How to protect a publicly listed company from costly D&O litigation

According to Woodruff Sawyer’s data analysis, securities class action lawsuit filings are increasing along with cost settlements.

“We’re getting to a stage where cases are taking longer to resolve, and the reason each individual case may take longer to resolve may be unique,” said Priya Huskins (pictured), senior who is vice president of Woodruff Sawyer’s management responsibility.

“What we know is that the duration of a case is related to the severity of the case, so it’s not surprising that they settle for more dollars.”

To avoid costly settlements, having strong risk management and prevention understanding can greatly reduce the financial impact of any potential litigation scenario.

During a conversation with Insurance BusinessHuskins reveals what questions and concerns should be top of mind for an insurance professional dealing with C-suite level clients and why newly publicized businesses are more susceptible to lawsuits than mature companies.

Understanding corporate governance

One of the most effective ways to avoid litigation or reduce its costs is to have a solid understanding of corporate governance.

“The first thing I ask a corporation is if it has adopted things like state choice of forum, and federal choice of forum provisions. I mean the certificate of incorporation or the bylaws, which can help to make the litigation that comes more efficient,” said Huskins.

When the Securities and Exchange Commission (SEC), the governing body that regulates all public companies in the US, issues new regulations for compliance, those who are slow to adopt these provisions creates an opportunity for shareholders and others to sue.

“This creates new exposures and vulnerabilities,” Huskins said.

For those corporations that do not take immediate or preparatory steps to comply with the SEC, cases may appear in federal and state courts, effectively doubling the exposure to litigation for the same issue.

“To avoid costly duplicative litigation, a company may want to adopt federal choice of forum provisions,” Huskins said.

“Those provisions would cause litigation over the registration statement to be in federal court, not in one or more of the 50 state courts.”

Have proper controls and procedures in place

Updating the corporate bylaws and the certificate of incorporation is the first step in strengthening a company against possible lawsuits.

The rest, as Huskins says, is about having appropriate controls and procedures in place.

“If you happen to engage in bare-bones short selling, that could create an opportunity for a plaintiff to say that your sale was timed when the market was high,” Huskins said. “If the stock falls after that, they can argue that the official is aiding in a fraud to keep the stock price up.”

To avoid this scenario, it is important to implement the SEC’s updated rules on 10b5-1 trading plans that were recently released.

Finally, Huskins advises that a company review its disclosure committee.

“Public companies often have information coming to them or generate their own information,” he said.

Thus, it is important that these committees are staffed with a group of people who get the right information brought to them so that they can make informed choices about what is shared with the public.

Growing pains

While litigation can occur in companies of any maturity, trends show that newer IPOs have an increased frequency of litigation, according to Woodruff Sawyer’s report.

“A company is more likely to be sued in the first three years of a public company’s life than at any other time,” he said.

Section 11 liability, which is directly related to an IPO registration statement that contains a material false statement or material omission, is easier for a plaintiff to prove.

“If you have a new public company, if a company is trading below the IPO price, then that creates an opportunity for the plaintiffs to say you lied in your registration statement,” he said. Huskins.

This can be related to newly public companies with a less mature management team or from a period of rapid growth.

“The less skilled the team, the more unpredictable the business,” Huskins said.

Thus, having strong D&O protection is a sure way to protect a company for the vulnerabilities that come with an IPO.

“There’s always the potential for fire, so it’s a good idea to have insurance in case a fire does strike,” Huskins said.