10 Questions D&O Powerpoint Presentation

10 (D&O) Questions Potential New 10 (D&O) Questions Potential New Directors Should Ask Before Directors Should Ask Before

Joining a Public Company BoardJoining a Public Company Board

Paul A. FerrilloPaul A. Ferrillo

Weil Gotshal & Manges, LLPWeil Gotshal & Manges, LLP

March 14, 2010March 14, 2010

10 D&O Questions a Potential New 10 D&O Questions a Potential New Board Member Should AskBoard Member Should Ask

This presentation is meant to be a guide for This presentation is meant to be a guide for individuals being recruited to join the Board of individuals being recruited to join the Board of Directors of a Public Company.Directors of a Public Company.Of all the issues that a potential new director Of all the issues that a potential new director might want information on, the issue of D&O might want information on, the issue of D&O insurance is uniquely personal.insurance is uniquely personal.The availability of, or lack of, good or sufficient The availability of, or lack of, good or sufficient D&O coverage can be directly proportional to the D&O coverage can be directly proportional to the potential for personal liability for the new director potential for personal liability for the new director (all other things being equal).(all other things being equal).


This presentation is not meant to be exhaustive, This presentation is not meant to be exhaustive, but rather will serve to stimulate the flow of but rather will serve to stimulate the flow of information that a potential new director might information that a potential new director might want to evaluate prior to joining a board.want to evaluate prior to joining a board.Several of the questions listed are not intuitive; Several of the questions listed are not intuitive; when in doubt a potential new director should when in doubt a potential new director should seek advice from either counsel or a seasoned seek advice from either counsel or a seasoned D&O insurance broker with experience in placing D&O insurance broker with experience in placing public company D&O insurance coverage, and public company D&O insurance coverage, and in resolving complex claims against directors.in resolving complex claims against directors.


• How much Coverage would I have if I joined today?How much Coverage would I have if I joined today?– Being underinsured Being underinsured is notis not a badge of honor. a badge of honor.– Lack of sufficient D&O coverage is red flag for potential new Lack of sufficient D&O coverage is red flag for potential new

directorsdirectors– The amount of D&O coverage a company carries should have The amount of D&O coverage a company carries should have

a strong relationship to its market capitalization (i.e. number of a strong relationship to its market capitalization (i.e. number of shares outstanding times price per share) and debt structure shares outstanding times price per share) and debt structure (senior/junior/secured/unsecured)(senior/junior/secured/unsecured)

– ““Basic” general rule of thumb – the “average” securities class Basic” general rule of thumb – the “average” securities class action (no SEC involvement/no accounting scandal) generally action (no SEC involvement/no accounting scandal) generally settles for 3-10 % of the market capitalization drop that a settles for 3-10 % of the market capitalization drop that a Company suffers in response to adverse news being Company suffers in response to adverse news being disclosed to investors (Caveat: the more detailed allegations disclosed to investors (Caveat: the more detailed allegations of alleged securities fraud, of alleged securities fraud, especially if sustained by a court especially if sustained by a court on motionon motion, the higher in the above range a case will settle)., the higher in the above range a case will settle).


1.1. Does the Company purchase Side A Non-Does the Company purchase Side A Non-Indemnifiable Difference in Conditions Indemnifiable Difference in Conditions Coverage/Independent Director (IDL) Coverage/Independent Director (IDL) Coverage?Coverage?

– Not only do gross limits of liability purchased matter, Not only do gross limits of liability purchased matter, but also “how” coverage is structured as well.but also “how” coverage is structured as well.

– Sufficient “traditional” coverage (covering both the Sufficient “traditional” coverage (covering both the entity and the individual directors and officers) entity and the individual directors and officers) should be available to handle most general claims should be available to handle most general claims scenariosscenarios


(Side A Coverage, cont’d)(Side A Coverage, cont’d)A Company should carry separate Side A Difference in A Company should carry separate Side A Difference in Conditions Coverage, which would protect only the Conditions Coverage, which would protect only the directors and officers (not the entity). Coverage is directors and officers (not the entity). Coverage is important for bankruptcy scenarios, and for the important for bankruptcy scenarios, and for the settlement of most shareholder derivative actions. settlement of most shareholder derivative actions. This coverage should be the broadest form and should This coverage should be the broadest form and should not contain most of the traditional exclusions found in not contain most of the traditional exclusions found in normal policies.normal policies.Side A DIC carrier should have strong claims handling/Side A DIC carrier should have strong claims handling/claims paying reputation, and long-term financial claims paying reputation, and long-term financial viabilityviability


(Side A coverage, cont’d)(Side A coverage, cont’d)

Finally, history has shown that in a melt-down Finally, history has shown that in a melt-down litigation, a company’s officers and inside litigation, a company’s officers and inside directors “erode” most of the D&O coverage for directors “erode” most of the D&O coverage for claims against them. Many pro-active claims against them. Many pro-active companies often carry independent director companies often carry independent director coverage that will only be available on a Side coverage that will only be available on a Side A non-indemnifiable basis to non-management A non-indemnifiable basis to non-management directors.directors.


1.1. Who is the Company’s Primary D&O Who is the Company’s Primary D&O carrier/Who are the first few carriers in carrier/Who are the first few carriers in the D&O Tower?the D&O Tower?

– Not all D&O carriers have a good claim-Not all D&O carriers have a good claim-handling and claim-paying reputation.handling and claim-paying reputation.

– D&O coverage is generally useless unless D&O coverage is generally useless unless the carriers “pay up,” and some don’t like to, the carriers “pay up,” and some don’t like to, even with favorable, pro-director policy even with favorable, pro-director policy wording.wording.


(Primary Carriers/Excess Carriers, cont’d)(Primary Carriers/Excess Carriers, cont’d)– Primary carrier should be “name brand” and have a Primary carrier should be “name brand” and have a

well-established reputation in the D&O market for well-established reputation in the D&O market for paying claims. No exceptions here should be paying claims. No exceptions here should be allowed. If primary doesn’t pay, chances are the allowed. If primary doesn’t pay, chances are the excess won’t either.excess won’t either.

– Carriers in the first few layers of excess coverage Carriers in the first few layers of excess coverage (“the burn layer”) should have a similar reputation. (“the burn layer”) should have a similar reputation. Again, no exceptions should generally be allowed, Again, no exceptions should generally be allowed, as these carriers too will potentially “on the hook”.as these carriers too will potentially “on the hook”.


1.1. Is the Side A Coverage Non-Rescindable?Is the Side A Coverage Non-Rescindable?– Side A coverage (which covers claims for “non-Side A coverage (which covers claims for “non-

indemnifiable loss” against directors and officers) is indemnifiable loss” against directors and officers) is critically important in bankruptcy related litigation critically important in bankruptcy related litigation and claims against directors. and claims against directors.

– Policy should expressly say that Side A coverage is Policy should expressly say that Side A coverage is “non-rescindable and non-cancelable,” meaning that “non-rescindable and non-cancelable,” meaning that it can’t be voided for any reason. No exceptions it can’t be voided for any reason. No exceptions allowed here.allowed here.


1.1. Is the Application Fully Severable?Is the Application Fully Severable?– Major D&O risk to directors is having policy Major D&O risk to directors is having policy

rescinded on the grounds that the rescinded on the grounds that the Company’s financial statements were Company’s financial statements were intentionally and materially misstated.intentionally and materially misstated.

– Financial restatements “typically” arise from Financial restatements “typically” arise from conduct of CEO’s and CFO’s (i.e. Enron, conduct of CEO’s and CFO’s (i.e. Enron, Worldcom, etc). These are the same people Worldcom, etc). These are the same people who would normally sign policy application who would normally sign policy application for D&O coverage.for D&O coverage.


(Severability, cont’d)(Severability, cont’d)– Policy should provide that the Application for Policy should provide that the Application for

coverage is fully severable; i.e. that the knowledge coverage is fully severable; i.e. that the knowledge of the person signing the application is not of the person signing the application is not “imputed” to any other Insured under the policy for “imputed” to any other Insured under the policy for the purpose of determining coverage.the purpose of determining coverage.

– Critically important since the absence of such a Critically important since the absence of such a provision in a financial fraud case will likely trigger a provision in a financial fraud case will likely trigger a declaratory judgment case by the carriers seeking declaratory judgment case by the carriers seeking to void coverage. to void coverage.


1.1. How does the D&O Policy work if the How does the D&O Policy work if the Company files for bankruptcy?Company files for bankruptcy?

– Bankruptcy/insolvency is a big potential Bankruptcy/insolvency is a big potential claims risk – will draw not only traditional claims risk – will draw not only traditional breach of fiduciary duty claims, but also breach of fiduciary duty claims, but also potentially creditor-related claimspotentially creditor-related claims

– Many of the earlier questions and comments Many of the earlier questions and comments herein equally apply in assessing insolvency herein equally apply in assessing insolvency scenarios, like non-rescindabilityscenarios, like non-rescindability


(D&O Policies in Bankruptcy, cont’d)(D&O Policies in Bankruptcy, cont’d)Additional questions to ask/issues to Additional questions to ask/issues to address:address:

– Policy should say that in bankruptcy no Policy should say that in bankruptcy no retention or deductible should applyretention or deductible should apply

– Policy should say that in bankruptcy there Policy should say that in bankruptcy there should be mandatory advancement of should be mandatory advancement of defense costsdefense costs

– Policy should have an “order of payments” Policy should have an “order of payments” provisionprovision


(D&O Policies in Bankruptcy, cont’d)(D&O Policies in Bankruptcy, cont’d)

Additional questions to ask/issues to addressAdditional questions to ask/issues to address– Policy should have broad carve-out from the insured Policy should have broad carve-out from the insured

versus insured (“IVI”) exclusion, so that not only versus insured (“IVI”) exclusion, so that not only claims brought by the company (as a debtor in claims brought by the company (as a debtor in possession) are expressly covered, but also that possession) are expressly covered, but also that claims brought by creditors committees, equity claims brought by creditors committees, equity committees and bondholder committees (brought on committees and bondholder committees (brought on behalf of the company) are also expressly coveredbehalf of the company) are also expressly covered


1.1. How are the “Conduct” exclusions worded?How are the “Conduct” exclusions worded?– Conduct exclusions (the personal profit exclusion, Conduct exclusions (the personal profit exclusion,

and the fraud and criminal acts exclusion) should and the fraud and criminal acts exclusion) should only apply if there is a final adjudication of the only apply if there is a final adjudication of the alleged conduct against the director and officeralleged conduct against the director and officer

– Conduct exclusion should also be severable, i.e, Conduct exclusion should also be severable, i.e, the conduct of one director or officer should not be the conduct of one director or officer should not be imputed to “innocent” directors and officersimputed to “innocent” directors and officers


1.1. How do the “Change in Control” provisions How do the “Change in Control” provisions work/Does the Policy Provide for Tail work/Does the Policy Provide for Tail Coverage?Coverage?

– Policy should clearly set forth what constitutes a Policy should clearly set forth what constitutes a “change in control” of the company (i.e. ownership “change in control” of the company (i.e. ownership or board control change).or board control change).

– Policy should expressly provide that upon a change Policy should expressly provide that upon a change in control that tail coverage (for a period of 3 or 6 in control that tail coverage (for a period of 3 or 6 years) is automatically provided (subject to years) is automatically provided (subject to payment).payment).


1.1. What Does the Primary Policy What Does the Primary Policy Cover/How Broad is Definition of Loss?Cover/How Broad is Definition of Loss?

– Defense costs, judgments and settlementsDefense costs, judgments and settlements– Damages alleged for Claims pursuant to Damages alleged for Claims pursuant to

Section 11 of the 1933 ActSection 11 of the 1933 Act– Beware of broadly worded bump up Beware of broadly worded bump up

exclusionexclusion


1.1. Who is the Company’s Insurance Broker?Who is the Company’s Insurance Broker?– D&O issues and policy wording are not intuitive. D&O issues and policy wording are not intuitive.

Experience matters. Experience matters. – Broker should have reputation for handling complex Broker should have reputation for handling complex

public company placements (i.e. it knows public public company placements (i.e. it knows public company D&O policies and has high-level carrier company D&O policies and has high-level carrier relationships).relationships).

– Broker should have experienced professionals to Broker should have experienced professionals to help companies resolve complex claims (i.e help companies resolve complex claims (i.e interface with the D&O carriers’ claims interface with the D&O carriers’ claims professionals)professionals)

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10 Questions D&O Powerpoint Presentation