I am grateful for the enthusiastic feedback I’ve received on my three-part blog post “Who is Winning the Securities Class Action War—Plaintiffs or Defendants?” I especially appreciate the time Kevin LaCroix took to write a post addressing my post in his leading blog, The D&O Diary.
With the benefit of 25 years’ experience defending directors and officers in securities class actions, shareholder derivative actions, and SEC investigations, I’ve had a front-row seat to the dynamics I described in my three-part post. Directors and officers expect that their D&O insurance will protect them when they are sued. They expect a high-quality defense at a cost that allows them to defend the litigation on the merits and to settle when it’s strategically smart, at a price that doesn’t bespeak guilt.
But I’m deeply concerned that directors and officers are getting far less than they expect—and it’s a double-whammy: while the cost of securities litigation defense has dramatically increased, the quality of this expensive defense has dramatically decreased. To be sure, a handful of defense firms provide a quality defense at a price that’s appropriate for the size of the litigation, especially in the so-called “mega cases.” However, in smaller cases, and overall, directors and officers face far greater reputational and financial risk than they appreciate. They expect better—and deserve better—from their lawyers and D&O insurance.
So my main message is simple: for defendants, the securities class action system is broken. The defense bar is highly splintered, comprising many dozens of firms, with multiple possible litigators within each firm. Far too many non-specialists are hired to defend cases simply because their law firm is well-known or handles the company’s corporate work. Although these lawyers know or can learn the basics of the law, they can never possess the things that set specialists apart, such as the years of investment necessary to build the trust of plaintiffs’ lawyers, mediators, and D&O insurers. The quality of defense, overall, is far lower than it should be. And, to add insult to injury, defendants typically pay a fortune for their defense, whether led by a specialist or generalist.
Securities class actions are manageable if they are defended correctly by the right lawyers for the particular case. But securities class action defendants can’t be reasonably expected to select the right lawyers for their unique case. The vast majority of director and officer defendants have never been through a securities class action before, and no one spends time researching whom they’d hire if they were to face a securities case someday.
Defendants are put in an awful position when a case is filed:
- From one side, dozens of defense firms descend on them and bombard them with bold boasts.
- From the other side, the company’s regular outside firm assures them that this is just a straightforward legal problem that their litigation department can easily handle just fine—and never mind that the law firm may have provided the legal advice on the very disclosures challenged in the litigation.
The result is near-anarchy—as I explained in Part II.
In contrast, as I explained in Part I, the plaintiffs’ bar comprises a relatively small number of full-time nationwide securities class action specialists. Within this small group, there is nevertheless a diversity of types of firms that allows them to efficiently cover all types of cases, large and small. The tailoring of plaintiffs’ firms to types of cases happens through self-selection inherent in firms picking particular cases to file, and through the lead plaintiff competition. The contingent-fee nature of their cases creates further efficiency.
Defendants can’t win the securities class action war unless the defense bar can match the plaintiffs’ bar’s effectiveness and efficiency. But to create the right defense bar, the defendants need help. The best sources of help—indeed the only practical sources—are D&O insurers, as I explained in Part III.
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.
I feel strongly about these issues and am encouraged by the agreement and enthusiasm I’ve heard from readers. But I’ve heard a bit of skepticism too, and would like to briefly address it.
How can defendants be losing the war given the high dismissal rate and various legislative and Supreme Court successes?
The big picture. Before evaluating individual battles, it’s useful to look at the big picture—and it’s bleak. Securities litigation defense, as a practical matter, doesn’t even involve defending securities litigation anymore. Settlement values as a percentage of damages are increasing. Defense costs are skyrocketing. Cases can’t be defended through summary judgment without risking that there won’t be enough insurance limits to cover both defense costs and a settlement. In my experience, most of the defense bar doesn’t actually defend cases past the motion to dismiss stage anymore. If defendants lose the motion to dismiss and defense counsel aren’t prepared to press a defense through summary judgment and toward trial (because of stage fright, fear of an economic catastrophe, or both), the only rational economic approach is to settle the case—and the plaintiffs’ bar is keenly aware of that dynamic.
Indeed, the words “litigation” and “defense” in the phrase “securities litigation defense” are misnomers. It’s hard to say that defendants are winning the war when they don’t actually fight.
Dismissal rate. As I wrote in Part II, the relatively high dismissal rate masks the defense side’s dysfunction. The right question to ask is how much higher the dismissal rate would be if securities class action defense bar comprised specialists, not generalists. While there can be no accurate answer to this hypothetical, I firmly believe defendants would win more than they do now. And I would guess it would be a lot more—maybe even 50% more.
U.S. Supreme Court. Although defendants have technically prevailed in most of the U.S. Supreme Court securities cases over the last decade, most of the decisions haven’t been very helpful to defendants in the big picture, outside of clarifying the standards for pleading falsity (Omnicare) and scienter (Tellabs). For example, Janus and Dura basically just restated the law; Amgen and Halliburton I were virtually meaningless; Halliburton II may well have had the lowest impact-to-fanfare ratio of any Supreme Court decision, ever; and Morrison backfired.
Legislative. Although it has had some unintended consequences, the Private Securities Litigation Reform Act of 1995 was indeed a victory for the defense bar (as was the Securities Litigation Uniform Standards Act of 1998).
The Reform Act illustrates the benefits of a specialized defense bar. With support from Silicon Valley securities litigators—the primary firms for oft-sued technology companies—defendants literally changed the rules of engagement. Indeed, my ideal securities class action defense bar would be very similar to the experience and economics of the Silicon Valley defense bar as it existed in 1995—as I discussed in Part II.
Isn’t the plaintiffs’ bar splintered too, given the diversity in types of firms and target defendants?
Over the past several years, I have written extensively about the evolution of the securities class action plaintiffs’ bar—which I summarized in Part I. The plaintiffs’ bar is indeed diverse, and the leaders of the dozen or so firms that bring cases certainly aren’t best friends.
But my point isn’t that the plaintiffs’ firms are homogeneous or friendly. It’s that the plaintiffs’ bar is specialized and small enough that they can be cohesive. They know who’s who, and they know who’s doing what. And they have the capacity to appreciate what is, and isn’t, in the interests of the plaintiffs’ bar as a whole.
That type of cohesion is non-existent in the defense bar. It is simply too splintered—as I explained in Part II. Despite having defended securities litigation for 25 years and full time for the past 20 years, I don’t even recognize the names of many of the defense lawyers listed on the dockets.
How can insurers create better cohesion in the defense bar, given the highly competitive business of D&O insurance?
To be sure, the D&O insurance community is large and competitive, with more than 50 markets writing primary and excess policies. Despite these issues the D&O insurance community is structurally unified.
- The community of D&O insurers comprises a relatively small, strong, and specialized group of companies and people. There is a small number of repeat-player primary insurers. At the less frequent primary and excess insurers, the underwriting and claims leadership is knowledgeable and strong—some of the most prominent professionals work there. These insurers are represented by a small and highly specialized bar of outside lawyers, who drive thought leadership across all carriers. The leading D&O insurance brokers also drive thought leadership. Professional organizations such as Advisen and PLUS further bring people and ideas together. This community of shared interests creates a common analytic framework, lexicon, and culture.
- D&O insurers’ strongest structural bond is their economic incentive to win both individual securities class action battles and the securities class action war. Indeed, they are the only group that cares both about individual cases and the big picture. Defendants themselves only care about winning the individual cases against them. D&O insurers share this goal, but they also care about all of the other cases as well—not just the ones they insure, but the other cases too, because they shape the legal and economic landscape and thus the risks they insure.
D&O insurers have substantial securities litigation expertise. The leading D&O insurance professionals have multiples more experience evaluating defense and resolution strategies than even the most prominent securities defense lawyers, and can provide significant strategic insights. Indeed, if I were sued in a securities class action and could assemble a dream defense team, I would hire a prominent D&O insurance lawyer on the team as a strategic quarterback—on securities class action issues.
Defendants’ success or failure in the securities class action war has significant implications for D&O insurance professionals. The lack of actual litigation defense in securities class actions will eliminate the need for any real claims management. That, in turn, will result in the death of any meaningful role by D&O insurers in the defense of securities litigation. The role of D&O insurance claims professionals will be merely to determine when defense costs have exhausted the policy limits. What a tragedy that would be not just for them, but also for defendants and specialized defense counsel who value their input, insight, and collegiality.
Do public companies really want their D&O insurers involved in the defense of claims?
If I had one wish concerning D&O insurance, it would be to dispel the myth that public companies distrust D&O insurers and don’t want them to stick their noses into the defense of a claim.
This myth is perpetuated by frequently contentious claims experiences, in which insureds’ representatives argue for coverage of defense costs and settlements that insurers are reluctant to pay. But these disagreements are just a symptom of a problem—they don’t identify the underlying problem. In my experience, the problem is most often defense lawyers, who set up their clients to have a strained relationship with their insurers, so that the lawyers have maximum freedom to do whatever tasks they want, at whatever cost they want to charge. Most public companies have never been through a securities class action before and have no idea what tasks are required and what they should cost. But D&O insurers do. And that’s the root of the problem.
So, defense lawyers condition their clients to believe D&O insurers are an adversary. But pre-claim, directors and officers don’t think that way. As I look back on the clients I’ve defended or advised on D&O insurance procurement, I can’t think of any who believed the insurer was an adversary. Just the opposite is true: they’ve often expressly regarded the D&O insurer as a teammate in the defense of the case.
This has been true even in my most difficult securities fraud cases. I’ve never had an insurer even seriously threaten to deny coverage on the basis of the fraud exclusion. An actual fraud-exclusion coverage denial is almost unthinkable under current policies, which exclude coverage only for finally adjudicated fraud in the case at hand. Nearly all cases settle, so the fraud exclusion isn’t even in play. And even a finally adjudicated securities fraud judgment would not often trigger the fraud exclusion, since the scienter standard under Section 10(b) is “recklessness,” not intentional fraud. For these reasons, any concern about the need for “regular” Cumis counsel in duty-to-defend cases is misplaced; far from regular, it would be rare.
Would public companies buy a policy giving D&O insurers greater control of the defense?
I strongly believe that there would be high demand for D&O insurance that placed greater control of the defense of claims in the hands of insurers—including an optional duty to defend feature.
In exchange for a reduction in premium or the self-insured retention, such a policy would be highly attractive to public companies, especially smaller companies, for which even five- or six-figure savings can mean the difference between profit and loss, and success and failure.
I appreciate that the idea of greater insurer control of the defense of public company D&O claims is novel. But I strongly believe it’s time for D&O insurers and brokers to re-think the structure of defense of D&O claims.
Currently, the line between indemnity and duty-to-defend is drawn at public versus private companies. A much more commercially logical line would be smaller public companies versus larger public companies. Just as many private companies would prefer the flexibility of indemnity insurance, many smaller public companies would prefer the certainty and efficiency of a duty-to-defend option.
Smaller public companies—say those with market capitalization of $1 billion or less—often lack larger-company infrastructure. They need and would welcome more insurer control and less financial risk. And with the increasing number of claims by smaller plaintiffs’ firms against smaller public companies now a permanent part of the securities class action landscape, now is a good time for insurers to make this type of change.
But even many larger companies would welcome more insurer control of claims, including a duty-to-defend option, in exchange for some reduction in the premium or self-insured retention. I’ve never met a CFO who didn’t want to save money on insurance. And, unfortunately for us lawyers, very few individual defendants are beholden to any particular lawyer or law firm—that type of connection typically happens at the level of in-house counsel, who unlike directors and officers, are not named as individual defendants in securities class actions.
The key for the success of a D&O policy with greater insurer control would be the quality of the defense. As the party with the biggest financial stake in the individual case and overall, D&O insurers certainly would ensure that the quality of the defense is high, and as repeat players, they know who’s who and are better situated than defendants to pick the right lawyers.
So I strongly disagree with any assertion that public companies wouldn’t buy such a product and brokers wouldn’t sell it. If the quality of the defense is high, and the price is lower through lower premiums and/or retentions, companies will buy it. And if they will buy it, brokers will sell it. It’s just basic economics.