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Feature

Evan Rosenberg
SVP and Global Specialty Lines Manager
Chubb Group of Insurance Companies

Will the Tellabs Case Impact the Need for D&O Coverage?

Yes, there is some enthusiasm about the Supreme Court decision’s potential as a pushback on class-action suits, but don’t get too excited.

By Evan Rosenberg

The U.S. Supreme Court’s recent headline-generating decision in the Tellabs, Inc. v. Makor securities case was nearly five years in the making. What impact will this decision have on your need for directors and officers liability insurance? A brief review the case will help answer that question.

In a 2002 securities fraud class-action lawsuit, plaintiff Makor Issues & Rights Ltd. alleged that the CEO of Tellabs Inc., a fiberoptic cable equipment manufacturer, misrepresented the strength of its product sales and earnings, thereby artificially inflating the company’s stock price. Under the Private Securities Litigation Reform Act of 1995, in order to survive a motion to dismiss, the plaintiffs must show scienter (that is, intent) and demonstrate that company executives knew about poor financial results that would drive down the stock price and knowingly or recklessly failed to disclose those results. The district court found that Makor’s complaints had insufficiently shown that Tellabs’s CEO had acted recklessly and dismissed the case.

The plaintiffs appealed, and the Seventh Circuit Court of Appeals reversed the lower court’s decision, holding that the plaintiff’s complaint adequately pleaded scienter. Tellabs then appealed the Seventh Circuit’s reversal to the U.S. Supreme Court.

High Court Ruling Levels Playing Field
On June 21, the U.S. Supreme Court reversed the Seventh Circuit’s decision and, in the process, formulated long-overdue guidelines to help federal courts determine when securities class-action claims are not properly pled and should be dismissed.

Up to this point, district courts applied securities class-action suit guidelines unevenly, with some courts being more stringent than others. With Tellabs, the Supreme Court leveled the playing field by articulating a “middle-of-the-road” standard and by recognizing that the defense position needs to be considered in weighing the merits of a case. It thus granted the lower courts greater discretion to consider the circumstances surrounding the allegations behind a securities class-action suit at an early stage.

In its discussion of the Tellabs case, the Supreme Court essentially concluded that one purpose of the Private Securities Litigation Reform Act was to reduce the number of frivolous securities class-action lawsuits. It observed in Tellabs that plaintiffs’ assertions of omissions and ambiguities in management’s statements will “count against inferring scienter” — i.e., suits asserting ambiguous allegations, such as questionable insider trading patterns or contradictory internal communications, are less likely to survive a motion to dismiss.

Tellabs is unlikely to affect cases with allegations of serious misconduct, such as manipulations of revenue recognition, hiding expenses, round-trip transactions, or other forms of fraudulent conduct by senior management.

No Material Impact
The Tellabs decision may enable courts to trim some suits from their dockets early in the litigation process, but it is unlikely to affect the bulk of securities class actions. The Supreme Court emphatically noted that securities suits serve as “an indispensable tool with which defrauded investors can recover their losses” and, as such, are “crucial to the integrity of domestic capital markets.”

Furthermore, we should not expect the decision to have a material impact on total securities class-action dollars paid. Experience tells us that it is serious claims, not frivolous claims, that drive overall directors and officers liability insurance costs.

As a result, your need for the critical protection offered in a D&O liability insurance policy remains undiminished.

Evan Rosenberg is senior vice president, Chubb & Son, and global specialty lines manager for Chubb Specialty Insurance (CSI), a business unit of the Chubb Group of Insurance Companies. In this position, he oversees CSI’s worldwide specialty lines coverages and new product development.