A Perfect D&O Storm

Economic headwinds, individual accountability and disruptive change, like forces of nature, are converging in a way that could change the game for directors & officers (D&O) risk.

In today’s on-demand, hyper-connected world, boards and executives find themselves caught between the seemingly insatiable performance demands of short-termism and potentially hurricane-force economic and geopolitical headwinds that can test the leaders’ mettle and spike volatility.

To get ahead of these risks, we recommend that C-suite and risk managers place financial/executive/cyber/professional liability insurance on their short list of priorities—with an eye toward assessing how well an organization’s coverage will respond to today’s heightened and dynamic exposures.

Economic Headwinds

In 2016, even historically successful companies may find it challenging to meet expectations. Global economic forecasts have ranged from slight growth to considerably ominous—like George Soros’s dire warning of a looming 2008-like crisis.

Today’s economic pressures are no small problem. Many on Wall Street expect the U.S. dollar will continue to strengthen, likely undermining the value of successful growth outside the U.S. and increasing deflationary pressures at home. Many experts also expect that 2016 will see upward pressure on wages, raising expenses for many companies and compressing profit margins. To make matters worse, it turns out that cheap oil may prove bad for the overall economy. Meanwhile, the Fed is expected to continue tightening its belt.

Headwinds also exist in the current geo-political climate. Think terrorism, instability in the Middle East, and unpredictability in Russia, China and in parts of Latin America. Thanks to innovations in connectivity and imperfect cybersecurity, once-local political instability now has a greater potential to reverberate globally. Perhaps even more concerning, the threats have broadened with the rise of numerous, diverse, capable non-state actors utilizing technology for crime and other nefarious purposes with unprecedented assertiveness and success.

Individual Accountability in a New Age of Enforcement

Federal Securities Class Action Litigation 2008Politicians around the world have been making hay appealing to disappointment and anger over perceived failures to prosecute individuals in the wake of the 2008 financial crisis. As a result, we will see more regulatory enforcement focus on individual accountability in 2016.

The Justice Department’s “Yates Memo” made it official that companies will not get cooperation credit for investigations unless they spill “all relevant facts about the individuals involved in corporate misconduct.” As if these game-changing prosecutorial rules were not enough, SEC Chair Mary Jo White has been active in the world of individual accountability as well.

Under pressure from Capitol Hill, the SEC instituted new guidance for Pay Disparity Ratio Disclosure and proposed a clawback rule requiring executives to pay back certain incentive-based compensation, on a pre-tax basis, should an accounting restatement establish that they were overpaid. As regulatory enforcement authorities make the pursuit of individuals a higher priority, companies too must make changes to their internal investigations and inquiries.

Disruptive Change—The New Normal

Companies chasing the opportunity of disruptive change in today’s fast paced world may find the tables quickly turned on them.

Cyber security concerns continue to predominate, now transcending data security into business interruption, infrastructure and vendor management. Things are likely to get worse, too. The internet of things is projected to add millions of new devices to the web, allowing companies—and criminals—to connect like never before. Cyber security-related litigation continues to evolve in concerning ways, highlighted by last year’s decision to allow a consumer class action to proceed against Neiman Marcus absent a showing of fraud on the customers’ accounts.

More change? Activist investors had a banner year in 2015, and there is no reason to suspect this trend will slow. Securities claims may become more expensive to resolve as the Supreme Court’s looming decision in Merrill Lynch, Pierce, Fenner & Smith Inc. v. Manning may give plaintiffs’ bar a new opportunity to forum shop and unleash a wave of securities class actions in state courts. Securities claim frequency is up year over year since 2012, and as a recent $830 million securities class action demonstrates, the potential for dramatic severity lives on. Another high court case, Universal Health Services v. United States ex rel Escobar, threatens new wave of False Claims Act claims.

If all of that wasn’t enough, M&A litigation may get more complex, too. The Delaware Supreme Court in RBC Capital Markets v. Jervis affirmed Rural/Metro confirming that financial advisers may be held liable for aiding and abetting a breach of directors’ fiduciary duties—even without a finding of gross negligence on the part of the directors.

Critical Action Points

In placing financial/executive/cyber/professional liability insurance on your list of priorities this year, consider these potential action points to prepare for the coming storm:

  • Prepare for headwinds and potential volatility:
    • Review limits adequacy.
    • Take advantage of advances in quantitative analytics to better understand your exposure to disruptive change and to get better insights into opportunities to maximize the value of insurance.
    • Larger companies should look to improve counter-party and contract risk by updating the structure of their D&O coverage tower.
    • Review cyber coverage. It has never been more important—even for companies that do not hold large amounts of personally identifiable data.
    • Business interruption coverage may be available. Regulators, clients and investors may want to know you are covered.
  • Prepare for the enforcement focus on individual accountability by ensuring that public company D&O policies have the critical severability and administrative features needed to ensure that one insured’s behavior does not compromise any other executive’s coverage, and that provide a defense where the company fails or refuses to advance or indemnify.
  • Prepare for disruptive change by looking to your insurance advisers to keep you up to date on today’s risks and the opportunities to mitigate or transfer them. Soft markets and recent innovations in coverage may present new, compelling opportunities and value.

About Rob Yellen

Rob Yellen is the D&O and Fiduciary Liability Product Leader for Willis Towers Watson’s FINEX North America pract…
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