Skittish Audit Committees
Still those directors — particularly on the audit committee — are plenty concerned about protecting their assets. After all, Sarbanes-Oxley has given them some hefty new powers, including hiring, firing, and oversight of independent auditors. They must also be up on the critical accounting policies and practices used by the auditor. And since their new authority and knowledge are bound to make them seem more like corporate insiders, they’re increasingly likely to be defendants in court.
So besides keeping their coverage intact, senior managers face the added burden of assuring audit committee members that despite the increased risk they face, they will be made whole if they are sued. Many of the tools commonly used to put directors’ insurance coverage out of harms’ way, however, are getting pricey or tough to find.
For example, “severability” provisions, under which each insured is separately covered, can assure innocent directors of coverage even if others commit fraud. But corporations would do well to buy that protection sooner rather than later. “Many insurers that offer severability are beginning to rethink that,” says Hartford’s Monteleone. The carriers are shy about covering directors who bear some culpability for falsely stated numbers even though they’re not guilty of outright fraud.
Directors who get a D&O perk from one corporation for sitting on the board of another are also at risk. Previously a throw-in on standard policies, such outside-directorship liability coverage is becoming scarce, says Marsh’s Layton. In the wake of recent high-profile bankruptcies, insurers know that an outside director could well be sitting on the board of a bankrupt company with depleted D&O insurance. In that case, the outside company’s insurer might have to pick up the legal bills.
Surprisingly, such concerns have even begun rippling through private companies. Although their D&O risks are milder than those of public companies, private-company boards can still be hit with lawsuits, says Rick Betterley, a risk-management consultant in Sterling, Massachusetts, and author of “The Private Company Management Liability Market Survey.” And their executives can be equally anxious about supplying directors with insurance protection. The president of a private company Betterley advises, for instance, recently asked him “to go to her board of directors and say, ‘No matter what happens to the company, we need to make sure that the directors are still protected.’”
David M. Katz is assistant managing editor at CFO.com.
The Worst Nightmare
The high price of directors’ and officers’ (D&O) insurance is bad enough. But there may be a bigger anxiety: Can an insurer deny a company’s existing coverage if a misstatement is alleged?
Currently, court-ordered D&O “rescissions” — which instead of canceling a policy going forward, effectively treats it as if it never existed — are rare. But insurers could pursue more of them if restatements mount, insurance experts say. And rescissions have already been mentioned as possibilities in the cases of Adelphia and Enron.
After all, unlike plaintiffs in shareholder suits, insurance carriers seeking to rescind coverage aren’t required to prove fraud in many states, explains Joseph Monteleone, vice president and claims counsel with Hartford Financial Products. All the underwriter must show is that the misrepresentation “was material to its evaluation of risk,” he adds.
The CFO and CEO signatures required under the Sarbanes-Oxley Act of 2002 might also provide the vehicles for proving such materiality. While D&O underwriters routinely ask senior officers to sign off on financials, certifications made under the new law could supply insurers with more legal proof of misrepresentation, says Robert Hartwig, chief economist at the Insurance Information Institute.
One way CFOs can avoid rescissions is to keep risk managers in the loop about reporting and governance procedures. For example, risk managers should be overseers of insurance applications, since the facts on such an application can become a condition of the policy, suggests Jeff Pettegrew, vice president of insurance and risk management at Westaff, a Walnut Creek, California-based temporary-staffing firm. “If I say the board meets every six months and they don’t, the policy could be negated,” he says. —D.K.