Directors & Officers Insurance Issues Seminar

Directors & Officers Insurance Issues Seminar McCarthy Tétrault LLP & Willis Canada Inc. January 23, 2007

Emerging Issues in Directors and Officers Liability Secondary Market Liability Regulatory Prosecution Bob Cooper

Secondary Market Liability

What is secondary market liability? 4 Creates a statutory cause of action for investors who purchase or sell in the secondary market Creates strict liability for issuers (and their officers and directors) who breach continuous disclosure obligations No need for investors to prove knowledge, intention or gross misconduct for misrepresentations in core documents such as AIF or MD&A Eliminates significant obstacle to class certification by not requiring reliance by secondary market purchasers on misrepresentations or omissions

Who is affected? 5 Applies to issuers, directors and officers, and influential persons and experts of responsible issuers Will apply to BC companies who are reporting issuers in Ontario, Alberta and Manitoba or have a real and substantial connection to those provinces Influential Person: Insider who is not a director or senior officer Control shareholder (20% or more of voting shares) Experts: Accountants Auditors Lawyers Geologists Financial Analysts Other qualified professionals making statements in their professional capacity

What does it mean? 6 No change to law requiring continuous (Financials, MD & A, AIF) and timely disclosure (material changes) Adds civil liability if there is a failure to meet these requirements and the issuer otherwise releases a misrepresentation or is not timely with disclosure Increased exposure to shareholder class action litigation Heightened concern for corporate and personal liability; financial and reputational risk

What are you liable for? 7 For a misrepresentation contained in a documents, directors at the time the document was released and officers who authorized, permitted or acquiesced in the release are liable For a misrepresentation made in a public oral statement or for failure to make timely disclosure, directors and officers who authorized, permitted and acquiesced in making the statement or in failing to make timely disclosure are liable

Are there defences? 8 Defendants must prove a reasonable investigation Factors include: Nature of issuer Adequacy of systems in place for disclosure Reasonableness of relying on system Reasonableness of relying on officers/employees Role and responsibility of the person making the misrepresenation

What is a reasonable investigation? 9 At a practical level, a reasonable investigation will likely turn on: What internal analysis preceded the disclosure/omission to disclose? Were appropriate officers, managers involved? What outside advice was sought and was it followed? Was the disclosure/omission made hastily under time pressure? Were internal compliance standards/systems followed? Was all of the above documented so as to be provable in a meaningful way?

What are the implications? 10 Increased risk of personal liability may make it difficult to recruit top flight directors Audit committees will require experienced directors and extraordinary time commitments Officers with direct preparation responsibility will face greater risk of liability and will need to document procedures followed Directors and officers may insist in written and more elaborate indemnity agreements Disclosure policies will be revamped to emphasize accuracy of public filings Earnings guidance may be less frequent

Will this open the floodgates? 11 Courts exercise a gatekeeper function Plaintiffs must demonstrate a reasonable possibility of success to proceed Damages are capped, absent a finding of fraud: For issuers or corporate influential person, damages cannot exceed the greater of 5% of market capitalization or $1 million For an officer, director or individual influential person, damages cannot exceed the greater of $25,000 or 50% of compensation received in the previous 12 months High barriers to entry present real risk to potential plaintiffs Only one action commenced in the first year (Imax)

Regulatory Prosecution

What happened to Bill C45? 13 The Westray Act came into force in 2004 The Criminal Code now requires: Everyone who undertakes, or has the authority, to direct how another person does work or performs a task is under a legal duty to take reasonable steps to prevent bodily harm to that person, or any other person, arising from that work or task This, together with provisions that made it easier for corporations to be charged criminally, was predicted to dramatically increase the number of criminal prosecutions for OH&S matters However, charges have only been laid in two cases

Is prosecution a risk? 14 Prosecution for regulatory offences in increasingly likely and organizations and individuals should not be complacent Senior officers, including directors and officers, are exposed to two types of prosecution regulatory and criminal There is an international trend which features the parallel existence of criminal law and OH&S regulation in protecting worker safety There is no clear line between the OH&S standard of negligence and criminal negligence

Is prosecution a risk? (cont d) 15 Parallel investigations by police and regulators are common in serious incidents or fatalities Organized labour and safety advocates apply coordinated pressure to lobby for prosecutions Many senior officers and organizations are not properly informed about their duties and do not place a priority on worker safety

What steps should be taken? 16 Compliance with applicable OH&S legislation is essential to demonstrate that all reasonable steps are being taken to prevent injury Due diligence needs to include senior management oversight of safety systems and matters A real commitment to workplace safety must be made with an effective program that demonstrates clear communication throughout the organization There must be proactive accident response plans to manage the complexities of dealing with criminal and regulatory investigations

17 Bob Cooper Partner Litigation Group Tel: 604-643-7960 rcooper@mccarthy.ca

Directors and Officers Liability Insurance: Fine-Tuning Protection to Serve Corporate and Individual Priorities McCarthy Tétrault LLP & Willis Canada Seminar January 23, 2007 Presented by: Catherine Richmond, Senior Vice President Executive Risk Practice Willis Canada Inc.

Agenda Overview of Directors and Officers Liability Insurance Critical D&O Issues for 2006 Indemnity Rescission Bill 198

D&O Insurance Policy Overview

D&O Insurance Policy E&O for running a company Who s insured: Directors, Officers Employees Entity - Securities, Oppression Spouses Employees Defined term: full-time, temporary, seasonal, parttime

The Three Sides of Directors & Officers Liability Side A covers individual directors and officers (and Trustees) for non-indemnifiable losses - those losses that the company cannot indemnify. No deductible Side B reimburses the company for payments it is required to make to individuals to cover the cost of claims, settlements and legal defense. Deductible. Side C reimburses the company for securities claims made against the corporate entity itself. Deductible. Sometimes includes pollution defense.

Program Design BROAD FORM (DIC)* EXCESS A-SIDE COVERAGE Broad Form A-Side DIC* Coverage Drops down to primary if underlying insurance: wrongfully refuses to indemnify is financially unable to indemnify is rescinded is subject to bankruptcy/financial impairment Annual, Aggregate Limit Is non-rescindable for any reason *DIC = Difference In Conditions A-SIDE COVERAGE EXECUTIVES PERSONAL ASSETS PROTECTION B-SIDE COVERAGE CORPORATE BALANCE SHEET PROTECTION C-SIDE COVERAGE CORPORATE ENTITY PROTECTION (securities claims only) NO DEDUCTIBLE DEDUCTIBLE

Triggering the Policy Policy Construct: Claims Made 3 rd Party Liability Policy All Risks Claim alleging Wrongful Act resulting in Loss

What is NOT covered by the policy Public Policy Exclusions: Conduct Exclusions: Fraud/Dishonesty Illegal Benefit Fines & Penalties Covered Elsewhere: Bodily Injury/Property Damage Exclusion Pollution Exclusion Pensions/ERISA Exclusion Professional Liability note securities carveout

What is NOT covered by the policy Narrow the Underwriting Exclusions: Major Shareholder Exclusion 10% Insured versus Insured Exclusion Pending and Prior Litigation Exclusion Pollution Securities Claims Exclusion - Secondary Market, 30 days notice Employment Practices Liability

Critical D&O Insurance Purchasing Issues

Critical Purchasing Issues Purchasing Decision is changing Directors/Trustees involvement Potential conflict between management and insureds (cost v. coverage) Third Party Reviews Program Structure Who should be insured? Adequacy of Limits Side A DIC ( Difference in Conditions) Coverage Certainty Indemnification Fraud

Coverage Certainty Indemnification Sources of indemnification may be more limited now than in the past due to: Insolvency Legally unable Incentives against indemnification- reduce limits available to innocents cooperation with criminal & regulatory investigators Plaintiff s strategies Indemnification availability has key implications for insurance program structure

Coverage Certainty Fraudulent Conduct Concern: increasing number of cases where officers admitting to participation in frauds, or overwhelming evidence of same. Implications: Denial of Claims Rescission of Coverage Threat of rescission used as a negotiating tool by insurer How can directors avoid rescission and denial of defence obligation? Full severability Fraud exclusion requires proven intentional conduct Consider Side A non-rescindable coverage Ensure broker has technical expertise and experience

Bill 198 What are the implications? Litigation: Powerful tool for investors in the secondary market increased class actions Damage caps increased allegations of knowing disclosure violations? Cross border actions? Outside directors minefield? Not involved in day to day operations Underwriting: Does the company have policies and procedures for: disclosure? Release of public oral statements, forward looking statements? Does the company receive outside expert advice?

Bill 198 What are the implications? Coverage: Who should be insured? Separate policies for directors and officers by group? Limits? Insured versus Insured claims? Conflict amongst defendants? Need for separate counsel increased cost

Catherine Richmond Senior Vice President, Executive Risk Practice Catherine.Richmond@willis.com (604) 605-5611

Insured v. Insured Exclusion Ariel DeJong

What Is It and Why Is It There 35 Side A, Side B and Side C coverage Excludes coverage for an action by one insured against another Important to know who is an insured past,present and future directors, officers, employees spouses Underwriting rationale is to prevent collusion Actual wording governs if clear not limited to collusive claims: Kohanski

Exceptions 36 Derivative actions brought by persons not insured who act without the solicitation, assistance or participation of any insured party Wrongful dismissal claims Claims for contribution or indemnity (if claim otherwise covered) Securities claims

Problems 37 Statutory limits on indemnities for directors and officers CBCA and BCBCA Broad definition of insured can expand exclusion and narrow derivative action exception Claims by liquidators/trustees in bankruptcy/receivers: Markham and People s Changes in control of the corporation Gaps in coverage for directors and officers Joint claims by insureds and non-insureds

Potential Solutions 38 Exception for claims by liquidator/trustee in bankruptcy/receiver Exception for change of control of company Expand derivative exception to require assistance of more than one insured Limit application of the exclusion to individual insureds while acting within their capacity as directors, officers or employees Get exception to exclusion for non-collusive claims

Potential Solutions 39 Stand alone, enhanced or broad form excess drop down difference in conditions Side A Non-rescindable, non-cancellable and fully funded run-off Side A Deal with allocation issue for covered and uncovered claims where claims by both insureds and non-insured

Final Comments 40 Read the exclusion and policy language carefully wording varies widely If possible address gaps in coverage and ensure coverage for gaps Determine your risk strategy and tolerance Be aware and make informed decisions

41 Ariel DeJong Partner Litigation Group Tel: 604-643-7107 adejong@mccarthy.ca

Directors & Officers Liability and its impact on Insurance Coverage McCarthy Tetrault LLP & Willis Canada Seminar January 23, 2007 Presented by: Murn Meyrick, Senior Vice President Executive Risk Practice Willis Canada Inc.

Impact of litigation: Underwriters Reaction & Tools Book of business: assessment of rate, retentions, limits, reserves. Is book profitable? Underwriting of risk: Application Warranties Disclosure Corporate governance Policy: Specific account - Endorsements - exclusions Across the book of business involved process D&O policy is static product functioning in a dynamic environment

Impact of litigation: Insureds Reaction & Tools Don t ignore!! Educate yourself about trends Identify where you stand in peer review Start early in renewal process Differentiate your risk - corporate governance Coverage review - educate yourself! Changes in purchasing decision: Directors involvement Outside consultants Bifurcation of purchasing decision

Impact of litigation: Claims management Increased sophistication & organization of plaintiffs counsel, including U.S. alliances Increased awareness of & attentiveness to coverage & claims handling Increased third party involvement (audit, coverage & monitoring counsel) Greater coverage disputes- rescission threat; nonrescindable endorsements Competing interests amongst insureds - severability; first past the post; limits preservation Excess layer involvement

A few current examples Executive compensation - stock option backdating & springloading Income trusts - increased exposure on trustees Institutional investors - pension plans, hedge funds increasing ownership and pushing aggressively for their agenda X-border implications - extradition; self-incrimination Criminal & Regulatory investigations/prosecutions

The new executive world? Enron Canada CEO, David Delainey, sentenced to 2.5 years, Sept. 2006

Negotiating the D&O Policy Great environment for customizing: New entrants Insurers willing to trade coverage to maintain price Insurers willing to differentiate by product offering not price New products - eg, Side A DIC (Difference in Conditions), Income Trust, Mutual Fund - Independent Review Committee Buyers more sensitive to coverage over price D&O policy no longer a commodity

Final Message Start the process early Determine your risk philosophy and prioritize Differentiate your risk to underwriters This isn t an auto policy - terms vary greatly EDUCATE & NEGOTIATE