Management liability trends in the US affect companies based outside the US in two ways. The most direct is where a company has stock traded on a US exchange. The less direct is where trends in litigation, types of claims made and underwriting actions eventually impact elsewhere. The news for companies and risk managers on all fronts is not good. Worldwide, the frequency of actions against management are increasing.
In the US the two key areas where the number of actions against companies is increasing are securities class actions and employment practices. As the number of non-US based companies with shares traded on US exchanges rises, so too does the potential for direct impact. Class law has yet to affect Europe significantly, but in the UK class actions are emerging (Railtrack, Claims Direct) and lawyers are recognising the potential.
Securities class actions
Once overseas companies are listed on US exchanges, they have to comply with the myriad US securities rules. The number of statements they have to make and the detail they must provide escalate. The more public stock-related statements a company makes, the more likelihood there is of a lawyer picking holes in them and suing on behalf of shareholders.
2001 was a record year for securities class actions, both by number and size of award. One reason for this is the existence of the Plaintiff's Bar, a dozen US law firms who only deal in securities class actions. In 2001, 487 securities claims were brought against non-US companies. It does not matter whether a company has 1% ,10% or 50% of its total stock listed in the US. To a lawyer, the only thing that matters is that they trade on US markets. These specialist lawyers effectively originate class actions on behalf of shareholders; they rarely wait for people to come to them. And they can originate an action within 24 hours of an event.
A new type of security claim in the US is laddering, always connected with initial public offerings (IPOs). These mostly originated during the tech boom years. The investment adviser placing the stock would do a deal with an institutional investor. The adviser would almost guarantee that a stock would rise after placing, and so allocated stock to investors in exchange for a commitment to buy a million shares a few months after launch. They did such deals with several investors, which meant that every time one of them came in to buy the stock as promised, the price would go up. This created an artificial market by a laddering process. The 140 laddering claims against finance houses have been for huge amounts of money.
Even without laddering, the number of securities claims is still increasing, despite law reforms. The hardest hit sectors are computer services, telecommunications, healthcare, pharmaceuticals and banking. There have been some huge settlements against companies on security class actions, including $3.5bn against Cendant. In the last three years, there have been 20 cases settled above $50 million, and the average claim is now for $20m. On average it takes four years to settle an action.
A key indicator that members of the Plaintiff's Bar look for is how the stock is moving. If it falls 15% to 30% in a day they assume there is a corporate problem. Restatements, where companies admit a financial error, are a further trigger, and effectively guarantee that a lawyer will initiate a class action, on the basis that they will almost certainly win.
In 2001, the number of securities class actions against foreign companies trebled. Such companies, often relatively small and not well attuned to the US, are key targets for lawyers, who believe they have a higher chance of success against them. With the contingent fees system the plaintiff has nothing to lose, and 97% of cases are settled out of court. There are many reasons why it is harder to bring a class action in Europe, but several law firms have already identified this area as one of potential. The UK equivalent of the Plaintiff's Bar cannot be far away.
On management liability trends, the US is invariably a year or two in advance of Europe, but on insurance price rises it is more a matter of months. The increase in US claims activity, economic uncertainty and insurers' problems in obtaining reinsurance have resulted in sharply rising prices, limited coverage and more self retention of risk (even the best risks are getting a 10% coinsurance clause). Although the impact on the UK is less severe, price increases and reductions in coverage are expected. UK companies can look forward to an increasing number of actions against them, on a wider range of issues than ever before, making directors and officers liability cover a priority purchase.
Ian Youngman is a freelance insurance writer and the author of "Directors' and Officers' Liability Insurance; a guide to international practice" (Woodhead Publishing).
Employment practices liability began in the US and has rapidly spread into Europe both as a source for claims and a specialist insurance cover. In the US, one in 50 of all law suits is EPL related. The average settlement is $100,000, an average that hides the mega awards of $50 or $60m. Companies fear the damaging publicity from an EPL lawsuit, so seek to settle quickly. Lawyers thrive in such circumstances. The most common EPL claims now relate to race, sex, age and disability. Multi-plaintiff actions, common in the US, are increasing elsewhere. Contingency fee fuelled claims are rising too.
In the recent soft markets, D&O cover increased in breadth without a corresponding rise in premiums. Entity coverage was included, as was blanket cover for outside directorships, reinstatement, EPL and employees, often all within a cut price three year deal. In today's hard market, insurers are looking for 40-60% premium increases for greatly reduced cover. Problem companies or sectors are finding it hard to obtain cover. To give companies an incentive to fight cases rather than settle, insurers are only giving entity cover with a 20-50% coinsurance.
These changes will hit companies with shares traded on US markets. The market elsewhere has not seen such dramatic changes, yet.