Aiding and abetting – implications for directors and officers
Discussion surrounding Scheme Liability, or “aiding and abetting,” continues to filter throughout the Directors’ and Officers’ Liability (D&O) world, particularly among publicly traded companies and those considering public offerings. The issue has caused debate for decades, but recent challenges to current securities law, from proposed amendments to shareholders class action suits, indicate an increased awareness about the risks of fiduciary, aiding and abetting claims throughout the D&O insurance community.
In 1994, the U.S. Supreme Court ‘s landmark opinion, Central Bank of Denver vs. First Interstate Bank, abolished secondary actor liability in civil litigation brought under Rule 10b-5(b), meaning private litigants may not bring aiding and abetting claims under the federal securities laws. The Court declared that only primary violators — those who actually commit an act (making a material misstatement or omission or the commission of a manipulative act) in violation of the Securities Exchange Act of 1934 (Exchange Act) – may be held liable under the Rule. The Central Bank decision (and later The Stoneridge case), determined that those who merely aid and abet a securities fraud cannot be sued. However, the Court also observed that “[t]he absence of §10(b) aiding and abetting liability does not mean that secondary actors in the securities markets are always free from liability” depending on whether or not all of the liability requirements under Rule 10b-5 are met. As a result, the distinction between primary and secondary actors (including lawyers, underwriters, banks and accountants) is not always clear and has caused significant controversy about “whom to sue” in securities fraud cases.
Following the U.S. economic and financial crises, as well as major Ponzi schemes like the Madoff scandal, securities laws came under scrutiny by several members of Congress who argued to amend sections of the SEA, mainly those that protected secondary actors. The end goal of these legislative efforts was to essentially overturn the Central Bank case, so that litigants could bring aiding and abetting causes of action in private security fraud suits. In 2009, Senator Arlen Spector introduced Senate Bill 1551, “Liability for Aiding and Abetting Securities Violations Act of 2009” to amend Section 20 of the Exchange Act so that “any person who knowingly or recklessly provides substantial assistance to another person would be subject to liability in a private action to the same extent as the person to whom such assistance is provided.”
Implications for D&O Insurance
Though the bill failed to pass, it signaled increased scrutiny into the role of company gatekeepers (rating agencies, auditors, lawyers and offering underwriters) and their role in scheme liability cases. The bill would not only have expanded the potential securities liability exposure for companies’ outside professionals, but also of all companies that do business with public companies. Furthermore, the case brought up questions about the impact a new law might have on management liability insurance (mainly D&O Insurance). Naming secondary actors liable in securities class action lawsuits would have likely caused insurers to raise their D&O insurance premiums to cover these new risks. In addition, secondary actors who suddenly became involved in aiding and abetting cases could have raised their fees for securities related work to off-set the new exposure.
Especially in light of D&O insurance underwriters’ scrutiny of Merger Objection related D&O litigation, buyers should pay particular attention to understanding their own unique exposure to aiding and abetting allegations, and to what extent their insurers are willing to provide them explicit coverage. In the M&A context, an aiding and abetting claim is generally a claim by the selling company’s shareholders against the buyer, asserting that the buyer “aided and abetted” the selling company’s directors in their breach of their fiduciary duties to the selling company’s shareholders. Depending on the specific wording of the buyer’s D&O policy, this type of “aiding and abetting” claim may not be entitled to insurance coverage.
In light of these recent cases and legislative events , it’s important that advisors to public companies consider their increasing liability exposure and review their policies, specifically with respect to the way in which the term “securities claim” is defined in the D&O policy. Private companies should also take extra precaution and review their coverage in the event that they face an aiding and abetting claim. The issue is especially challenging for private companies since most private D&O policies contain securities claims exclusions that are tied to the public offering of the insured company’s own securities.
About the Author
Marcus Janus is a Vice President in the ExecutiveRisk Practice. He specializes in assisting organizations and their executives with protection and advocacy for their exposures in the areas of Directors’ & Officers’ Liability, Employment Practices Liability, Fiduciary Liability, Professional Liability, Crime, and Kidnap & Ransom.