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Directors & Officers Liability: A Rise in Whistleblower Complaints


D&O Liability A Rise in Whistleblower ComplaintsReview Directors & Officers Policy Language for Coverage

The U.S. Securities and Exchange Commission (SEC) in its annual report to Congress revealed that the number of whistle-blower tips and complaints under its program increased 7.9% from the previous year to 3,238 in fiscal year 2013. The SEC’s Office of the Whistleblower, mandated by the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, was established in August 2011 and since then has received a total of 6,573 tips and complaints from whistle-blowers.

Under the SEC’s program, whistle-blowers are entitled to an award between 10% and 30% of the monetary sanctions collected in actions brought by the federal agency if they exceed more than $1 million. The most common complaint categories reported by whistleblowers in the 2013 were: Corporate Disclosures and Financials (17.2%), Offering Fraud (17.1%), and Manipulation (16.2%).

According to the SEC report, in 2013, $14,831,965.64 in award payments were made to whistleblowers under the program. Of that total amount, on September 30, $14 million was paid to one whistleblower whose information led to a Commission enforcement action that recovered substantial investor funds.

“Our whistle-blower program already has had a big impact on our investigations by providing us with high-quality, meaningful tips,” said SEC Chair Mary Jo White. “We hope an award like this encourages more individuals with information to come forward.”

Indeed many fear that this is a harbinger of what is to come, as the SEC has in its whistle-blower coffers about $440 million to spend. Moreover, when you see this type of money being awarded, the publicity it garners may drive more people to go directly to the SEC, rather than their own companies first.

What can companies do to help prevent a whistle-blower claim against them?

In a recent article in Business Insurance, legal experts recommend establishing a corporate culture that encourages employees to feel comfortable reporting problems internally. This serves as the most effective factor in discouraging whistle-blowers from first going to federal agencies. “You have to instill that culture from the ground all the way to the top in the C-suite, so that everybody gets the message that ‘We take this very seriously,’” said Michael E. Clark, special counsel with law firm Duane Morris L.L.P., Houston. “Follow up on complaints and provide feedback as to what the company is doing so it doesn’t look like a whitewash.”

Firms must also have a corporate culture that removes “some of the intimidation and fear that goes along whenever an employee raises an issue”, according to W. Gregory Valenza, managing partner at San Francisco law firm Shaw Valenza L.L.P. And, with the right culture in place, companies can proceed to effectively encourage whistle-blowers to report their complaints internally by introducing appropriate procedures and processes, including anonymous hotlines, appointing a member of management to handle complaints, and effective training.

D&O Insurance

In addition to implementing practices that will help mitigate and address a potential whistle-blower’s concerns, a review of one’s Directors & Officers Liability (D&O) insurance is in order. The policy’s language regarding whistleblowers should be looked at very carefully to ensure that certain coverage exclusions are not triggered.

In general, D&O coverage provides three broad categories of coverage: Side A protects individual officers and directors who find themselves the targets of claims of wrongdoing in their capacity as directors or officers in those cases where the corporation has not indemnified the individual for such claims. Side B reimburses the corporation for the costs of indemnifying the individual under Side A protection. Side C provides coverage to the corporate entity, itself, and is usually limited to the company’s liability for alleged violations of securities laws.

Potential coverage issues that should be explored include: 1) whether any “insured vs. insured” exclusions commonly found in D&O policies may provide a basis for the insurance company to argue that the whistleblower investigation claim is excluded from coverage, 2) whether costs associated with a whistleblower investigation are covered, and 3) whether the SEC bounty portion of any resolution would be considered a covered loss.

Policyholders should also examine their D&O policies to determine whether the obligation to defend or to pay defense and investigation costs would apply from the inception of the whistleblower investigation and before the formal commencement of an administrative, criminal, or civil proceeding. In addition, policyholders should determine whether their D&O policies would cover as “loss” the amount that is paid to the whistleblower as a “bounty” if they’re required to pay a fine to the SEC to resolve any proceeding.

Additionally, as D&O policies are sold on a claims-made basis, a policyholder must provide notice of the claim during the policy period. When the SEC serves a letter, notice or subpoena alleging a securities law violation, the policyholder should immediately send a notice letter to his/her D&O carrier.

At Axis Insurance Services, LLC, we provide D&O insurance for a wide range of organizations, including public companies, private companies, nonprofits, educators, public officials, financial institutions and general businesses. It is especially important in this evolving regulatory landscape to regularly analyze an insured’s policy to help ensure their insurance coverage is aligned with these changes. Give us a call at (877) 787-5258 to review your D&O insurance.

Sources: SEC, Business Insurance, Morgan-Lewis

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Blogged on: December 10, 2013 by Mike Smith
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