Shareholder Securities Lawsuits Against Directors and Officers on the Rise with COVID-19
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December 23, 2020 | Expert Institute
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Thanks to Anjelica Cappellino, J.D.
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The COVID-19 pandemic has damaged businesses around the globe, causing financial disaster and bankruptcy across many industries. As a company’s survival is now based on their ability to make a profit in the midst of COVID-19, disclosures to its shareholders concerning pandemic survival plans are of the utmost importance. As COVID-19 continues to ravage businesses, there has been an uptick in shareholder lawsuits alleging securities violations in connection to representations—or misrepresentations—made by a company regarding its COVID-19 response, with nearly 20 cases currently pending.
In turn, directors and officers (D&O) liability insurance—insurance protecting the personal assets of corporate directors and officers from lawsuits—is at the forefront of concerns. Whether D&O policies sufficiently protect the corporate players involved in COVID-19-related securities violations is a question still awaiting answers as these cases make their way through the courts.
What is D&O Insurance?
Directors and officers liability insurance protects a company’s directors and officers in the event that they are personally sued alleging they acting wrongfully in managing the company. D&O policies act as indemnification provisions, holding directors and officers harmless for any losses caused while also covering legal fees, settlements, and other costs associated with litigation. These policies also provide coverage when the insured company cannot indemnify the director or officer due to applicable law, company policy, or financial condition.
Many D&O policies provide entity coverage, which insures any claims made against the company directly. For public companies, this type of coverage is typically limited to securities claims, although the characterization of securities claims is usually broadly defined “as any and all claims involving an actual or alleged violation of state or federal securities laws.” A D&O policy with entity coverage may also provide protection against other claims, such as shareholder derivative demands, breach of fiduciary duty, or issues related to subpoenas and government or regulatory investigations.
Pandemic-Related Securities Lawsuits
The first securities lawsuit filed due to COVID-19 was against Norwegian Cruise Lines Holdings, Ltd. and its officers. Its shareholders allege violations of the Securities and Exchange Act of 1934 due to false and misleading statements made by the company concerning the safety of its cruise ships during the pandemic. According to leaked emails, the cruise line directed its sales staff to lie to its customers by playing down the severity of the virus and referring to it as “an overhyped pandemic scare.” As an immediate result of these misrepresentations, the company’s stock price fell by more than 50%.
In another suit, the shareholders of a molecular diagnostics company, Co-Diagnostics, Inc. allege the directors and officers, including the Chief Technology Officer, violated securities laws when they falsely stated the company’s COVID-19 tests were 100% accurate. In actuality, according to the complaint, the tests were materially less than completely accurate, and that the company’s misrepresentations were exposed when regulatory authorities contradicted the accuracy claims.
Zoom Video Communications, Inc. also faces a shareholder class action suit, alleging that the popular video conferencing app—upon which so many have relied during the pandemic—misrepresented its privacy standards and failed to disclose its video conferences are not end-to-end encrypted. These security shortcomings have resulted in uninvited participants appearing in supposedly secure meetings. Zoom’s Chief Executive Officer responded to the suit, admitting that the company had fallen short of its privacy standards and was attempting to fix the problem. But to the shareholders, the damage was already done. Upon media reports exposing the privacy flaws, the company’s stock quickly plummeted.
The Viability of D&O Claims During COVID-19
The securities claims that are covered under a D&O policy typically protect both the company and its individual officers and directors, including protections against misstatements made in the course of business operations. In the above lawsuits, the allegations of false statements would typically qualify for security-related entity coverage. However, allegations of fraud and deceit would fall outside the scope of such entity coverage as well as D&O policies, as conduct exclusion clauses prohibit coverage for intentionally dishonest conduct. Whether conduct rose to this level would be determined by a final adjudication—i.e. a trial. Therefore, officers and directors would still be entitled to defense costs. And if a settlement is reached prior to adjudication, the conduct exclusion does not apply and the insurer must indemnify the company for the settlement. In light of the broadness of many D&O policies, it can be argued that the policies will insure against the recent pandemic-related securities claims.
According to an AM Best Special Report surveying members of the Professional Liability Underwriting Society, directors and officers liability has been the most affected area of professional liability insurance. Two-thirds of respondents indicated D&O has been the most severely impacted by COVID-19, with medical professional liability coming in second. Accordingly, there is increased pressure on D&O renewal pricing and more restrictive terms and conditions. If the insurance market is any indication, securities claims are still cause for concern in the age of COVID-19.
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