Directors and Officers Liability policies traditionally targeted public corporations. These corporations began to face a large increase in the number of shareholder derivative lawsuits in the 1970s and 1980s and D&O policies existed to help companies handle the risks involved in these lawsuits. These lawsuits are often by significant drops in a company’s share price or valuation and therefore are easier to bring against public companies. This often leads to the mistaken belief that private companies do not need D&O insurance or that they need very basic minimal D&O policies. Recent cases though show the error in that line of thinking.
Perhaps the major case making big news in this area involved the medical company Theranos. Theranos was considered a unicorn - a start-up company valued at more than $1 billion - due its supposed success developing low cost comprehensive blood testing. In raising capital from outside investors, the company obtained a $9 billion valuation. However, subsequent investigations showed that the company’s blood testing procedures did not work and several people accused the company of falsifying previous results.
Now as a result of those investigations, Theranos and its directors and officers face multiple lawsuits from investors and potential regulatory action from the Security and Exchanges Commission. Federal security laws do not only apply to public corporations. They apply to any offering of securities and forbid misstatements or material omissions in those offerings. This highlights a number of complications for both insurers and insureds under traditional D&O policies.
First, the insurance industry has often treated D&O for private companies differently than D&O for public companies to the point of using different standard forms for each. The traditional D&O policy for a private company excludes coverage for public offerings of security but does not explicitly bar coverage for pre-initial public offering activity. As the number of securities liability actions brought against private companies increase and these companies received greater scrutiny from the SEC, D&O policies that failed to consider this policy may greatly increase the risk to insurance carriers and lead to a re-writing of these policies to exclude private security transactions from coverage as well as public ones.
Additionally, unlike commercial general liability policies, D&O policies may not include duty to defend provisions. Instead, these policies can involve the insurance company advancing or reimbursing defense costs while the insured entity chooses their own counsel and has more control over the handling of the defense. As their liability for private securities litigation increases, some may wish to rethink the terms of their coverage.
For now, private companies need to be alert to this trend and ensure that their D&O policies provide them adequate coverage to meet their potential exposures and mitigate against potential losses. As this area evolves, smart and informed companies have the opportunity to shop for coverage and coverage options that best meets their individual needs.