Willis D&O Dictionary Expands and Clarifies, as D&O Terms Dazzle and Defy We present a synopsis of the dictionary in this issue

Insurance Advocate Cover Story

Willis North America, the global broker has published its Directors and Officers Liability (D&O) Insurance Dictionary, offering firms a comprehensive overview of terms that are likely to be used in describing their D&O insurance and liability exposures. This Willis publication, updated in response to recent significant changes to the litigation environment facing executives and their firms, as well as related developments in D&O insurance coverage, is a useful tool for risk management practitioners and those making key decisions about financial and executive matters. The dictionary details over one-hundred terms and provides important context for why the term may be relevant. The updated publication includes new terms that have entered the vernacular, including:

• Bump-up claims: In the context of an acquisition, these are claims by shareholders of the company-to-beacquired alleging that the company has been undervalued. These actions seek to have the purchase price raised or “bumped-up.”

• Clawback: Generally, money or benefits that were distributed and later taken back under special circumstances. Both Sarbanes-Oxley and the Dodd-Frank Act create circumstances where compensation may be “clawed back” from executives following financial statements at their companies.

• Entity versus insured exclusion: A recent (favorable) variation on the Insured vs. Insured exclusion found in a D&O policy. It precludes coverage for claims brought by the company or insured organization against other insureds. So the company itself can’t sue its Directors or Officers and gain coverage for their defense or settlement under the D&O policy.

• Double derivative claim: A rare derivation on derivative suits, this is a lawsuit brought by a shareholder of a parent corporation on behalf of a wholly owned subsidiary for alleged wrongs to a subsidiary. They generally occur where shareholders have lost standing to maintain a standard derivative action due to the acquisition of the corporation in a stock-forstock merger; the shareholder, in his new capacity as a shareholder of the acquirer, then reasserts the claim double derivatively.

• Updated information as it relates to Sections 11, 12, & 15 of the 1934 Act dealing with securities offerings, including IPOs.

Commenting on the dictionary, Ann Longmore, Executive Vice President, WNA FINEX, said, “In discussions regarding D&O insurance, we invariably mingle the language of law, finance and insurance; all otherwise separate and distinct disciplines with their own unique concepts and terms of usage. This makes every conversation potentially full of pitfalls for unwary individuals knowledgeable in their own areas of expertise, but not so much when addressing insurance matters.” “In the rapidly evolving environment of executive risk, keeping up with the latest terms and technical components of a D&O program can be a challenge. Our goal was not to just describe what something plainly is, such as “Application,” but also to provide context as to why the term may be relevant,” said Longmore. D&O GLOSSARY

10(b)(5), Rule: A rule created by the U.S. Securities and Exchange Commission (SEC), under the ‘34 Act which prohibits any act or omission causing fraud or deceit in connection with the purchase or sale of any security. It is the most frequently alleged violation in D&O securities claims: _ Rule 10b-5: Employment of Manipulative and Deceptive Practices: “It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange, _ (a) To employ any device, scheme, or artifice to defraud, _ (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading, or _ (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.”

‘33 ACT: The Securities Act of 1933 deals with the offer and sale of securities. Prior to the ’33 Act, this was regulated primarily by state law (usually referred to as “blue sky laws”). Enacted in the aftermath of the U.S. stock market crash of 1929 and during the ensuing Great Depression, the ‘33 Act left existing state securities laws in place. The Act requires issuers to fully disclose all material information that a reasonable investor would require in order to make up his or her mind about the potential investment. It also requires offers or sale of securities using the means and instrumentalities of interstate commerce to be registered with the SEC unless an exemption exists under the law. The term “means and instrumentalities of interstate commerce” is interpreted very broadly, making it virtually impossible to avoid this statute. Any use of a telephone, for example, or the mails, would probably be enough to subject the transaction to the statute. See Section 11, Section 12, Section 15.

‘34 ACT: The Securities Exchange Act of 1934 (also called the Exchange Act), governs the secondary trading of securities in the U.S., that is, trading between shareholders on a stock exchange (in contrast with the ’33 Act which regulates the initial sale of securities from the original issuing firms to investors). The Act and related statutes form the basis of regulation of the financial markets and their participants in the U.S. In regulating the secondary trading of securities, the ’34 Act often deals with persons other than the issuer; most frequently, this includes securities brokers or dealers. See 10(b)(5). ADMITTED COVERAGE: Insurance which is purchased from an insurance company licensed in the state/country in which the policy is purchased. Insurance is regulated locally, as a general rule, and where there is local property or persons that would be covered by the insurance, local country insurance regulators may require admitted (local) policies to be used. See: Non-admitted insurance.

ADR (AMERICAN DEPOSITARY RECEIPT): An ADR is a stock that trades in the U.S. which represents a specified number of shares in a foreign corporation. ADRs are bought and sold on American markets just like regular stocks, and are issued/sponsored in the U.S. by a bank or brokerage firm. U.S. financial institutions purchase a bulk lot of shares from the company, bundle the shares into groups, and reissue them on a stock exchange, with the foreign company providing detailed financial information to the sponsor institution. There are three different types of ADRs issued: See: ADRs Level I, II and III. ADRS, LEVEL I: ADRs which are not listed on any U.S. stock exchange, but are traded in the over-the-counter (OTC) market, most commonly on the Pink Sheets electronic market. They offer a foreign company the opportunity to diversify their shareholder base by giving U.S. investors an easy way to purchase securities while remaining exempt from U.S. reporting requirements under SEC Rule 12g3-2(b) and SOX. Registration of these ADRs under the ‘33 Act only requires the filing of a shortform registration statement, and the underlying ordinary shares are exempt from registration. These facilities have been growing due to the implementation of more stringent reporting and regulatory requirements under SOX for Level II or III ADRs and the ‘34 Act. A drawback is that Level I programs cannot be used to raise capital in the U.S.

ADRS, LEVEL II: ADRs which are listed on a U.S. stock exchange and may better position a firm to move to a Level III program to raise capital, as they may qualify to use a shortform registration statement (not available to Level I issuers). Level II ADR programs must comply with the full registration and reporting requirements of the ’34 Act.

ADRS, LEVEL III: Are the most prestigious of the three ADRs and is where an issuer raises capital in the U.S. by floating a public offering of its ADRs on a U.S. exchange. Level III ADRs must comply with various SEC rules, including the full registration and reporting requirements of the ’34 Act.

AGGREGATE LIMIT OF LIABILITY: An insurance term which refers to the total amount that the insurers will potentially pay under a given insurance policy. For D&O insurance, this would generally include defense costs, settlements and judgments. This amount is not increased by the number of claims made under the policy, the number of insureds who seek payment under the policy, or otherwise. The retention or deductible is not included or added to the Aggregate Limit of Liability. Any retention or deductible on the policy must be spent by the insured before any payment will be due under the policy.

ALLOCATION: A determination of the portion of a loss that will be covered by an insurance policy when less than 100% of the loss is covered. It refers to the determination of the precise portion of a loss that will be allocated to the insurance policy

(and therefore payable by the insurer) and which portion will not. Allocation issues arise when the insurance doesn’t cover all of the defendants in a claim and/or when the policy doesn’t cover all of the allegations in a claim.

In the D&O world, allocation issues had historically arisen when both a company, or entity, and its insured directors and officers were named in a suit, but the entity was not covered by the policy. Under these circumstances, insurers took the position that a portion of loss relating to defense costs, settlement or judgment should be allocated to the entity and, therefore, not covered by the policy. There has been a substantial amount of litigation regarding the issue of allocation and, as a result, most D&O carriers now offer entity coverage in some form, or contractually agree to a pre-set allocation. See: C-Side or Entity Coverage.

APPLICATION – MAIN FORM: A formal written submission for D&O insurance that asks for all pertinent information about the company applying for insurance, including financial information about the company and any subsidiaries, identification of all directors and officers sought to be covered, current insurance information, and claim history, among other things. The most significant feature of a main form application is that it expressly asks about potential claims or circumstances that could lead to claims and requires that the signatory essentially warrants (often on behalf of all potential insureds) that no such potential claims or circumstances exist. Where potential claims or circumstances are indicated on the main form application, the insurance typically would not cover those potential claims or circumstances.

Where it is later determined that at the time the main form application was signed, an insured knew or should have known of the existence of a potential claim or circumstance likely to lead to a claim, the insurer may seek to rescind or revoke the entire policy, as to all insureds. This is in contrast to a Renewal Application, which typically does not ask warranty questions. See: Severability.

APPLICATION – RENEWAL: A renewal application is typically shorter than a main form application and does not usually require a warranty that no potential claims or circumstances exist. A-SIDE COVERAGE: D&O insurance coverage for the directors and officers for situations when the company legally or financially cannot (or possibly just does not) indemnify them for the costs of defense, settlements or judgments resulting from claims made against them.

The traditional D&O policy includes both A-Side and B-Side coverage (and today, C-Side as well). Note that the Aside of a D&O policy generally has no retention or deductible, because individuals are not expected to bear the retention themselves.

Today, many companies purchase dedicated A-Side policies (with no B- and C- side coverage). These forms usually contain fewer exclusions and other limitations, but as a note of caution, the terms of dedicated A-Side policies can vary significantly. Some are triggered only if the company is not legally permitted or financially able to indemnify the Ds and Os. Others are more liberal and apply where the company simply does not indemnify the individual. See: Presumptive Indemnification.

B-SIDE COVERAGE: Coverage under a traditional D&O policy to pay the company for amounts it pays, or would be obligated to pay, on behalf of its directors and officers for defense costs, settlement amounts or judgments resulting from claims made against them relating to their service to the firm. Most D&O claims fall under the B-side of the policy, since most companies are legally required and financially able to indemnify their directors and officers. The B-side of the policy usually has a retention which is paid by the company.

In the U.S., where there is a long-standing tradition and legal basis for indemnification, companies almost always indemnify their directors and officers, and therefore, B-side coverage is most often utilized. See: Presumptive Indemnification. BUMP-UP CLAIMS: In the context of an acquisition, these are claims by the company-to-be-acquired’s shareholders alleging that the company has been undervalued. These actions seek to have the purchase price raised or “bumped-up.” See Bumpup Exclusion.

BUMP-UP EXCLUSION: An exclusion found in many if not most D&O policies, this precludes coverage for settlements or court awards resulting from Bump-up claims or claims broadly based upon, arising from, or in consequence of the actual or proposed payment of allegedly inadequate consideration in connection with its purchase of securities by the company. CAPACITY or INSURED CAPACITY or COVERED CAPACITY: The role or position in which the insured individual was acting when the acts at issue were alleged to have occurred. Under a D&O policy, directors and officers are insured for acts taken in their capacity as directors or officers. If an individual who just happens to be a director or officer of a company is sued unrelated to his or her service to the company, then the individual was not acting in his or her capacity as a director or officer and so would not have the benefit of the D&O policy. Capacity issues can arise when an individual acts in more than one capacity (i.e., a shareholder).

CLAIM: The coverage trigger for a D&O insurance policy. This is exceedingly contract-specific. Most D&O policies would cover legal proceedings (including arbitration and mediation) along with written demands where there is an allegation of a wrongful act by a Director or Officer, but the definition of claim usually varies based on who is insured – with broader coverage for Ds and Os than for the entity or company. Where a public company is involved, coverage may be triggered only for Securities Claims. Today, much of the focus is on pre-claim investigations, where there is an inquiry but no specific allegation of wrongful acts by an insured. See: Investigative Cost Coverage.

CLAIMS-MADE: A claims-made insurance policy is one that covers claims that are first asserted during the policy, generally without regard to when the alleged wrongful acts occurred (unless the policy specifically excludes claims arising from acts that occurred prior to a specific date). The opposite of a claims-made policy is an occurrence policy which responds to covered events that arose during the coverage period (past or present) – regardless of when those claims are reported. As a result, occurrence policies are significantly more expensive and not available for D&O coverage.

CLAIMS-MADE AND REPORTED: A claims-made policy that specifically requires that any claim made during the policy period also be reported to the insurance carrier during that same policy period. D&O policies are usually very specific as to when the insured must provide notice to the insurer of a claim and the notice requirements may be identified as a condition precedent to coverage. Most D&O policies are claims-made and reported policies. Many policies require notice as soon as practicable during the policy period or during some identified period (most commonly, 60 days) after the end of the policy, sometimes referred to as a post-policy reporting window.

THE CLASS ACTION FAIRNESS ACT (CAFA): A federal law enacted to reduce forum shopping by plaintiffs in class actionfriendly states. Signed into law in 2005, it was intended to reduce perceived abuses of the class action structure by expanding federal courts’ original jurisdiction, relaxing limitations on defendants’ ability to remove actions from state court, hindering federal courts’ authority to remand actions back to state court, and regulating settlements.

CLAWBACK: Generally, money or benefits that were distributed and later taken back under special circumstances. Both SOX and the Dodd-Frank create circumstances where compensation may be “clawed back” from executives following financial restatements at their companies. CO-DEFENDANT COVERAGE: Coverage granted to individuals or entities that would otherwise not be covered by the D&O policy, so long as at least one insured under the policy is also named as a defendant in the same Claim.

CO-INSURANCE: The percentage of all loss that is the company’s sole responsibility. Sometimes co-insurance applies only to defense costs, or only to settlements and judgments, but usually it applies to all loss under a D&O policy. Today, most D&O policies do not contain a co-insurance provision. COMBINATION or COMBINED POLICY: See MULTI-LINE POLICY.

CONTINUITY: Continuous coverage without gaps. The issue of continuity most commonly arises when there is a change in insurance carriers as the new insurers may add wrongful acts dates (or other limiting wording) on new policies that precluded coverage for acts that occurred prior to their inception. Alternatively, some carriers require warranties that may have the same or similar limiting effect. See Warranties. CONTROL-MASTER PROGRAM: This refers to a type of D&O program structure where there is both a global master policy and separate locally admitted policies, all tied in to a single global aggregate limit of liability or coverage in the master policy.

C-SIDE COVERAGE (OR ENTITY COVERAGE): Coverage under a D&O policy for claims against the company or entity (typically limited to Securities Claims where the company is publicly traded). Historically, D&O policies didn’t provide entity coverage, as the intent of the policy was to protect the directors and officers from the risk of personal liability. However, the company itself was typically named in lawsuits along with the directors and officers, especially in the securities context. Heated debates over allocation then arose over just what portion of defense costs, settlement amounts and/or judgments should properly be credited to the insured directors and officers and what should be credited, or allocated, to the uninsured company. The result is that D&O policies in the U.S. now typically include entity or C-Side coverage or have an express allocation provision. See: Allocation.

CONDUCT EXCLUSIONS: This refers to the exclusions found in virtually every D&O policy addressing intentional illegal conduct, fraud and illegal personal profiting by insureds.

DARCSTAR: Directors’ All Risk Cover (DARCSTAR™) is an innovative new D&O product introduced by Willis in London for non-U.S. D&O clients. The groundbreaking new D&O policy seeks to eradicate the indemnification uncertainties in D&O insurance (especially prevalent outside the U.S.) and cut through the complexities of traditional D&O cover to advance all directors’ costs in the event of an allocation dispute. In less than half the length of a standard D&O policy, it delivers broad and relevant cover in an easy to understand policy that offers directors and officers significantly enhanced protection.

DEDUCTIBLE: In the D&O world, the terms deductible and retention are often used interchangeably. The term refers to the amount of covered loss that the company has to pay before the policy will come into play. [It should be stressed that these terms are NOT interchangeable when used as respects other types of insurance.] A policy’s deductible or retention only applies to covered loss. Accordingly, if there is an allocation because some part of a claim is not covered by the policy, then the allocation must be determined before the deductible or retention is applied. For example, several defendants are sued, some of which are insured under a D&O policy. It costs a total of $5 million to defend and settle the suit and the insurer and insured agree to allocate 50% of the costs of defense and settlement to the insureds. Since the deductible or retention only applies to “covered loss”, the allocation must occur before the deductible or retention is applied. In this case, the allocation results in a potential maximum of $2.5 million being covered by the insurance. However, it takes $1 million in paid loss by the company before the assumed policy deductible or retention of $500,000 is satisfied; the insurer then pays only 50% of the remaining $4 million loss or $2 million. See: Allocation.

DEFENSE OUTSIDE THE LIMITS: This refers to a provision where the defense costs provided under a D&O policy would be paid in addition to, or “outside” the aggregate limit of liability. Sadly, for those seeking coverage, such a provision is not available in today’s D&O marketplace. This means that all costs and expenses paid by the insurer in the defense of the claim are “inside” the limits and serve to erode or reduce the limit of coverage provided under the D&O policy. Accordingly, if an insured has a $10 million policy, and spends $2 million on defense costs alone, there is only $8 million left to satisfy a settlement or judgment, or deal with other claims, assuming that the policy’s retention has already been met.

DERIVATIVE DEMANDS: A procedural requirement in many states which requires a shareholder who wants to bring a derivative suit to first make a demand on the board of directors that it rectify the perceived wrong. Failure to bring a derivative demand, absent limited exceptions, such as futility, can act as a strict bar to a derivative suit. See: Derivative suits.

DERIVATIVE SUITS: A lawsuit, usually by a shareholder of a corporation, brought under state law on behalf of the corporation, to enforce or defend a legal right or claim of the corporation. Made against both individual directors or officers and the company itself, the stated goal of a derivative suit is to put the company back in the position that it would have been in but for the breach of duty by the executives. The corporation is therefore both a defendant and the nominal plaintiff, while the relief which is granted goes to the corporation itself. Typical allegations include the failure to properly manage or supervise the company and/or conflicts of interest. In the world of D&O liability and insurance, these suits have special significance, as settlements and court awards of derivative claims are generally understood to be non-indemnifiable and thus fall within the A-Side of D&O policy. See: Derivative demands.

DIFFERENCE IN CONDITIONS (DIC): An insurance provision sometimes found in excess insurance which states that the excess policy will drop down within an insurance program and in-fill coverage where the excess coverage is broader, paying a claim (or portion of a claim) otherwise uncovered under an underlying policy. See: Primary Insurance and Follow Form. DISCOVERY: An additional extended period of time after the end of the D&O policy during which the insureds can notify the insurer of claims made against them (“discovered”) during the extended period for alleged wrongful acts that took place during or prior to the original policy period.

Most D&O policies will have two alternatives: both an embedded post-policy reporting window (usually 30, 60 or 90 days during which to report claims that were made against the insureds during the policy period) and a multi-year option. The multi-year option is generally only available where coverage is not renewed with the carrier. It will have a specific length of time and cost (usually a percentage of the premium originally paid for the expiring policy). Note that the discovery or extended reporting period usually does not have its own, additional limits of coverage but instead, is an extension of the original aggregate limit of liability in place immediately prior to the election of discovery. The right to purchase discovery (or an extended reporting period) can be triggered mid-term in a D&O policy upon a particular occurrence, such as the acquisition of the company by another firm or group of owners acting in concert.

DODD-FRANK ACT: The Dodd-Frank Wall Street Reform and Consumer Protection Act became law in 2010 as a response to the global financial crisis and the resulting calls for sweeping overhaul of the U.S. financial system. The emphasis in the mammoth new law is on addressing systemic risk and protecting the economy as a whole. While it deals largely with firms in the financial sector, it also creates new rules for U.S. public companies in the areas of executive compensation (and clawbacks), proxy voting and whistleblowing.

DOMESTIC PARTNER EXTENSION: This provision extends coverage to domestic partners of directors and officers (similar to the Spousal Extension) who are sued solely because of their position as a domestic partner. Domestic partners may be sued in jurisdictions where a judgment against a director or officer would not otherwise be fully collectible because his or her domestic partner has a significant ownership interest in the assets of director or officer. See: Spousal Extension.

DOUBLE DERIVATIVE CLAIM: A rare derivation on derivative suits this is a lawsuit brought by a shareholder of a parent corporation on behalf of a wholly owned subsidiary for alleged wrongs to a subsidiary. They generally occur where shareholders have lost standing to maintain a standard derivative action due to the acquisition of the corporation in a stock-for-stock merger; the shareholder, in his new capacity as a shareholder of the acquirer, then reasserts the claim double derivatively. See: Derivative Suit. DUTY TO DEFEND: A contract right and obligation of an insurer to appoint counsel, develop and implement defense strategy, and generally take care of a claim against an insured. Typically, private and not-for-profit D&O policies generally are duty-todefend contracts, while those for publicly-traded companies do not have duty to defend provisions.

The fact that public company D&O policies are not duty-todefend policies means that it is the insured’s responsibility to retain defense counsel and make defense decisions. Even without a defense obligation, however, the insurer usually has a contract right to participate in the defense of a claim covered by the D&O policy. Different insurers want to participate to different degrees but usually this includes approval over the selection of counsel, the reasonableness of defense expenses and settlement approval. See: Effective Association.

EEOC: The U.S. Equal Employment Opportunity Commission (EEOC) enforces federal laws that make it illegal to discriminate against a job applicant or an employee based on a protected category (such as race, color, religion, sex [including pregnancy], national origin, age, disability or genetic information) along with illegal employment retaliation against a person who complained about discrimination, filed a charge of discrimination, or participated in an employment discrimination investigation or lawsuit. The Commission investigates charges of discrimination against employers covered by federal law. Where they determine that discrimination has occurred, they will try to settle the charge. If this isn’t successful, they have the authority to file a lawsuit to protect the rights of individuals and the interests of the public; in the alternative, they may issue a “right to sue” letter to potential plaintiffs allowing the individuals to bring their own legal actions. Most employers with at least 15 employees are covered by EEOC laws (20 employees in age discrimination cases).

EFFECTIVE ASSOCIATION: This term is used by insurers to stress the amount of participation they desire in the claim handling process. Some insurers want to have a say in motion practice, trial strategy and settlement negotiations. Effective association usually means more than keeping the insurer informed of the progress of the claim, but less than having an actual duty to defend. This term has not been examined in any detail by a court to date. Some carriers have established claim handling guidelines (usually not referenced in the actual D&O policy) that can provide additional insight into a carrier’s expectations. EMPLOYMENT PRACTICES CLAIM: Usually, this means a claim by an employee against his or her employer (or prospective or former employer) and perhaps against other individuals employed by the employer relating to the terms of employment. Separate policies are sold that specifically address these types of claims and each such policy has its own definition. Some D&O policies include specific provisions clarifying that the D&O policy includes elements of employment practices coverage. Employment practices claims are usually defined to include, at a minimum, wrongful termination, failure to promote, breach of employment contract, discrimination and harassment.

ENDORSEMENT: A separately negotiated clause (sometimes referred to as a rider) in the insurance contract that is not part of the main form or boilerplate of the policy. Endorsements are added to modify or amend the basic or boilerplate policy. Many insurers have standard required endorsements that must go on every account and are not considered negotiable. Most states also require certain amendatory provisions to the basic form and these are found in state amendatory endorsements, usually dealing with cancellation, non-renewal and discovery.

ENTITY COVERAGE: See C-Side Coverage. ENTITY VERSUS INSURED EXCLUSION: A recent (favorable) variation on the Insured vs. Insured exclusion found in a D&O policy. It precludes coverage for claims brought by the company or insured organization against other insureds. So the company itself can’t sue its Ds or Os and gain coverage for their defense or settlement under the D&O policy. See: Insured vs. Insured exclusion.

ERISA: The Employee Retirement Income Security Act of 1974 (ERISA) is the U.S. statute which regulates privately sponsored pension and welfare benefits provided for employees and their beneficiaries. The Act:

• Broadly defines the term “fiduciary” and creates a high level of personal liability for ERISA fiduciaries: the prudent- expert rule

• Instructs ERISA fiduciaries that their primary duty is to the plan and plan beneficiaries

• Acknowledges the fact that many fiduciaries may wear two hats as employees of the organization and fiduciaries of the employer’s plan

• Limits an organization’s ability to exculpate or hold harmless such fiduciaries

• Mandates the purchase of an ERISA surety bond which protects plan assets against theft

• Permits the purchase of ERISA Fiduciary Liability insurance EXCESS INSURANCE: Companies who want a substantial amount of D&O coverage may not be able to buy or may prefer not to purchase it all from a single insurer. In that case, companies will buy insurance from more than one insurer and each insurer will have a different attachment point, at which time their insurance may be implicated by a claim. The first insurer that would be called upon by the insured is referred to as the primary insurer.

Excess policies are specifically identified as such and generally triggered only after the primary insurer and all intervening insurers have paid, have committed to pay, or are otherwise obligated to pay, their full limits. Excess policies may follow form (duplicate the wording) of the primary policy or provide broader coverage. See: Difference in Conditions. EXHAUSTION OF LIMITS (AKA SHAVING OF LIMITS) PROVISION: This refers to a policy provision relevant to excess layers of coverage. A number of U.S. courts have held that a plain reading of some excess D&O insurance policies requires the actual payments of full policy limits by all underlying carriers before additional excess insurance is triggered. The outcome of such decisions, if unaddressed, would be the potential loss of excess coverage if someone other than an underlying carrier paid all or part of a claim. In response, exhaustion of underlying limits provisions were negotiated to address the situation where someone else – the company itself, a third party, excess insurance under a difference in conditions provision – pays part or all of a claim. Note that the provision does NOT provide that the excess carrier itself will drop down, but rather that it will recognize the erosion of the underlying limits by payment by someone other than an underlying insurer.

EXTENDED REPORTING PERIOD: See Discovery. EXTRADITION COSTS COVERAGE: A coverage clarification for the (reasonable and necessary) costs associated with responding to extradition demands which may be made against a director or officer in relation to a D&O claim. This is usually found in either the definition of loss in a D&O policy or within the definition of the claim.

FINRA: The Financial Industry Regulatory Authority (FINRA) is the independent regulator for all securities firms doing business in the U.S. Its chief role is to protect investors by maintaining the fairness of the U.S. capital markets. It touches every aspect of the securities business: from registering and educating industry participants to examining securities firms, writing rules, enforcing those rules and the federal securities laws, informing and educating the investing public, providing trade reporting and other industry utilities,, and administering the largest dispute resolution forum for investors and registered firms. It also performs market regulation under contract for the major U.S. stock markets, including the New York Stock Exchange, NYSE Arca, NYSE Amex, The NASDAQ Stock Market and the International Securities Exchange.

FOLLOW FORM: This term is usually used in an excess policy and means that the excess insurance incorporates by reference all of the provisions of the primary policy, except as may be specifically changed in the excess policy itself. The variation of this is a difference-in-conditions policy or provision where the excess coverage is intended to be broader than the underlying or primary insurance. See: Difference in Conditions.

FOREIGN CORRUPT PRACTICES ACT (FCPA): The U.S. Foreign Corrupt Practices Act makes it unlawful for persons and entities to make payments to foreign government officials to assist in obtaining or retaining business. Since 1977, these antibribery provisions have applied to all U.S. persons and certain foreign issuers of securities. After amendment in 1998, the antibribery provisions of the FCPA now also apply to foreign firms and persons who cause, directly or through agents, an act in furtherance of such a corrupt payment to take place within the territory of the U.S. The FCPA requires companies whose securities are listed in the U.S. to meet its accounting provisions which are designed to operate with its anti-bribery provisions. These provisions require relevant corporations to (1) make and keep books and records that accurately and fairly reflect the transactions of the corporation and (2) devise and maintain an adequate system of internal accounting controls. Violations of the FCPA can result in fines, penalties, and for the individuals involved, possible jail time. Today, most major nations around the globe have local provisions similar to the FCPA. See: UK Bribery Act.

FRAUD-ON-THE-MARKET: In D&O securities fraud cases, a legal theory under which the plaintiffs are presumed to have relied (versus needing to prove reliance) upon the defendant’s material misrepresentation regarding a security traded in the open market where the (mis)representations affected the price of the security.

FREEDOM OF SERVICES (FOS): Under this convention, an insurance policy issued in any one European Union member country is deemed to be legal, binding and enforceable in any other EU country. This is directly relevant for EU countries when considering rules on non-admitted coverage, as such rules might otherwise impede the free movement of insurance services. Within the European Union, Article 56 of The Treaty on the functioning of the European Union provides that any restrictions on “freedom to provide services” within the Union are prohibited. Article 57 specifies that the provisions on the free movement of services cover all industrial and commercial activities – which would include insurance. This is further expanded to include Iceland, Liechtenstein and Norway under the European Economic Area (EEA) Agreement which guarantees the freedom to provide services on a non-discriminatory basis anywhere within these countries and the EU.

HAMMER CLAUSE: Although the term of art is not actually used in a D&O policy, it refers to a provision typically found in the defense section of a D&O policy which relates to the carrier’s right to consent to a settlement. Most D&O policies give the insured the right to consent, and therefore, to withhold consent, to covered settlements. It applies in situations where the carriers and the claimants want to settle a claim, but the insureds refuse. It provides that in the event that the insureds’ refusal to settle a claim results in additional costs (i.e., the case settles for more, or results in a higher judgment) then the insurer is not liable for those additional amounts. For the hammer clause generally states that the insurer’s liability for any subsequent settlement is limited to the amount for which the case could have been settled, plus defense costs incurred to date. Some carriers may be willing to delete the hammer clause on some policies or to modify it to provide some proportional additional coverage.

INDEMNIFIABLE: This refers to a company’s ability to hold its directors and officers harmless for claims against them in their corporate capacity. The ability to indemnify a D or O arises under the local law which permitted the creation of the organization; in the U.S. this usually means the relevant state law under which the entity was organized. Such rules typically provide for mandatory as well as permissive (more expansive) indemnification. There are also legal exceptions or limitations to indemnification. See: Non-Indemnifiable. Delaware Code, Title 8. Corporations, Chapter 1. General Corporation Law, Subchapter IV. Directors and Officers Indemnification of officers, directors, employees and agents.

§ 145 (a) A corporation shall have power to indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of the corporation) by reason of the fact that the person is or was a director, officer, employee or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorneys’ fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by the person in connection with such action, suit or proceeding if the person acted in good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe the person’s conduct was unlawful. The termination of any action, suit or proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent, shall not, of itself, create a presumption that the person did not act in good faith and in a manner which the person reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had reasonable cause to believe that the person’s conduct was unlawful.

INDEPENDENT DIRECTOR LIABILITY (IDL) COVERAGE: A newer form of A-Side coverage which responds to claims solely against the independent or non-executive directors (that is, without coverage for inside directors or any officers). Typically, this is the last layer of coverage after the depletion of all other insurance in the tower.

INSURANCE PREMIUM TAXES (IPTS): Insurance is a service and many jurisdictions impose a tax on insurance premiums (or that portion of a premium allocable to that jurisdiction).

INVERTED WARRANTY: Rather than the insureds signing a warranty when coverage is first purchased, or where additional, new limits of coverage are being added, a policy provision is added which precludes coverage for any claims arising out of or attributable to matters that the insureds knew about at the time of coverage, that could (reasonably) lead to a D&O claim being made against them. See: Warranty.

INVESTIGATIVE COST COVERAGE: Sometimes referred to as Inquiry Coverage, this refers to what are typically considered to be pre-claim costs relating to informal investigations where documents or interviews are sought from a company’s executives, but where there is no actually alleged wrongful act by or involving such individual.

INSURED VERSUS INSURED EXCLUSION: This exclusion was found in virtually all U.S. D&O policies and precludes coverage for claims by any insured under the policy against any other insured.

The exclusion (also referred to as the “one v. one exclusion” and the “1v1 exclusion”) was intended to preclude collusive suits between insureds (i.e., you sue me, our insurance will pay, and we will recover under the policy); however, it is not limited to only collusive suits. Any claim by an insured against another insured is precluded from coverage unless it falls within one or more of the many caveats to this exclusion. See: Entity versus Insured Exclusion

INTERRELATED WRONGFUL ACTS: Most D&O policies include a provision or definition of what is “interrelated” in order to treat the potential host of claims that might arise out of a single event or series of events – as a single D&O claim. This means that if more than one claim is made which alleges the same or similar acts, then even if the claims are not consolidated by their respective courts, they will be treated by the insurer as if they were consolidated into a single claim. The good news is that a single retention applies to the interrelated claims, but the bad news is that so does a single aggregate limit of liability.

INITIAL PUBLIC OFFERING (IPO): Refers to the first time a private firm sells stock to the investing public. In the U.S., this would be under the requirements of the ’33 Act. See: Secondary Offerings.

MULTI-LINE POLICY: This type of policy provides more than one kind of insurance coverage. For example, D&O insurance may be sold as a package with Fiduciary Liability Insurance, Employment Practices Liability Insurance, and/or Commercial Crime or Fidelity coverage. This is how D&O coverage is typically purchased at private firms and not-for-profit organizations. There may be a shared aggregate limit of liability or separate limits of coverage for the differing types of coverage.

MULTI-YEAR POLICY: Most D&O policies are for a one-year period, which commits both insurer and insured to that time frame. Other than multi-year discovery policies, most carriers are highly reluctant to write D&O insurance for longer periods.

NON-ADMITTED COVERAGE: Insurance issued by an insurer not licensed in that location (state, country, etc.). Insurance is regulated locally, as a general rule. Local country insurance regulators may require locally issued admitted policies to be used where there is property or persons in the local country that would be covered by the insurance. Otherwise, non-admitted coverage may be unenforceable, or in the worst cases, illegal, in jurisdictions which mandate admitted insurance. See: Admitted insurance.

NON-INDEMNIFIABLE: While a company may desire to protect and hold its Ds and Os harmless by indemnifying them for all claims against them, there may be relevant legal exceptions as well as possible financial constraints to doing so. Just as the ability to indemnify a D or O arises under the local law which permitted the creation of the organization [in the U.S. this usually means state law], this is also where we will find legal restrictions placed on this power.

When considering the Delaware Corporations Code, for example, we see that the power to indemnify an individual exists if “…the person acted in good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe the person’s conduct was unlawful.” [Delaware Code, Title 8. Corporations, Chapter 1. General Corporation Law, Subchapter IV. Directors and Officers, § 145 (a) Indemnification of officers, directors, employees and agents.] See: Indemnifiable.

NOTICE OF FACTS OR CIRCUMSTANCES: While reporting actual claims to a D&O carrier is mandatory, most D&O policies also allow for the discretionary reporting of facts or circumstances that, while not claims, are reasonably believed to potentially result in claims.

The positive reason for providing a carrier with notice of facts and circumstances is that if these facts and circumstances do later result in a claim, that claim will be covered by the earlier policy under which the notice of facts and circumstances was given. However, such notice will require some elements of specificity. A simple notice to the carrier that the insured is at risk that someone will sue them for something, is insufficient to meet the requirements of this provision. The downside is that if a notice of circumstances is provided and it lacks specific details, there may be both a disagreement as to whether the notice was sufficient to trigger coverage under the earlier policy and a prior claim exclusion on a later policy which may preclude coverage under the subsequent/current policy.

OUTSIDE DIRECTORSHIP LIABILITY (ODL) COVERAGE: This is an extension of coverage to include claims against a director or officer for acts taken in the officer’s or director’s capacity as a director of another company, as long as the officer or director is acting in that “outside” director capacity at the request of his or her employer.

OTHER INSURANCE CLAUSE: All D&O policies contain Other Insurance Clauses which are intended to indicate that if other insurance applies to a claim, then the other insurance applies first. This clause is widely quoted in coverage coordination disputes. While different insurers use different language in this section, all generally indicate that their insurance is excess over any other insurance that might be applicable to the claim. Courts have interpreted Other Insurance Clauses, finding that most are equivalent and therefore, all other coverage issues being equal, the policies will attach on a proportionate basis. Courts vary as to whether this proportionate basis will be determined based on differing limits of liability, or some kind of analysis of which policy the court believes to be the most applicable. Companies may ask their own directors or officers to act as directors on unrelated outside company boards because of a particular business deal in the works, to protect a security interest, to enhance a business relationship, or for any number of other reasons.

OUTSIDE DIRECTORSHIP LIABILITY, or ODL coverage is usually on a “double excess” basis which means that the insurance will apply as excess over the outside company’s indemnification obligations and then excess over the outside company’s insurance. If coverage is on a “triple excess” basis, then in addition to exhausting the insurance and indemnity at the other organization, coverage only applies excess of indemnification from this firm.

ORDER OF PAYMENTS PROVISION: See Priority of Payments Provision.

PANEL COUNSEL: A number of major D&O carriers have a pre-approved list of defense firms to respond to D&O claims, often referred to as the “panel counsel” list. [Even if a D&O policy is not a duty-to-defend contract, the carrier usually reserves the right to approve defense costs and often the firm(s) selected to defend the D&O claim.]

PINK SHEETS: This is a daily publication compiled by the National Quotation Bureau with bid and ask prices of overthe- counter (OTC) stocks. Pink sheets also refers to OTC trading generally.

Unlike companies which trade on a stock exchange, companies quoted on pink sheets don’t need to meet minimum requirements or file with the SEC. OTC Pink companies choose the level of information they provide to investors and may have limited or no public disclosure. [Pink sheets got their name because they were actually printed on pink paper. Companies traded on the pink sheets will have a stock symbol ending in PK.] PREDETERMINED ALLOCATION (PDA): Where A- and BSide D&O coverage is purchased, without entity or C-Side coverage, a way of addressing the uncertainty as to how shared costs will be handled by the policy when both the insured executives and the uninsured company are tagged with a claim. This is done by presetting the percentage of the joint expenses that will be attributed or allocated to the insured persons versus the uninsured entity. There may be different percentages for defense costs versus settlements and court awards. This percentage allocated to the insured persons could be as high as 100%. See: Allocation. PRIMARY INSURANCE: The first layer of insurance coverage which will respond to a claim. It sets out the basic terms and conditions which may then be followed by the additional excess insurance, if the excess is written as follow form.

PRIORITY OF PAYMENTS (AKA ORDER OF PAYMENTS) PROVISION: A provision often found in or added to D&O insurance policies addressing the order in which the policy’s proceeds will be applied if the amount of insurance is exceeded by the size of the claim payment to be made. Generally it provides that claims are paid for persons before parties (entities) and nonindemnifiable claims prior to indemnifiable claims. In D&O jargon, this is “A before B before C” when referring to the traditional insuring agreements. This can aid in understanding the intent of the parties as to how the policy’s proceeds shall be administered. Also see: A-Side, B-Side and C-Side coverages.

PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995: The Reform Act was designed to reduce the number of frivolous federal securities suits in the U.S. It provides that investors cannot proceed with a case unless they already have facts that strongly suggest a deliberate wrongful act. Previously, some cases could proceed with minimal evidence and use pre-trial discovery to search for more, depending on the jurisdiction. Now, plaintiffs need such evidence just to begin, which may be difficult to obtain. The Act imposes new rules on securities class action lawsuits. It allows judges to decide the most adequate plaintiff in class actions and mandates full disclosure to investors of proposed settlements, including the amount of attorneys’ fees. It bars bonus payments to favored plaintiffs and permits judges to scrutinize lawyer conflicts of interest. Some of the main provisions in this Act include:

• A safe harbor for forward-looking statements

• Limitations on joint and several liability

• Increased pleading and proof requirements

• Class action procedural reforms

PRESUMPTIVE INDEMNIFICATION: The insurer presumes that the company will indemnify its directors and officers to the fullest extent allowed by law. The D&O insurer not only hopes that the company will take care of its directors and officers in the event of a claim but typically states in a D&O policy that it will presume that the company has done so when interpreting the terms of the D&O contract.

Indemnification is central to determining whether the A-Side or the B-Side of a traditional D&O policy has been triggered, which determines whether there is an applicable deductible or retention to be paid (the B-Side having a retention which can range from the low 5 figures into the tens of millions of dollars). Under a standalone A-Side policy, this analysis may be critical to determining if there is any coverage at all for a claim. PRIMARY INSURANCE: Insurance designated as primary is the first insurance to be applied in connection with a claim, versus excess coverage.

PROXY: A written authorization by a shareholder for another person to represent him/her at a shareholders’ meeting and exercise voting rights.

REINSURANCE: A mechanism used by insurers to pass on some of the risk that the insurer is assuming or underwriting – it is essentially insurance for the insurer. Reinsurance is not available directly to the insured to pay claims.

RESCISSION: As in securities parlance, this means undoing a transaction so that each side to the transaction is back to where they started before the transaction took place. In the D&O insurance context, an insurer who attempts to rescind wants to negate the policy, as if it never existed, by giving the insured its premium back. Rescission is an extreme remedy that is not often asserted. Proving a basis for rescission differs from state to state but generally requires that the insurer be able to show that the insured made material misrepresentations regarding the risk being insured and that, but for the misrepresentations, the insurer would not have issued the policy. RETENTION: See: Deductible.

RETROACTIVE DATE: D&O policies with retroactive dates, or retro dates, provide coverage for wrongful acts that allegedly occurred any time after this date (precluding coverage for wrongful acts that occurred prior to that date). Some insurers identify the retro date as the inception date of the first D&O policy issued to the organization and continuously renewed. ROAD SHOW: A tour taken by a company preparing for a security offering in order to attract interest in the deal. Attended by institutional investors, analysts and money managers by invitation only.

RUN-OFF: A D&O policy automatically converts into a “runoff ” policy when there has been a change in control of the company, or the company ceases to exist. Most D&O policies contain a Change in Control provision stating that once a change in control has occurred, then coverage will continue only for claims arising from wrongful acts that allegedly occurred prior to the date of the change in control. In the context of a corporate transaction, the Merger or Sales Agreement will typically include a provision requiring the continuation of discovery coverage for a multi-year period for the target company. Coverage is usually requested for six years to protect (and collateralize any indemnification) for the Ds and Os for acts taken prior to the transaction. See: Discovery.

S-1: Document filed with the Securities and Exchange Commission announcing a company’s intent to go public. Includes the prospectus; also called the registration statement. SARBANES-OXLEY ACT (SOX): U.S. legislation enacted in 2002 in response to the corporate governance and financial scandals of the day. Its goal was to heighten corporate responsibility and transparency.

SECONDARY OFFERINGS: The issuance of new stock for sale to the public from a company that has already made an initial public offering (IPO). Usually made by companies wishing to refinance or raise capital for growth. The additional shares may be primary shares (shares actually being sold by the company itself) or may come from large existing holders of the stock. See: ’34 Act.

SECTION 11: A provision in the ’34 Act (dealing with securities offerings, including IPOs) which assigns accountability where a registration statement contained an untrue statement of a material fact or omitted to state a material fact necessary to avoid misleading the investing public. Those potentially liable include: (1) every person who signed the registration statement, (2) every person who was a director of (or person performing similar functions) the issuer at the time of the filing of the registration statement, (3) every person who consented to being named in the registration statement as being or about to become a director, (4) accountants who prepared or certified the registration statement and (5) every securities underwriter with respect to the security.

SECTION 12: A provision in the ’34 Act (dealing with securities offerings including IPOs) which holds liable anyone who sells or offers to sell a security by means of a prospectus or oral communication, which includes an untrue statement of a material fact or omits to state a material unknown fact to the person purchasing such security. The purchaser may sue to recover the purchase price for such security with interest, less any related income received, upon tendering the security, or for damages if he no longer owns the security.

SECTION 15: A provision in the ’34 Act (dealing with securities offerings including IPOs) which holds everyone liable who controls any person liable under section 11 or 12, jointly and severally with and to the same extent, unless the controlling person had no knowledge of or reasonable ground to believe in the existence of the facts giving rise to the liability. See: Section 11 and Section 12.

SECURITIES CLAIM: Securities claims are the most severe of all D&O claims and also have a high frequency level. Most D&O policies today define securities claim, usually in the context of providing the entity some coverage if a claim occurs. Definitions vary with the broadest being any claim brought by or on behalf of a security holder.

SECURITIES LITIGATION UNIFORM STANDARDS ACT (SLUSA): A federal law, SLUSA amends the ’33 Act and ’34 Act to preempt state-based securities class actions alleging fraud under state law ”in connection with the purchase or sale” of securities. After the Private Securities Litigation Reform Act was passed in 1995, many plaintiffs sought to escape its new restrictions by avoiding federal court altogether. For a short period, state law-based securities class actions became common. Congress subsequently enacted SLUSA in 1998 to stem the shift from federal to state courts and to prevent state private securities class action lawsuits from being used to frustrate the objectives of the Reform Act. See: the Private Securities Reform Act. SEVERABILITY: In the D&O context, severability means that the wrongful acts or misstatements of one insured will not void the contract or otherwise adversely impact coverage thereunder for other insureds. Severability typically comes up in two ways: Severability of the exclusions and Severability as to the application.

SEVERABILITY OF THE EXCLUSIONS: Such a provision states that if the conduct of one insured implicates an exclusion (for example, the illegal personal profiting exclusion) then while coverage will be denied to that individual insured, coverage for the other insureds will not be negatively impacted. Most D&O policies automatically include a statement about severability either at the beginning or end of the exclusions section, or directly underneath the exclusions relating to wrongful conduct.

SEVERABILITY AS TO THE APPLICATION: This provides that if the signer of the application and/or any warranties made a material misstatement or misrepresentation which induced the carrier to issue the D&O policy, that individual’s misstatement or misrepresentation will not void the coverage for all other insureds. Some D&O policies automatically provide severability of the application. Other insurers are typically willing to consider providing severability. See: Warranty.

SPIN DOCTOR COVERAGE: A possible sublimit of coverage in a D&O policy for the services of a media relations expert in relation to specified events that might lead to or have resulted in a D&O claim. Usually not subject to the policy’s deductible.

SPOUSAL EXTENSION: Extends coverage to spouses of directors and officers who are sued solely because of their position as a spouse. Spouses run the risk of being sued primarily in community property states where a judgment against a married director or officer would not be fully collectible because his or her spouse has a significant ownership interest in the assets of a director or officer. Spousal extensions expressly do not provide coverage for claims against a spouse alleging wrongful act by the spouse.

TAIL COVERAGE: See: Discovery and Run-off. TERRITORY: The geographic scope of coverage. However, even where a D&O policy has a worldwide Territory clause, this does not mean that the carrier will necessarily pay claims locally. If non-admitted coverage is not permitted in that jurisdiction, the carrier may instead pay where the D&O insurance contract was (legally) made rather than where the claim was brought.

U.K. BRIBERY ACT: The new U.K. law focuses on bribery, historically illegal under prior legislation and common law in the U.K., but for which there had been only limited enforcement activity. Companies subject to the Bribery Act include companies with operations or a presence in the U.K. The Act is similar to but not the same as the U.S. anti-bribery provisions; in some respects, surpassing the FCPA. See: Foreign Corrupt Practices Act.

VENTILATED LIMITS: An insurance program with multiple layers of coverage, where the same carrier(s) provide more than one layer separated by intervening coverage supplied by other carriers (example: the same carrier is on both the first and fifth layers of a D&O program, while the third carrier also provides the eight and twelfth layers).

WARRANTY: Typically seen when D&O coverage is first purchased, or where additional, new limits of coverage are being added, the warranty from the insureds would be relied upon by the insurers and attests to the lack of knowledge by the insureds as to anything that could (reasonably) lead to a D&O claim being made against them. Anything that they are aware of would be excluded from the new coverage. This statement can be made by one or more persons and might be made on behalf of (and binding on) all parties to be covered by the insurance. See: Inverted Warranty

“WELLS NOTICE”: A preliminary decision by SEC staff recommending civil action. At times, the Commission has moved to formal legal action very quickly after issuing such a notice.

WHISTLEBLOWER: A person (usually an insider at an organization, but potentially a client, customer, business partner or other) who raises a concern about wrongdoing occurring at the organization. Whistleblowers may make their allegations externally (to regulators, law enforcement agencies, to the media or to groups concerned with the issues) or internally (to other people within the accused organization). Until recently, if such activities were legally protected, this was done largely under state law. With SOX and Dodd-Frank, both federal laws, this has changed for employees of public companies.

Edition: 11.11

For past issues of our publications on other topics of interest, please visit the Executive Risks website. This document and our Executive Risks Alerts and Newsletters provide a general overview and discussion on a wide range of topics. They are not intended, and should not be used, as a substitute for legal advice in any specific situation, nor guidance on any particular insurance policy or program.

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