News & Insights

Directors Governance Center

September 18, 2015

The DOJ’s New “Yates Memo” Increases the Need for and Scrutiny of Side A D&O Ins



Introduction

*Directors and officers continue to face increased risk of regulatory scrutiny, as highlighted by the Department of Justices recent Yates Memo requiring corporations to give up information on individual Ds and Os to get cooperation credit from the government.

*Companies and their boards should take a fresh look at their D&O insurance in light of the Yates Memo, particularly their Side A D&O insurance, which covers individuals for non-indemnifiable claims.

*A recurring question is whether to have the same insurance carrier in their primary A/B/C and Side A coverage towers. In the past, some companies and brokers have avoided overlap between the primary and Side A carriers.

*This article examines the concerns regarding overlapping carriers and concludes they are more theoretical than real, and should not always compel the conclusion that a company should avoid having the same carrier provide primary and Side A coverage. In many circumstances, insureds can benefit from using the same carrier in both positions.

The DOJs Yates Memo

On September 9, 2015, the U.S. Department of Justice issued a new policy memorandum entitled Individual Accountability for Corporate Wrongdoing, which is aimed at strengthening and prioritizing the Departments pursuit of individual misconduct in the course of corporate investigations. The DOJs new policy uses cooperation credit as both a carrot and a stick to incentivize corporations to provide evidence against individual wrongdoers as part of any plea negotiation. In public remarks accompanying the issuance of the memo, Deputy Attorney General Sally Quillian Yates summed up the new policy by explaining that [e]ffective today, if a company wants any consideration for its cooperation, it must give up the individuals, no matter where they sit within the company. [1]

The DOJs policy shift requiring more focus on the accountability of individual directors and officers follows changes in SEC enforcement policy in 2013 restricting neither admit nor deny settlements by requiring admissions of securities laws violations by individuals and corporations to resolve many SEC enforcement proceedings. [2]

These recent regulatory policy shifts portend increased government enforcement activity and shareholder litigation against individuals, triggering the need for companies and their directors and officers to carefully examine their D&O insurance protection. Corporate indemnification for governmental investigations of individuals which focus on potential criminal misconduct or securities laws violations can be withheld or refused, or may be unavailable from a cash-strapped company. In other situations, the companys own liability can exhaust the entire tower of A/B/C insurance, leaving nothing available to protect the individual Ds and Os. This has led many companies and boards to include in their D&O program Side A Difference-in-Conditions (DIC) insurance policies that provide coverage for the individual Ds and Os only when indemnification is not available or not provided for any reason.

These regulatory changes specifically targeting individual directors and officer will cause many companies to evaluate purchasing new or increased Side A coverage. A recurring question is whether it is appropriate for the same carrier to provide both the primary D&O policy and the lead Side A DIC policy. In the past, certain companies and brokers have been reluctant to place primary D&O insurance and lead Side A DIC coverage with the same carrier. The following discussion explores the stated concerns about having overlapping carriers for both primary A/B/C and lead Side A DIC coverage and concludes that such concerns may be overblown, particularly in light of potential benefits of consolidating such coverage with a single carrier.

A. Historical Objections to Having Overlapping Carriers for Primary and Side A DIC policies

In the past, some brokers and commentators have expressed the view that a companys lead Side A DIC policy should be purchased from a carrier which does not participate in the companys underlying D&O insurance program to maximize the benefit of the DIC coverage. Several explanations have been offered for this viewpoint, including the underlying primary insurers potential insolvency risk and the risk that having the same primary/DIC carrier could increase the risk that the primary carrier would deny or restrict coverage. Examination of these potential risks, however, suggests that they are more theoretical than real.

1. Potential Carrier Insolvency

The oft-cited risk with overlapping carriers is that the primary insurer could become insolvent, leaving the company not only bare at the primary layer level, but also without the additional layer of protection from the DIC policy dropping down to fill the hole left by the insolvent underlying carrier.

While diversification to lower the impact of potential insurer insolvency may be a reason to avoid overlapping carriers, many D&O insurance towers have the same carrier in more than one layer in the program, particularly where the financial strength of an overlapping carrier is perceived to present minimal insolvency risk. Over the last twenty years, brokers and insureds have refined and strengthened their processes for evaluating carrier financial strength and future claims paying ability. Insurance regulators have become more sophisticated and demanding in their approach to solvency requirements. Rating agencies have improved their processes and ability to accurately assess carrier financial strength and stability following criticisms they received in the aftermath of the Great Recession. While carrier solvency risk can never be eliminated, with improved tools and information for evaluating carrier insolvency risk, companies are growing increasingly comfortable with using the same financially strong carrier at more than one attachment point within the same insurance tower.

2. Increased Risk of Coverage Denial Under the Primary Policy

A second cited reason for why a company should avoid overlapping primary and DIC carriers is that using the same carrier for both coverages could create incentives for the carrier to deny coverage in the primary layer, and push any loss to the typically broader coverage provided in the Side A DIC layer. While the carrier might end up paying the full amount of its DIC limit, the thinking goes that because the common primary/DIC carrier would not subrogate against itself for wrongful denial of coverage in the primary layer, the carrier could reduce its overall loss exposure by trumping up reasons for denying coverage in the primary layer to contain the carriers loss to a single limit in the DIC layer, rather than potentially two limits in the primary and DIC layers. This risk of bad claim behavior would arguably be heightened where the carriers potential exposure in the primary layer exceeds its potential exposure in the Side A DIC tower (e.g., $10 million primary exposure, but only $5 million in the Side A DIC policy).

This potential risk, however, appears far more theoretical than real. Although a carrier might not subrogate against itself, any carrier wrongfully denying coverage faces the risk of direct action by its insureds, with the possibility of enhanced penalties under many states laws for bad faith coverage denials and other intentional misconduct. Moreover, marketplace realities substantially mitigate the concern over primary carriers with DIC positions playing games with coverage denials in the primary layer. News of a carrier engaging in dubious claims tactics to shift loss out of the primary layer to a DIC policy would travel quickly, and any carrier engaging in such bad claim behavior would be severely damaged in the marketplace. The cost in terms of reputational loss and diminished future policy sales would appear to far outweigh any benefit to an overlapping primary and DIC carrier from unwarranted and pre-textual coverage denials in the primary layer.

B. Potential Benefits of Overlapping Primary and Side A DIC Carriers

Notwithstanding prior conventional wisdom, upon closer examination, the reasons for avoiding overlapping carriers seem largely theoretical and contrary to marketplace realities. In assessing their D&O insurance programs, companies and their boards should consider whether the benefits of consolidating their primary and Side A DIC D&O coverages with a single carrier outweigh possible risks. These benefits include:

*Working with a financially strong carrier with a demonstrated track record of timely paying claims and that has historical familiarity with the company, its board, and its risk management team;

*Ease (and leverage) in negotiating policy language enhancements across both programs with a single carrier at the same time, which can include significantly broadening the terms of coverage under the primary policy;

*Greater likelihood of a good fit between policies and lower likelihood of coverage gaps;

*Greater consistency in claims handling and reduction in the risk of being caught between contradictory coverage positions taken by multiple carriers;

*The DIC insurers familiarity with the claims from day one;

*Greater efficiency in claim resolution resulting from having fewer carriers involved; and

*Potential for improved pricing and terms. [3]

C. Conclusion

DOJ and SEC regulators are under increased political pressure to hold directors and officers personally accountable for corporate misdeeds. Given state law limitations on indemnification for certain acts, it is more important than ever that Ds and Os have adequate D&O insurance covering defense costs, settlements, and judgments for potentially non-indemnifiable regulatory proceedings and related shareholder litigation, which includes robust and ample Side A insurance covering non-indemnifiable loss.

Companies and their boards examining their Side A options are increasingly faced with the issue of whether to allow overlap between the primary and Side A carriers. As explored above, the reasons that have been cited in the past for avoiding overlapping carriers should not always compel the conclusion that a company and its board should never consider having its primary A/B/C and lead Side A DIC coverages with a single carrier. In many circumstances, a company and its board could realize some benefit from using the same carrier in both positions. Companies and their risk management teams should avoid knee-jerk reactions to possible use of overlapping carriers, and should engage with their D&O insurance broker and legal counsel to assess the potential risks and benefits associated with consolidating primary and DIC coverages with a single carrier.

After a thorough examination of the market, if a company and its board can achieve the best coverage terms, pricing, and convenience by choosing a single financially healthy carrier to provide both primary and DIC coverages, a company and its board need not avoid doing so based solely on largely theoretical concerns about the potential risks associated with consolidating coverage.

[1] For a more in-depth look at the DOJs new policy which includes links to the policy memorandum and the interpretive remarks, see King & Spalding Client Alert: DOJ Announces New Policies Prioritizing Efforts to Pursue Individual Accountability for Corporate Wrongdoing, at http://www.kslaw.com/imageserver/KSPublic/library/publication/ca091115.pdf

[2] SeeKing & Spalding Partner Russell Ryan on Neither Admit Nor Deny and the SECs Burden of Proof, July 30, 2013 Corporate Crime Reporter,found at: http://www.corporatecrimereporter.com/news/200/russellryan07302013/#sthash.CgffSs2v.dpuf

[3] Consolidating coverage with a single carrier may or may not result in more competitive pricing and coverage terms on that ground alone. However, as explored above, a company should not submit to less competitive pricing and coverage terms for its primary A/B/C and lead Side A DIC coverage simply so it can split the coverage between two or more carriers.