This is the third of a three-part post that analyzes why plaintiffs are winning the securities class action war and what defendants can do about it.

At stake is a system of securities litigation that sets up one side or the other to win more cases in the long term.  It has real-world consequences for directors and officers—they expect companies, D&O insurers and brokers, and the securities defense bar to fight for a system of securities litigation defense that will allow them to get through a securities case comfortably and safely.

But despite winning many battles, defendants are losing the war.

Part I of this three-part post explained that the plaintiffs’ bar is back, and better than ever.  It comprises a small group of about a dozen firms with lead partners who are full-time national securities litigators.  Given the size and focus, the plaintiffs’ bar is specialized and has the capacity to coordinate.

Part II explained that, in contrast, the defense bar is splintered, relatively inexperienced, and highly inefficient.

This third and final part discusses how defendants can overcome these disadvantages and close the gap between the plaintiffs’ bar and defense bar.

The Potential Paths Forward

Because the current path is leading to a strategic and economic cliff—as I’ve mapped out in Part I and Part II—we need to backtrack, examine the landscape, and pick the right path forward.  What are the possible paths?

Elimination or Further Reform of Securities Class Actions

One alternative path is to try to kill securities class actions, or further undermine them.  Over the years, various constituents have sought to eliminate or reform securities cases.  Most recently, in Halliburton Co. v. Erica P. John Fund, Inc., 134 S. Ct. 2398 (2014), the U.S. Chamber of Commerce and others supported Halliburton in trying to abolish the fraud-on-the-market presumption established in Basic Inc. v. Levinson, 485 U.S. 224 (1988)—the legal mechanism that allows securities cases to proceed as class actions.  And, of course, industry groups achieved a significant legislative victory in 1995, through the Private Securities Litigation Reform Act.

Continuing to try to kill securities class actions would be an enormous error.  Securities class actions are far superior for defendants than the alternatives.  If securities class actions didn’t exist, the plaintiffs’ bar would adjust, not perish.  In place of class actions, they would file non-class securities actions that would be vastly less manageable than class actions.  For evidence of what would happen without a class action mechanism, we need look no further than the global securities class action landscape in the wake of Morrison v. National Australia Bank, 561 U.S. 247 (2010).  And without securities class actions as an enforcement safety net, the SEC would doubtless increase enforcement.  Companies are better off with one of a handful of plaintiffs’ lawyers as an adversary than an often-unknown and aggressive SEC enforcement lawyer.  (I examined this question in depth, in my post “Be Careful What You Wish For, Part II: Would Companies Be Better Off Without the Fraud-on-the-Market Doctrine?”)

Further legislative reform could be helpful.  The Reform Act mostly has helped defendants—though it has come with a steep price tag, as I mentioned in Part I.  Although I could come up with some additional defendant-friendly reforms, they would mostly be about correcting problems the Reform Act has caused (see, for example, my post ”Be Careful What You Wish For, Part I: Does the Reform Act Need Reforming?”) or improving litigation procedures (see, for example, my post “5 Wishes for Securities Litigation Defense: Early Damages Analysis and Discovery”).

Most defense lawyers would probably suggest further raising the pleading standards.  I don’t think that would help much.  I’ve always believed that the top of the plaintiffs’ bar isn’t really bothered by higher pleading burdens—at core, pleading a fraud claim involves convincing a judge that the defendants are bad-guys, and a good motion to dismiss involves convincing a judge that the defendants are good-guys.  The pleading standards are just a way to convey those arguments.  Plaintiffs’ lawyers are still able to get past motions to dismiss in a high percentage of cases and certainly in the lion’s share of difficult cases.  Even with even higher pleading standards, the plaintiffs would still file cases they think are the right ones, and I’d predict they’d defeat motions to dismiss at roughly the same rate.

Formation of Industry Groups to Oversee Securities Class Actions

Another alternative path is to form industry groups to create cohesion among groups of defendants—for example, technology companies, biotechs, retailers, etc.  Many years ago, this type of securities-litigation cohesion worked for accounting firms who, as a group, were a formidable foe.  They were represented by a small group of lawyers—there were just a few key lawyers.  Although the accounting firms were fierce competitors in the business of auditing, they took a big-picture approach to the industry’s litigation risk.  Together, they basically chased off the plaintiffs’ securities bar.  Indeed, today accounting firms are typically joined as a securities class action defendant along with its audit client only in the very largest cases.

Part of accounting firms’ success, and the reason they aren’t sued much anymore, is the Supreme Court’s abolition of aiding-and-abetting liability, in Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164 (1994).  But it’s more than that.  Auditors make statements that can still yield primary liability—most typically, by opining that a company’s financial statements conform with GAAP and the audit was performed in accordance with GAAS.  But accounting firms, with their small bar of specialized lawyers, helped to largely insulate those statements from attack under the securities laws.  And when accounting firms were sued along with their audit clients, the accounting firms’ specialized and experienced lawyers brought significant firepower to the defense group—making the claim against the main defendants, the company and their officers and directors, more difficult.  As a result, plaintiffs’ firms have sued accounting firms less and less.

Can public companies adopt this type of cohesive approach as a path forward?  Unfortunately, a number of factors suggest it wouldn’t work.  The types of companies sued in securities class actions are far more numerous and diverse than the Big-X accounting firms.  I watch the cases come over the transom, and the companies sued are a real mishmash, even if the types of cases seem to align in a dozen or so buckets.  Even the technology industry—historically the most frequently sued type of company, and the industry that primarily spurred the adoption of the Reform Act—isn’t sued with the consistency it once was.  Biotech companies are probably the best candidate for a cohesive approach, but most of those companies have their heads down working on their drug candidates, without the time or resources necessary to coordinate.

But most fundamentally, it’s hard to imagine that any group of potential-defendant companies could come together and agree on a small, focused set of securities defense specialists to defend cases against them—or to engage in enough repeat hiring that such a set would naturally develop.  Once again, one of the core problems with securities litigation defense is the hordes of lawyers who comprise the so-called “securities defense bar.”  Until that fundamental problem is fixed, the quality of defense will continue to suffer, and the cost of even the current low-quality defense will remain ridiculously high.

Greater Control by D&O Insurers Is the Only Clear Path

While there is no group of defendants that can replicate the accounting-firm model, D&O insurers can play a similar unifying role across all categories of defendants.

In nearly every securities class action, there is a group of D&O insurer representatives associated with the defense of the litigation.  D&O insurers are the only repeat players on the defense side and as a group, they see the big picture in a way no defense firm ever could.  They have the greatest economic interest in the outcome—both overall and in individual cases.  A victory for the defendants is a victory for them.  They employ highly experienced claims professionals, many of whom have been involved in exponentially more securities class actions than even the most experienced defense lawyers.  I have achieved superior results for many clients by working collegially with insurers—from helping shape motion-to-dismiss arguments, to learning insights about particular plaintiffs’ lawyers and their latest tricks, to selecting the right mediator for a particular case, to achieving favorable settlements that don’t leave the impression of guilt.

Given this expertise and alignment of interests, defense counsel should involve insurers in the defense of the case as part of their responsibility to their clients.  Defense counsel should involve insurers in key strategic decisions—working with them to help find the right defense counsel for the particular case, to help shape the overall defense strategy at the inception of the case, and to help make good decisions about the use of policy proceeds.  And defense counsel who involve insurers undoubtedly help their clients make it through securities cases more successfully, efficiently, and comfortably than those who don’t.

Yet insurers usually are shut out of meaningful involvement in the defense, with most defense lawyers treating them almost like adverse parties and other defense lawyers merely humoring them as they would a rich relative.  Although this dysfunction is rooted in a complex set of factors, it could easily be fixed.

When the general public thinks about insurance, they usually think of auto insurance or other duty-to-defend insurance, under which the insurer assumes the defense of the claim for the insureds.  But public-company D&O insurance is indemnity insurance:  The insurer is obligated to reimburse the company and its directors and officers for reasonable and necessary defense costs and settlement payments, up to the policy’s liability limit.

Indemnity insurance gives the defendants control over the litigation, including counsel selection and strategic approach, with the insurer retaining limited rights to participate in key decisions.  Although those rights give insurers a foot in the door, the rights are not robust or frequently exercised.

Insurers often take a relatively hands-off approach to D&O claims because they assume that their customers want them to stay out of the defense of the claim.  But in my experience, this is a misconception.  The priority for most companies and their directors and officers is simply the greatest protection possible, including assurances that they will not be left to pay any uncovered legal fees or settlement payments.  In fact, not only do most insureds not want to be stuck paying their lawyers for short-pays, they don’t even want to write any checks at all after satisfying the deductible.  Instead, they prefer that the insurer take charge of the bills and pay the lawyers and vendors directly.

In other words, most public companies actually want their D&O insurance to respond more like duty-to-defend insurance, particularly if it were offered at a slightly lower price or with lower self-insured retentions.  This is especially so for smaller public companies, for which the cost of D&O insurance and the self-insured retention can be real hardships and who often lack the resources of larger companies, such as in-house counsel.  Significantly, these are the types of companies against which the plaintiffs’ bar is bringing more and more securities class actions.  Outside directors also lack intense allegiance to any particular defense firm.  Loyalty to particular law firms is typically rooted at the level of in-house counsel, who are often beholden to particular law firms for personal reasons.  In contrast, smaller public companies and outside directors typically just want to be defended well, at no cost to them.

So why do insurers mistakenly think that the insureds would rather have them stay out of the defense of the claim?  To be sure, after a claim is filed, the insurer often gets an earful from the insureds’ lawyers and broker about the insureds’ indemnity-insurance freedoms.  But these aggressive positions are typically not the positions of the insureds themselves. Instead, these positions are driven by defense counsel, usually for self-interested reasons:  to get hired, to justify excessive billing, or to settle a case for a bloated amount because the defense is compromised by mounting costs or the defense lawyer’s inability to take the case to trial.

Frequently, defense lawyers will set the stage for their clients to have a strained relationship with their insurers by feeding them a number of stock lines:

  • “This is a bet-the-company case that requires us to go all-out to defend you, so we have to pull out all the stops and do whatever is necessary, no matter what the insurer has to say.”
  • “The insurer may ask you to interview several defense firms before choosing your lawyers.  Don’t do that. They’ll just want to get some inferior, cut-rate firm that will save them money.  But you’ll get what you pay for—we’re expensive for a reason!  And don’t forget that we’ve stood by you through thick and thin since before your IPO, back when you were a partner here.  Plus, we gave you advice on your disclosures and stock sales, so we’re in this thing together.”
  • “The business of any insurance company is to try to avoid paying on claims, so the insurer may try to curtail our level of effort and even refuse to pay for some of our work.  But trust us to do what we need to do for you.  You might need to make up the difference between our bills and what the insurer pays, but we can go after the insurer later to try to get them to pay you back for those amounts.”
  • “We’ll need you to support us in these insurance disputes.  You don’t have to get involved directly—we can work with the insurer and broker directly if you agree.  Agree?  Good.”

That’s how defense lawyers set the insurer up as an adversary, but these self-serving talking points get several key things wrong:

  1. Most importantly, D&O insurers are not the insured’s adversaries in the defense of a securities class action. To the contrary, insurers’ economic interests are aligned with those of the insureds. Insurers want to help minimize the risk of liability through good strategic decisions. Although keeping defense costs to a reasonable level certainly benefits the insurer, it also benefits the insureds by preserving policy proceeds for related or additional claims on the policy, so that the insureds will not need to pay any defense or settlement costs out-of-pocket, and will avoid a significant premium increase upon renewal.
  2. Insurers want their insureds to have superior lawyers—inferior lawyers would increase their exposure. Their interest in counsel selection is to help their insureds choose the defense counsel that is right for the particular case. The key to defense counsel selection in securities class actions, for insureds and insurers alike, is to find the right combination of expertise and economics for the particular case—in other words, to find good value.
  3. A D&O insurer’s business is not to avoid paying claims. D&O insurance is decidedly insured-friendly, which isn’t surprising given its importance to a company’s directors and officers. D&O insurers pay billions of dollars in claims each year, and there is very little D&O insurance coverage litigation. Although D&O insurance excludes coverage for fraud, the fraud exclusion typically requires a final adjudication—it does not even come into play when the claim is settled, and even if the case went to trial and there was a verdict for the plaintiffs, it would only be triggered under limited circumstances.
  4. If utilized correctly, D&O insurers can be highly valuable colleagues in securities class action defense.  Because they are repeat players in securities class actions, they are able to offer valuable insights in defense-counsel selection, motion-to-dismiss strategy, and overall defense strategy.  They have the most experience with securities class action mediators and plaintiffs’ counsel, and they often have key strategic thoughts about how to approach settlement.  The top outside lawyers and senior claims professionals for the major insurers have collectively handled many thousands of securities class actions.  Although their role is different from that of defense counsel, these professionals are more sophisticated about securities litigation practice than the vast majority of defense lawyers.

D&O insurers most definitely have the practical ability to effect these changes.  Although the number of insurers may seem large to many, from my perspective it is a relatively small and close-knit group.  Every major D&O insurer has highly experienced internal or external claims personnel who track securities litigation developments very closely, in individual cases and the big picture.  There is a relatively small number of primary insurers who write the lion’s share of primary D&O policies.  And there is a handful of professionals who drive thought leadership.  Without question, the D&O insurance community is well-suited to be the glue that fixes the fractured defense bar.

All that would be necessary are a few simple D&O insurance contract modifications.  A duty to defend structure for a “Securities Claim” would work best, and I am certain it would be highly attractive to smaller companies, if offered at a lower premium or with a lower self-insured retention.  Since very few cases actually involve exclusion of coverage under the fraud exclusion, the lurking problem of conflicts of interest is often not present, and in any event can be cured by Cumis counsel (i.e., an attorney employed by a defendant in a lawsuit when there is a liability insurance policy covering the claim and there is a conflict between the defendant and the insurer arising from a coverage issue).

But even within the current indemnity structure, D&O insurers could easily tweak terms to give insurers a stronger voice in three areas:

>  Select the right defense counsel for the particular case—which would tend to create a defense bar that rivals the specialization of the plaintiffs’ bar.  Insurers don’t need to choose counsel for defendants to make sure that they have the right counsel in place.  They can require insureds to conduct an interview process that includes firms that they believe would be right for the case for strategic and/or economic reasons.  Currently, insurers can’t unreasonably refuse to consent to the insureds’ choice of counsel.  Although stronger counsel-selection language could easily be added—for example, that the insurer can propose a range of firms, and the insureds can’t unreasonably refuse to consent to the insurers’ options—even the current formulation allows insurers to reasonably refuse to consent to counsel who aren’t sufficiently experienced or are too expensive for the particular case.

>  Make defendant-focused strategic and settlement decisions—which would approximate the strategic coherence of the plaintiffs’ bar.  Insurers don’t need to have an attorney-client relationship with defense counsel to have a meaningful say in strategic decisions.  The current cooperation clause already gives them this right, and it could be slightly enhanced to make clear that insurers can and should provide strategic input about the full range of decisions.  In this way, insurers could not only make a difference in individual cases, but in the big picture, similar to a portfolio manager’s investment decision-making.

>  Use policy proceeds only for defense costs that further the defendants’ interests—which would allow defendants to approach the efficiency the plaintiffs’ bar achieves through their contingent- fee structure.  Insurers should be allowed to refuse to pay defense expenses that are not in the interests of the defendants—including billing rates and staffing practices that exceed what is reasonable and necessary.  Insurers simply need the contractual right to require a defense firm to live with the insurers’ decisions and prevent a defense firm from seeking reimbursement of unpaid amounts from the defendants.  In my experience, defendants actually believe that insurers are better able to judge what is reasonable than they are and are perfectly willing to defer to the insurer.  The rancor typically comes from defense counsel, not the insureds.

Again, a duty-to-defend option would be the very best way to accomplish necessary change.  But even these types of modest changes within the current indemnity-contract framework would enable D&O insurers to greatly improve securities class action defense.

A key consideration, of course, is whether brokers would be motivated to sell policies with these modifications.  I’m absolutely certain that directors and officers would want to buy them.

And I’m confident that client-focused brokers would want to give their clients the option to purchase a policy that would help the particular client and the broader public-company community to defend securities class actions better.


The only way for defendants to win the securities class action war is to make the defense bar more effective and efficient.  And the only way to do so is for D&O insurers to have greater control of claims.  Defendants are entitled to a defense that allows them to get through securities litigation safely and comfortably, and without any real financial risk.  Indeed, they already expect that their D&O insurers will take care of them.  Giving insurers a greater role in defending securities class actions will allow insurers to do exactly that.