Demystifying D&O Liability & Insurance: Numbers, Basics, & Trends

1. Carol A.N. Zacharias Deputy General Counsel ACE North America Leslie A. Lamb Director of Global Risk Management Cisco Systems, Inc. Demystifying D&O Liability & Insurance:Numbers, Basics, & Trends Edward M. Joyce Partner Jones Day

2. The views expressed by the speakers are not those of the speaker’s employer, firm, clients, or any other organization.  The opinions expressed do not constitute legal or risk management advice.  The views discussed are for educational purposes only, and provided only for use during this session.

3. Agenda • The Numbers • The Basics of D&O Coverage • International Coverage • Current Trends in D&O Liability

4. The Numbers: SCA Filings Number of Securities Class Action Filings, 1997-2013 (Average: 191) Cornerstone Research, “Securities Class Action Filings: 2013 Year in Review”, www.cornerstone.com.

5. The Numbers: SCA Filings • Number of Companies Listed on U.S. Exchanges • 1997-2013 • Listings • 1997: Over 8000 • 2013: Just over 4,000 • 46% decline • Declined 6% annually 1998-2004 • Declined 3% annual decline thereafter Cornerstone Research, “Securities Class Action Filings: 2013 Year in Review”, www.cornerstone.com.

6. The Numbers: SCA Filings Cornerstone Research, “Securities Class Action Filings: 2013 Year in Review”, www.cornerstone.com.

7. The Numbers: SCA Filings Filings By Statute (Percentage of Total Filings) Percentages do not add to 100% as complaints may include multiple statutory allegations Cornerstone Research, “Securities Class Action Filings: 2013 Year in Review”, ww.cornerstone.com

8. The Numbers: SCA Filings Filings by Allegations (Percentage of Total Filings1) 1Percentages do not add up to 100% as complaints may include multiple allegations 2Allegations represent GAAP allegations even if GAAP not expressly referenced 3First identified complaint alleges GAAP violation even if GAAP not expressly referenced, and refers to restatement announcement 4First identified complaint t alleges internal control weakness over financial reporting 5First identified complaint alleges internal control weakness over financial reporting and refers to an internal controls weakness announcement 4 4 Cornerstone Research, “Securities Class Action Filings: 2013 Year in Review”, ww.cornerstone.com Cornerstone Research, “Securities Class Action Filings: 2013 Year in Review”, www.cornerstone.com.

9. The Numbers: SCA Filings Defendants in Securities Class Actions Note: Percentages are for cases filed between 2000 and 2003. Michael Klausner and Jason Hegland, 2010, “How protective is D&O insurance in securities class actions? - Part I”, Professional Liability Underwriting Society Journal, Vol. 23, No. 2, pp. 1-4, cited by Jason D. Schloetzer, ”Corporate Misconduct and the Market for Directorships”, Director Notes, No. DN-016, November 2010.

10. The Numbers: SCA Settlements Median Settlements 2013 • Cases without public pension fund lead plaintiff: $ 3mm • Cases with public pension fund as lead plaintiff: $23mm • 43% of settling cases had public pension fund as lead plaintiff: 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Cornerstone Research, “Securities Class Action Settlements: 2013 Review and Analysis”, www.cornerstone.com.

11. The Numbers: SCA Settlements Settlements by Select Industry Sectors 1996-2013 (Dollars in Millions) Cornerstone Research, “Securities Class Action Settlements: 2013 Review and Analysis”, www.cornerstone.com.

12. The Numbers: SCA Settlements • Settlements by Select Industry Sectors • Credit crisis cases settling out: • 2011: 18% 2012: 30% 2013: 22% • Shift of settlements to pharmaceutical sector: • 1996-2012: 6% 2013: 18% Cornerstone Research, “Securities Class Action Settlements: 2013 Review and Analysis”, www.cornerstone.com.

13. The Numbers: SCA Settlements Settlements By Statutory Basis (Dollars in Millions)

14. Agenda • The Numbers • The Basics of D&O Coverage • International Coverage • Current Trends in D&O Liability

15. Types of D&O Coverage • Side A: • Covers losses of D&Os which are not indemnified by the company • No coverage for claims against the entity • Side B: • Reimburses entity for its indemnification of losses incurred by D&Os • No coverage for claims against the entity

16. Types of D&O Coverage Side C: Covers losses of entity on account of claims against the entity No coverage for losses of D&Os Typically limited to securities claims if the entity is a public company; no such limitation if the entity is a private or not-for-profit company.

17. Types of D&O Coverage Side A Policies: Non-indemnifiable loss: Derivative settlements or judgments (circular) Some statutory violations (FCPA; adjudicated securities violations) Non-indemnified loss: Changes to right to indemnity under law/articles Financial inability Polarized former D&O

18. Types of D&O Coverage Side A Policies: Non-dilution of limits by entity Broad coverage (DIC; exclusions)

19. “Claim”

20. “Claim”

21. “Claim”

22. “Claim”

23. “Claim”

24. “Claim”

25. “Claim”

26. “Claim”

27. “Claim”

28. “Claim” • SEC investigation may not be a claim or a securities claim: • Binding adjudication for relief not possible • Insured person may not be identified as object of potential proceeding • May be excluded by policy language Foster v. Summit Med. Sys. Inc., 601 N.W.2d 350 (Minn. App. 2000), Office Depot, Inc. v. National Union Fire Ins. Co. of Pittsburgh, Pa., 734 F. Supp. 2d 1304 (S.D. Fla. 2010), aff’d 453 F. App’x 871 (11th Cir. 2011)

29. “Claim” • SEC investigation may be a claim: • Policy language expressly covers informal inquiries • SEC subpoenas and orders seeking testimony and documents are ‘demands’ for ‘relief’ • Minuteman Int’l, Inc. v. Great Am. Ins. Co., 2004 U.S. Dist. LEXIS 4660 (N.D. Ill. March 18, 2004), MBIA, Inc. v. Fed. Ins. Co., 2009 U.S.Dist. LEXIS 124335 (S.D.N.Y. Dec. 30, 2009), aff’d in part, 652 F.3d 152 (2d Cir. 2011)

30. “Claim” • State criminal investigation may be a claim: • Threat of criminal indictment constitutes a demand for non-monetary relief, in policy definition • Investigation constitutes a criminal proceeding as well as a state or local proceeding, in policy definition • Gold Tip, LLC v. Carolina Cas. Ins. Co., 2012 U.S. Dist. LEXIS 120166 (D. Utah Aug. 23, 2012)

31. “Claim” • Grand jury proceedings may not be a claim: • No adjudication for liability for damages or other relief. • No indictment or demand for relief • No allegation of wrongful act of insured JB Oxford Holdings, Inc. v. Certain Underwriters at Lloyd’s, London, 2001 Cal. App. Unpub. LEXIS 111 (Cal. Ct. App. Oct. 5, 2001); Diamond Glass Cos., Inc. v. Twin City Fire Ins. Co., 2008 U.S. Dist. LEXIS 86752 (S.D.N.Y. Aug. 18, 2008); Fed. Ins. Co. v. Illinois Funeral Director’s Ass’n, 2010 U.S. Dist. LEXIS 129747 (N.D. Ill. Dec. 8, 2010)

32. “Loss”

33. “Loss” • Disgorgement: Return to shareholders of the value of overpayment for stock • Level 3 Communications, Inc. v. Federal Insurance Company, 272 F.3d 908 (7th Cir. 2001) and progeny

34. “Loss” • Disgorgement: Settlement with the SEC – for overpayment by shareholders • Vigilant Insurance Company v. Credit Suisse First Boston, 800 N.Y.S.2d 358 (N.Y. Sup. Ct. 2003), aff’d on appeal, 782 N.Y.S.2d 19 (N.Y. App. Div. 2004)

35. “Loss” • Disgorgement: Express disavowals in settlement agreement • CNL Hotels & Resorts, Inc. v. Houston Cas. Co., 505 F. Supp. 2d 1317 (M.D. Fla. 2007)

36. “Loss” • Disgorgement: Coverage for associated defense costs • Millennium Partners, L.P. v. Select Ins. Co., 882 N.Y.S.2d 849 (N.Y. Sup. Ct. 2009)

37. “Loss” • Disgorgement: Settlement with the SEC – for improper profits acquired by customers • J.P. Morgan Sec. Inc. v. Vigilant Ins. Co., 21 N.Y.3d 324 (N.Y. 2013)

38. Executive Compensation

39. Interrelated Wrongful Acts • Policy definitions: • ‘Causally connected’ • ‘Common nexus’

40. Interrelated Wrongful Acts • Impact: • Late notice

41. Interrelated Wrongful Acts • Impact: • Late notice • Prior claim

42. Interrelated Wrongful Acts • Impact: • Late notice • Prior claim • Multiple limits

43. Interrelated Wrongful Acts • Impact: • Late notice • Prior claim • Multiple limits • Multiple retentions

44. Interrelated Wrongful Acts • Impact: • Late notice • Prior claim • Multiple limits • Multiple retentions • Multiple policy terms and conditions

45. Personal Conduct Exclusions • Illegal or improper profit/advantage • “arising out of, based upon or attributable to the gaining in fact of any profit or advantage to which the Insured was not legally entitled“ • Fraud, willful violations or criminal conduct • “arising out of, based upon or attributable to the committing in fact of any deliberate criminal or deliberate fraudulent act by the Insured”

46. Personal Conduct Exclusions • “Final adjudication” v. “in fact” • “final adjudication” – established in the underlying action, not the insurance coverage action • “in fact” – established by any fact finder • Non-imputation clause (severability) • facts pertaining to or knowledge possessed by one insured shall not imputed to another insured

47. Other Exclusions • Insured v. insured exclusion • excludes any claim “brought or maintained by or on behalf of any insured” • exceptions: • shareholder derivative claims • claims by bankruptcy trustee/examiner or other officials appointed by court re bankrupt estate • whistleblower claims – maybe?

48. Other Exclusions • Contractual liability exclusion • “for any actual or alleged liability of any Insured under any express contract or agreement” • exception/carve back for defense costs – maybe • insurer funds uncovered settlement to avoid further defense costs • future estimated defense costs if no settlement • allocation provisions promising 100% defense costs

49. Advancement of Defense Costs • Payment of defense costs per policy provisions • Allocation determination – who controls • Pay on a “contemporaneous basis” – means what? • Failure to make timely payments – breach? • Duty to defend v. advancement of defense costs • Gon v. First State Ins. Co. (9th Cir. 1989); Federal Ins. Co. v. Kozlowski (N.Y. App. Div. 1st Dept. 2005)

50. Excess • Limits: • Failure of primary to pay full limit • Insolvency of underlying causing failure to pay full limit • Ability of insured to pay gap