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The rise in UK securities litigation: a D&O coverage and placement perspective

Securities litigation claims are rising in the UK due to group litigation, litigation funding, ATE insurance, and increased shareholder activism. Though less frequent than in the US, UK claims tend to be high severity. This article explores UK legislative routes and implications for D&O programs.

Securities litigation claims, previously seen as the preserve of jurisdictions such as the US and Australia, are on the rise in the UK. This increase is attributable to a number of factors including: the increased use of group litigation, the rise in litigation funding, and the availability of After the Event (ATE) insurance. Shareholder activism and the increased willingness of shareholders to challenge the governance and management of listed companies are also factors.

While UK securities claims are as yet nowhere near the level seen in the US, there are certain characteristics of these claims — for example, they tend to be low frequency but high severity — which are a cause for concern. In this article, we will look at the two main legislative routes available in the UK to investors seeking redress and will consider the implications of the increase in these actions for your directors and officers (D&O) programme.

The law

There are two main routes available to investors seeking compensation for loss as a result of untrue or misleading statements or omissions made to the market. These are contained within sections 90 and 90A of the Financial Services and Markets Act (FSMA) 2000. There are other potential common law causes of action available in the UK, for example, misrepresentation and the tort of deceit, but these are outside the scope of this article and are mentioned for completeness.

Section 90 FSMA

Section 90 allows for compensation for investors who have acquired securities and who have suffered loss as a result of untrue or misleading statements, or certain omissions, in listing particulars or prospectuses. Liability can attach to “any person” responsible for those listing particulars, and this can include the company, its directors, and potentially its advisors.

The legislation does not require investors to show that they relied on the misstatements or omissions in question. It is sufficient that such misstatements or omissions negatively impacted the share price of the acquired shares, causing loss. It is a defence to these claims if the defendant can show that they held a reasonable belief that the statement in question was true and not misleading or that matters were properly omitted.

Section 90A FSMA

Section 90A gives investors a potential remedy against the issuers of securities where loss has been suffered as a result of a misleading statement or dishonest omission in certain published information (such as annual or half-year reports), or a dishonest delay in publishing such information. Section 90A is, therefore, much broader in scope than section 90 and could include any misleading statement or dishonest omission in a published document. One concern is that this provision will be used much more in areas such as environmental, social, and governance (ESG) related disclosures.

While the ambit of section 90A is potentially much broader than section 90, the requirements to establish liability are more stringent. The issuer will only be liable if a person discharging managerial responsibilities (a PDMR) within the issuer knew the statement to be untrue or misleading or was reckless as to whether it was untrue or misleading. Similarly, the issuer is only liable in respect of an omission if the PDMR knew the omission to be a dishonest concealment of a material fact. A person’s conduct is regarded as dishonest if, first, it would be regarded as dishonest by persons who regularly trade on the securities market in question and, second, the person was aware (or must be taken to have been aware) that it was so regarded.

Unlike section 90, there is a reliance requirement. An investor needs to show that, as a matter of fact, they relied on the statement or omission when acquiring, holding or disposing of securities, and without this, they will be unsuccessful in their claims. The extent of that reliance is, however, still a developing area of law and one actively being considered by the UK courts.

A cause for concern?

To fully understand why these claims are causing concern, it is helpful to look at an example of how they can unfold. A company may be faced with a regulatory investigation which first triggers the insured’s D&O policy. Years later, after a lengthy investigation, the company enters into a deferred prosecution agreement (DPA) with the regulator. News of that DPA spreads and subsequently triggers a significant drop in the company’s share price, which leads shareholders to pursue litigation against the company for that diminution in value. There are subsequent follow-on claims.

So, a claim or claims of this nature carry a number of serious risks. They can play out over many years and can be very costly (easily running into the tens of millions of pounds) to defend. With the broad aggregation language often found in D&O policies, such claims may also attach back and aggregate to an earlier policy, thereby leading to a real risk that the policy limit for that earlier D&O tower could be exhausted.

Other concerns include the complexity of defending these matters and the potential quantum, defence costs, and any subsequent settlement or award. Whilst to date there have been an estimated 13 cases in the UK courts (some still ongoing), many of these cases settle. Further, whether the cases are litigated or settle, they can run into the hundreds of millions to dispose of. For example, the first litigated section 90 case, which arose out of a rights issue by a well-known bank, settled for £200million plus defence costs. This explains why many of these cases are compromised before they go to court, leading to further issues with regard to the lack of decided cases and uncertain legal landscape as a result.

Finally, and perhaps most importantly from the perspective of directors and officers, there is the prospect of becoming embroiled in lengthy, complex investigations and litigation. This can be so even where they are not the defendants to an action, but the state of their knowledge becomes critical for evidential purposes.

Your D&O programme

Those involved in the structure and placement of D&O programmes are well aware of the critical importance of keeping abreast of developments in any areas that impact the potential liability of their insureds. The D&O programme should be forward looking, both meeting the needs of the insureds’ current risk profile while anticipating new risks as they emerge. In that sense, the programme is not static year on year but regularly reviewed to take account of evolving risks. To this end, the rise in the number of securities claims in the UK does give rise to a number of potential issues that merit further consideration.

(a) Programme structure

The insuring clause in the D&O policy tends to be split into three sections (or sides of cover, as they are often called): A, B, and C.

Side A protects the directors and officers by providing cover in circumstances where the company cannot or will not indemnify. Usually, these costs are available from the “ground up,” meaning there is no applicable retention.
Side B offers balance sheet protection, in that it reimburses the company in circumstances where it has indemnified its directors and officers.
Side C provides entity cover for securities claims.

Depending upon the size and nature of the company, they may buy a mixture of Sides A, B, and sometimes C. There are a considerable number of permutations, and each company’s needs are different. It is extremely important that a company buys the right “mix” of D&O insurance, and it can involve some complex analysis as to the appropriate structure. One factor is price, and it is noteworthy, for example, that during the most recent “hard market” where prices increased, a number of companies decided to buy less Side C or indeed to stop buying it altogether. We have, however, seen this trend reverse somewhat as the market has softened. Given the current increase in securities claims, it would be advisable to review your programme structure with your broker to ensure that it remains appropriate for your risk profile.

(b) D&O programme limit

Again, there are a multiplicity of complex factors that go into determining the D&O programme limit purchased by companies. These include, but are not limited to: risk profile, industry, benchmarking (limits purchased by comparable peers), claims history, and claims benchmarking. Corporate risk appetite is also a key factor.

In a hard market, programme limits can sometimes be reduced owing to capacity constraints or exceptionally high premium costs. Over recent years, we have, however, seen some reversal as buyers have begun to buy increased limits as the market in the UK has softened. It is difficult to overstate the importance of ensuring the D&O programme limit accurately reflects the risk profile of insureds. When considering limit and structure, consideration may also be given to the appropriateness of a ring-fenced limit for directors and officers, if needed (Side A-only coverage). Utilisation of facilities may also assist in ensuring adequate programme limits at appropriate pricing levels.

With this in mind, one of our main observations is the potentially significant costs that can be incurred in defending section 90 and 90A claims, and it is conceivable that they could erode and ultimately exhaust even very significant D&O towers. As such, it is important to work with your broker to ensure that you have purchased sufficient limit and that your programme is appropriately structured. Given that we are currently in a market favourable to D&O purchasers in the UK, it may be advisable to undertake this review on your next renewal.

(c) Coverage

With regard to securities claims, it is prudent to review the policy to ascertain what cover is available. More specifically, and just by way of example, is your definition of insured persons broad enough? For the purposes of section 90A, for example, would that definition cover all persons falling within the scope of a PDMR? Is there any prospectus cover within your D&O policy, or is it excluded? Is there any cover for a failed offering or prospectus? Given the recent increase in securities claims, it is important to ensure that your D&O coverage is appropriate for your risk profile.

Similarly, if you are proposing to undertake a public offering of securities, given the risks under section 90, have you purchased an appropriate public offering of securities insurance (POSI) policy? These are just some of the questions for consideration, and again, are subjects for discussion with your broker well in advance of any renewal or public offering.

Conclusion

Securities claims are on the rise in the UK. They can be complex, costly, and difficult to defend. They have the potential to significantly erode, or in the worst cases, exhaust D&O towers. The potential to embroil directors and officers in complex, difficult, and uncertain litigation simply increases the concern.

Now, more than ever, D&O programmes need to be robust, forward looking, and appropriate for your risk profile as insureds. It is, therefore, important to work with your broker to understand this and other new and emerging risks, as they occur, so that you ensure your programme remains ideally suited to your needs as an insured.

Should you have any queries arising from this article, please contact your usual Marsh advisor.

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