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The Cost of Capital: How High Will Director & Officer Insurance Premiums Climb for Non-U.S. Businesses?

American businesses, especially those whose securities are publicly traded on exchanges in the U.S. capital markets, know full well that their shareholding owners may sue them for mismanagement and also for failing to be frank about performance and/or risks. Adding to potential shareholder claims, among other things, are environmental pollution, sexual misconduct, and breaches of cybersecurity. A key factor in the American legal system is the availability of class actions, especially those involving alleged violations of federal or state securities laws. In a class action, one shareholder can sue as a representative of all shareholders, thus turning what might be one individual’s claimed loss of dollars into a class claim of millions or even billions. Recognizing that serving as a director or officer of a business exposes those individuals to the “equal opportunity” to be named as defendants in those lawsuits, most persons will only agree to serve as a director or officer (no matter what remuneration may otherwise accrue to them), IF that business purchases Director & Officer (“D&O”) insurance to cover them.

D&O insurance provides funding for two separate and important matters. First, the insurance will pay (subject to policy limits) for the costs of defending an individual defendant (money for his or her lawyer, investigators, experts, and the like). The costs of defense even where the individual is found blameless in an investigation or a formal proceeding can reach well into seven figures, if not more. Second, in the unhappy event that an individual wishes to settle a claim or is found liable in a proceeding, D&O insurance will also (subject to policy limits) fund the settlement or judgment amount.

Until quite recently, most other countries, including even Britain (from whose legal system America derived much of its foundations), had not experienced the magnitude or frequency of shareholder claims found in the U.S. A risk-averse soul might well, as a consequence, seek to avoid activities which would bring him or her within the reach of American courts and their legal system. However, the extraordinary growth and depth of American capital markets, especially since the latter half of the 20th century, make the U.S. an irresistible attraction to businesses worldwide.

It is now well known that approximately 20% of the companies listed on the New York Stock Exchange or Nasdaq are based outside the U.S. and over 20% of the class action securities lawsuits filed in U.S. courts in 2018 were against foreign companies. Clearly, D&O insurance is just as important for the individuals managing foreign businesses, at least if they have American shareholders. Unfortunately for non-U.S. businesses, the insurance underwriters who have evaluated the exposure of those businesses and their managers to expensive claims have become aware of the “globalization” of the American legal system, especially for those businesses that access American capital markets. As a result, premiums for D&O insurance for non-U.S. companies (and their D’s & O’s) have increased up to 30% over prior years. While this at first glance may sound outrageous, consider, for example, Alibaba Group Holding, which raised $25 billion in an initial public offering in 2014. Purchasers of Alibaba American Depository Receipts sued, claiming that Alibaba and its management (including Jack Ma) had failed to disclose meeting with Chinese government agencies before the IPO, where those agencies warned Alibaba that its e-commerce platforms were being used for numerous and persistent illegal practices that Alibaba and the individual defendants ignored, participated in, and/or covered up. In a settlement, Alibaba and the individual defendants denied all claims, but paid $75 million, reportedly most by insurance.

If you are a Director or Officer of a non-U.S. business, or about to become one, and your business has operations in the U.S., or even more if your business has securities traded in the U.S., you need D&O insurance, and it will cost more.

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