By Keenan, R. Mark
Strategic Finance , Vol. 84, No. 11
Does it come as a surprise to you that over 40% of all outside directors of Fortune 1,000 companies have been sued in connection with their board service? Does it surprise you that claims against directors of small, closely held corporations are also a common problem? Or that directors of charitable organizations aren't immune from suit?
In the aftermath of Enron, WorldCom, and the other miscreant corporations, hundreds of class action securities claims have been filed along with numerous indictments--both state and federal. Meanwhile, the rules have literally changed. The federal government enacted the Sarbanes-Oxley Act to clean up corporate management, and numerous rule changes have since been endorsed by the New York Stock Exchange, the American Stock Exchange, NASDAQ, and others.
While significantly increasing the corporate governance responsibilities of officers and directors--particularly independent directors--these regulations have added new criminal provisions, increased the penalties for violations of existing securities laws, and dramatically increased directors' and officers' exposures to civil sanctions.
New corporate responsibilities include (among others):
* The CEO and CFO are required to personally certify financial reports filed with the Securities & Exchange Commission (Sarbanes-Oxley [section]302(a)).
* An audit committee of independent directors must be established and will be directly responsible for the appointment, compensation, and oversight of that company's auditors.
* Executives will be required under certain circumstances to reimburse any equity-based compensation or other bonuses or stock profits they receive if the company is required to restate its financial statements.
* Audit committees must approve all related-party transactions.
* Shareholder approval is required for all stock option plans involving officers or directors.
* Going-concern opinions, board changes and vacancies, and any warnings received for corporate governance violations must be disclosed.
* New board committees of independent directors are responsible for, among other things, director nomination and compensation.
* Codes of conduct are required to be established addressing conflicts of interest, compliance with applicable laws, and enforcement mechanisms.
* Accelerated disclosure of insider transactions is mandated.
* Director "continuing education" is mandated.
* A new crime called "securities fraud" has been enacted (Sarbanes-Oxley [section]807).
* A new obstruction-of-justice offense was established for the destruction of, among other things, corporate audit records (Sarbanes-Oxley [section]802).
* New criminal penalties for retaliation against any whistle-blower in a federal criminal proceeding were enacted (Sarbanes-Oxley [section]1107).
With these new responsibilities and sanctions, there's an even greater likelihood that an officer and director will be sued no matter how spotless his or her performance. Will insurance cover your potential liabilities?
DIRECTORS' AND OFFICERS' INSURANCE
The primary vehicle for protecting a director or officer is the specialized insurance policy known as Directors' and Officers' (D&O) Liability insurance. The D&O policy protects directors and officers against claims alleging wrongful acts, i.e., any negligent act, error or omission, or breach of duty committed by the director or officer in the discharge of his or her duties and solely in his or her capacity as a director or officer.
But it's extremely important to understand what a D&O policy covers and what it doesn't.
A D&O policy is designed to have a limited scope. As a result, assertions of claims under D&O policies frequently lead to coverage disputes. While insurance companies are familiar with the types of insurance issues that will arise when a D&O claim is submitted, policyholders aren't. …