With some eighty companies reportedly being investigated by the Securities and Exchange Commission over the possible illegal backdating of stock options, a set of related worries is cropping up among senior managements: the emergence of backdating-related shareholder lawsuits and the possible dwindling of directors and officers liability insurance.
Concerned about the shareholder suits and the insurance claims that crop up whenever a widespread corporate scandal erupts, D&O insurers generally seek out ways to deny coverage, contends attorney Mark Keenan of the firm Anderson, Kill & Olick in New York, which represents corporate insurance policyholders.
While it’s tough to forecast how high the level of shareholder claims against companies and officers will rise in the coming months as more and more companies are named, Keenan predicts that, “given the creativity of plaintiffs’ trial attorneys, they’ll be quite a number of actions based on the backdating of stock options.” And with those actions will come quite a number of coverage exclusions by insurance companies, he says.
To be sure, backdating—the practice of adjusting stock option grant dates to an earlier time than they were actually granted in order to provide a windfall to the new option holder—isn’t illegal, per se. “Failure to accurately disclose how the options were awarded and accounted for is where concern lies,” explains Jennifer Sharkey, senior vice president in the Executive Risk Practice of William Gallagher Associates Insurance Brokers in Boston.
When it comes to disclosure, there are some hefty legal concerns. From the corporate point of view, says Steve Shappell, managing director of the legal and claims practice for the financial services group of Aon, the big insurance brokerage: “If you give me a stock option at $20, but at the time you give it to me, it’s really worth $40, that $20 difference needs to be treated as an expense and an income to the individuals that it’s being granted to.”
If that extra $20 doesn’t jibe with the expense the company had told its shareholders it was going to dole out, the new option holder potentially owes that money back to the company, according to Shappell, who noted that in such a case the company officials who approved the backdating could be liable to the shareholders.
More potentially onerous is the risk that the company’s stock traded artificially high as a result of the misrepresentations executives might have made on the company’s SEC’s filings. Then, when the announcement of the missteps is made, and the share price drops off a cliff, shareholders could well sue for fraud, he says. Such lawsuits, which are often class actions, can yield very high settlements.
Further, there’s the exposure to significant legal fees, which can represent a big cost for insurers and employers alike. That’s so because backdating and other high-profile governance litigation “tends to be handled by the country’s best lawyers, who charge the highest fees and rates,” says Wayne Borgeest, a lawyer with Kaufman, Borgeest and Ryan who represents insurers.