Canadian Class Action Securities Claims: Legal Fees increase in Early Stage of Securities Claim

August 22, 2011

In Pennyfeather v Timminco Limited, here, the court determined that Plaintiff particulars can be compelled prior to the class action certification order, but, in turn, the statement of defence may be required prior to the order as well.

In the Pennyfeather case the plaintiff did not provide particulars, and argued that defendant’s request was premature because they are only necessary in order to plead a defence and this is not required pre-certification. He also argued that this would provide a “tactical manoeuvre for defendants, and would delay the hearing of the leave (to pursue claim under Part XXIII.1 of the Ontario Securities Act – secondary market misrepresentation) and certification motion, causing prejudice to the plaintiff and class members.”

Justice Perell decided that demanding plaintiff particulars, as well as the statement of defence pleadings, be closed “before the action moves to a certification motion” because, 1) the first of the five interdependent class action certification criteria, under s. 5 (1) of the Class Proceedings Act, 1992, is “show a cause of action”, and this would be resolved without the delay of the traditional challenge of the statement of claim, 2) early dismissal of the class would reduce costs, and, 3) it could reduce the common outcome of plaintiff’s request for leave to amend statement of claim.

If other judges apply this logic, early stage legal costs will be more expensive, but the result could be expedited decisions, earlier settlements, earlier dismissals, and shorter term distraction of management, directors and financial analysts.

This is a big case, as it pits Won Kim of Kim Orr against Alan D’Silva of Stikeman Elliott. A number of months ago both individuals were on a panel discussing Bill 198 and Secondary Market Liability and Class Actions Securities Claims, hosted by Chartis. A few of the developments they discussed included, 1) the current Canadian court split decisions on plaintiffs getting access to the defendant’s Directors’ and Officers’ liability policies, 2) the extraordinary costs of e-discovery, and 3) the significant number of Canadian class action securities claims.

The underlying action in Pennyfeather is a $520 million class action, launched in May 2009 against Timminco and certain officers and directors. It alleges that they knowingly mislead investors about growth and profit potential between March and November
2008, specifically regarding its solar-grade silicon. The case was awarded to Kim Orr in late 2009.

The D&O insurance implication are very interesting. The 2009 Management Information Circular suggested their D&O policy had a policy period of May 1 2008 to May 1 2009, with a $40 million limit and $100,000 deductible, as well as a $5 million excess Side A DIC (which commonly is a policy where the limit of liability is dedicated to non-indemnified claims against individual directors and officers,  written on a difference in conditions basis whereby the terms of the policy are broader than the underlying D&O policy.) Some information circulars will mention a split deductible for “securities” claims and for non-securities claims, which would give a good indication that the underlying policy provides considerable extensions to the corporate entity, thereby subjecting the policy to the risk of limit erosion or exhaustion to the detriment of individual Insured Persons. This circular provides no such guidance.

The 2010 circular suggests the same structure was renewed in 2009-2010 with the addition of a new additional excess limit of $5 million Side A DIC available only to independent directors. The premium increase year over year (and then again in 2011) was not extraordinary, which could suggest that the 2008-2009 policy was the one triggered by this claim. Under most common D&O policies that means that this is the only policy that would respond to all future loss “based upon, arising from, or in consequence of the prior noticed claim, including any future claims based on interrelated wrongful acts”.

A common reaction of D&O insurers to a potential limit loss claim is to extend limits of liability with each subsequent renewal and not provide a “refreshed” policy. However, even if insurers do provide a new policy, with new limits, it is rare that those new limits will have any exposure to an existing claim or related downstream claims.

Not knowing the level of “Entity Coverage” in the underlying D&O policy it is difficult to comment on the adequacy of limit in the first triggered policy. But, when the share price is $30 in mid 2008, $3 at the end of 2008, and 30 cents in 2011, and there are 196 million shares issued and outstanding, it would take an army of lawyers to make me comfortable that $45 million is going to carry this litigation over the many years it may have left.

Directors of all public companies should be requesting from their insurance broker commentary on the extent of “limit sharing” in their D&O program. The answer should not stop at Insuring Clause 3 “Entity Coverage for Securities Claims”, but should consider all extensions, endorsements, definitions and exclusion ‘carve-backs.’ Directors should also look at the precedent setting claims and seek outside legal advice on the potential cost to defend these claims and litigate their various motions and counter claims. Then directors should turn their focus internally to determine their unique circumstances to help determine appropriate limits of liability based on their priorities and insurance coverage structure. I have provided a few ideas in an earlier blog post, here.

Be wary of insurers bearing gifts, because a broad policy is not necessarily beneficial to all stakeholders in that policy. Insurers underwrite policies knowing and accepting the possibility of a limit loss. If they are going to suffer a limit loss no matter what the extent of coverage (insuring agreement A, B, C, D or 1,2,3,4) it might just be in their best interest to make the policy extremely broad, extract to most premium they can, and write their cheque very early in the claim process. Payment of the limit usually terminates their involvement in the litigation (except perhaps in Quebec where they will continuously apply to the court to end their ‘defence outside the limit’ costs), and therefore no more distraction or claim management costs, and a big pat on (their own) back for paying a limit loss.

There are many competing and conflicting interests in a D&O policy, and the only way to navigate that potential mine field is to determine coverage priorities before the policy is purchased or renewed. Entity Coverage is an extremely valuable use of premium dollars, but that value might inure only to the shareholders who are suing you.

Greg Shields is a D&O, Professional Liability and Crime insurance specialist and a Partner at the University and Dundas (Toronto) branch of Mitchell Sandham Insurance Services. He can be reached at gshields@mitchellsandham.com,  416 862-5626, or Skype at risk.first. And more details of risk and loss control can be found on the Mitchell Sandham blog at https://mitchellsandham.wordpress.com/

CAUTION: This article does not constitute a legal opinion or insurance advice and must not be construed as such. It is important to always consult a registered and truly independent insurance broker and a lawyer who is a member of the Bar or Law Society of the relevant jurisdiction with regard to this material before making any insurance or legal decisions. All material is copyrighted by Mitchell Sandham Inc. and may not be reproduced in any form for commercial purposes without the express written consent of Mitchell Sandham Inc. Anyone seeking to link this document from any external website must receive the consent of Mitchell Sandham Inc. by sending an e-mail to gshields@mitchellsandham.com.


Long Tail Liability for Canadian Directors and Officers

August 4, 2011

This new case, based on old alleged wrongful acts, hits home because it is a Canadian Company in the insurance industry that is active in the US but not listed on a regulated US exchange. The case involves a July 2011 class action securities suit against Fairfax
Financial Holdings Limited (USA) and its Pink Sheet OTCBB trading, here. The allegations are common “violations of the Securities Act of 1933 and the Securities Exchange Act of 1934” and issuing “materially false and misleading statements regarding the Company’s business practices and financial results.” These allegations surround certain reinsurance contracts and the alleged
concealment of its lack of liquidity. Even the significant alleged financial damage (“a decline in market capitalization of approximately $300 million”), and the lead plaintiff being a pension fund, is not a surprise in the securities class action world. The interesting thing is the class period of May 21, 2003 to March 22, 2006. This is a great example of the very long period that can exist between the alleged “wrongful act” and the ultimate litigation and resulting claim that is noticed to the insurer.

This case is also a great example of systemic risk in the D&O insurance business. The Fairfax case is not unique because “in November 2004 the SEC and Attorney General for the State of New York began inquiries into the use of so-called “finite reinsurance” contracts” and launched a number of investigations against many well-known industry players.

Systemic risk in the long-tail, high-severity products should be a key concern for industry-based insurance programs (reciprocals, risk retention groups, group captives.) These programs may have value as a risk-management, defence management, deductible/retention management, political lobby or loss control tool, but should be used very carefully as a pure risk transfer vehicle.

The risk management spin: the plaintiff lawyer’s website, Robbins Geller Rudman & Dowd LLP, here, provides the complaint, here, which details the alleged “gimmicks” used to “artificially inflate the value of its assets” as well as the “lack of internal controls.” Complaints and legal decisions can present useful information for corporate governance risk identification and loss control activities, and with every public case there comes an increased expectation that other boards and senior management will learn for such cases. Here are a few of the governance issues I took from this case:

  1. Procedures to assess whether finite reinsurance contracts meet the prerequisites for risk transfer,
  2. Product inventory and coverage / risk explanations and evaluations of traditional and non-traditional products,
  3. Use of “reinsurance accounting” or “deposit accounting” and the risk transfer test, and understanding of the local accounting practices,
  4. Evaluation of management assumptions for reporting of profit or loss in foreign private investments,
  5. Evaluation of consolidated financial reporting,
  6. Controls for reporting of intercompany purchases and sales, write-offs, advances and foreign currency accounting, receivables,
  7. Adequate internal controls and (discoverable) communication regarding those controls, including bid/quote tracking, expense guidelines,
  8. Public statement oversight for accuracy of details and forward-looking statements,

The insurance spin: don’t let your insurance broker convince you that the only way to get coverage for a securities claim is to purchase “securities coverage” or the “side C” insuring agreement as part of your directors’ and officers’ liability insurance program. This coverage is very valuable, but that value may favour of the corporate entity. Depending on the structure and fine details of your D&O insurance program, the addition of “securities coverage” could be damaging to individual directors and officers of the organization.

The Towers Watson, 2010 Directors and Officers Liability Survey, here, suggested that 54% of respondents did not conduct any independent review of their D&O liability policy. The survey did not comment on the breadth or value of that independent review done for the other 46%. My question would be if that review included all areas in the policy that presented a risk of limit erosion or limit exhaustion to the detriment of individual directors and officers (not just “insuring clauses” or “definition of insured”, but “severability”, “allocation”, “predetermined defence costs”, “exceptions to exclusions”, “final adjudication in the conduct exclusions”.) My assumed answer “no in 98% of the 46%”, because most insurance brokers will provide a “free audit” of an insurance program, and in most of those cases, you get what you pay for.

The survey also suggests that 60% of participants purchased Side A/B/C coverage, and 14% were not sure how their program was structured. 24% said their coverage was blended with other non-D&O coverage like employment practices and fiduciary liability (but this could also include professional liability, crime, and others, even workers comp.) This blending of “first party” and “third party” claim, “entity” and “individual” coverage, and “claims-made (and reported)” and “occurrence/sustained” triggers can create very significant complications for eventual claim handling.

On the issue of exclusive policy limits for independent/outside directors only 4% said there was some such coverage in place. 80% of public company respondents said they purchased an “Excess Side A” or and “Excess Side A with Difference In Conditions (DIC)” features. Note, Side A is the “non-indemnified” loss insuring agreement for individual insured persons, it is not specific to independent or outside directors.

The Fairfax case could become a very good example for insurance company risk management, as the case may be part D&O, party Entity Coverage for Securities Claims, part Insurance Company Errors and Omissions (professional liability), and part Outside Directorship Liability insurance. The insurance risk is that the defence costs, judgments and/or settlement loss may be only partially or not at all covered by any of these policies. But the reality is that though the class action securities litigation risk may be very public, the resulting insurance risk will not likely see the light of day. The lack of publicity of insurance risk means the learning opportunity and loss control lessons are much more difficult to find.

If you would like to learn more about insurance risk, securities class action risk, D&O/E&O/Fidelity insurance or loss control for publicly traded companies or insurance companies; or if you would like to have an in-depth review of your insurance program,
please contact me directly.

Greg Shields is a D&O, Professional Liability and Crime insurance specialist and a Partner at the University and Dundas (Toronto) branch of Mitchell Sandham Insurance Services. He can be reached at gshields@mitchellsandham.com,  416 862-5626, or Skype at risk.first. And more details of risk and loss control can be found on the Mitchell Sandham blog at https://mitchellsandham.wordpress.com/

CAUTION: This article does not constitute a legal opinion or insurance advice and must not be construed as such. It is important to always consult a registered and truly independent insurance broker and a lawyer who is a member of the Bar or Law Society of the relevant jurisdiction with regard to this material before making any insurance or legal decisions. All material is copyrighted by Mitchell Sandham Inc. and may not be reproduced in any form for commercial purposes without the express written consent of Mitchell Sandham Inc. Anyone seeking to link this document from any external website must receive the consent of Mitchell Sandham Inc. by sending an e-mail to gshields@mitchellsandham.com.