FCPA's High Costs May Cause Tightening In D&O Market

Law 360

Law360 (June 4, 2021, 11:56 AM EDT) -- U.S. authorities' recent probing of Toyota for possible Foreign Corrupt Practices Act violations illustrates the heightened enforcement risks faced by corporate policyholders, which could encounter an even harder market for directors and officers insurance, according to legal experts.

Toyota in March disclosed its cooperation with U.S. authorities on concerns about FCPA violations based on bribery allegations involving a subsidiary in Thailand. Law360 exclusively reported last week that the U.S. Securities and Exchange Commission and the U.S. Department of Justice are gathering more evidence on the accusations.

The episode shows the increasing risks to major companies from FCPA and other government-led investigations. Despite the COVID-19 pandemic, the SEC continued its far-reaching enforcement activities last year. The agency's investigations across 715 separate cases, including foreign bribery charges, collected a record $4.7 billion in fines in 2020, according to a May report by a unit of Allianz Global, and insurers have seen large claims as a result.

On the FCPA front, the SEC in 2020 reported nine settlements by companies resolving investigations under the act. Most significantly, Goldman Sachs agreed in October to pay $2.9 billion to resolve the U.S government's criminal investigation into the bank's role in the 1Malaysia Development Bhd. scandal. As a result of the investigation, Goldman Sachs has been fighting a proposed shareholder class action.

This enforcement activity could lead to a hardening of the D&O insurance market, which typically occurs with an unexpected rise in securities litigation under changing laws or corporate practices, according to legal experts. And if FCPA investigations and derivative lawsuits keep mounting, insurers will likely use their risk control tools to limit exposure in future policies, experts said.

David E. Wood of Barnes & Thornburg LLP, who represents policyholders, said liability to shareholders based on poor outcomes of FCPA investigations "was very much on insurers' radar as a risk factor to watch for."

But COVID-19 has changed the D&O landscape as the economy collapsed in some sectors with foreign operations, Wood told Law360. For example, some companies with international operations were being told they were a bad risk, Wood said, when in reality insurers "had become spooked by a major equities market correction caused by a badly understood pandemic."

The perceived risk of FCPA liability was an excuse that insurers could use "to justify dialing back D&O coverage in response to uncertain economic conditions," Wood said.

Mary P. Hansen of Duane Morris LLP, who handles securities litigation, told Law360 she believes the Biden administration will pursue more enforcement actions than its predecessor.

"There is a belief that the Biden administration will be more aggressive. There will be more SEC and DOJ investigations, so insurers are preparing to have to provide coverage for these investigations," Hansen said.

Peter A. Halprin of Pasich LLP, who represents policyholders, told Law360 some of the current investigations are likely holdovers from the last administration.

"'Silly season' describes the interesting time when you have an outgoing administration pursuing leads that get kicked into hyperdrive during the transition to force the incoming administration to continue the investigations and pursue enforcement actions," Halprin said.

Legal experts said large corporate policyholders have three key expenses to consider when being investigated for a FCPA violation: costs to investigate the alleged violation, costs for any liability for a violation supported by evidence and costs to shareholders for potential litigation.

Investigation costs, according to Geoffrey Fehling of Hunton Andrews Kurth LLP, can be as much as costs tied to follow-on litigation based on the allegations in wide-ranging FCPA investigations. That's because internal investigations often force companies to send attorneys, accountants, experts and consultants globally to resolve the matter.

"The costs on the front end can be significant, and many times if there is coverage for pre-claim and investigation costs, those coverages may be sub-limited and not an open-ended coverage grant," said Fehling, who represents policyholders.

Carrie Maylor DiCanio of Anderson Kill PC, who also represents policyholders, told Law360 she agreed that a corporate policyholder's internal investigation could result in substantial costs and possibly more than those in litigation. "It is a case-by-case basis," she said, depending on the severity of the allegations.

Across the board, legal experts agreed the D&O market has hardened. With the potential of more aggressive enforcement by a new administration and a rise in high-value investigations and follow-on litigation, the market could see an evolution on FCPA-specific coverage, they said.

The increased scrutiny of potential FCPA exposures, experts said, would be impacted by the company's global presence and the revenue generated outside the United States.

Insurance companies "have a way of managing their risk by writing exclusions into policies," DiCanio said. If investigations increase, policyholders could expect higher premiums or FCPA-related exclusions, she said.

Oliver M. Sherman of Jackson & Campbell PC agreed that in an already hardened D&O market, a growth in FCPA investigation costs and shareholder suits could mean more stringent underwriting standards and a narrowing of terms and conditions in policies.

"Dissatisfied insureds may feel compelled to explore alternative options, such as a captive insurance arrangement," said Sherman, who represents insurers.

Halprin said brokers have suggested to him that the hardening of the market is primarily driven by the increases in derivative action awards and class action settlements. Insurance companies also like to talk about "social inflation," or exponential increases in damages over a period of time, Halprin said.

But "naturally things seem to be going up," he said.

--Additional reporting by Frank G. Runyeon, Dean Seal and Reenat Sinay. Editing by Marygrace Murphy.

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