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
2

• 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
3

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
4

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
5

Today’s Presenters
6
Robb Adkins
Co-Chair
White Collar, Regulatory
Defense, and Investigations
Practice
San Francisco
radkins@winston.com
Jerry Loeser
Bank Regulatory Practice
Chicago
jloeser@winston.com
John Schreiber
Securities Litigation
Practice Group
New York/Los Angeles
jschreiber@winston.com
Yelitza Dunham
Insurance Recovery
Practice
San Francisco
ydunham@winston.com
Christine A. Edwards
Chair
Chicago
cedwards@winston.com

• 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
7

• 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.
8

• 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)
9

• 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
10

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?
12

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
14

• 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
15

16
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
17

• 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
18

• 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
19

• 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
20

• 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
21

• 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
22

• 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
23

• 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
24

• 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
25

• 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
26

• 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
27

• 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
28

• 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
29

• 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
30

• 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
31

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
33

• 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)
34

• 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
35

• 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
36

• 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
37

• 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
38

• 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)
39

• 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)
40

• 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
41

• 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
42

• 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
43

• 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
44

• 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)
45

• 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
46

• 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
47

• “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)
48

• 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)
49

• 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
50

• 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)
51

• 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”
52

• 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)
53

• 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
54

• 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)
55

• 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
56

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
58

• “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?
60

• 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?
61

• 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
62

• 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
63

• 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).
64

• “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).
65

• 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
66

• 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”)
67

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
69

• 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
70

• 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
71

• 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)
72

• 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
73

• 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
74

• 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
75

Questions?
76
Robb Adkins
Co-Chair
White Collar, Regulatory
Defense, and Investigations
Practice
San Francisco
radkins@winston.com
Jerry Loeser
Chicago
jloeser@winston.com
John Schreiber
Securities Litigation
Practice Group
New York/Los Angeles
jschreiber@winston.com
Yelitza Dunham
Insurance Recovery
Practice
San Francisco
ydunham@winston.com
Christine A. Edwards
Chair
Chicago
cedwards@winston.com

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