Directors' and officers' liability (D&O) insurance should continue to offer protection if insureds are vigilant, just as D&O insurers have covered other event-driven litigation – reluctantly or not. Thus far, some of the major D&O insurance carriers are suggesting that claims under D&O policies should be "manageable."2 Care also should be taken in the insurance renewal process, especially with respect to required disclosures of pending incidents.
To start, the context. The two COVID-19-related shareholder actions filed to date have alleged essentially typical claims for securities fraud under section 10(b) and Rule 10b-5 promulgated thereunder and section 20(a) of the Securities Exchange Act of 1934. The allegations are focused of course on COVID-19.
The complaint in Norwegian Cruise Lines alleges that the company made materially false and misleading statements in its SEC filings concerning the impact of COVID-19 on its cruise business and the procedures in place to protect the health, safety, security, and well-being of its crews and guests.
The complaint in Inovio asserts that the company's CEO made false public announcements on television and to the president that the company had developed a COVID-19 vaccine and intended to start human clinical trials by summer. Once it became known that the CEO’s statements were false, the complaint alleges that the company's stock price declined 71 percent from its class-period high.
The U.S. Securities and Exchange Commission (SEC) has issued guidance as well. On March 4, 2020, the SEC issued an order providing conditional regulatory relief for certain reporting obligations for publicly traded companies, including allowing an additional 45 days to file disclosure reports that would otherwise be due between March 1 and April 30, 2020.3 In an accompanying press release, SEC Chairman Jay Clayton stated that the manner in which regulated companies plan for and respond to COVID-19 may constitute a material investment decision that must be reported in SEC filings:
We also remind all companies to provide investors with insight regarding their assessment of, and plans for addressing, material risks to their business and operations resulting from the coronavirus to the fullest extent practicable to keep investors and markets informed of material developments. How companies plan and respond to the events as they unfold can be material to an investment decision, and I urge companies to work with their audit committees and auditors to ensure that their financial reporting, auditing and review processes are as robust as practicable in light of the circumstances in meeting the applicable requirements. Companies providing forward-looking information in an effort to keep investors informed about material developments, including known trends or uncertainties regarding coronavirus, can take steps to avail themselves of the safe harbor in Section 21E of the Exchange Act for forward-looking statements.4
The SEC's March 4, 2020, guidance was not its first concerning COVID-19. On February 19, 2020, the SEC met with senior leaders of the largest U.S. audit firms to discuss the potential of the coronavirus and its effects on financial disclosures and audit quality, such as auditor access to company information and personnel in impacted regions. Based on these concerns and others, the SEC urged companies to consider potential disclosure of subsequent events in the notes to the financial statements and to request appropriate relief from filing deadlines if companies cannot timely complete, with the required review and attention, required filings due to circumstances beyond their control.5
6 create an environment from which litigation may well emerge. Future allegations in securities and shareholder lawsuits (if any) could include:
- Failure to disclose or adequately disclose risks that company faced - or failure of the company to update prior disclosures as circumstances evolved;
- Inadequate steps to mitigate risks;
- Failure to observe recommended or required protocols; or
- Failure to develop adequate contingency plans.
In light of these and other risks, reports indicate that boards have already begun planning for long-term fallout from the COVID-19 pandemic.7 With this as the backdrop and current reality, what steps should policyholders be taking and how should they proceed with respect to their current and future D&O policies?
BI/PD allegations. We expect D&O policies to continue covering these types of securities lawsuits. Companies should, however, be on the lookout for assertions that may implicate bodily injury and property damage (BI/PD) exclusions. A common iteration of the exclusion may state that the insurer shall not be liable to pay loss in connection with any claim made against the Insureds "for any actual or alleged bodily injury, sickness, disease, or death of any person, or damage to or destruction of any tangible property including loss of use." In many modern D&O policy forms, the BI/PD exclusion should be narrowly drafted (like the above) to apply only to claims that are directly "for" bodily injury, such that they should apply only to claims by plaintiffs who became sick or have family members who became sick or die from the coronavirus, and not to claims alleging only financial injury or corporate governance issues connected to the coronavirus. Companies should, if feasible, ensure at their next renewal that any BI/PD exclusion is drafted as narrowly as possible with "for" trigger wording, and not broader prefatory language such as "based upon or arising out of bodily injury or property damage."
Enhanced Side A-only protection for directors and officers. Companies should also consider increased Side A-only limits. "Side A" D&O coverage protects directors and officers from personal liability for claims asserted against them when the company is prohibited from or financially unable to indemnify them, such as if the company becomes insolvent. Given the uncertainties in the current economy, companies and their directors and officers should ensure sufficient limits to protect their personnel and to continue to attract talented management.
Give timely notice of claim. As with any fast-moving crisis, companies should remain vigilant on notice and reporting requirements under their D&O (and other) insurance policies. Risk management and legal personnel should review the notice and reporting provisions of the policies and, in the event of a claim, give timely notice under the primary and all excess policies. Notice requirements may be "as soon as practicable" after a claim is made or within a set time period such as 30 or 60 days. This requires analyzing what constitutes a "claim" under the policy. In addition to civil lawsuits, most modern D&O policies include as covered "claims" written demand letters, requests to toll a statute of limitations, and formal regulatory investigations of directors and officers. Companies should also consider whether to provide a "notice of circumstances." Notice of circumstances provisions generally provide companies with the option of reporting a potential claim, so that any future claim based on those circumstances will be "parked" in the current policy period.
Promptly obtain consent to defense arrangements. We do not currently know whether any securities lawsuits arising out of COVID-19-related events will be successful, but as with other securities litigation, we do know that they may be expensive to defend, and D&O insurance should cover those expenses. Companies should confirm any defense requirements in their policies. D&O policies typically are not "duty to defend" (meaning that the insurer has the obligation to provide its insured with a defense against claims), but consent to the insured's chosen counsel is usually required. Some policies also require the use of "panel counsel." Consider specifying in your policy certain firms you may want to utilize and obtain advance consent to using such firms. Similarly, review and confirm any provisions requiring consent to incur defense costs and to settle claims or engage in settlement discussions.
Allegations of recklessness and fraud. Actions under section 10(b) of the Securities Exchange Act and Rule 10b-5 are predicated on allegations of fraud. Whether claims of securities fraud will implicate a fraud or "conduct" exclusion in a D&O policy will depend both on the nature of the allegations and the wording of the exclusion. For instance, it may be possible for a securities plaintiff to sustain their claim based on proof of recklessness alone, which may not constitute "deliberate fraud," the term used in many formulations of the conduct exclusion. Furthermore, conduct exclusions in most modern D&O insurance policies require a final adjudication of fraud (or other excluded conduct) before the insurer can apply the exclusion as a defense to coverage. Companies should ensure that the conduct exclusion in their D&O policies requires a final, non-appealable adjudication establishing that an insured committed a deliberate fraudulent or deliberate criminal act before the insurer can apply the exclusion.
Companies potentially at risk for securities or shareholder litigation arising out of COVID-19 should undertake a holistic review of their primary and excess D&O insurance policies, as well as other insurance policies in their portfolio. Timely notice should be provided under all potentially applicable insurance policies in the event of a demand or suit that may trigger coverage. If you have any questions about the content of this article or the current state of your company's coverage for COVID-19 liabilities, please contact one of the authors of this article or any other member of Reed Smith's Insurance Recovery Group.
- Douglas v. Norwegian Cruise Lines, et al., No. 20-cv-21107 (S.D. Fla.); McDermed v. Inovio Pharmaceuticals, Inc., No. 20-cv-1402 (E.D. Pa.).
- businessinsurance.com.
- See Order Under Section 36 of the Securities Exchange Act of 1934 Granting Exemptions from Specified Provisions of the Exchange Act and Certain Rules Thereunder, Release No. 34-88318 (SEC March 4, 2020), available at sec.gov/34-88318.
- See SEC Provides Conditional Regulatory Relief and Assistance for Companies Affected by the Coronavirus Disease 2019 (COVID-19), Press Release 2020-53 (SEC March 4, 2020), available at sec.gov/news/2020-53 (emphasis added).
- See Public Statement, Statement on Continued Dialogue with Audit Firm Representatives on Audit Quality in China and Other Emerging Markets; Coronavirus - Reporting Considerations and Potential Relief (SEC February 19, 2020), sec.gov/news.
- See, for example, washingtonpost.com.
- wsj.com.
Our Reed Smith Coronavirus team includes multidisciplinary lawyers from Asia, EME and the United States who stand ready to advise you on the issues above or others you may face related to COVID-19.
For more information on the legal and business implications of COVID-19, visit the Reed Smith Coronavirus (COVID-19) Resource Center or contact us at COVID-19@reedsmith.com.
Client Alert 2020-145
