant Ins. Co., 21 N.Y.3d 324, 336 (2013) (coverage not barred where “the disgorgement payment was (at least in large part) linked to gains that went to others”).

• Typically exempts civil or criminal fines or penalties. • But some policies permit recovery in some states where, for example, punitives are

triggered by finding of gross negligence.


“Loss” arising out of “claim” based on “wrongful act” by insured officer or director

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• Definition may include any/all of the following: • written demand for monetary or non-monetary relief • civil, criminal, administrative, regulatory or arbitration proceeding initiated by complaint,

indictment, notice of charges or similar documents • regulatory investigations against individual insureds commenced by service of a Wells

notice, target letter or similar document

• Nature of proceeding may affect availability of coverage. For example, what if board is asked to investigate? What if individuals are fact witnesses? Is a document subpoena enough to trigger coverage? • How broad is the Claim definition? • Any specialized cost coverage that minimizes coverage gaps? • Look to case law. E.g., Second Circuit recently found that a state agency letter stating

that it “may” bring an enforcement action against the insured if the insured did not voluntarily cease a certain activity was a “demand” under the D&O policy and therefore constituted a claim. Weaver v. Axis Surplus Ins. Co. (2d Cir. Mar. 7, 2016).



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• “Wrongful act” frequently defined as ”any actual or alleged error, misstatement, misleading statement, act, omission, neglect or breach of duty” committed or attempted in capacity as a director or officer.

• Insurer might argue that allegations involve individual acting to advance interest as a shareholder, or that not acting in capacity of D/O of insured entity (e.g., acting in capacity of more junior employee, or in capacity of D/O of uninsured entity.) But see Raychem Corp. v. Federal Ins. Co., 853 F.Supp. 1170, 1184 (N.D. Cal. 1994) (definition of wrongful act not limited to misleading statements made "solely" in the capacity as D/O).



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• Policy requires “claim” made against insured during policy period. • “Wrongful act” must occur after “retroactive date” specified in policy. • All related later claims covered under initial policy period —viz.,

coverage under multiple policies typically not available where claims involve related wrongful acts.

• Also can give notice of potential claim (sometimes called a “circumstance”) which locks in coverage under that policy if claim later arises.


Claims Made Against Insured During Policy Period

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• Some policies provide firm time period (e.g., 15 days) for providing notice after receipt of claim. Some courts strictly enforce; others apply prejudice standard.

• Even in absence of firm time period, Insured should promptly report claim to insurer. Certainly no later than by end of policy period or, where permitted by policy, within specified time thereafter. Courts will strictly construe.


Submission of Claim to Insurer (“Notice”)

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Exclusions and Other Conditions

• D&O policies typically contain exclusions that bar coverage for misconduct on the part of an insured. • Personal Profit Exclusion bars coverage for claims of “gaining of any profit or advantage

to which the insured was not legally entitled.”

• Fraud/Dishonesty Exclusion bars coverage for claims “arising out of, based upon, or attributable to the committing . . . of any deliberate criminal or deliberately fraudulent act by the insured.”

• While a large percentage of D&O claims include allegations of fraud or illegal personal profiting, the simple allegation is not enough to trigger the exclusion. • Most exclusions require something like a court determination of guilt or an admission of

guilt before the exclusion can apply. Either the words "final adjudication" or "in fact" will be used in the exclusion to indicate how high the hurdle is for the carrier to apply these exclusions.

• Exclusionary language can be refined to D/O’s advantage in a number of ways including, but not limited to, addition of ‘non-appealable’ modifier to requirement that there be a final adjudication before exclusion applies.


Conduct Exclusions

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• Most policies exclude coverage for claims asserted by insureds against other insureds, including claims brought by or against the company.

• Insurers may argue that excludes coverage where companies sue officers/directors for recovery of profits.

• Exceptions to insured v. insured exclusion typically made for derivative actions.

• Wording is critical—Does it bar claims brought “on behalf of” insured as well as claims “brought by” insured?


Insured v. Insured Exclusion

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• What is the application? Just the present one or prior ones too? SEC application? Submissions to regulators? Financial statements? • Some courts hold misstatements concerning financial condition are material as

a matter of law. Shapiro v. American Home Assurance Co., 584 F. Supp. 1245, 1249 (D. Mass. 1984); Unencumbered Assets, supra at 1025.

• Others hold policy language controls. National Union Fire Ins. Co. v. Continental Illinois Corp., 658 F.Supp. 775, 779 (N.D. Ill. 1987).

• States vary on whether misstatements must be intentional. Some specify in statutes like Cal. Ins. Code §359. Others in cases: Illinois requires knowing/intentional false statement (National Union v. Continental, supra at 778, 779) while California does not (Superior Dispatch, Inc. v. Ins. Corp. of New York, 181 Cal.App.4th 175, 191 (2010)).


Misrepresentation and Rescission

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• Materiality - “whether the information would have caused the underwriter to reject the application, charge a higher premium, or amend the policy terms.” A subjective test. See, e.g., West Coast Life Ins., Mitchell v. United National Ins. Co., and Superior Dispatch, Inc. v. Ins.Corp. of New York, supra. • After submitting application, best practice is to ask insurer in writing to advise

in writing whether it needs any additional information.

• Duty to defend continues until determination that insurer has right to rescind. See, e.g., In re WorldCom, Inc. Securities Litigation, 354 F.Supp.2d 455, 465 (S.D.N.Y. 2005); Federal Ins. Co. v. Kozlowski, 792 N.Y.S.2d 397, 402 (N.Y.App.Div. 2005); Continental Cas. Co. v. Marshall Granger & Co., LLP, 921 F.Supp.2d 111, 130 n. 22 (S.D.N.Y. 2013).


Misrepresentation and Rescission (cont’d)

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• Does wrongdoing by one director/officer affect coverage for others? • Depends on whether policy contains “severability” provision and if so,

scope of provision. • Full severability - Separate application for each individual

• Limited severability – Knowledge of the signer or of specified executive is imputed to all.

• Where severability provision present, wrongdoing of one not affect coverage for others. Wedtech Corp. v. Federal Ins. Co., 740 F. Supp. 214, 218 (S.D.N.Y. 1990).

• But where no severability provision, can bar coverage for all. TIG, supra at 371; Continental Cas. Co. v. Marshall Granger & Co., LLP, 921 F.Supp.2d 111, 121-22 (S.D.N.Y. 2013).


Severability

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• Insurer may seek to limit coverage by seeking apportionment between covered loss and non-covered loss– as when individuals are covered but the entity is not, or as between covered and non-covered claims.

• Policy often ambiguous as to how allocation should be made and policyholders can often negotiate a better percentage share.


Allocation

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• Review and negotiate key insurance policy terms at purchase and at each renewal period • Things to aim for:

• Broad definitions of “Claim” and “Defense Costs” to maximize coverage

• Limiting scope of “crime/fraud” and “personal profit” exclusions

• Nonrescindable coverage or, at minimum, severability provision

• Separate Side A only policy or, at minimum, inclusion of Priority of Payments provision which guarantees individual insured losses paid first over entity losses

• Allow sufficient lead up time to have broker and coverage counsel review for new coverage gaps created by new laws/remedies/regulations, availability of new insurance products


Final Takeaways

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Questions?

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Robb Adkins Co-Chair

White Collar, Regulatory Defense, and Investigations


[email protected]

Jerry Loeser Bank Regulatory Practice

Chicago

[email protected]

John Schreiber Securities Litigation

Practice Group New York/Los Angeles

[email protected]

Yelitza Dunham Insurance Recovery


[email protected]

Christine A. Edwards Chair

Bank Regulatory Practice Chicago

[email protected]

Thank You

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