Securities Litigation and D&O Insurance: Understanding Your Exposure and Minimizing Your Risk Nina (Nicki) Locker Steven Guggenheim Michael Winograd

The “Truth” Is Revealed 2

The Basics 3 Who are the plaintiffs? –Investors who purchased during the class period and held through the bad news What is their basic claim? –Company made a false statement upon which plaintiffs relied in purchasing or selling the Company’s stock –Section 11 versus 10b-5  Intent to defraud  Circumstantial evidence enough Who do plaintiffs typically sue? –Company, CEO,CFO –Directors?

What Plaintiffs Look For Bad News + Significant stock drop + Insider trading/offering = 4

A Really Bad Week For MyStockDropped.com Day 1 – Contrary to company’s revenue recognition policy, major reseller claims no obligation to pay until resale; GC investigates Day 2 – Reseller sends GC supporting its claim Day 3 – Sales person admits agreement but claims isolated instance Day 4 – Earnings announcement and conference call 5

A Really Bad Week (cont’d) Day 5 – GC’s investigation uncovers evidence suggesting widespread practice and raising questions regarding CFO knowledge Day 6 – Audit Committee retains regular outside counsel to conduct investigation Day 7 – CEO sells 50,000 shares 6

The Aftermath Two year restatement of company’s financial statements Government commences investigation Shareholders file securities class action lawsuit 7

What Went Wrong? Problem – Disclosures mishandled Solution – Best practices for disclosing bad news –Don’t “spin” news –Provide updates when necessary –Stick to historical facts –Avoid premature explanations –Designate single spokesperson 8

What Went Wrong? Problem – No insider trading policies Solution – Control insider stock sales –Insider trading policy  Prohibition against trading on the basis of material, non-public information  Procedures to communicate policy to directors, officers and employees  Pre-clearance  Blackout periods  Compliance officer –Proactively closing trading window –10b5-1 plans 9

What Went Wrong? Problem – Investigative counsel lacked credibility and objectivity Solution – Carefully consider who should conduct investigation –Inside counsel, regular outside counsel vs. independent counsel  Relationship of counsel to issues under review  Seniority of employees potentially involved  Seriousness and nature of suspected activity 10

What Went Wrong? Problem – s that make a bad situation worse –Board member to Board member “I had concerns about his [the CFO’s] integrity from the outset. But I was overruled. Turns out I was right. ” Solution – Educate directors, officers and employees to treat with caution –Limit discussion of sensitive topics via –Avoid post-mortems –Understand that /instant messaging creates a permanent message 11

You Got Sued: Now What? Call your Board Notify your insurance broker/insurance consultant Notify your outside counsel/auditors Preserve your documents Consider communication to employees and customers Hurry up and wait 12

Selection of Limits: MyStockDropped.Com 13

Directors and Officers Insurance Hot Issues: Dishonesty Exclusion Problem: Carrier can deny coverage for “dishonest conduct” Solution: Language requiring some kind of “final adjudication” Pitfalls: Avoid soft or vague triggers 14

Directors and Officers Insurance Hot Issues: Severability Problem: An insurer can rescind (revoke) the policy against all insured persons if there are false statements in the insurance application. Solution: Language limiting rescission to those who knew of the false statements and forcing the insurer to sue to rescind. Pitfalls: Avoid so-called “non-rescindable” endorsements. 15

Directors and Officers Insurance Hot Issues: “Exhaustion” Problem: Language in excess policy may allow excess insurer to avoid paying under policy if underlying insurer paid less than its full policy limits Solution: Language specifically allowing insured to pay reminder of underlying limits where underlying insurer fails to pay Pitfalls: Avoid language that requires “admission of liability” by underlying insurer or language which only requires payment by excess carrier under limited circumstances 16

Out of Pocket Contributions by Directors and Officers Empirical studies show that out-of pocket contributions are still rare –Officers less than 5% of settlements –Outside Directors less than 1% of settlements 17

Out of Pocket Contributions by Directors and Officers – The Perfect Storm Factors –Bankruptcy –Inadequate insurance –Strong merits  Section 11  SEC imposed penalties  Suspicious insider selling –Wealthy directors Enron, Worldcom 18