Directors' Personal Finances Shielded by Insurance Plans

SPECIAL REPORT - Banking & Finance: Boards Under Fire What Do They Know?


Staff Reporter

Directors, relax. While scores of class action lawsuits involving securities fraud and other wrongdoing are in the works, directors can rarely be held personally liable.

Most board members are protected by corporate indemnity agreements in combination with directors' and officers' liability insurance, which are intended to attract good directors by shielding them from lawsuits.

"Up until now it has not been something that has come to bear on board members," says Prof. Edward Lawler, director at the Center for Effective Organization at USC's Marshall School of Business. "They have not had to dip into their own fortunes."

Typically, companies will indemnify in other words agree to pay any losses directors might suffer. They also get a certain level of insurance to cover their losses.

The insurance, which covers all directors and corporate officers, might run a large company $1 million for $100 million, with a deductible of $250,000 or more, according to local brokers.

"You put a big bull's eye on their (directors') backs" without it, says attorney Irving Einhorn, a former Securities and Exchange Commission official who does corporate defense work.

But the cost of D & O; insurance has risen sharply in some cases by as much as 100 percent or more in industries like health care and technology.

And even insurance does not completely protect directors. If a director has violated the law by trading on insider information, that could be a criminal violation. Also, insurance companies won't pay up and directors could be personally liable if there is a finding that a director has breached his fiduciary duty to a company.

That's not easy, said Henry Cheeseman, a professor at the Marshall School who specializes in business and securities law. In order to find that fiduciary duty has been breached, there must be a finding that directors have breached their so-called "duty of loyalty" through conduct that might be fraudulent or dishonest.

Or, there could be a finding of simple negligence. But that is even harder to prove if a director claims that the board made a "reasonable" investigation of the facts before taking a particular action, Cheeseman said.

Scores of lawsuits have accused officers and directors of all sorts of wrongdoing in the wake of the stock market meltdown and several have resulted in big payouts over $100 million.

One such case was the $457 million paid last year by Waste Management Inc. to settle a class action suit relating to a merger, accounting scandal and a $1.8 billion write off the company took in 1999.

But despite the amount of money it can take to settle such lawsuits, directors are protected and insurers must pay up unless a judge or jury finds some wrongdoing, said insurance broker Eric Andersen, who heads Aon Corp.'s Los Angeles office and formerly directed its financial services practice.

"A settlement doesn't count," he said.

The big class action law firms that bring such litigation often are not interested in taking cases to trial but in getting the largest payout. That means a settlement in which the insurance company pays, said Edward Merino, who heads up Office of the Chairman, a consulting firm specializing in corporate governance.

"It's driven by the mechanics of the legal process," Merino said.

However, given the failure of Enron Corp., some wonder whether that might change the rules of the game and directors might start paying out of their own pocket as insurance runs out and companies that file for bankruptcy can't meet their indemnity agreements.

"The shareholder bubble they created is coming back to haunt them," said Darren Robbins, a partner with Milberg, Weiss, Bershad, Hynes & Lerach, which is bringing a class action lawsuit against Enron. He said alleged fraud at Enron is so large that it dwarfs the firm's liability insurance.

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