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McCarthy Tétrault LLP & Willis Canada Inc. January 23, 2007 Directors’ & Officers’ Insurance Issues Seminar
McCarthy Tétrault LLP & Willis Canada Inc.January 23, 2007
Directors’ & Officers’Insurance Issues Seminar
Secondary Market LiabilityRegulatory Prosecution
Bob Cooper
Emerging Issues in Directors’ and Officers’ Liability
Secondary Market Liability
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What is secondary market liability?
• Creates a statutory cause of action for investors who purchase or sell in the secondary market
• Creates “strict liability” for issuers (and their officers and directors) who breach continuous disclosure obligations
• No need for investors to prove knowledge, intention or gross misconduct for misrepresentations in “core” documents such as AIF or MD&A
• Eliminates significant obstacle to class certification by not requiring reliance by secondary market purchasers on misrepresentations or omissions
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Who is affected?• Applies to issuers, directors and officers, and influential
persons and experts of responsible issuers• Will apply to BC companies who are reporting issuers in
Ontario, Alberta and Manitoba or have a “real and substantial connection to those provinces”
• Influential Person:• Insider who is not a director or senior officer• Control shareholder (20% or more of voting shares)
• Experts:• Accountants• Auditors• Lawyers• Geologists• Financial Analysts• Other qualified professionals making statements in their professional
capacity
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What does it mean?
• No change to law requiring continuous (Financials, MD & A, AIF) and timely disclosure (material changes)
• Adds civil liability if there is a failure to meet these requirements and the issuer otherwise “releases” a misrepresentation or is not timely with disclosure
• Increased exposure to shareholder class action litigation
• Heightened concern for corporate and personal liability; financial and reputational risk
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What are you liable for?
• For a misrepresentation contained in a documents, directors at the time the document was released and officers who authorized, permitted or acquiesced in the release are liable
• For a misrepresentation made in a public oral statement or for failure to make timely disclosure, directors and officers who authorized, permitted and acquiesced in making the statement or in failing to make timely disclosure are liable
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Are there defences?
• Defendants must prove a “reasonable investigation”
• Factors include:• Nature of issuer • Adequacy of systems in place for disclosure• Reasonableness of relying on system• Reasonableness of relying on officers/employees• Role and responsibility of the person making the
misrepresenation
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What is a “reasonable investigation”?
• At a practical level, a “reasonable investigation” will likely turn on:
• What internal analysis preceded the disclosure/omission to disclose?
• Were appropriate officers, managers involved?• What outside advice was sought and was it followed?• Was the disclosure/omission made hastily under time
pressure?• Were internal compliance standards/systems followed?• Was all of the above documented so as to be provable in a
meaningful way?
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What are the implications?
• Increased risk of personal liability may make it difficult to recruit top flight directors
• Audit committees will require experienced directors and extraordinary time commitments
• Officers with direct preparation responsibility will face greater risk of liability and will need to document procedures followed
• Directors and officers may insist in written and more elaborate indemnity agreements
• Disclosure policies will be revamped to emphasize accuracy of public filings
• Earnings guidance may be less frequent
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Will this open the floodgates?
• Courts exercise a gatekeeper function• Plaintiffs must demonstrate a “reasonable possibility
of success” to proceed• Damages are capped, absent a finding of fraud:
• For issuers or corporate influential person, damages cannot exceed the greater of 5% of market capitalization or $1 million
• For an officer, director or individual influential person, damages cannot exceed the greater of $25,000 or 50% of compensation received in the previous 12 months
• High barriers to entry present real risk to potential plaintiffs
• Only one action commenced in the first year (Imax)
Regulatory Prosecution
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What happened to Bill C45?
• The “Westray Act” came into force in 2004• The Criminal Code now requires:
“Everyone who undertakes, or has the authority, to direct how another person does work or performs a task is under a legal duty to take reasonable steps to prevent bodily harm to that person, or any other person, arising from that work or task”
• This, together with provisions that made it easier for corporations to be charged criminally, was predicted to dramatically increase the number of criminal prosecutions for OH&S matters
• However, charges have only been laid in two cases
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Is prosecution a risk?
• Prosecution for regulatory offences in increasingly likely and organizations and individuals should not be complacent
• “Senior officers”, including directors and officers, are exposed to two types of prosecution – regulatory and criminal
• There is an international trend which features the parallel existence of criminal law and OH&S regulation in protecting worker safety
• There is no clear line between the OH&Sstandard of negligence and criminal negligence
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Is prosecution a risk? (cont’d)
• Parallel investigations by police and regulators are common in serious incidents or fatalities
• Organized labour and safety advocates apply coordinated pressure to lobby for prosecutions
• Many senior officers and organizations are not properly informed about their duties and do not place a priority on worker safety
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What steps should be taken?
• Compliance with applicable OH&S legislation is essential to demonstrate that all reasonable steps are being taken to prevent injury
• Due diligence needs to include senior management oversight of safety systems and matters
• A real commitment to workplace safety must be made with an effective program that demonstrates clear communication throughout the organization
• There must be proactive accident response plans to manage the complexities of dealing with criminal and regulatory investigations
Directors and OfficersLiability Insurance:
Fine-Tuning Protection to Serve Corporate and Individual Priorities
McCarthy Tétrault LLP & Willis Canada Seminar January 23, 2007
Presented by: Catherine Richmond, Senior Vice PresidentExecutive Risk PracticeWillis Canada Inc.
Agenda
• Overview of Directors and Officers Liability Insurance
• Critical D&O Issues for 2006• Indemnity
• Rescission
• Bill 198
D&O Insurance Policy Overview
D&O Insurance Policy
• E&O for running a company
• Who’s insured:• Directors, Officers• Employees• Entity - Securities, Oppression• Spouses
• Employees • Defined term: full-time, temporary, seasonal, part-
time
The Three Sides of Directors’ & Officers’ Liability
• Side A covers individual directors and officers (and Trustees) for non-indemnifiable losses - those losses that the company cannot indemnify. No deductible
• Side B reimburses the company for payments it is required to make to individuals to cover the cost of claims, settlements and legal defense. Deductible.
• Side C reimburses the company for securities claims made against the corporate entity itself. Deductible. Sometimes includes pollution defense.
Program Design
Broad Form A-Side DIC* Coverage• Drops down to primary if underlying insurance:• wrongfully refuses to indemnify• is financially unable to indemnify• is rescinded• is subject to bankruptcy/financial impairment
• Is non-rescindable for any reason*DIC = Difference In Conditions
DEDUCTIBLE
BROAD FORM(DIC)*
EXCESS A-SIDE COVERAGE
A-SIDE COVERAGE
EXECUTIVES’PERSONAL ASSETS
PROTECTION
B-SIDE COVERAGE
CORPORATEBALANCE SHEET
PROTECTION
C-SIDE COVERAGE
CORPORATEENTITY
PROTECTION(securities claims only)
Annual, Aggregate Limit
NO DEDUCTIBLE
Triggering the Policy
• Policy Construct:• Claims Made• 3rd Party Liability Policy• All Risks
• “Claim” alleging “Wrongful Act” resulting in “Loss”
What is NOT covered by the policy
• Public Policy Exclusions:• Conduct Exclusions:
• Fraud/Dishonesty• Illegal Benefit
• Fines & Penalties
• Covered Elsewhere:• Bodily Injury/Property Damage Exclusion• Pollution Exclusion• Pensions/ERISA Exclusion• Professional Liability – note securities carveout
What is NOT covered by the policy
• Narrow the Underwriting Exclusions:• Major Shareholder Exclusion – 10%• Insured versus Insured Exclusion• Pending and Prior Litigation Exclusion • Pollution• Securities Claims Exclusion - Secondary Market, 30
days notice• Employment Practices Liability
Critical D&O Insurance Purchasing Issues
Critical Purchasing Issues
• Purchasing Decision is changing• Directors/Trustees involvement• Potential conflict between management and insureds (cost
v. coverage)• Third Party Reviews
• Program Structure• Who should be insured?• Adequacy of Limits• Side A DIC ( Difference in Conditions)
• Coverage Certainty• Indemnification• Fraud
Coverage Certainty
Indemnification Sources of indemnification may be more limited now than in the past due to:
InsolvencyLegally unableIncentives against indemnification- reduce limits available to “innocents”“cooperation” with criminal & regulatory investigatorsPlaintiff’s strategies
Indemnification availability has key implications for insurance program structure
Coverage Certainty
Fraudulent Conduct
Concern: increasing number of cases where officers’ admitting to participation in frauds, or overwhelming evidence of same.
Implications:Denial of ClaimsRescission of CoverageThreat of rescission used as a negotiating toolby insurer
How can directors avoid rescission and denial of defence obligation?Full severabilityFraud exclusion requires proven “intentional” conductConsider Side A non-rescindable coverage Ensure broker has technical expertise and experience
Bill 198 – What are the implications?
• Litigation:• Powerful tool for investors in the secondary market –
increased class actions• Damage caps – increased allegations of knowing
disclosure violations?• Cross border actions?• Outside directors – minefield? Not involved in day to day
operations• Underwriting:
• Does the company have policies and procedures for: disclosure?
• Release of public oral statements, forward looking statements?
• Does the company receive outside expert advice?
Bill 198 – What are the implications?
• Coverage:• Who should be insured? Separate policies for
directors and officers by group?• Limits? • Insured versus Insured claims? • Conflict amongst defendants? Need for separate
counsel – increased cost
Catherine RichmondSenior Vice President, Executive Risk [email protected](604) 605-5611
Insured v. Insured Exclusion
Ariel DeJong
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What Is It and Why Is It There
• Side “A”, Side “B” and Side “C” coverage• Excludes coverage for an action by one insured
against another• Important to know who is an “insured”
• past,present and future directors, officers, employees• spouses
• Underwriting rationale is to prevent collusion• Actual wording governs if clear – not limited to
collusive claims: Kohanski
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Exceptions
• Derivative actions brought by persons not insured who act without the solicitation, assistance or participation of any insured party
• Wrongful dismissal claims• Claims for contribution or indemnity (if claim
otherwise covered)• Securities claims
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Problems
• Statutory limits on indemnities for directors and officers – CBCA and BCBCA
• Broad definition of “insured” can expand exclusion and narrow derivative action exception
• Claims by liquidators/trustees in bankruptcy/receivers: Markham and People’s
• Changes in control of the corporation• Gaps in coverage for directors and officers• Joint claims by insureds and non-insureds
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Potential Solutions
• Exception for claims by liquidator/trustee in bankruptcy/receiver
• Exception for change of control of company• Expand derivative exception to require
assistance of more than one insured• Limit application of the exclusion to individual
insureds while acting within their capacity as directors, officers or employees
• Get exception to exclusion for non-collusive claims
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Potential Solutions
• Stand alone, enhanced or broad form excess “drop down” difference in conditions Side “A”
• Non-rescindable, non-cancellable and fully funded run-off Side “A”
• Deal with allocation issue for covered and uncovered claims where claims by both insureds and non-insured
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Final Comments
• Read the exclusion and policy language carefully – wording varies widely
• If possible address gaps in coverage and ensure coverage for gaps
• Determine your risk strategy and tolerance• Be aware and make informed decisions
Directors’ & Officers’ Liability and its impact on Insurance Coverage
McCarthy Tetrault LLP & Willis Canada Seminar January 23, 2007
Presented by: Murn Meyrick, Senior Vice PresidentExecutive Risk PracticeWillis Canada Inc.
Impact of litigation: Underwriters’ Reaction & Tools
• Book of business: assessment of rate, retentions, limits, reserves. Is book profitable?
• Underwriting of risk: • Application• Warranties• Disclosure• Corporate governance
• Policy: • Specific account - Endorsements - exclusions• Across the book of business – involved process• D&O policy is static product functioning in a dynamic
environment
Impact of litigation: Insureds’ Reaction & Tools
• Don’t ignore!! Educate yourself about trends
• Identify where you stand in peer review
• Start early in renewal process
• Differentiate your risk - corporate governance
• Coverage review - educate yourself!
• Changes in purchasing decision:• Directors’ involvement• Outside consultants• Bifurcation of purchasing decision
Impact of litigation: Claims management
• Increased sophistication & organization of plaintiffs counsel, including U.S. alliances
• Increased awareness of & attentiveness to coverage & claims handling
• Increased third party involvement (audit, coverage & monitoring counsel)
• Greater coverage disputes- rescission threat; non-rescindable endorsements
• Competing interests amongst insureds - severability; first past the post; limits preservation
• Excess layer involvement
A few current examples
• Executive compensation - stock option backdating & springloading
• Income trusts - increased exposure on trustees
• Institutional investors - pension plans, hedge funds increasing ownership and pushing aggressively for their agenda
• X-border implications - extradition; self-incrimination
• Criminal & Regulatory investigations/prosecutions
The new executive world…?
Enron Canada CEO, David Delainey, sentenced to 2.5 years, Sept. 2006
Negotiating the D&O Policy
• Great environment for customizing:• New entrants
• Insurers willing to trade coverage to maintain price
• Insurers willing to differentiate by product offering not price
• New products - eg, Side A DIC (Difference in Conditions), Income Trust, Mutual Fund - Independent Review Committee
• Buyers more sensitive to coverage over price
• D&O policy no longer a commodity
Final Message
• Start the process early
• Determine your risk philosophy and prioritize
• Differentiate your risk to underwriters
• This isn’t an auto policy - terms vary greatly
EDUCATE & NEGOTIATE
