Why Cyan is making insurers blue
Talk to any US directors and officers (D&O) insurer at the moment and the conversation will soon turn to Cyan....
No, we haven't all become obsessed with colour wheels and interior design. Cyan is shorthand for a case that came before the Supreme Court in early 2018 to decide jurisdictional issues for registration statement litigation.
How and why has this now become an issue? To answer this, a little history is needed: The Private Securities Litigation Reform Act (PSLRA) in 1995 was widely interpreted as requiring that lawsuits arising out of the federal securities laws be heard in federal court, a position that the Securities Litigation Uniform Standards Act (SLUSA) in 1998 seemed to reinforce. And so for 16 years cases were heard in federal court until some enterprising lawyers started bringing a selection of cases in California's state court.
The difference between state and federal courts is material. A state court judge often has twice as many cases on their docket as a federal court judge, and probably half the number of law clerks - they may therefore not have the time to digest a well-reasoned but detailed motion to dismiss an argument. In addition, federal judges are appointed by the President for life so aim to transcend politics, while many state judges are elected: the position of state courts may thus be more political.
Turning to registration statement litigation, there are two main types of securities law breaches:
- Those from statements made in a registration statement linked to raising money or shares - typically in an initial public offering (IPO) or secondary offering (s.11 cases under the 1933 Securities Act) - and
- Those from ongoing disclosures (s.10b cases from 1934 Securities Act).
The latter cases are all heard in federal court, so we are only concerned with s.11 cases here. Unlike s.10b cases (for which fraud must be proved), s.11 has strict liability with no fraud requirement - thus a negligent misstatement is enough to cause liability.
The troubles for insurers and clients started in San Mateo County in northern California. Insurers defending these cases quickly became used to very low dismissal rates and settlements higher than any we would have expected for a similar case in federal court. All that was required for jurisdiction over the cases was a link to San Mateo - an office, a member of the board who lives there, or even the office of the offering bank. The resourceful plaintiff bar quickly spread these cases throughout California, although San Mateo has remained the most challenging jurisdiction for insurers.
Cyan was a case brought before the US Supreme Court attempting to challenge the jurisdiction of state courts, and move the s.11 securities cases to federal court. Most of the market (insurers, commentators, defence lawyers etc) expected the court to rule in favour of insurers and clients, but in a 9-0 unanimous verdict, the court held that s.11 cases can be heard in state court. They signalled that they didn't necessarily agree with all of the content of SLUSA (one justice called it "gibberish") but that the legislation was clear on this aspect.
Following the Cyan judgment, state court filings have mushroomed in numerous states outside of California including Texas, Massachusetts, Colorado and New York. They also have not been confined to IPO cases, and s.11 cases have been brought in a merger situation where a registration statement was issued to raise capital for the transaction.
So what does this mean for insurers and insureds? Are IPOs even insurable? In the past few weeks we have seen steep rises in both premiums and retentions, although we believe that both the severity and frequency of claims justifies further corrective action. In the absence of legislation to amend SLUSA, IPO companies can expect heightened premiums and retentions for the foreseeable future.