Energy Insurance Mutual’s 2008 Risk Managers’ Information Meeting

February 25, 2008Omni Orlando Resort

Orlando, FL

Kevin M. LaCroix, Esq.

Partner, OakBridge Insurance Services, LLC, Beachwood Ohio

– OakBridge is an insurance intermediary specializing in management liability insurance placements for public and private companies, as well as private equity and venture capital funds and other alternative investment vehicles.

1995 to 2005: President, Genesis Professional Liability Managers, Inc. (a Berkshire Hathaway company)

Previously, Partner, Ross, Dixon & Bell, Washington, D.C.

Professional Liability Underwriting Society (PLUS):

– President (2004)

– Board Member (1999-2005)

– Foundation Board Member (current)

Co-Chair, PLUS D & O Symposium, 2007 and 2008

Author, The D & O Diary (Internet weblog)

Current Issues in D & O

Global Climate Change

Emerging Frequency Issues

– Subprime-Related Litigation

– Other Frequency Trends

Options Backdating Update

Important Legal Developments

– Tellabs, Stoneridge

– Class Action Trials: JDS Uniphase, Apollo Group

Emerging Issues

– Class Action Opt-Outs, FCPA

Global Climate Change

Scientific Issue

Political Issue

Economic Issue

Legal Issue

– Property Damage, Bodily Injury Liability Issues

– Investor Liability Issue

Important Context for D & O Liability Issues

Supreme Court’s April 2007 Decision in Mass. v. EPA

Existing SEC Disclosure Requirements

Growing Sentiment for Additional Disclosure Requirements

Shareholder Expectations

Massachusetts v. EPA (U.S. Supreme Court, April 2, 2007)

Holding: EPA violated Clean Air Act (CAA) by improperly declining to regulate new vehicle emissions standards to control for carbon dioxide emissions.

Court did not rule:

– CAA or EPA should regulate mobile source emission

– Auto companies should be liable for emissions

Two Particularly Significant Elements of Court’s Holding:

– Harm from climate change can confer standing to sue EPA for failure to comply with CAA requirements

– Greenhouse Gas Emissions (GGE) are “pollutants” under the CAA.

Existing SEC Disclosure Requirements

Regulation S-K, Item 101(c)(1)

– Companies must disclose “material effects” of compliance with environmental regulations

– As new regulations and expectations accumulate, Item 101 Environmental Disclosure will become more significant

Regulation S-K, Item 303

– Companies required to disclose “material risks, trends and uncertainties” that could impact revenue or income.

Recent SEC Environmental Disclosure Actions

ConAgra Foods (June 29, 2007)

– Company reversed $35 million of legal and environmental expenses to income

– Company allegedly misleadingly failed to disclose that at least $23.8 million of the reserves were “excess” in prior periods

– One of several allegedly improper practices that misstated company’s financial performance

– CFO paid $425,000 disgorgement

Safety-Kleen (Sept. 12, 2002)

– Company allegedly created fictitious income by “reducing several environmental reserve accounts”

– CFO later plead guilty to criminal securities fraud

SEC Enforcement (cont’d)

Ashland, Inc. (November 28, 2006)

– Director of Environmental Remediation allegedly improperly reduced environmental remediation estimates by approximately $160 million

– Materially understated reserves, understated income

– Company agreed to internal control changes

July 26, 2007 Jenner & Block Legal Memo

“The SEC has turned its attention on environmental financial disclosures.”

“Corporations and corporate executives should certainly be cognizant of the increased number of civil and criminal actions being brought by the SEC against corporations and officials who fail to observe existing environmental reporting requirements.”

Disclosure: Recent Developments

September 14, 2007: NY AG Andrew Cuomo Subpoenas Five Major Energy Companies

– AES Corporation, Dominion Resources, XCEL Energy, Dynegy, Peabody Energy

– Demanded Information Regarding Their Analysis of Climate Change related “financial, regulatory and litigation” Risks

– Strongly suggested the need for greater disclosure

September 18, 2007: CERES SEC Disclosure Petition

– CERES, Environmental Defense Fund, 22 other petitioners (including public pension funds, etc.)

– Asks SEC to issue interpretive guidance clarifying obligations to disclose climate change financial impacts

Recent Developments (Continued)

January 10, 2008: CERES and Risk Metrics Report

– Assessment of 40 largest global banks

– Measured how banks are “addressing climate change through board oversight, management execution, public disclosure, greenhouse gas emissions accounting and strategic planning”

February 11, 2008: Institutional Investors Group on Climate Change and CERES: Electric Utility “Disclosure Framework”

– “will make it easier for investors to assess and compare risks and opportunities posed by climate change”

– “captures those climate change issues that are relevant specifically for electric utilities

– “a unique format for presenting quantitative and qualitative issues in a coherent way”

Recent Developments (cont’d)

Oct. 18, 2007: Senators Lieberman and Warner introduce America’s Climate Security Act of 2007

– Introduces Carbon Emissions Cap and Trade System

– Directs the SEC to confirm Under Items 101 and 303 of Reg. S-K that “global warming constitutes a known trend”

– Bill still before the Committee on the Environment and Public Works

Implications

Mounting Pressure by Investors, Shareholders, Regulators to evaluate financial impacts from climate change

Investor Groups Are Focused on Disclosure Issues– In 2007, more than 43 shareholder disclosure responses were filed with

U.S. Corporations

– Average shareholder support was 21%

Heightened Expectations Could Create “Disruptive Disclosures” or Allegations of “Omissions”

Implications

BOTTOM LINE: In this environment, it is prudent to assume that investor claims and other D & O claims will arise

BETTING LINE: Securities Litigation Watch Over/Under Date of May 31, 2008

Insurance Implications

Most Policies Do Not Explicitly Address Climate Change or Global Warming Issues

“Standard” Pollution Exclusion in Many D & O Policies

– Tailored to Specific Existing Environmental Statues

– AEGIS Policy Omits Pollution Exclusion

– Most Insurers Will Amend to Carve Back Coverage for Securities and Derivative Claims

– “pollutants”: Does not necessarily include GGE?

Concerns

– Carve back language should avoid presumption that the claims will arise in the U.S.

Insurance Implications (cont’d)

Bodily Injury/Property Damage Exclusion (BIPD)

– Avoid having the BIPD exclusion taking away carve back coverage grant

– “For” wording preferable rather than “based upon, arising out of, etc.”

Rescission Issues

– Some carriers are starting to introduce climate change issues in renewal applications

– Increased Significance of “Full Severability” and limited “Imputation”

Insurance Implications (cont’d)

Side A/Difference in Condition (DIC)

– Increasingly standard part of D & O insurance program

– Many Side A/DIC policies omit the pollution exclusion

– Potential drop down coverage if traditional D & O policy is unavailable due to coverage preclusion or otherwise

Class Action Frequency Trends: Overview

Two-Year Lull Between July 2005 and July 2008

Second Half of 2007: SCA Filings Returned to Historical Levels

Number of Filings During November 2007 Highest since January 2004

Subprime Litigation was Most Important Factor, but NOT the only factor

Over 80 SIC Code Categories

Significant other groups include Pharmaceuticals (14); Semiconductors (7); Radio & Telephone Equipment (6)

Class Action Trends: Subprime

Subprime-related Shareholder Suits

– 43 Securities Class Actions

– 9 ERISA/401(k) Lawsuits

Source: The D & O Diary (as of 2/12/08)

Many Types of Defendants

– Loan Originators; Securitizers; Residential Home Builders; Bond Insurers; Credit Rating Agencies

Spreading Wave:

– Defendants outside Financial Sectors

– Defendants Outside NY, CA, FL

– Other Professional Defendants (Accountants, Offering Underwriters)

Class Action Trends: Subprime (cont’d)

Likely to Continue to Emerge Well Into 2009

– Plaintiffs’ Lawyers’ Estimate: More SCAs in 2008 than any year since PSLRA (1995)

Significant Challenge for Professional Liability Insurance Industry

– Estimated Losses Range: $3 bb to $8-9 bb

Underwriting Response?

– Limited to Financial Institutions (so far)

– Has not affected Capacity, Pricing (so far)

Options Backdating Update

Lawsuit Scoreboard– 36 Securities Class Action Lawsuits (including 2 in 2008)

– 166 Shareholder’ Derivative Lawsuits

– 4 ERISA/401(k) Lawsuits

Class Action Resolution Scoreboard– 3 Dismissals, 7 Settlements Totaling $244 mm

– 26 SCAs Remain Pending

Derivative Lawsuits Resolution Scoreboard– 21 Dismissals, 17 Settlements Totaling $60 mm

– (Not Counting $900 mm UnitedHealth Group Settlement)

– 128 Cases Remain Pending

Source: The D & O Diary (February 12, 2008)

Options Backdating Update (cont’d)

Known settlements total over $300 mm (not including UnitedHeath Group)

Many more settlements to go, substantial defense fees continue to accrue

Bottom Line: Backdating Will Prove to Have Been a Big Deal for D & O Insurers

Supreme Court Case Developments

Tellabs, Inc. v. Makor Issues & Rights, Ltd. (June 2007)

– Courts must weigh “competing inferences” in order to determine whether allegations raise a “strong inference of scienter

– Inferences must be “cogent and at least as compelling” to survive motion to dismiss

– Portrayed as defense victory, but in reality: neutral

– On remand to the 7th Circuit, applying Supreme Court standard, once again reversed district court’s dismissal

– BOTTOM LINE: Balanced approach unlikely to have significant impact on many cases

Supreme Court Case Developments (cont’d)

Stoneridge Investment Partners LLC v. Scientific Atlanta (January 2008)

– Court rejected “scheme liability” claims against secondary actors (vendors) alleged to have aided primary violators misrepresentations

– IF case had gone the other way, would have been a plaintiffs’ victory and significant increase in exposure, BUT

– BOTTOM LINE: Actual outcome essentially a Status Quo Decision

• Unsurprising outcome given prior Central Bank decision

• Third parties can still be held liable as primary violators

• SEC still has statutory “scheme liability” enforcement authority

A Rare Spectacle: Two Class Action Trials

November 27, 2007: JDS Uniphase Trial

– Defense Jury Verdict

January 16, 2008: Apollo Group Trial

– Plaintiffs verdict, Damage Award up to $277 million

Both Cases Still Pending, Likely to Appeal

Significance?

– Are cases more or less likely to go to trial?

– Will magnitude of Apollo verdict embolden plaintiffs?

– Potential threat to insurance coverage?

Emerging Issues

Class Action Opt-Outs

– Unprecedented Settlements

• AOL Time Warner: Opt out settlements $795 million

• Qwest: $410 mm Opt Out > $400 million opt outs

– Just an vestige of Corporate Scandals or Lasting Effect?

– Challenge for Insurers and for Policyholders

• Loss Estimates, Reserving

• Claims Settlement

• Limits Adequacy

Emerging Issues (Cont’d)

Foreign Corrupt Practices Act (FCPA)

– Record Number of 2007 Enforcement Actions

– Record Fines and Penalties

– Increasing Trend toward Follow on Shareholder Lawsuits

• Derivative Lawsuits: Baker Hughes, Siemens, BAE Systems

• Class Action Lawsuits: Willbros Group ($10 mm); Immucor ($2 mm)

The D & O Diary

The D & O Diary

http://www.dandodiary.com

Contact Information

Kevin M. LaCroix

OakBridge Insurance Services

2000 Auburn Drive, Suite 200

Beachwood, Ohio 44122

(216) 378-7817

klacroix@oakbridgeins.com