This Partners' Perspective will focus on the recent press reports regarding former WorldCom directors paying millions of dollars out of their own pockets as part of the pending securities fraud related class-action lawsuits. What motivated the outside directors to pony up personal assets? What liability precedent has been set? What impact might this have on your Directors & Officers/General Partnership Liability insurance? At this point, there are still more questions than answers. Here are some initial thoughts:
For those of you more worried about where Spitzer is going next and who missed the details - a brief summary. Ten outside Directors from the former WorldCom Inc. will pay $54.0 million, including $18.0 million from their own pockets, to settle their portion of a class action lawsuit brought by bondholders and shareholders in the wake of the company's massive accounting scandal.
- Why did the former WorldCom directors forfeit the opportunity to pursue accessible Side-A (non-indemnifiable) D&O insurance (the $36M paid by insurers apparently did not fully tap out the available insurance coverage) to pay for their individual liability? Perhaps the outside directors of WorldCom feared (possibly as a result of their own intimate knowledge of the debacle combined with the advice from defense counsel) that refusing to settle the class action cases and going to court might result in a far more costly individual, uninsured liability than the $18.0 million that is part of the settlement. While no evidence has yet surfaced that shows they were aware of the $11.0 billion accounting fraud as it was ongoing, they were not exactly asking probing questions either.
- Are the directors trying to offer up some sort of perceived goodwill in light of all of the bad press that has resulted from the seemingly never-ending string of corporate scandals and in light of the increased scrutiny that will undoubtedly continue in the wake of Sarbanes-Oxley and beyond?
- Keep in mind that the settlement agreement is expected to stipulate that the former directors deny that they have committed any wrongdoing and that they are entering the settlement solely to eliminate the uncertainties and expense of further litigation.
- Did the insistence by the lawsuit's lead plaintiff, the New York State Common Retirement Fund, that the former WorldCom directors pay a significant portion of the settlement from their personal assets have any significant influence on the directors?
- In the most recently amended complaint, the New York Fund wrote that "WorldCom's board of directors was utterly derelict in fulfilling the most basic functions of a true board."
- Did the former directors strike a deal with the D&O insurance carriers to have some portion of the Side-A coverage respond to the claims after the carriers initially took a hard-line position on trying to rescind coverage altogether?
- If the policies had been rescinded, the former directors would most likely have paid out substantial defense costs, in addition to being responsible for any potential judgment against them.
- Will the WorldCom settlement expand the potential liability for corporate directors whose companies commit accounting or other fraud on their watch?
Remember, none of the former directors was a direct participant in the accounting related fraud and all suffered large, personal economic losses as a result of the company's downfall.
Independent directors operate under a microscope and more is expected of them than ever before. Shareholders, employees, competitors, the government, the media and others are watching them and their decisions closely under the light of the Sarbanes-Oxley Act. Understanding the scrutiny under which they work, independent directors must take every precaution to protect themselves. In addition to indemnification and insurance protection, corporate governance "best practices" are now more important than ever and will help reduce risk profile.
For further information, please contact your Equity Risk Partners professional.