The Lockton report on Shareholder Securities Litigation Affecting Directors & Officers Liability Insurance Claims.

• Author: Nygren, Thomas L.

August 2005

PURPOSE

The goal of this study is to provide our clients with meaningful and useful quantitative data on directors and officers liability losses through examination of shareholder class action securities claims specifically involving directors and officers. We focus exclusively on litigation that directly names directors and officers, and, therefore, also triggers the corporation's directors and officers liability insurance.

Our study analyzes all shareholder class action securities lawsuits filed in the Federal courts during the preceding nine years, from 1996 through 2004, against Fortune 1000 corporations. Specific details of each case were gathered, analyzed, and sorted into meaningful categories and subgroups for analysis. We believe the results are presented in ways that will be most valuable for our audience--Lockton Financial Services clients and other Fortune 1000 companies--as they consider their D & O liability exposures and insurance options, and will enable all to better understand shareholder D & O litigation as the most potent force driving the D & O Liability insurance market.

INTRODUCTION

The market for Directors and Officers Liability insurance has undergone radical fluctuations over the past five years. Virtually all publicly traded corporations buy D & O liability insurance to protect their directors and officers from personal loss, and, secondarily, to transfer the corporate indemnification obligations to professional risk takers. Almost all public corporations have seen the cost of D & O insurance increase from 100% to 1000% over the past five years. Many D & O insurance industry participants, including the author, have opined on the reasons underlying the highly volatile, cyclical booms and busts of the D & O insurance market. Unfortunately, while most of these observations are on target, they cannot be supported by meaningful empirical data. D & O insurers are not obligated to reveal D & O underwriting results, and have consistently chosen not to do so. All domestic insurers are required to file detailed financial statements (Convention Statements) with state regulatory agencies, however very few of these statements provide separate account entries for D & O premiums and losses. Most often D & O results are homogenized into general casualty insurance categories. Accurate annual measurements of D & O premiums and losses, and thus also insurers' profitability, are simply not obtainable. We therefore focused on the prime driver of the D & O insurance market, the underlying body of shareholder litigation, to gauge the market.

Various available resources such as Securities Class Action Services, LLC (SCAS), Stanford Law School Securities Class Action Clearinghouse (SCAC), National Economic Research Associates (NERA), and Cornerstone Research offer data and analysis on shareholder class action securities litigation. This information can be very helpful since shareholder class action litigation is the bellwether by which D & O market results can be evaluated. Historically, shareholder litigation has represented about 50% of all claims made against corporate directors and officers, although shareholder claims are universally acknowledged to be the most severe and troubling for both corporate directors and officers and D & O insurers alike. Indeed, the author believes that D & O liability insurance would fade to insignificance if shareholders were denied the right to litigate against directors and officers.

Unfortunately, the available services do not present data and analysis in ways most useful to D & O insurance buyers. Our purpose in undertaking this project is to produce a more meaningful view of shareholder securities litigation to make D & O market fluctuations more explicable, and conceivably to provide a tool for forecasting the future marketplace.

STUDY PROTOCOL

The annual Fortune 1000 lists provide a stable and meaningful control group from which to analyze shareholder litigation. While the participants in the Fortune 1000 (hereafter "F1000") change from year-to-year as companies come and go, the basis for analysis is always consistent, 1000 participants per year. We used the F1000 lists from 1996 through 2004 as the basis for this study. We then cross referenced the F1000 lists, year by year, against the two litigation reporting resources, SCAC, and SCAS, to develop specific information on each securities lawsuit involving the directors and officers of a F1000 company during the study period. We manipulated this data using various measuring standards to produce different views of litigation frequency and severity for the nine-year study period.

Fortune categorizes the Fortune 1000 participants into 72 industry classes. For more meaningful comparisons, we consolidated these 72 classes into ten more workable Lockton Business Sectors. We also segmented the F1000 into subgroups based on size rankings. In addition, we resourced a bankruptcy reporting service, bankruptcy.com, and numerous public documents filed by the F1000. Using the bankruptcy data, we identified those F1000 companies that filed for bankruptcy during the study period, and then correlated that data to determine the frequency and severity of litigation associated with a bankruptcy filing.

The F1000 lists are especially useful because the rankings are based on revenues, irrespective of profit or loss. They provide excellent cross-sections of public companies having varying degrees of financial success and, presumably, varying levels of exposure to litigation.

The litigation reporting services identify and count all class action litigation against all public corporations. We used the following protocol to identify and segregate those cases germane to the study from the litigation universe

* At least one director or officer must be a named defendant. This virtually guarantees that the corporation's D & O liability insurance was triggered.

* Only cash settlements are counted. Pure non-cash (stock) settlements are eliminated. D & O insurers are unlikely to have contributed to a non-cash (usually company stock) settlement.

* Where a settlement involves both cash and non-cash components, the non-cash component is eliminated from the settlement amount whenever possible.

* Separate partial settlements by third party defendants--the bankers, accountants, investment bankers, and brokers are excluded. These partial settlements do not involve contributions by directors and officers and/or D & O insurers.

* Joint settlements that include settling directors and officers are accounted for at the gross settlement amount unless third party contributions can be clearly identified. Where identified, amounts contributed by third parties are excluded from the total settlement amounts. For example, the total settlement fund for the WorldCom shareholder litigation is reported at $6,062,370,000. This report only considers the amounts actually contributed by WorldCom's directors and officers: $60,750,000. See Chart #1.

 WorldCom, Inc. Securities Class Action Settlements Settlement Fund as of March 22, 2005 Totals $6,062,370,000 J.P. Morgan

$2,000,000,000 Bank of America $460,500,000 Deutsche Bank

$325,000,000 ABN Amro $276,300,000 Tokyo Mitsubishi

$75,000,000 WestLB AG $75,000,000 Lehman Bros.

$62,700,000 Directors* $60,750,000 Caboto Holding

$37,500,000 BNP Paribas $37,500,000 Mizuho Int'l $37,500,000 CS First Boston $12,540,000 Goldman Sachs $12,540,000 UBS AG $12,540,000 Citigroup $2,575,000,000 Source: Securities Class Action Services Alert, April 2005 *Only the directors settlement is included. Suits against the principal executives remain unsettled as of 4/1/05. Chart #1 Note: Table made from pie chart.

* The litigation must have commenced within one calendar year after a corporation was dropped from the Fortune list. For example, if a corporation was an F1000 company in 2000 and then dropped off the list in 2001, only litigation commenced before December 31, 2001 was counted as litigation against an F1000 company.

* Participants in the F1000 vary from year-to-year due to mergers and acquisitions, bankruptcies, offshore re-incorporations, and sales fluctuations. We used the 2004 F1000 list as the basis for our Business Sector analyses, postulating that variations in total participants in each Sector from year-to-year are not meaningful to the study results.

* The 2004 Fortune 500 issue identified 72 industry classifications. To produce more meaningful data, we consolidated these 72 classes into 10 Lockton Business Sectors:

Lockton Business Sectors

 Class Code Business Sector 1

Banks, Brokers, and Other Financial Institutions and

Intermediaries 2 Business & Professional Services, Including Real Estate 3 Health Care 4 Manufacturers & Wholesalers: Consumer Products 5 Manufacturers & Wholesalers: Non-Consumer Products 6 Oil & Gas 7 Retailers & Consumer Services 8 Technology 9 Transportation & Trucking 10 Utilities Including Energy Trading Companies

* SEC enforcement suits are excluded since fines and penalties assessed against individuals are not likely to be insured, and because these cases otherwise fall outside the study parameters. However, recent SEC and state regulatory settlements have designated all or portions of the settlements for recovery by shareholders. We are researching these cases to determine if D & O insurers contributed to the settlements, and will evaluate adding these cases as a new category in future reports.

* Analyst suits, suits against mutual fund managers over late trading, and IPO laddering suits targeting investment bankers and brokers are all excluded. However shareholder lawsuits by equity holders of publicly traded Financial Institutions are included, even if based on analyst, late trading, or IPO laddering issues.

Significant Anomalies and Considerations

Three significant circumstances had disproportionate impact on the data and required continuing recognition and/or special treatment...