Tuesday, March 14, 2006

TIG Ins. Co v. Homestore, Inc. (Cal. Ct. App. - March 13, 2006)

Here's another reason never to become a director or officer of a public company. Justice Perluss holds that TIG can rescind the D&O policy that covers Homestore because Homestore's CFO, who signed the policy application, attached Homestore's latest 10-Q, which contained financial data that the CFO knew was false.

In other words, because the CFO engaged in fraud, and because that fraud was part of a document submitted (as most insurers require) as part of the application, none of the directors and officers have D&O coverage. So these individuals -- even if they had utterly no knowledge of any fraud -- are personally on the hook for both their defense costs in the resulting (huge) securities class actions, as well as potentially tens or hundreds of millions of dollars in damages.

Judge Mayeda grants summary judgment to TIG, and Justice Perluss affirms. Both of these judges are smart and deliberate. I can find no fault in their legal reasoning, and hence I must agree with the result they reach. But I do so reluctantly. The law should be different. Insurers shouldn't be permitted to rescind a D&O policy, and thereby cause massive harm to innocent D&O's, merely because a different corporate officer committed financial fraud and attached a 10-Q to the application. The whole purpose of D&O coverage is to encourage people to agree to accept positions as D&Os. Holdings like this one only serve to discourage responsible and ethical individuals from agreeing to take on such positions.

D&Os who are innocent, and who didn't know about or participate in any fraud, should be entitled to coverage, and should not be forced to shoulder themselves the massive costs of defending securities class actions. And they should be able to accept such positions without fear that the insurer will be allowed to rescind the policy based upon the financial misconduct of someone else.

The law, and policy provisions, to the contrary should be changed.