Halliburton – another catalyst for increased Shareholder Derivative litigation?
Shareholder derivative lawsuits have become increasingly problematic for both Directors’ & Officers’ Liability carriers and the companies they insure. Their increased frequency has led to both an increase in losses paid by carriers, and to additional legal/settlement costs paid directly by companies on behalf of their directors and officers. Furthermore, the spike in these lawsuits has also led to higher premiums and self-insured retentions for many companies.
Unlike shareholder class-actions, which are brought against companies and their directors and officers by shareholders on their own behalf, derivative lawsuits are filed by shareholders on behalf of the company itself. The concept is that any person/entity that has harmed the company’s share price should have to repay the company for their transgression . In practice, plaintiffs often bring derivative lawsuits in parallel with class actions to augment their ability to secure larger/faster settlements for class actions. While the total cost for defending and settling a class action is usually multiple times higher than for a derivative lawsuit, companies and their defense attorneys are almost always more confident in the class action process and its outcome, especially since D&O insurance is likely to cover most of their costs.
Ironically, the surge in derivative actions has largely been driven by recent Court rulings designed to curb the impact of class action suits. This law of unintended consequences may take on even greater significance when the Supreme Court rules this June on a case involving Halliburton Co. to decide whether one of its landmark decisions Basic vs . Levinson should be overturned. By endorsing the “fraud on the market presumption theory”, the Supreme Court’s 1988 ruling on Basic provided the plaintiffs’ bar with a much lower threshold for bringing class actions. The theory has three main tenets:
- Assumes that there is an “efficient” stock market
- We assume that at any given point a company’s stock price reflects all publicly available
information about that company, including any statements that turn out to be misrepresentations
- Therefore, a buyer or seller of stock who relies on stock prices is in effect, relying on the alleged misrepresentations
As a result, a company that makes material misrepresentations has therefore perpetrated a “fraud on the market” – which is why this is often called the “fraud on the market” theory.
If the Supreme Court modifies its position on Basic via its upcoming ruling on Halliburton, many pundits agree that plaintiffs will face a higher threshold for bringing class actions, since each member of a putative class may have to prove that they relied on the company’s information when they made their investment decision. These same pundits also agree that derivatives would likely become an even more important and frequently used tool for the plaintiffs’ bar. Individual shareholders may receive less-direct benefits from a derivative suit versus a class action settlement (even though shareholders typically end up with pennies on the dollar in most class action settlements). Still, derivatives do provide them with the ability to participate in a lawsuit, even if they did not sell their shares when the share price dropped. On the other hand, shareholders can only participate in class actions if they sold their shares at a loss based on the company’s misinformation/fraud.
In conclusion, we can count on the following:
- The plaintiffs’ bar will continue to find ways to “protect investors”, (i.e. their business model will evolve.)
- Companies and their attorneys will adapt to “changes in the game.”
- D & O carriers will, initially, incur unanticipated losses before revising their coverage/pricing retention models.
- D & O liability and insurance will forever be in flux.
Stay tuned for further developments.
About the Author
Rich Leavitt is a Principal and the Risk Management Practice Leader at WGA, he is responsible for the firm’s overall strategy for attracting and retaining large clients with complex risks and dynamic needs, as well as the delivery of solutions and services to those organizations.