COMMITTEE ON INSURANCE COVERAGE LITIGATION

Section of Litigation American Bar Association John E. James and Laura A. Foggan, Committee Cochairs Editor in Chief: Erik A. Christiansen Published by LexisNexis Volume 18, Number 4, July/August 2008 Insurance Coverage and the Subprime Crisis: A Broad Overview by Matthew L. Jacobs, Lorelie S. Masters and Daniel I. Weiner

ment on which actors, if any, bear primary - Matthew L. Jacobs and Lorelie S. responsibility. Given the amount of money at stake, Masters are partners and Daniel I. Weiner is an however, the subprime meltdown, like past financial associate in the Washington office of Jenner & crises, will almost certainly generate extensive litiga- Block, LLP. This article reflects their views, and tion targeting a wide array of covered persons and none of the views or statements in this article is entities. to be attributed to any of the clients of Jenner & In this article, we first provide a brief overview of Block, LLP. The authors would like to thank the subprime meltdown and its possible causes. We Alistair McVan, a Jenner & Block project then chart some of the specific litigation trends emer- assistant, who provided extremely helpful ging in the wake of the impairment of the subprime research and technical editing assistance. real estate market. Third, we describe several of the most clearly applicable types of insurance coverage that are likely to protect individuals and entities involved in various mortgage lending and securitiza- Introduction tion processes. Fourth, we discuss possible defenses that carriers may raise to limit their coverage obliga- Within the past 10 years, the business and legal tions. Finally, in the remaining sections, we discuss communities were rocked by a series of accounting three specific insurance issues, the duty to defend, and securities fraud scandals known primarily by the severability, and default, which tend to be of names of the companies involved, such as Enron, special importance to covered individuals and enti- Tyco and WorldCom. These disruptions had national ties, and are likely to play important roles in this and worldwide economic implications, and most particular context as well. generated costly, ongoing legal battles that in turn implicated a wide array of insurance coverage The ‘‘Subprime Meltdown’’ issues. They barely had subsided when a new finan- cial crisis appeared on the horizon, this time centered Subprime mortgage loans are high interest loans on a single industry, mortgage lending and securiti- made primarily to borrowers with high credit risk, zation, but again with implications throughout the either because of a low credit score or a high debt- world economy. This new series of financial disrup- to-income ratio. In 2005 such loans accounted for 20 tions has come to be known collectively as the percent of all mortgage loans, up from approximately ‘‘subprime meltdown.’’ In contrast to scandals like 5 percent a decade ago.1 The vast majority (approxi- Enron, Tyco and WorldCom, which centered on alle- mately 90 percent) of these loans carry hybrid gations of accounting fraud, the subprime meltdown adjustable interest rates—i.e., a low fixed rate for is the product of a complicated set of economic the first two or three years, followed by periodic factors. While allegations of flawed decision- resets to substantially higher rates.2 In 2003-2004, making abound, at this juncture there is little agree- when interest rates were relatively low and property

Coverage–1 values were booming nationwide, hundreds of thou- placement agent (often an investment bank). Other sands of borrowers who might not otherwise have actors in the process include credit rating agencies been able to buy into the market did so by obtaining that rate the bonds, loan servicers (i.e., companies subprime financing.3 Hundreds of thousands more hired to collect loan payments from the borrower borrowed against their rapidly appreciating real and deal with delinquencies and foreclosures), and estate to obtain cash for a variety of other purposes. credit risk insurers who provided credit enhancement Between 2003 and 2007, the raw total of subprime coverage to increase the rating, and therefore the debt outstanding increased almost threefold, from value, of the bonds.14 In 2003, when property $332 billion to almost $1.3 trillion.4 values were booming, subprime MBS appeared to Then, in 2006 and early 2007, in the face of higher be an extremely attractive investment for all of interest rates and a slump in certain sectors of the these parties because they offered the prospect of a economy, the housing market began to cool, and fixed-income and little risk, like all MBS, combined subprime borrowers like other homeowners began with higher returns due to the high adjustable rates to see their equity depreciate significantly. When and the fact that many of the underlying loans carried the low introductory rates attached to loans made in prepayment penalties that were intended to insure 2003 and 2004 expired, many borrowers’ monthly longer payback periods (and therefore more overall payments jumped beyond their ability to pay, but interest paid).15 In reality, however, the market many individuals were unable to refinance or even underestimated the likelihood of default by many sell their property. The result was a nationwide spike subprime borrowers. Estimates as of late 2007 in foreclosures; the rate increased by 90 percent from projected that investors around the world would 2006 to 2007.5 In the third quarter of 2007, it was lose $300-$400 billion.16 higher than it had been any time since 1972.6 Rising Along with erroneous market projections, another foreclosure rates have, in turn, driven real estate cause of the subprime meltdown may have been the prices even lower, further exacerbating the plight of governmental bias in favor of individual home many homeowners, particularly those with high ownership that prevailed throughout the 1990s, one adjustable rate mortgages.7 As of late 2007, it was of whose most notable adherents was the former projected that as many as half of those borrowers Federal Reserve Chairman, Alan Greenspan.17 This whose adjustable rates were due to reset in the first attitude arguably abetted the relaxation of under- three months of 2008 eventually would lose their writing standards across the board, for example homes to foreclosure.8 In the meantime, many through reduced documentation requirements and subprime lenders have declared bankruptcy.9 the use of automatic screening, which ultimately The effects of the subprime meltdown have spread allowed many under-qualified borrowers to obtain well beyond the subprime lending industry and high loans they could not afford.18 The nature of the secur- credit risk borrowers. Most obviously, falling house itization process itself also contributed to the problem prices have reduced the wealth of millions of home- by segmenting and ‘‘packaging’’ relatively risky owners regardless of their credit risk, and they no mortgage debt in such a manner that some investors longer have sufficient equity in their homes to did not understand what they were buying.19 Finally, finance a variety of other pursuits like consumer some borrowers have alleged that they were either spending and education.10 As one commentator misled about the feasibility of paying back their noted, cash-strapped home owners are likely to mortgages or simply did not understand their obliga- make mortgage payments a priority over paying off tions because nobody explained the agreements they other types of debt.11 For this reason, the effect on the signed (although many may also have shared the wider credit industry may be particularly severe. In same unrealistic expectations of the housing market just the first five months of 2007, late credit card prevalent in the rest of the economy).20 payments rose 30 percent.12 The damage caused by the subprime meltdown additionally has been compounded because many Even at this preliminary stage, the subprime subprime mortgages (about 63 percent in 2006) are meltdown already has generated several securitized.13 The securitization process involves hundred distinct lawsuits and government pooling loans with similar characteristics together investigations, and the number is expanding for sale to investors as mortgage-backed bonds, or rapidly. mortgage-backed securities (MBS). These bonds typically are conveyed by the original lender to a trust entity, which in turn sells them to individual In short, unlike the financial accounting scandals and institutional investors through an underwriter/ of several years ago, most of which centered on

Coverage–2 massive allegations of fraud, the root causes of the June 2007 the mortgage lender NovaStar paid $5 subprime meltdown may have more to do with the million to settle a borrower class action alleging inevitable consequences of widespread but highly that it violated Washington consumer protection unrealistic expectations about the capacity of the laws when it failed to disclose to prospective housing market to sustain long term gains, perhaps borrowers that it paid ‘‘yield spread premiums,’’ combined with some degree of carelessness and due which are premiums paid to mortgage brokers when diligence failures on the part of many different they negotiate interest rates that are higher than the actors, including ordinary home purchasers, mort- rate for which a borrower would otherwise be quali- gage lenders, financial institutions, and the U.S. fied.23 Borrower class actions also have alleged a government. The degree to which blame can be variety of other ‘‘predatory’’ lending practices, shared among many different individuals and enti- including failure to make required disclosures and ties has, unfortunately, resulted in more, not less, the alleged use of otherwise misleading loan docu- litigation, as all actors seek to assign blame else- ments,24 other allegedly misleading representations where and minimize their own exposure. The more by mortgage brokers,25 alleged fabrication of credit diffuse character of the subprime meltdown and its information,26 alleged schemes to inflate home effects—combined with ongoing sharp debates values,27 the collection of supposedly illegal or other- regarding its consequences—mean that, while there wise improper interest,28 various alleged overcharges are certainly significant parallels between the for settlement services,29 and the alleged payment of coverage issues it raises and those which surfaced illegal kickbacks and referral fees by lenders to title in past financial scandals, there is also a pressing insurance agents.30 Many of these suits state claims need for a fresh analysis. for relief under state consumer protection and real property laws as well as federal statutes like the Litigation Trends Truth in Lending Act (TILA), the Real Estate Settle- ment Procedures Act (RESPA), RICO, and even Even at this preliminary stage, the subprime melt- federal antitrust laws (in the case of some alleged down already has generated several hundred conspiracies to inflate home values). A number of distinct lawsuits and government investigations, and suits against lenders also have alleged that low the number is expanding rapidly. Navigant, a income African American and Hispanic customers respected, experienced consulting firm, has estimated were particular targets of risky or inappropriate that the litigation fallout from the crisis is likely to loans, which, if true, might violate the federal Fair surpass even that of the S&L crisis in the early Housing and Equal Credit Opportunity Acts.31 1990s.21 The majority of these actions have been commenced by or on behalf of subprime borrowers, In addition to lawsuits brought directly by investors in MBS, or shareholders in the various enti- borrowers, a number of subprime-related consumer ties involved in the mortgage securitization process. protection actions also have been initiated by state That said, a variety of other parties also have attorneys general. For example, the attorney general commenced litigation, including lenders, under- of Ohio has sued 10 mortgage lenders, accusing them of pressuring real estate appraisers to inflate writers and the beneficiaries of ERISA retirement 32 plans that have lost money due to the subprime melt- the value of homes. Likewise, the attorney general of New York has brought a similar action down. We do not intend here to provide an exhaustive 33 survey of all litigation related to the subprime crisis, against First American, a title insurance company, and is investigating a number of other corporations in but simply to explore several different types of litiga- 34 tion matters that are likely to give rise to covered connection to the same allegations. The attorney claims. general of Massachusetts has sued Fremont General, a savings and loan, alleging that it charged Borrower Lawsuits: excessive broker’s fees and induced consumers to take out loans they obviously could not afford,35 As of early 2008, approximately 140 to 170 lawsuits while the attorney general of the District of Columbia and investigations had been commenced by or on has sued New Century Financial for allegedly taking behalf of aggrieved subprime borrowers, making part in an ‘‘equity stripping’’ conspiracy to rob finan- this category the most numerous of subprime- cially distressed homeowners through bogus related litigations. Primarily, borrowers have sued refinancing deals.36 Three cities, Baltimore, Cleve- mortgage lenders and other participants in the real land and Buffalo, also have brought actions against estate closing process like title insurers (who may lenders. Baltimore alleges violations of the Fair be implicated by the lenders themselves even if Housing Act by lenders targeting minority residents they are not named by the plaintiffs).22 Some of for inappropriate loans, while both Cleveland and these actions have already settled. For example, in Buffalo allege that negligent, irresponsible lending

Coverage–3 practices in general led to the abandonment of houses the level of risk, had they performed the requisite due across each city due to foreclosure, resulting in urban diligence on the loans in question, they would not blight and violations of state nuisance and other laws have marketed them as safe investments. Banker’s concerning the use of real property.37 Finally, there Life seeks recovery for negligent misrepresentation, also has been at least one criminal case, involving the common law fraud, breach of the duty of care, viola- local U.S. attorney in Miami, who has charged a tion of various federal and state securities disclosure group of local brokers, sellers and appraisers with laws, and civil conspiracy.43 participating in a fraud ring to inflate home prices.38 Banker’s Life is certainly not the only case of its Finally, while most consumer protection-type type.44 Moreover, as of early 2008 allegations that lawsuits on behalf of subprime borrowers have investors were misled by major financial institutions targeted lenders and other participants in the settle- about the risks associated with subprime MBS also ment process, at least two actions have targeted major had triggered dozens of investigations of major finan- financial institutions such as Lehman Brothers and cial institutions by the SEC,45 the United States Merrill Lynch, on the theory that they aided and attorneys for the Southern and Eastern Districts of abetted allegedly predatory behaviors by subprime New York,46 the attorneys general of New York lenders through their participation in the mortgage and Connecticut, and the Massachusetts secretary of securitization process.39 state.47 Several states also have commenced litiga- In the long run, the types of allegations at issue in tion against underwriters on behalf of their own litigations commenced by or on behalf of aggrieved employees, some of whose pension funds have lost borrowers may have significant staying power, even money due to the subprime crisis.48 relative to some of the other types of subprime- What makes Banker’s Life particularly interesting related litigation discussed below. For example, of relative to the above matters is the fact that Banker’s 32 motions to dismiss filed by defendants in such Life not only sued the financial institution that sold it cases last year, only about a third were successful MBS, but also various other companies, including in dismissing all claims (compared to two thirds in Triad Guarantee Insurance, the insurer that provided the context of securities litigation, for example).40 At ‘‘credit enhancement’’ coverage for the securities, this stage, it is too soon to say how many of these and Bank of New York, which acted as trustee for lawsuits will actually be successful, but it is clear that the underlying mortgage loans.49 As with many other subprime-related litigation by or on behalf of MBS, those purchased by Banker’s Life were backed borrowers is likely to be a significant cost of doing by a credit enhancement insurance policy designed to business for many different parts of the mortgage- shield investors from losses in the event that a certain lending and housing industries for the foreseeable percentage of the underlying loans entered into future. default. As in most cases, however, the actual policy- holders were not the investors but the trustee and Investor Lawsuits: lender, who had fiduciary and contractual duties to pursue coverage on the investors’ behalf. Alongside A second group that alleges harm as a result of the the alleged misrepresentations by Credit Suisse and subprime meltdown and has turned to litigation its affiliates, a key allegation in Banker’s Life is that consists of investors in subprime mortgage-backed after Triad denied coverage on the grounds that losses securities. To date, investors or those seeking to had exceeded policy limits, Bank of New York did protect their interests have commenced approxi- not vigorously challenge Triad’s decision and thus mately 50-55 lawsuits and investigations. The most breached its contractual obligations to Banker’s obvious target for these actions consists of the finan- Life as the third party beneficiary of the Triad cial institutions from whom many investors policy.50 The decision to name Triad itself, as an purchased subprime MBS. The most high profile alleged coconspirator and in the breach of contract case thus far has been a suit brought by Banker’s claim,51 may be a further indication of investors’ Life Insurance against Credit Suisse First Boston desire to recover on insurance policies obtained for (CSFB) and several of its subsidiaries and affiliates, 41 their protection but whose enforcement was assigned who sold Banker’s Life MBS. Banker’s Life to other entities. alleges that the securities it purchased from CSFB almost immediately declined in value to almost Thus far, this strategy has met with mixed success. zero due to credit rating downgrades by Moody’s. On April 22, 2008, U.S. District Judge Elizabeth Banker’s Life further alleges that it was induced to Kovachevich dismissed all of the claims of Banker’s purchase these securities by defendants’ representa- Life against Triad, along with its civil conspiracy tions that they were ‘‘safe,’’ low-risk, fixed income claims against all defendants, but upheld the 42 remainder of Banker’s Life’s claims and also products. Its Complaint goes on to claim that, even 52 if the defendants did not intentionally misrepresent granted it leave to amend. An Amended Complaint

Coverage–4 was filed on May 6, 2008, in which all of the afore- ratings to bonds backed by risky subprime mentioned allegations were re-alleged.53 mortgages ...’’. 64 A final set of parties who may draw investors’ ire In addition to shareholder suits, the plaintiffs’ bar are the credit rating agencies. Commentators have also has started to target other parties it claims share suggested that the agencies, who are already being blame for overvaluation of companies’ subprime- investigated by the SEC54 and the attorneys general related assets. For example, the auditor Deloitte & of Ohio and New York,55 may be vulnerable to the Touche was named as a defendant in an action extent that they helped fuel the growth of the market connected to a secondary offering of four million for subprime mortgage-backed securities by under- shares by American Home Mortgage, which was stating the risk these securities posed. The completed on April 30, 2007, less than four months agencies’ vulnerability here may be enhanced by before the company went bankrupt. The complaint the fact that they have admitted to working actively alleges that Deloitte certified certain reports and with many issuers during deal processes to help them statements used in the offering materials that were achieve desired ratings for various types of mort- materially inaccurate.65 Transactional lawyers may gage-backed bonds. Having supposedly taken such be another potential target, to the extent that they an interactive role in many deals, it is thought that too are thought to have been involved in overvaluing the agencies may now be vulnerable to charges of subprime-related assets.66 negligence and self-dealing when they try to assert Apart from shareholder class actions, many of the that they did nothing more than offer neutral opinions SEC investigations regarding the overvaluation of as to credit worthiness.56 subprime mortgage-related assets also implicate allegedinjurytoshareholders.67 As of early 2008, Shareholder Lawsuits: there were also over a dozen criminal investigations in progress, again focusing on allegations that com- A third important category of subprime related panies fraudulently inflated the value of their assets, as lawsuits and investigations are those that have been well as allegations that individual executives with brought by or on behalf of shareholders, of which knowledge of the impending meltdown sold stock in there are currently around 100. To date, mortgage violation of insider trading restrictions.68 lenders,57 financial institutions that served as under- writers,58 providers of credit enhancement While shareholder-related litigation has prolifer- insurance,59 companies that invested in subprime ated in the wake of the subprime meltdown, such MBS,60 and the credit rating agencies, and/or their actions face considerable obstacles, perhaps even top executives, all have been targeted by their own greater than those in other areas, notably because shareholders in class action lawsuits.61 The allega- there is generally so little evidence of conscious tions in most of these suits are broadly similar, wrongdoing (like insider sales of large quantities of namely that the companies and/or named executives stock—the aforementioned exceptions notwith- violated various federal securities laws and regula- standing). It may also be difficult, given the overall tions by inaccurately portraying the extent or nature economic slow down, to pin the cause for plaintiffs’ losses on eventual disclosures related to companies’ of the company’s involvement with subprime mort- 69 gage lending in SEC filings and other public subprime holdings. Accordingly, it is not entirely documents, thereby causing stock values to be artifi- surprising that only about one out of three securities- cially inflated. For example, the class action lawsuit related subprime lawsuits filed last year survived a filed against the mortgage lender Countrywide, its ruling on a motion to dismiss (although a number were also consolidated). Moreover, no putative plain- CEO and its CFO, alleges that the company down- 70 played the extent of its subprime lending activities in tiff class in this area has yet been certified. The a series of filings and press releases until July 2007, numerosity of such lawsuits thus may have artifi- when its losses due to mounting foreclosures finally cially inflated preliminary perceptions of their became apparent and its stock plummeted.62 A ultimate significance, though of course even rela- similar lawsuit against the investment bank UBS tively frivolous suits may still carry significant and its three top executives alleges that, as of late defense costs. as March 2007, the bank intentionally overvalued ERISA Beneficiary Lawsuits: its subprime-related assets, even though valuations of similar assets were being slashed by its hedge A fourth category of lawsuits consists of class actions fund unit, Dillon Read.63 Even the class action brought on behalf of beneficiaries of ERISA retire- lawsuit filed against the CFO of the credit rating ment savings plans, of which there are currently at agency Moody’s follows this same basic pattern, alle- least 30 to 40. These suits generally have targeted the ging that the defendant ‘‘misrepresented or failed to trustees of company-sponsored retirement plans disclose that the Company assigned excessively high (usually either company executives or third party

Coverage–5 financial institutions). The principal allegation has circumstances. There are three basic types of D&O been that the plan trustees invested recklessly in coverage: Side A, Side B and Side C, or ‘‘entity’’ subprime mortgage-backed securities, thereby coverage. Side A covers the cost of defending failing to manage plan assets prudently in compliance against, settling or satisfying a judgment in connec- with their fiduciary duties under ERISA.71 Although tion with a claim for which a director or officer is not most of these suits have involved plans benefiting indemnified by the corporation. Side B provides employees of mortgage lenders and financial institu- reimbursement coverage for the corporation where tions, some have been connected to company it has provided indemnification to individual direc- retirement plans in entirely unrelated industries, tors and officers (as is usually the case). Finally, further proof of the wide sweep that the subprime claims against the company itself are covered by mortgage crisis is taking through the economy.72 Side C, or ‘‘entity,’’ coverage. Shareholder claims alleging violation of disclosure requirements in Buyback Lawsuits: federal securities law and regulations are an exceed- ingly common type of D&O covered claim.74 A small fifth category of subprime-related lawsuits consists of actions initiated by underwriters and inves- tors against lenders who refused to buy back defaulted Virtually all of the lawsuits and investigations loans, allegedly in violation of their contractual obli- 73 discussed above allege some type of ‘‘wrongful gations. Most agreements for the sale of mortgage act’’ by directors, officers or professionals. loans by lenders to underwriters contain ‘‘buy back’’ provisions obligating the lender to repurchase mort- gages under certain circumstances. These provisions Like D&O coverage, E&O—or professional liabi- vary considerably, however, making it difficult to lity coverage—protects against claims derived from generalize regarding the probable exposure generated alleged wrongful acts, in this case committed in the by these types of litigations. course of delivering ‘‘professional’’ services. E&O coverage protects those who provide such services, Applicable Insurance Coverage including mortgage lenders, bankers, lawyers and The lawsuits and types of claims described above auditors, as well as the professional business entities implicate at least four types of insurance coverage: for which such individuals work. It typically covers directors and officers (D&O) liability coverage, most claims of negligence, recklessness or other errors and omissions (E&O) liability coverage, fidu- misconduct.75 In contrast to the typical D&O ciary liability coverage and credit risk coverage. policy, a typical E&O policy explicitly obligates D&O, E&O and fiduciary liability coverage apply the insurer not only to reimburse the insured for to alleged wrongful acts committed by individuals coveredlosses,butalsotodefendtheinsuredin and entities in the course of various business activ- any litigation implicating a covered claim.76 ities. A key component of D&O and E&O coverage Because those insured under a typical D&O policy in particular is the defense obligation found in such usually are entitled to have defense costs advanced to policies. As we discuss in a later section, the defense them, this distinction tends to matter much less than obligationislikelytobecriticalinthepresent might first appear to be the case (an issue discussed at context, as it was in litigation arising out of past greater length below). financial disruptions. Credit risk coverage, on the Virtually all of the lawsuits and investigations other hand, serves quite different purposes. Rather discussed above allege some type of ‘‘wrongful than protect against litigation-related liabilities, it is act’’ by directors, officers or professionals. The vast intended to help absorb the underlying financial majority of these acts, such as negligent or reckless losses. The key question in this regard will be misrepresentations about companies’ subprime activ- whether carriers will, in fact, be able to honor their ities, the use of ‘‘predatory’’ lending tactics, and policy obligations. failures to perform adequate due diligence, are neces- sarily committed during the course of individuals’ D&O and E&O Coverage: professional or managerial duties, making it likely that all or part of these litigations are covered by D&O and E&O coverage are forms of liability insur- the defendants’ D&O or E&O policies. ance covering business entities and individuals. D&O coverage in particular is familiar from many of the Fiduciary Liability Coverage: financial accounting scandals. It is intended to cover losses resulting from claims based on alleged Another form of coverage that is likely to be called wrongful acts by individuals committed in their capa- upon in response to the many claims described herein city as directors or officers, or the entity under certain is fiduciary liability insurance. Companies with

Coverage–6 ERISA and other employee benefits plans typically than expected default, the insurer absorbs the purchase such policies, which afford coverage for losses.81 In the prime market, this role traditionally ERISA plan trustees in connection with acts, errors had been filled by government-sponsored entities or omissions allegedly committed while adminis- (GSEs) like Fannie Mae and Freddie Mac, but the tering a trust or benefits plan. exponential increase in subprime lending has led to A typical definition of ‘‘wrongful act’’ in a fidu- a proliferation of private label credit enhancement ciary liability policy states that the term means: policies.82 ‘‘With respect to any trust or plan, any breach of Private label credit enhancement policies could the responsibilities, obligations or duties imposed mitigate the fallout from the subprime meltdown. upon fiduciaries of the trust or plan by the [ERISA] Mortgage lenders may be able to collect on PMI of 1974 ...or any negligent act, error or omission in policies purchased by individual borrowers, and on the administration of any trust or plan.’’ As with most bond insurance policies purchased as credit enhan- E&O and D&O policies, this definition is broad cers. In both cases, they will be expected to use the enough to encompass many subprime-related proceeds to satisfy the claims of investors, for whose claims. Notably, there are many claims being made protection such policies were generally purchased.83 by plan participants who have alleged in various In the case of bond insurers, however, there are pending lawsuits that plan trustees breached their worrying signs that some carriers either will be fiduciary duties, or acted negligently, when they unable or unwilling to meet all of their obligations. decided to invest the plan’s funds in mortgage- In the Banker’s Life case discussed above, for backed securities that involved subprime mortgages. instance, the insurer Triad asserted that all investors’ Plan trustees have also been accused of failing to claimed losses exceeded the policy limit of approxi- exercise due diligence, or invest prudently, when mately $21.1 million, and therefore denied making investments in supposedly low-risk products coverage.84 More broadly, as discussed below, the that were marketed as being as liquid an investment recent spate of ratings downgrades calls into question as cash, such as ‘‘safe’’ collaterized debt obligations the ability of bond insurers to cover even the commit- or even Auction Rate Securities, some of which ments they do not dispute. proved to be significantly more risky than they at 77 first appeared. Potential Defenses to Coverage Thus, when an ERISA plan and its trustees are sued by plan participants, a company should review Although many of the claims being asserted against its fiduciary liability coverage to determine if the the various participants in the subprime meltdown are allegations potentially could trigger coverage. undoubtedly covered by D&O, E&O or credit risk policies, some insurers likely will attempt to deny Credit Risk Coverage: coverage based on a number of defenses, many of which were, and are still being, raised in the large A final type of coverage meriting discussion is credit securities fraud lawsuits brought earlier in the risk coverage. Credit risk coverage (sometimes called decade. We would hope, however, that fewer ‘‘accounts receivable’’ coverage) was not a signifi- claims will be denied in the wake of the present cant issue in earlier financial disruptions, but it may crisis, given that most of the wrongful conduct prove to be a major factor in the fallout from the alleged to date clearly falls within the scope of subprime meltdown. This type of coverage usually most D&O, E&O or credit risk policies. Under the covers losses due to default by a borrower on a 78 doctrine of contra proferentem, ambiguities in such loan. For example, many high risk borrowers are policies must be interpreted in favor of the insured, so required to purchase private mortgage insurance long as the result reflects the purpose of the policy, (PMI), a type of credit risk coverage that protects the insured’s reasonable expectations of coverage, the lender in the event that an individual borrower 85 79 and ‘‘common sense.’’ As always, a carrier bears defaults. Another type of credit risk coverage is the burden of proving any defense.86 bond insurance. Bond insurance traditionally has been used to increase the credit rating of municipal 80 bonds by guaranteeing against default by the issuer. Potentially Excluded Claims: In the last 10 years, however, bond insurers began to market their product to lenders and underwriters as a The most basic defense to coverage is that a parti- credit enhancement for MBS. Rather than protecting cular claim is explicitly excluded from the relevant against default by one entity, a typical mortgage bond policy. For example, virtually all D&O and E&O insurance policy guarantees a certain return based on policies contain some form of exclusion for claims the projected rate of default among all the borrowers resulting from the insured having realized improper whose loans back the insured security—if more loans personal profit, or having engaged in intentionally

Coverage–7 fraudulent or dishonest conduct. Many policies also knowing misrepresentations, rather than those that exclude coverage for any claim based upon a are reckless or negligent, can serve as a proper wrongful act that the insured knew or could reason- basis for excluding a claim.94 Because even those ably have foreseen could lead to a claim (this is securities actions that allege intentional misrepresen- sometimes referred to as the ‘‘prior acts’’ or ‘‘prior tation generally also allege reckless or negligent knowledge’’ exclusion).87 Many policies also misrepresentation, it is remote that insurers would exclude ‘‘insured v. insured’’ claims, i.e., claims be able to deny coverage entirely in these cases, if arising out of suits brought by one insured against at all, and carriers certainly cannot avoid their another, although there are typically several excep- defense obligations merely due to allegations of tions, including one for derivative suits.88 Some E&O intentional misconduct. policies (but not D&O policies) also exclude claims Another exclusion that will be asserted in some arising out of criminal acts by the insured; acts of cases is the personal profit exclusion.95 That exclu- discrimination on the basis of race, gender, creed or sion applies only to gains to which the insured is not disability; and securities or ERISA violations.89 legally entitled. Because allegations of insider Finally, certain types of damages, like punitive trading and other self-dealing have been relatively damages and restitution, are uninsurable in some rare in the subprime-related cases to date, this exclu- jurisdictions and contexts.90 sion is less likely to arise than in past scandals. In the context of litigation arising out of the Carriers may also try to assert the ‘‘prior knowledge’’ subprime disruption, the exclusion that is likely to or ‘‘prior acts’’ exclusion applicable to claims alle- be asserted most often is that for intentional fraud ging wrongful acts the insured could have reasonably and dishonesty that may have contributed to the foreseen and prevented.96 Finally, in the case of insured’s losses. As noted above, the real cause of shareholder lawsuits other than derivative suits, the collapse in the subprime market appears to be carriers may seek to assert the ‘‘insured v. insured’’ unreasonable expectations regarding the housing exclusion, although the underlying purpose of this market, perhaps combined with failures to perform exclusion—the prevention of collusion between due diligence in some instances. Nevertheless, insureds—is rarely an issue in shareholder actions, certain types of suits, like the many shareholder making courts reluctant to apply it in this context.97 actions against lenders, underwriters and other parti- The common exclusions listed above are found in cipants in the mortgage securitization process, many policies, but of course the actual exclusions a feature allegations of intentional fraud. Note, carrier may attempt to apply to deny a particular however, that this type of exclusion almost always claim will be highly case-specific. Credit risk policies carries an ‘‘in fact’’ or ‘‘final adjudication’’ require- in particular vary greatly based on the contractual ment, meaning that the insurer may not deny terms, which may include or exclude specific types coverage until the fraud has been established by a of borrower insolvency, like forced liquidations or final adjudication in a court of law (at which point protracted disputes, that greatly affect the total it can demand retroactive reimbursement for the payout to the insured.98 insured’s defense costs).91 For example, Bernard Ebbers, WorldCom’s CEO who was convicted of Rescission: conspiracy, securities fraud and false regulatory filings and sentenced to up to 85 years in prison, Another defense to coverage is the extreme reaction continued to receive D&O insurance coverage until of rescission—cancellation, retroactively, of the the day he was found guilty.92 entire insurance policy. The most commonly cited Moreover, it is highly doubtful that the fraud basis for rescission is a material misrepresentation exclusion as it currently appears in many policies in the insurance application and supporting mate- canevenbeassertedinrespecttomanyalleged rials—i.e., a misrepresentation but for which the subprime-related misrepresentations. Shareholder insurer would not have issued the policy (or actions make up 47 percent of all D&O liability charged a higher premium or issued an endorsement claims affecting for-profit organizations in the under some state law). As with common exclusions United States; most of these actions involve some like fraud, rescission is not available to the insurer as allegation of securities fraud.93 If the fraud exclusion a unilateral remedy. Circumstances justifying rescis- were applied broadly—inconsistent with black-letter sion must be proven in court.99 Moreover, most coverage principles—to many of these suits, there policies permit rescission only for intentional misre- would be little left to many companies’ coverage, presentations, and contain ‘‘severability of which is contrary to the reasonable expectations of application’’ provisions that do not permit rescission the policyholders when they purchased broad liability with respect to all potential insureds under a policy coverage. Thus, courts have concluded that only solely because of intentional dishonesty by one.100

Coverage–8 As discussed below, the broader the severability Even more than D&O and E&O policies, credit provision, the greater the protection for ‘‘innocent’’ risk policies frequently provide very short deadlines directors and officers in the face of an attempt to for filing claims for loss and proof that the loss is rescind. covered, making notice a particularly challenging Another rescission issue that may arise concerns issue in that context.105 the definition of ‘‘application.’’ In an effort to avoid Claim: In the D&O and E&O contexts, disputes having to defend certain claims, some insurers have sometimes arise regarding the definition of what taken the position that the insured’s application constitutes a ‘‘claim’’ against the insured. Although includes all financial statements ever filed with the some policies define a claim narrowly, most contain a SEC.101 Some courts have accepted this position with definition that is at least broad enough to encompass respect to statements submitted along with an insur- not only civil proceedings in court and formal admin- ance application,102 but others have not.103 istrative hearings, but also written demands for monetary compensation and investigations by government agencies or self-regulating bodies (such We anticipate that rescission will again be as a stock exchange) regarding alleged violations of asserted only in those rare cases, primarily law.106 On the other hand, it is unclear whether because the underlying subprime litigations internal investigations brought about by the threat generally do not involve allegations of of a likely government investigation or private suit widespread intentional fraud. are covered, although there is a growing trend to require insurers to pay pre-notice defense costs where doing so does not prejudice the carrier and Because it renders an entire policy void from its defending the matter promptly to reduce liability is inception, rescission is a drastic remedy that is the proper action to take.107 exceedingly difficult to obtain. Although it was threa- Loss: D&O policies cover ‘‘loss’’ resulting from tened repeatedly in the late trading/market timing and covered claims against the insured. Loss is often related financial scandals, relatively few policies expressly defined as the total amount that an were actually rescinded. We anticipate that rescission insured becomes legally obligated to pay on will again be asserted only in those rare cases, account of each claim for a wrongful act for which primarily because the underlying subprime litigations coverage applies, including damages, judgments, generally do not involve allegations of widespread settlements, costs and defense costs. The policy intentional fraud. may contain added caveats affording the carrier a Other Defense Issues: basis for excluding certain types of settlements, however. For instance, the insured may want to A number of other issues pertaining to defenses to avoid settling a regulatory investigation through coverage also are likely to be raised in coverage liti- payment of ‘‘fines and penalties,’’ which are some- gation or ADR proceedings following on the times excluded from the definition of loss. The subprime meltdown. They include: insured should also avoid characterizing any settle- Notice: Both D&O and E&O policies are primarily ment payment as ‘‘restitution’’ or ‘‘disgorgement’’ ‘‘claims-made’’ policies, meaning that they apply because most carriers contend that such categories only to claims first made against the insured during of payment cannot constitute covered loss by 108 the policy period. Moreover, such policies rarely law. When the insured has been ordered or cover claims made after the end of the policy agreed to pay sums of money that the insured had period, unless the insured has paid an additional been earning through its regular business operations, premium for an extended reporting period.104 D&O it has paid ‘‘damages.’’ and E&O policies also require that claims be reported to the carrier during the policy period. Claims-made Duty to Defend policies also permit the insured to place the carrier on notice of ‘‘circumstances that would eventually result In addition to defenses to indemnification, one of the in a claim.’’ Once the claim is eventually made most important coverage-related issues likely to arise against the insured it will relate back to the policy out of the subprime disruption, as in the past, will period in which the notice of circumstances was undoubtedly be the duty to defend. When an given. Some older policies may be ‘‘occurrence’’ insured is sued for at least one covered claim, its policies, which cover losses arising out of matters insurance carrier has two separate obligations: that took place or ‘‘occurred’’ during the effective indemnification for all settlements and payments date of the policy, regardless of when a claim is arising from covered claims, and defense of any filed against the insured. potentially covered claims or allegations. The duty

Coverage–9 to defend is triggered whenever a complaint, notice primary source of value to covered entities and they of hearing, or notice of investigation alleges facts are critical to preserving the long-term financial suggesting a ‘‘reasonable potential for coverage.’’109 health of many companies. As a matter of basic black-letter law, the duty to defend is inherently broader than the duty to indem- Severability nify,becausethedutytodefendisonlyavoided Severability is another important coverage-related where a carrier has shown no conceivable basis for 110 issue, although perhaps less so here than in past finan- coverage. Claim expenses can only be deducted cial scandals. Severability provisions in policies once a possible exclusion is proven in fact, usually 111 protect innocent insureds from losing coverage based on developments in the underlying case. because of actions taken by their coinsureds. The Most E&O policies explicitly require the carrier to most common and valuable type of severability provide the insured with a defense for the entire liti- provision, a ‘‘full-severability’’ or ‘‘severability of gation, including those aspects that involve application’’ provision, protects innocent insureds uncovered claims or allegations. In contrast, D&O when an insurer attempts to rescind or declare a policies generally require the carrier to reimburse policy void based on alleged misrepresentations or (or, more favorably, advance) defense costs that are omissions in the insurance application caused by a 112 reasonably related to covered claims. As a prac- coinsured.118 The second type of severability provi- tical matter, however, this is a distinction without a sion, a ‘‘severability of exclusions’’ provision, difference, and most courts have held that the duty to prevents insurers from imputing to all insureds exclu- advance defense costs is as broad as the duty to sions that may apply to one insured because of his or 113 defend. Also, as long as a potentially covered— her wrongdoing.119 That claims against one indivi- and liability-inducing—claim results in a lawsuit, the dual are severable due to his or her wrongful acts carrier must afford a defense to the entire lawsuit. In does not obviate the carrier’s duty to defend the recent years, courts also have rejected carrier entire litigation. Rather, the carrier’s remedy is to demands that insureds allocate defense costs ex seek reimbursement after the underlying litigation 114 ante between covered and noncovered claims. is concluded.120 Instead, the carrier’s remedy is to seek reimburse- It goes without saying that inclusion of a broader ment at the conclusion of litigation for those costs severability provision will benefit the insured.121 it can show were not reasonably related to covered 115 Conversely, the failure to include a broad severability claims. provision can have serious consequences because it In the financial accounting scandals, which gener- may allow the carrier to seek to cut off coverage for ated immense litigation expenditures, the issue of all ‘‘innocent’’ directors and officers based on a availability of defense costs, and for whom, literally wrongful act committed by a single individual. 116 took on constitutional proportions in some cases. Severability was very important in the Enron and From an insurance coverage perspective, the number WorldCom litigations, where regulators and plain- of meritless claims filed against companies, and the tiffs sought to make examples of individual sheer complexity of even those suits that arguably directors by seeking recovery from their personal had some basis in fact, make the carrier defense obli- assets. In the WorldCom case, the position of these gation absolutely vital. This remains particularly true individual directors was arguably weakened because in jurisdictions where certain types of damages, the company’s D&O policy lacked a broad sever- including punitive damages and restitution for ability provision, which made it easier for insurers wrongfully acquired gains, are uninsurable as a to threaten rescission of the entire policy unless the 117 matter of law. In all such cases, the carrier’s directors contributed some of their own money. defense obligation is of immense value to the insured. These directors ended up contributing $18 million of their own funds to the eventual settlement.122 Thus, carrier defense obligations will once Even with broad severability provisions, covered again be a primary source of value to covered entities should take care to insure that they do not entities and they are critical to preserving the accept provisions that are ambiguously worded. long-term financial health of many companies. Although ambiguities in insurance agreements are to be interpreted in favor of the insured, a poorly worded severability provision may nevertheless leave room The proliferation of lawsuits and investigations for a court to side with an insurer and deny coverage following in the wake of the subprime meltdown by imputing one individual’s acts to all coinsureds, as includes many large consumer protection and share- happened in the recent case of Cutter & Buck, Inc. v. holder class actions involving thousands of plaintiffs. Genesis Ins. Co. in the U.S. District Court for the Thus, carrier defense obligations will once again be a Western District of Washington.123 The contrary

Coverage–10 result reached in another case, In re HealthSouth of default. For example, Ambac now faces serious Corp., where the court refused to impute one indivi- questions about its ability to stay afloat—reflected dual’s misrepresentations to all other innocent in its one-day 52 percent stock plummet. Another insureds, illustrates the benefits of a carefully agency, Moody’s, plans to review its rating not worded severability provision.124 only for Ambac, but also MBIA, the nation’s In the context of litigation arising out of the largest bond insurer.129 One particularly outspoken subprime meltdown, there are some allegations of public official, now retired, dubbed the consequences the type of intentional wrongdoing that insurers may of this wave of downgrades a potential ‘‘financial assert as a basis to apply dishonesty, fraud and inten- tsunami.’’130 tional wrongdoing exclusions. In some cases, insurers Of course, because many different types of compa- may also attempt to argue, based on alleged misrepre- nies, including other insurance carriers, invested in sentations in financial statements regarding mortgage backed securities, the risk of default companies’ subprime-related activities, that there resulting directly from the subprime meltdown is are grounds for rescission. It would appear so far not necessarily unique to credit risk insurers. They that the alleged wrongful acts that are most at issue are, however, far more likely to be among the melt- in subprime related cases, however, have more to do down’s first victims. Moreover, to the extent that with careless, reckless or inappropriate decisions and credit risk insurers are unable to meet their obliga- failures to perform due diligence than with wide- tions to cover losses suffered by investors who did spread fraud and personal profiteering. For these not think they were buying high risk assets, the latter reasons, the applicability of certain conduct exclu- naturally will look elsewhere for compensation. The sions or contract rescission will be more difficult for end result could be increased exposure for other insurers to demonstrate, and severability may likewise mortgage lending and securitization actors, and ulti- prove to be less of a concern. mately for D&O and E&O carriers.

Risk of Default Conclusion: What the Future Holds A final coverage issue is the risk of default, a concern Looking ahead, the slump in housing prices shows particularly relevant to the subprime crisis because of few signs of abating soon, meaning that it is unlikely the widespread use of bond insurance. On one level, that borrowers quickly will recoup the equity they bond insurers are somewhat more removed than other have lost—bad news also for investors holding insurers from the subprime fallout because, as billions of dollars in subprime debt. At this juncture, discussed above, their policyholders tend to be other the most likely factor to mitigate losses is some form parties besides the actual policy beneficiaries (i.e., of government-sponsored intervention. As of early investors—although, as we note above, some investors 2008, the Bush administration already had brokered have attempted to reach credit risk policies through a deal with the mortgage industry to help up to 1.2 tort and third party breach of contract allegations).125 million financially distressed subprime borrowers At the same time, unlike most other carriers, credit avoid foreclosure. Under the terms of the deal, risk insurers acted in many instances as first party certain borrowers experiencing financial difficulty participants in the subprime mortgage securitization may be eligible to have their adjustable rates frozen process when they actively sought to move out of for a period of five years.131 The deal excludes all their traditional fields of operation. Because of borrowers whose homes are already in foreclosure, recent ratings agency downgrades of MBS, the however, as well as those with high credit scores stock of credit risk insurers already has plummeted. (who have been deemed more equipped to negotiate For example, the value of stock in the bond insurer on an individual basis with creditors). The adminis- ACA Capital was down over 90 percent for the year tration also has made clear that it has no plans to help 2007.126 Naturally, shareholder lawsuits have bail out investors.132 Both of the leading Democratic followed—three had been filed as of late 2007, contenders for the presidency have promised to against ACA Capital, Security Capital Assurance, provide greater assistance, at least to homeowners. and the Radian Group, all alleging that the companies Separately, Congress also has moved, with tentative materially concealed the level of their involvement in White House support, to loosen restrictions on the subprime market.127 Worse still, the major credit Federal Housing Administration (FHA)-backed rating agencies are considering downgrading many loans, which are generally cheaper than private insurers’ ratings,128 as they already had for the loans but governed by more stringent terms. More insurers MGIC, Triad Group and Ambac as of early of these loans may now become available to 2008. A ratings downgrade throws into doubt an distressed subprime borrowers looking to refi- insurer’s ability to guarantee debt, triggering a nance.133 It goes without saying that the more the chain reaction that vastly increases the ultimate risk government takes responsibility for helping to

Coverage–11 mitigate subprime-related losses, the more the use of ADR pares down the costs of underlying volume of litigation resulting from these losses will subprime-related litigation, both carriers and fall, as will the volume of resulting insurance claims. covered entities will again benefit. Another potential source of relief may be the use of Ultimately, the total liability to which carriers are ADR to resolve coverage disputes, although this is at likely to be exposed as a result of the subprime crisis best a mixed blessing for many covered entities. is too difficult to assess, even leaving aside the poten- ADR through mediation or binding arbitration is tial that some credit risk insurers may not be able to mandated under many D&O and E&O policies, but meet all of their obligations. Estimates of D&O liabi- usually according to terms that potentially make it lity, for instance, have ranged from $3 billion per unfairly disadvantageous to policyholders relative year for the next three years, to as much as $15 to traditional litigation, specifically by the elimina- billion.136 A great deal depends on the terms of indi- tion of widely accepted common law insurance vidual policies, for which it is too soon for any type of principles like contra proferentem and the reasonable systemic analysis.137 Because the pace of litigation expectations of coverage doctrine.134 On the other tends to lag behind the actual economic develop- hand, ADR may also emerge as a means to resolve ments that precipitate it, it may be some time some of the underlying lawsuits initiated by subprime before the full coverage implications of the subprime borrowers and shareholders.135 To the extent that the meltdown are known.

1 Faten Sabry & Thomas Schopflocher, ‘‘The Subprime Meltdown: A Primer,’’ June 21, 2007, at 1, available at http://www.nera. com/image/SEC_SubprimeSeries_Part1_June2007_FINAL.pdf. 2 See Centre for Responsible Lending, ‘‘A Snapshot of the Subprime Market’’— http://www.responsiblelending.org/pdfs/snapshot-of- the-subprime-market.pdf, Nov. 28 2007, at 1 [hereinafter ‘‘Snapshot Report’’]. 3 For Federal Reserve interest rates, see http://federalreserve.gov/releases/h15/; see also Snapshot Report, at 1 (describing increases in overall subprime lending). 4 Snapshot Report, at 1. 5 Snapshot Report, at 3. 6 See Michael Phillips, et al., ‘‘Battle Lines Form Over Mortgage Plan,’’ Wall St. Journal, Dec. 7, 2007, at 1. 7 See Phillips, et al., at 1. 8 See Phillips, et al., at 1. 9 See RTTnews.com, ‘‘Almost 150 Mortgage Companies Were Casualties in 2007,’’ Jan. 22, 2008, available at http://www.rttnews.- com/forex/economicnews.asp?date=01/22/2008&item=21. 10 See Phillips, et al., at 1. 11 See Kevin LaCroix, ‘‘Subprime Contagion: Where will the Litigation Wave Spread Next?,’’ D&O Diary,Dec.3,2007,at http://dandodiary.blogspot.com/2007/12/subprime-contagion-where-will.html. 12 See Kevin LaCroix, ‘‘Subprime Contagion: Where will the Litigation Wave Spread Next?,’’ D&O Diary,Dec.3,2007,at http://dandodiary.blogspot.com/2007/12/subprime-contagion-where-will.html. 13 Sabry & Schopflocher, at 4. 14 Sabry & Schopflocher, at 4–8. 15 See Center for Responsible Lending, ‘‘Prepayment Penalties in Subprime Loans: When Qualifying for a Better Mortgage Doesn’t Pay Off,’’ June 18, 2004 (updated Mar. 16, 2005), at http://www.responsiblelending.org/pdfs/ib008-PPP_in_Subprime_Loans-0604.pdf. 16 See John Glover, ‘‘Subprime Losses May Reach $400 Billion, Analysts Say’’ (Update 5), Bloomberg.com, Nov. 12, 2007, at http://www.bloomberg.com/apps/news?pid=20601087&sid=a3fCFxLIgT2s&refer=worldwide. 17 See Edmund L. Andrews, ‘‘Fed Shrugged as Subprime Crisis Spread,’’ N.Y. Times, Dec. 18, 2007, at A1. 18 Sabry & Schopflocher, at 10. 19 See Thomas Musil, ‘‘Subprime Mortgage Risks Were Recognized Too Late,’’ Pitt. Post-Gazette, Feb. 17, 2008, at P8. 20 See, e.g., ‘‘Feeling Misled on Home Price, Buyers Sue Agent,’’ N.Y. Times, Jan. 22, 2008, at A1. 21 See Press Release, Subprime Mortgage Litigation Outpacing Saving and Loan Crisis of the Early 1990s, According to Navigant Consulting Study, Feb. 14, 2008, available at http://biz.yahoo.com/bw/080214/20080214005906.html?.v=1. 22 See Christopher E. Kentra, ‘‘Caught in the Wake of Mortgage Suits,’’ Chicago Daily Law Bulletin, Nov. 21, 2007, at 5. 23 See Phuong Cat Lee, ‘‘Mortgage Lender NovaStar to Settle Suit,’’ Seattle Post-Intelligencer, June 23, 2007, at C1; Pierce v. NovaStar Mortgage, Inc, 05-CV-05835 (W.D. Wash.) (Voluntarily Dismissed). 24 See, e.g., Rodriguez v. Capital One Home Loans LLC, No. 08-CV-1723 (N.D. Il.) (Complaint Filed); Reichert v. UB Mortgage LLC, et al., No. 08-CV-158 (E.D. Ark.) (Complaint Filed); Poland v. Downey Savings & Loan, No. BC381724 (Cal. Sup. Ct. Los Angeles) (Dismissed). 25 See, e.g., Jordan v. Wells Fargo Bank, N.A., et al., No. 08-CV-1394 (N.D. Il.) (homeowners allegedly promised lower rate if they refinanced but were actually locked into high interest subprime loans) (Complaint Filed); Boisjolie v. SBMC Mortgage, No. 07-CV-5521 (C.D. Cal.) (homebuyers allegedly promised low fixed rates but induced to sign agreements for high adjustable rate mortgages)

Coverage–12 (Complaint Filed); Romero v. First Magnus Financial Corp., 07-CV-4491 (C.D. Cal.) (same) (Dismissed); Megitt v. Indymac Bank FSB, No. 07-CV-3018 (D. Mass.) (lender failed to provide notice of right to rescind) (On Appeal). 26 See, e.g., Tingley v. Beazer Homes Corp., No. 07-CV-176 (W.D.N.C.) (alleged falsification of loan applications for unqualified buyers) (Dismissed); Morris v. First Franklin Financial Corp., No. 07-CV-614 (N.D. Ga.) (alleged falsification of credit reports) (Motion to Dismiss Filed). 27 See, e.g., Wilson, et al. v. D.R. Horton, Inc., et al., No.08-CV-592 (S.D. Cal.) (Complaint Filed); Bolden v. KB Homes, et al., No. BC385040 (Cal. Sup Ct. L.A. Cty.) (Complaint filed). 28 See, e.g., Chrisman v. Countrywide, No. 07-CV-333 (E.D. Tenn.) (improper application of mortgage payments to maximize interest paid) (Complaint Filed); Long v. Wells Fargo Corp. Holdings Corp., No. 07-CV-9551 (S.D.N.Y.) (collection of illegal interest on Co-op refinances) (Motion to Dismiss Denied). 29 See, e.g., Partell v. Lawyer’s Tit. Ins. Corp., No. 08-CV-166 (W.D.N.Y.) (excessive title insurance fees) (Complaint Filed); Fernandes v. Southland Title Corp., No. 07-CV-6690 (C.D. Cal.) (excessive ‘‘email’’ and ‘‘notary’’ fees) (Complaint Filed); Dorsey v. EMC Mortgage Co., No. 07-CV-3903 (E.D. Pa.) (excessive attorney fees) (Dismissed); Wooten v. Quicken Loans, No. 07-CV-478 (S.D. Ala.) (unearned ‘‘loan discount fee’’) (Dismissed). 30 See, e.g., Alexander v. Washington Mutual, Inc., et al., No. 07-CV-4426 (E.D. Pa.) (Motion to Dismiss Filed); Moore v. GMAC LLC, et al., 07-CV-4296 (E.D. Pa.) (Motion to Dismiss Denied). 31 See, e.g., Cobb v. Chevy Chase Bank, No. 08-CV-2474 (C.D. Cal.) (Complaint Filed); Chavers v. Option One Mortgage, No. 07- CV-4916 (N.D. Ill.) (Complaint Filed); Sanchez v. Washington Mutual, No. 07-CV-5542 (C.D. Cal.) (Motion to Dismiss Filed); Ventura v. Wells Fargo Bank, No. 07-CV-4309 (N.D. Cal.) (Complaint Filed); Miller v. Countrywide Bank, No. 07-CV-11275 (D. Mass.) (Complaint Filed); Rodriguez, et al. v. Bear Stearns, et al., No. 07-CV-1816 (D. Conn.) (Motion to Dismiss Filed); NAACP v. Ameriquest Mortgage, et al., No. 07-CV-0794 (C.D. Cal.) (Complaint Filed). 32 Dann v. Apex Mortgage Services, et al., No. 07-cv-1996 (Ohio Ct. Com’n Pl. Belmont Cty.) (Complaint Filed). 33 People of the State of New York v. First American Corp., No. 07-cv-10397 (N.Y. Sup. Ct. N.Y. Cty.) (Removed to Federal Court). 34 See, e.g., Press Release, New York Attorney General Andrew Cuomo Sends Letters of Notice and Demand to Freddie Mac & Fannie Mae, available at http://www.oag.state.ny.us/press/2007/nov/nov7a_07.html. 35 Kimberly Blanton, ‘‘Subprime Lender Under Predator Law,’’ Boston Globe, Oct. 6, 2007, at 10C; see also Commonwealth of Massachusetts v. Fremont Investment & Loan, et al., No. 07-4373 (Mass. Sup. Ct. Suffolk Cty.) (Preliminary Injunction Granted). 36 District of Columbia v. Metropolitan Money Store, No. 2007 CV 006023B (D.C. Sup. Ct.) (Complaint Filed). 37 See Christopher Maag, ‘‘Cleveland Sues 21 Lenders Over Subprime Mortgages,’’ N.Y. Times, Jan. 12, 2008, at A9 (describing Baltimore and Cleveland suits); see also Mayor and City of Baltimore v. Wells Fargo Bank, N.A., et. al., No 08-cv-00062 (D. Md.) (Complaint Filed); City of Buffalo v. ABN Amro Mortgage Group, Inc., et al., No. ___ (N.Y. S. Ct. Erie Cty.) (Complaint Filed); City of Cleveland v. Deutsche Bank Trust Co., et al. No. CV 08 646970 (Ohio Ct. Cm. Pl. Cuyahoga Cty.) (Complaint Filed). 38 See Carrie Johnson, ‘‘Mortgage Probes Face Big Hurdles,’’ Wash. Post, Dec. 27, 2007, at D1. 39 Baumgartner v. Lehman Brothers, Inc., No. 07-CV-4038 (D. Minn.) (Voluntarily Dismissal Without Prejudice); see also Maag, at A9 (noting that Cleveland suit names underwriters as well as original lenders). 40 See Amir Efrati, ‘‘Subprime Crisis Lawsuits 2008: By the Numbers,’’ WSJ Law Blog, Apr. 24, 2008, at http://blogs.wsj.com/ law/2008/04/24/subprime-crisis-lawsuits-2008-by-the-numbers/ [hereinafter Efrati, ‘‘Subprime Crisis Lawsuits 2008...’’]. 41 See Banker’s Life v. Credit Suisse First Boston, No. 07-cv-00690 (M.D. Fla.). 42 See Complaint 14-36, Banker’s Life v. Credit Suisse First Boston, No. 07-cv-00690 (M.D. Fla.). 43 See Complaint 74-135, Banker’s Life v. Credit Suisse First Boston, No. 07-cv-00690 (M.D. Fla.). On April 22, 2008, the court dismissed the Plaintiff’s common law fraud allegations pursuant to Fed. R. Civ. P. 9(b), but granted Plaintiff leave to amend. See Slip Op, at 9–10. Banker’s Life re-alleged its common law fraud allegations in its Amended Complaint, filed May 6, 2008, along with all of its other fraud and negligence allegations. See generally Second Amended Complaint, 37-88. 44 For instance Metro PCS Communications, another investor in subprime mortgage backed securities, has leveled similar charges against Merrill Lynch. See MetroPCS Communications v. Merrill Lynch & Co., et al., No. 07-12430 (Dist. Ct. Tx. Dallas Cty.) (Complaint Filed). Another recent target is Bear Stearns. The collapse of two mortgage-related hedge funds resulted in two arbitration claims being filed against its subsidiaries. See ‘‘Bear Stearns Hedge Fund Losses Lead to Arbitration Claims,’’ Marketwatch, Dec. 5, 2007, at http://www.marketwatch.com/news/story/bear-stearns-hedge-fund-losses/story.aspx?guid=%7B193F9E0C-8933-41E7-B8CE- 757406F5A481%7D. 45 See Reuters, ‘‘SEC Eyes Disclosure in Subprime Probe,’’ Feb. 9, 2008, at http://www.reuters.com/articlePrint?articleId= USN0919055220080209; Paritosh Bansal, ‘‘SEC Probing Three Dozen Subprime Cases,’’ Boston Globe Online, Dec. 21, 2007, at http://www.boston.com/business/articles/2007/12/21/sec_probing_three_dozen_subprime_cases_source/. 46 Karen Freifeld and David Scheer, ‘‘NY, Connecticut Probe Wall Street Loan Disclosures,’’ Bloomberg.com, Jan. 12, 2008, at http://www.bloomberg.com/apps/news?pid=20601087&sid=a8ry4S5dGsFs&refer=home. 47 See Vikas Bajaj & Jenny Anderson, ‘‘Inquiry Focuses on Withholding of Data on Loans,’’ N.Y. Times, Jan. 12, 2008, at A1; Ross Kerber, ‘‘Galvin Wants Data on Subprime Lenders,’’ Boston Globe, Mar. 14, 2007, at F1. 48 See Press Release, Attorney General Mark Dann Sues Freddie Mac on Behalf of Ohio Public Employees Retirement Fund, available at http://www.ag.state.oh.us/press/08/01/pr080122.pdf; Mark Jewell, ‘‘State Street Sued Over Bond Fund Losses,’’ USA Today Online,

Coverage–13 Nov. 1, 2007, at http://www.usatoday.com/money/economy/2007-11-01-2787099883_x.htm (describing similar suit on behalf of Alaska public employees). 49 See Complaint 37, 116–120, Banker’s Life v. Credit Suisse First Boston, No. 07-cv-00690 (M.D. Fla.). 50 See Complaint 116–120, Banker’s Life v. Credit Suisse First Boston, No. 07-cv-00690 (M.D. Fla.). 51 See Complaint 116–120, 132–35, Banker’s Life v. Credit Suisse First Boston, No. 07-cv-00690 (M.D. Fla.). 52 See Slip Op., at 11–12, 19, Banker’s Life v. Credit Suisse First Boston, No. 07-cv-00690 (M.D. Fla.). 53 See generally Second Amended Complaint, Banker’s Life v. Credit Suisse First Boston, No. 07-cv-00690 (M.D. Fla.). 54 See Stephen Labaton, ‘‘Debt-Rating Agencies Under Scrutiny by SEC,’’ N.Y. Times, Sept. 27, 2007, at C4. 55 ‘‘Ratings Agencies Not Off the Hook: AG,’’ N.Y. Post Online, Feb. 8, 2008, at http://www.nypost.com /seven/02082008/business/ rating_agencies_not_off_hook__ag_290635.htm (describing investigation by Attorney General Cuomo of New York); Katie Banner & Adam Lashinsky, ‘‘Subprime Contagion?’’, CNN.com, July 5, 2007, at http://money.cnn.com/2007/07/05/news/economy/subprime. fortune/index.htm (describing investigation by former Attorney General Dann of Ohio). 56 LaCroix, ‘‘Ratings Agencies and the Subprime Lending Meltdown,’’ D&O Diary, May 13, 2007, at http://dandodiary.blogspot. com/2007/05/rating-agencies-and-subprime-lending.html (citing Joseph Mason & Joshua Rosner, ‘‘Where Did the Risk Go? How Misapplied Bond Ratings Cause Mortgage Backed Securities and Collateralized Debt Obligation Market Disruptions,’’ available at http://www.hudson.org/files/publications/Hudson_Mortgage_Paper5_3_07.pdf). 57 See, e.g., Casey v. Nat’l City Corp., No. 08-209 (N.D. Ohio) (Complaint Filed); Adcock v. NetBank, No. 07-cv-02298 (N.D. Ga.) (Consolidated in Case No. 07-2631); In re: Beazer Homes USA, Inc. Securities Litigation, No. 07-cv-00725 (N.D. Ga.) (Complaint Filed); Pappas v. Countrywide Financial, No. 07-CV-05295 (C.D. Cal.) (Consolidated in Case No 07-725); Reese v. Indymac Financial, No. 07-CV-01635 (C.D. Cal.) (Amended Complaint Filed); Boyd v. NovaStar Financial, No. 07-CV-0139 (W.D. Mo.) (Motion to Dismiss Filed); Gold v. New Century Financial, No. 07-cv-00931 (C.D. Cal.) (Consolidated in Case No. 07-931); Atlas v. Accredited Home Lenders, No. 07-CV-0488 (S.D. Ca.) (Motion to Dismiss Denied in Part, Granted in Part); Greenberg v. American Home Mortgage, No CV-07-3152 (E.D.N.Y.) (Complaint Filed); Freudenberg v. E*Trade Financial Corp., No. 07-CV-8538 (S.D.N.Y.) (Complaint Filed). 58 See, e.g., Reese v. O’Meara, No. 08 C 1119 (N.D. Ill.) (suit against Lehman Bros.- Voluntary Dismissal); Stratte-McClure v. Lynch, No. CV08-00963 (C.D. Cal.) (suit against Morgan Stanley- Complaint Filed); Cohen v. Bear Stearns, No. 07-CV-10453 (S.D.N.Y.) (Complaint Filed); Nelson v. Washington Mutual Inc., No. 07-CV-1809 (W.D. Wash.) (Consolidated in No. 08-1919). 59 See, e.g., Clark v. Security Capital Assurance Ltd., No. 08-CV-00158 (S.D.N.Y.) (Complaint filed); Rose v. ACA Capital Holdings, Inc., No. 08-CV-00253(RWS) (S.D.N.Y) (Complaint Filed); Cortese v. Radian Group, S.A., No. 07-CV-3375 (E.D. Pa.) (Complaint Filed). 60 See, e.g., Cornwell v. Credit Suisse Group, No. 08 CIV 3758 (S.D.N.Y.) (Complaint Filed); Wesner v. UBS AG, No. 07-CV-11225 (S.D.N.Y.) (Complaint Filed); Life Enrichment Foundation v. Merrill Lynch & Co., No. 07-CV-9633 (S.D.N.Y.) (Complaint Filed); Briarwood Investments, Inc. v. Care Investment Trust, Inc., No. 07-CV-8159 (S.D.N.Y.) (Complaint Filed); Kornfield v. Opteum, Inc., No. 07-CV-14278 (S.D. Fla.) (Complaint Filed). 61 See, e.g., Nach v. Huber, No. 07-CV-4071 (N.D. Ill) (Transferred to S.D.N.Y. Case No. 08-1536); Teamster’s Local 282 Pension Trust Fund v. Moody’s Corp., No. 07-CV-8375 (S.D.N.Y.) (Complaint Filed); Reese v. Bahash, No. 07-CV-1530 (D.D.C.) (Complaint Filed). 62 Complaint 1-2, Pappas v. Countrywide Financial, No. 07-CV-05295 (C.D. Cal.). 63 Complaint 1-5, Wesner v. UBS AG, No. 07-CV-11225 (S.D.N.Y.). 64 See Complaint 4, Nach v. Huber, No. 07-CV-4071 (N.D. Ill). 65 See Marlin v. Citigroup Global Markets, et al., No. 07-3580 (E.D.N.Y.) (Consolidated in No. 07-1898). 66 See Marc Tracy, ‘‘With CEO Heads Rolling, Lawyers May Be Next,’’ Financial Services Law 360, Nov. 5, 2007. The article does note that lawyers appear to have played less of a role in causing the subprime meltdown than they did in certain financial scandals, such as those related to options-backdating. 67 Johnson, at D1. 68 See Associated Press, ‘‘FBI Probes Fourteen Companies in Subprime-related Mess,’’ Jan. 30, 2008, at http://www.msnbc.msn.com/id/22903197. 69 LaCroix, ‘‘Dismissal Granted in Subprime-related Securities Law Suit,’’ D&O Diary, Dec. 4, 2007, at http://dandodiary.blogspot. com/2007/12/dismissal-granted-in-subprime-related.html; see also, e.g., Motion to Dismiss, Tripp, et al. v. Indymac Bank Corp., No. 07- cv-01635 GW VDK (C.D. Cal.). 70 Efrati, ‘‘Subprime Crisis Lawsuits 2008...’’. 71 See, e.g., Howard v. The Bear Stearns Companies, Inc., No, 08-2084 (S.D.N.Y.) (Complaint Filed); Bussey v. Washington Mutual, Inc., No. 07-CV-1879 (W.D. Wash.) (Complaint Filed); Esposito v. Merrill Lynch & Co., No. 07-CV-10687 (S.D.N.Y.) (Complaint Filed); McCoy v. Plan Comm., No 07-CV-2693 (C.D. Cal.) (Consolidated in No. 07-2693); Unisystems Profit Saving Plan v. State Street Bank & Trust Co., No. 07-cv-9319 (S.D.N.Y.) (Consolidated in No. 07-8488); Patterson v. Countrywide Financial Corp., et. al., No. 07- CV-1141 (C.D. Cal.) (Complaint Filed); see also Greenberg Traurig LLP, ‘‘Subprime Mortgage Crisis Impacts ERISA Plan Investment in Employer Stock,’’ January 2008, available at http://www.gtlaw.com/pub/alerts/2008/0100j.pdf. 72 See generally, e.g., Complaint, Unisystems, Inc. Employee Profit Sharing Plan v. State Street Bank & Trust, No. 07-CV-9319 (S.D.N.Y.) (case involves publishing company).

Coverage–14 73 Aurora Loan Services LLC v. Fieldstone Mortgage Co., No. 07-CV-1892 (D. Co.) (Dismissed); DB Structured Products v. Imperial Lending LLC, No. 07-CV-4105 (S.D.N.Y.) (Complaint Filed); DLJ Mortgage Capital, Inc. v. Netbank, Inc., No. 07-CV-15211 (S.D.N.Y.) (Dismissed); Morgan Stanley Mortgage Capital, Inc. v. Baltimore American Mortgage Corp., Inc. No. 07-CV-723 (D. Md.) (Judgment for Plaintiff). 74 See Matthew L. Jacobs & Erika Kane, ‘‘PLI Insurance Law: Understanding the ABCs: Basic Principles of Professional Liability Insurance,’’ PLI Order No. 11214 (July 2007) § II [hereinafter Jacobs & Kane]. 75 Paul D. Krause, ‘‘Professional Liability Insurance Including E&O and D&O Policies,’’ PLI Order No. H0-00H7 (April 2002), § I. 76 Krause, § V. 77 See Notes 71-72 and accompanying text; LaCroix, ‘‘Auction Rate Securities: The Next Subprime Litigation Wave?,’’ D&O Diary, Feb. 13, 2008, at http://www.dandodiary.com/2008/02/articles/subprime-litigation/auction-rate-securities-the-next-subprime-litigation- wave/. 78 Dickstein Shapiro LLP, ‘‘Insurance Coverage for Subprime Lending Losses, Litigation, and Investigations,’’ August 2007, available at http://www.dicksteinshapiro.com/files/Publication/25cd85c7-c4c6-4937-a187-01ea61e019c6/Presentation/Publication Attachment/22fe1763-82b3-4e22-96d100973f882edc/Subprime_Lending_Alert%2010.2.2007.pdf [hereinafter Dickstein Shapiro, ‘‘Insurance Coverage for Subprime Lending...’’]. 79 Dickstein Shapiro, ‘‘Insurance Coverage for Subprime Lending...’’. 80 Dickstein Shapiro, ‘‘Insurance Coverage for Subprime Lending...’’. 81 Sabry & Schopflocher, at 4–5. 82 Sabry & Schopflocher, at 4–5. 83 See Dickstein Shapiro, ‘‘Insurance Coverage for Subprime Lending...’’. 84 Complaint 37, Banker’s Life v. Credit Suisse First Boston, No. 07-cv-00690 (M.D. Fla.). 85 See, e.g., In re: HealthSouth Corp. Ins. Litigation, 308 F.Supp.2d 1253, 1269 (N.D. Ala. 2004). 86 See, e.g., Bell Lumber and Pole Co. v. U.S. Fire Ins. Co., 60 F.3d 437, 441 (8th Cir. 1995). 87 Matthew L. Jacobs & David T. Case, ‘‘Insurance Coverage Alert: Insurance Coverage for Subprime Lending Lawsuits and Investigations,’’ March 2007, available at http://www.klgates.com/newsstand/Detail.aspx? publication=3702 [hereinafter Jacobs & Case]. 88 See Dickstein Shapiro, ‘‘Insurance Coverage for Subprime Lending...’’. 89 Krause, § IV. 90 Krause, § V; see also Vigilant Ins. Co. v. Credit Suisse First Boston Corp., 10 A.D.3d 528 (N.Y. App. Div. 2004) (‘‘The risk of being directed to return improperly acquired funds is not insurable. Restitution of ill-gotten funds does not constitute ‘damage’ or a ‘loss’ ...’’). 91 Jacobs & Case. 92 Brooke A. Masters, ‘‘WorldCom’s Ebbers Convicted,’’ Wash. Post, Mar. 16, 2005, at A01. 93 Krause, § VI(A). 94 See., e.g., Faulkner v. American Cas. Co. of Reading Pa., 584 A.2d 734 (Md. Ct. App. 1991). 95 Jacobs & Case. 96 Jacobs & Case. 97 See Dickstein Shapiro, ‘‘Insurance Coverage for Subprime Lending...’’. 98 See Dickstein Shapiro, ‘‘Insurance Coverage for Subprime Lending... .’’. 99 John D. Green, ‘‘Check Your Policy: Does your D&O Insurance Cover Backdating Issues?,’’ Dec. 20, 2006, available at http://www.fbm.com/index.cfm/fuseaction/publications.detail/object_id/a20194d2-b396-4991-8fe9-84405d75dc04/CheckYouPolicy- doesyourDOinsurancecoverbackdatingissues.cfm. 100 See, e.g., In re: HealthSouth Corp. Ins. Litigation, 308 F.Supp.2d 1253, 1280 (N.D. Ala. 2004). 101 William Kapell, ‘‘Directors & Officers Securities Coverage, Insurer Rescission Claims,’’ N.Y. Law Journal, Nov. 22, 2006, available at http://www.winston.com/siteFiles/publications/Kapell_NYLawJournal.pdf [hereinafter Kapell, ‘‘Directors and Officers Securities Coverage...’’]. 102 Kapell, ‘‘Directors and Officers Securities Coverage...’’]. 103 See HealthSouth, 308 F.Supp.2d at 1281. 104 Jacobs & Case. 105 See Dickstein Shapiro, ‘‘Insurance Coverage for Subprime Lending...’’. 106 Jacobs & Case. 107 See, e.g., Liberty Mut. v. Black & Decker, 383 F. Supp.2d 200 (D. Mass. 2004); Smith & Nephew, Inc. v. Fed. Ins. Co., 2005 U.S. Dist. LEXIS 31309 (W.D. Tenn., Nov. 10, 2005). 108 Jacobs & Case. 109 Brown v. Am. Int’l Group, Inc., 339 F. Supp.2d 336, 346 (D. Mass. 2004). 110 See, e.g., Slip. Op., Sun-Times Media Group, Inc., et al. v. Royal SunAlliance Ins. Co. of Canada, et al., No. 06-11-108 (Del. Super. June 20, 2007); Fireman’s Fund Ins. Co. v. Bradley Corp., 660 N.W.2d 666, 674 (Wis. 2003). 111 See, e.g., Sun-Times, No. 06-11-108 (Del. Super. June 20, 2007); Fireman’s Fund Ins. Co. v. Bradley Corp., 660 N.W.2d at 674.

Coverage–15 112 Jacobs & Case; see also Pan Pacific Retail Properties v. Gulf Ins., 471 F.3d 961, 970 (9th Cir. 2006). 113 See, e.g., Slip Op., at 20, Acacia Research Corp., et al. v. Nat’l Union Fire Ins. Co. of Pittsburgh, PA, No. 05-cv-501 (C.D. Cal., Feb. 8, 2008); Hurley v. Columbia Cas. Co., 976 F. Supp. 268, 275 (D. Del. 1997); Shapiro v. Am. Home Assurance Co., 616 F. Supp. 906, 913 (D. Mass 1985); Am. Chem. Soc’y v. Leadscope, Inc., 2005 Ohio App. LEXIS 2428 (Ohio Ct. App., Franklin Cty., May 24, 2005). 114 See. e.g., Slip Op., Sun-Times, No. 06-11-108 (Del. Super. June 20, 2007) (refusing to force allocation of defense costs based on applicability of exclusions). 115 See, e.g., Slip Op., Sun-Times, No. 06-11-108 (Del. Super. June 20, 2007). 116 See, e.g., United States v. Stein, 435 F. Supp.2d 330 (S.D.N.Y. 2006). 117 See, e.g., Level 3 Comm., Inc. v. Fed. Ins. Co., 272 F.3d 908, 911 (7th Cir. 2001); Granite State Ins. Co. v. Aamco Transmissions, Inc. 57 F.3d 316, 320 (3d. Cir. 1995); Executive Risk Indemnity, Inc. v. Pacific Educational Services, Inc., 2006 US. Dist. LEXIS 61101, at * 8 (D. Haw. August 25, 2006); Krause, § V. 118 The following is a typical example of a severability of application provision in a typical D&O policy: ‘‘Coverage under this policy shall be void as to the following: (1) any insured person who knew, as of the inception date of the policy period, the facts that were not accurately and completely disclosed in the application; (2) the company to the extent it indemnifies any insured person who knew that facts were not accurately and completely disclosed as of the inception date of the policy period; and (3) the company if any past or present chief executive officer, chief financial officer or chief operating officer of the organization knew, as of the inception date of the policy period, the facts that were not accurately and completely disclosed in the application.’’ 119 The following is a typical example of a severability of exclusions provision in a typical D&O policy: ‘‘For the purpose of determining the applicability of Exclusions 4(a) through 4(c) and 4(f) [personal profit; illegal remuneration; dishonest, criminal, or fraudulent acts; wrongful acts occurring prior to the continuity date that one could reasonably foresee could lead to a claim] the facts pertaining to or knowledge possessed by any Insured Person shall not be imputed to any other Insured Person.’’ 120 See Note 111. 121 Jacobs & Kane, § III(A). 122 See Thomas M. Reiter & Roberta D. Anderson, ‘‘A Timely Lesson from the WorldCom and Enron Settlements: Make Sure Your D&O Program is Adequate,’’ January 2005, available at http://www.klgates.com/files/Publication/d263ed22-0e16-4fa1-98ab- 29c412df7c90/Presentation/PublicationAttachment/00d6d217-5bee-497c-bf49-35e39e320291/ica0105a.pdf. 123 See Cutter & Buck, 306 F.Supp.2d 988, 1011–12 (W.D. Wash. 2004), aff’d, 144 F. App’x 600 (9th Cir. 2005). 124 See HealthSouth, 308 F.Supp.2d 1253, 1281 (N.D. Ala. 2004). 125 See, e.g., Second Amended Complaint, 89-96, Banker’s Life v. Credit Suisse First Boston, No. 07-cv-00690 (M.D. Fla.) (third party breach of contract allegations against Triad). 126 LaCroix, ‘‘Subprime Litigation Wave Hits Bond Insurer, Freddie Mac; Larger Problems Loom,’’ D&O Diary, Nov. 22, 2007, at http://dandodiary.blogspot.com/2007/11/subprime-litigation-wave-hits-bond.html. 127 See Note 59. 128 Christine Richard & Matt Miller, ‘‘ACA Capital May Get ‘Thrown to Wolves,’ JP Morgan Says,’’ Bloomberg.com, Nov. 21, 2007, at http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aL_bJEd3m9Tc. 129 Tomoeh Murakami Tse, ‘‘Insurer Of Bonds Loses Top Rating,’’ Wash. Post, Jan. 19, 2008, at D01. 130 See Dan Wilchins (Reuters), ‘‘Bond Insurer Woes Could Become Market Tsunami: Spitzer,’’ Wash. Post Online, Feb. 14, 2008, at http://www.washingtonpost.com/wp-dyn/content/article/2008/02/14/AR2008021400013.html. 131 Phillips, et al., at 1. 132 Phillips, et al., at 1. 133 ‘‘Senate Passes Bill Easing Home Loan Rules,’’ N.Y. Times, Dec. 16, 2007, at C8. 134 Most of these provisions instead mandate that the insurance policy be construed in an ‘‘even-handed’’ fashion — despite the fact that the policy is almost never drafted by both parties. 135 See Linda DeBene, ‘‘Viewpoint: Navigating the Crisis,’’ Origination News, Dec. 1, 2007, at 4. 136 LaCroix, ‘‘About Those Subprime D&O Loss Estimates,’’ D&O Diary, Feb. 10, 2008, at http://www.dandodiary.com/2008/02/ articles/d-o-insurance/about-those-subprime-d-o-loss-estimates/. 137 In the last few years, for example, many financial institutions have only purchased Side A D&O coverage. Given the prevalence of indemnification in suits against directors and officers, the absence of Side B coverage is likely to reduce carrier exposure significantly, but many of the higher estimates of total D&O liability do not take this fact into account.

Coverage–16