D&O Coverage Considerations Ahead of and IPO
The private business you started years ago has grown steadily and you’re now considering taking it public. Going public is a significant milestone that can offer many financial benefits, including:
- Greater access to more sources of capital for growth and expansion, at lower costs.
- The use of stock to attract and retain company officers and key personnel, as well as fund mergers and acquisitions activity.
- Enhanced company image.
- An exit strategy for early investors.
But an initial public offering (IPO) also materially changes a company’s risk profile and adds significant exposure to the personal assets of its directors and officers. Ensuring you have comprehensive directors and officers liability (D&O) insurance in place will be critical to all involved.
Road Show Risks
The journey from private to public company can bring several new risks and exposures. Exposure to securities liability typically begins with the company’s IPO road show, or even as a business makes legal, tax, and operational decisions leading up to a road show. Investors rely heavily on statements made during road show presentations and on any information provided within the road show prospectus. Allegedly misleading statements made during this time can lead to claims post-IPO.
If a company has D&O insurance in place prior to an offering, it is usually written on a private company policy form and coverage is typically tailored to the needs and risks of a private company. Some D&O policies allow for road show coverage as part of the base policy wording. Other insurers, however, specifically exclude this coverage — meaning that the policy form would need to be endorsed.
If a company does not have any D&O insurance in place, it should consider purchasing such coverage prior to its road show and preliminary prospectus filing. It is important for the company and its directors and officers to seek proper advice early in the process in order to ensure that coverage needs are properly addressed. This is also the case for companies able to take advantage of the JOBS Act’s easing of the IPO filing requirements.
Public companies are subject to greater regulatory scrutiny than private companies, and must comply with extensive securities laws designed to enhance public trust and corporate governance. Disclosure requirements for public companies can create significant liability. All statements made during a road show or contained within the prospectus and any subsequent public disclosures of material information should be carefully considered.
One of the biggest IPO risks is that the stock does not perform well after listing. In this event, lawsuits could be filed against the company and its directors and officers alleging mismanagement, misrepresentation in the prospectus, or other claims. Such lawsuits are almost always based on the strict liability provisions of Section 11 of the Securities Act of 1933. Under this law, any material misrepresentation — even if negligently made — could form the basis of liability against a corporate director or officer.
While the vast majority of securities class-action complaints are filed in federal court, in recent years Section 11 claims have increasingly also been filed in state court (especially in California) which has seen more lenient pleading standards, more permissive procedures, and lower dismissal rates than in federal courts. When a complaint is filed in both federal and state courts, this is known as a “concurrent jurisdiction” claim and has led to an increase in both frequency and severity of IPO claims.
Depending upon the severity of the problem and the drop in the stock price, an IPO could also draw the attention of state and federal securities regulators and other enforcement agencies, which could also result in concurrent regulatory investigations, further increasing the overall costs. Common post-IPO trigger events leading to securities claims include:
- Accounting restatements.
- Earnings failing to meet projections.
- Announcement of products or services failing to perform as expected or being delayed.
- Investigations by the Securities and Exchange Commission, Department of Justice, or other regulators into corporate or individual director or officer conduct.
- Internal investigations based on whistleblower complaints.
- Inadequate disclosure regarding mergers, acquisitions, and divestitures.
Building An Effective D&O Program
Before launching an IPO, businesses should work with their insurance advisors to build a D&O insurance program that addresses their critical risks before, during, and after an offering. Businesses can follow a simple timeline (see Figure 1) that can minimize time and effort while better ensuring robust coverage is in place. In building D&O programs ahead of IPOs, companies should work with their insurance advisors to:
- Assess limits needed and optimal program design based upon tailored benchmarking and securities class action claim modeling.
- Obtain initial insurance quotes using the draft prospectus and latest financial statements.
- Schedule face-to-face meetings with underwriters before road shows to finalize competitive quotes.
- Ensure coverage for the ancillary lines such as employment practices liability, fiduciary liability and crime is properly placed.
- Determine if any locally admitted D&O policies are needed outside the US.