Tag Archives: conflict of interest

5 Misunderstandings on Home Insurance

Hiring an insurance broker should mean ease, speed and extra security. But not everything about putting a middle man in the process of buying insurance is great. Mistakes and mishaps are bound to happen at some point.

Misunderstandings between homeowners and insurance brokers aren’t uncommon. The insurance industry has become a lot more chaotic. More clients are finding it hard to trust agents and brokers, who do sometimes use unethical tactics to earn a living.

Let’s take a look at some of the most common misunderstandings.

1. Conflict of interest

Insurance brokers get remunerated through a fee or commission for their services. They can get paid by the insurer for bringing a large volume of business to the company. They can also get a commission from their clients by finding the best deal and insurance for them.

The risk of conflict arises when the insurance broker favors his personal gains over his duty to his client. This can result in the client agreeing to higher prices or extra coverage he doesn’t really need.

See also: A Wakeup Call for Benefits Brokers  

2. Nondisclosure and negligence

Before a client signs up for insurance, it is his responsibility to divulge all pertinent information, including his income, medical history, home values and details of his home security. Failure to disclose all this information can render him uninsured when he files a claim.

There are cases, however, where even forthright and honest men can forget pieces of information. Having an insurance broker handling all the processing can make it more likely to happen. And negligence by a broker can result in a costly misunderstanding.

3. Failure to understand exclusion

Clients mostly shop around for price and reputation without realizing the other important factors that can affect their coverage.

Insurers are slowly cutting back on coverage and increasing their deductibles in an attempt to increase profits. While insurance brokers can give their best when discussing the exclusion clauses buried in lengthy policies, they can still miss critical details, and one word or phrase can mean thousands of dollars when it’s time to make a claim.

A carport, for example, does not technically fall into the category of a building, which means that a client should not expect his insurance to cover a collapse.

4. Underinsurance

When doing an assessment, a typical insurance broker would need the help of real estate appraisers or an online program to know how much coverage a homeowner can get. If the broker is fairly new and untrained, he may even obtain figures by directly asking the homeowner how much exactly he is expecting to get.

This lack of knowledge can mean that homeowners are greatly underinsured. Yet they will have a false sense of assurance and only realize their problem in the wake of a disaster, such as a tornado or flash flood.

Another common misunderstanding between homeowners and insurance brokers involves replacement cost and market value. Most homeowners expect to receive a coverage that will equate to their home’s market value. Replacement cost, on the other hand, is generally higher than the amount a buyer is willing to pay for a house. It’s based on a lot of factors, including the materials used, cost of labor for the demolition and repair, etc. An agent or a broker needs to be very thorough in discussing these details so that he and his client can determine the right insurance and coverage.

See also: A ‘Perfect Storm’ of Opportunity (Part 3)  

5. Change of policies

It’s the insurer’s obligation to notify its clients about any changes in their insurance coverage. It’s also a part of the broker’s responsibilities to let his client know the terms of renewal, cancellation and expiration of the insurance he’s offering and to make sure the client understands.

But sometimes clients don’t get the message and are underinsured or even uninsured when they file a claim. In cases like this, a client can take legal action against the broker. He may also file a case against the insurer, if it changes the insurance without its client’s consent.

When Not to Use Regular Counsel

When selecting counsel to defend them against a securities class action, companies usually face the question of whether they want to hire attorneys from their regular outside corporate firm. Sometimes, companies will retain their regular outside firm as a matter of course, without even going through an audition process to interview other potential defense firms.

While such an arrangement is frequent, it can be inappropriate.  Ethical and practical conflicts lurk beneath the surface that can make it unwise for a company to hire its regular outside firm for securities class action defense — and these conflicts need to be examined more closely by companies, their insurance carriers and the counsel seeking to represent them.

It is a dilemma that all securities counsel faces at one time or another — when should they turn down representation of a firm client in a securities lawsuit? Over the years, I have struggled with that question, and my analysis has evolved and grown sharper.  The north star of the analysis is a basic principle: Attorneys should not represent a client when they have a conflict that could compromise the client’s defense.

In the context of securities litigation defense, a conflict can arise when it is in the client’s interest to rely on the defense firm’s corporate work as a defense against allegations of falsity or scienter (intent or knowledge of wrongdoing), or to establish a due-diligence defense. For the client, it is a question that boils down to whether the same firm that provided disclosure or stock-trading advice can make an objective decision about whether to disclose that advice to assert these defenses.

The company, not its lawyers, makes disclosures. But lawyers play a prominent role in many disclosures, by drafting or editing them, by giving advice to the company about their adequacy and by weighing in on decisions not to disclose certain information. This is more true of some disclosures than others — public offering materials, for example, are likely to be largely drafted by the attorneys, who will weigh in on every important disclosure decision. Lawyers also advise on matters that bear on scienter — primarily the presence or absence of material nonpublic information in connection with establishment of 10b5-1 plans and periodic stock sales, and on stock offerings. Even if lawyers have not technically provided legal advice or representation on these matters, directors and officers often rely on their regular counsel to object to potential misrepresentations or ill-advised stock sales about which they had notice.

I am not suggesting that it is never appropriate for a company to hire its regular outside firm to defend a securities class action — in some cases, the firm may not have had any involvement in the disclosures or decisions that are being challenged, or that are likely to be challenged as the case proceeds. For example, if the stock price drop that triggered the litigation was caused by a restatement, the litigation likely will not implicate the lawyers’ disclosure advice, because the case will be about the company’s financial statements, on which the lawyers didn’t work.The above considerations yield two guiding principles:

  • If the securities class action challenges a disclosure on which a firm has provided disclosure advice, as to what was disclosed or what was not disclosed, the firm generally should not defend the litigation.
  • If the securities class action relies on stock sales as evidence of scienter, a firm that advised on the stock sales – or 10b5-1 plans under which the stock sales were made – generally should not defend the litigation.

In addressing this issue, some law firms tend to emphasize only the lawyer-as-witness problem, which in many states can be avoided by having another firm examine the defense firm’s lawyers. But the problem can be more significant than this.

Let’s analyze the situation with a simple hypothetical. A securities class action against Acme Corporation challenges a statement in Acme’s 10-K. Acme’s regular outside corporate counsel provided advice to the company about the challenged disclosure, including advice that certain omitted information that allegedly made it misleading did not need to be disclosed. As evidence of scienter, the lawsuit cites Acme’s officers’ sales of company stock pursuant to 10b5-1 plans established during the alleged class period. Corporate counsel advised that the officers had no material nonpublic information when they established the plans.

Acme and the individual defendants will have an interest in defending themselves by asserting that they relied on the law firm’s advice, both as to the disclosure decision and the stock sales. At first blush, it may seem that the positions of Acme and its law firm are the same — both want to defend the correctness of the disclosures and stock-sale decisions. But their interests are not the same. Even if their lawyers’ advice was wrong, the defendants may be able to avoid liability, as long as their reliance upon it was reasonable and genuine.

On the other hand, Acme’s lawyers have an interest in preventing the disclosure of incorrect legal advice, which could not only prove embarrassing but also expose them to liability. And even if their advice was defensible, lawyers do not like to have their legal work, including their internal law firm communications, produced in discovery — and potentially dissected by competing firms. And, like everyone, lawyers have a natural aversion to testifying, or to making themselves the focus of litigation.

This all means that defense firms that also serve as corporate counsel have enormous incentives to avoid having their clients introduce evidence about their legal work, even if that evidence is plainly in the clients’ interest. These defense firms are motivated, consciously or not, to steer the clients away from a defense based on reliance on legal advice — something that may be easy to do without many questions being asked, because of the general bias against revealing privileged information. This may not result in substantial prejudice if there are good defenses otherwise, but no doubt there is prejudice in many cases, which is largely (if not entirely)  invisible to the client — through, for example, higher settlement amounts than would otherwise be necessary, or pressure to settle a case that might otherwise be a good trial candidate.

So why do companies hire their corporate counsel so often? I’d say there are three reasons.

First, it’s fair to say that outside counsel law firms don’t routinely go through this kind of analysis with their clients, before asking that they be hired to defend a securities class action. Few companies have been through securities class actions, so they need to be guided through this analysis in a candid fashion. At most, regular outside counsel discusses the lawyer-as-witness problem, and correctly notes that it’s common for regular outside counsel to defend securities claims.

Second, companies often regard securities class actions as frivolous and don’t take the counsel-selection process as seriously as they should. Most companies think their case will be dismissed, so there won’t ever be any conflict issues, and it is safe to just hand the lawsuit off to their regular firm.

Third, firms tell companies that if a case does not get dismissed, it will settle — so, again, conflict issues will never arise.

Because the conflicts that arise from these situations are largely invisible to the clients and the carriers, and any visible effects — such as potentially higher settlements — cannot be measured, there is no outcry against the practice. But the fact that the harm is difficult to detect or measure doesn’t mean it doesn’t exist, or that it is not potentially significant in some cases.

All of the above problems are exacerbated when a company hires its regular outside firm without even interviewing other firms. In failing to interview other firms, companies fail to get an outside reality check regarding conflict issues, miss out on the free legal advice they will receive from the firms they interview and give up the leverage they have during the selection process to get economic concessions from the firm that they ultimately hire. In addition, without an audition process, companies have no way to compare the securities litigators from its regular outside firm with other securities litigators, and sometimes unknowingly engage less effective and efficient lawyers than they would if they simply took a half a day to interview a handful of firms.

There is a simple, common-sense remedy: The company should conduct an interview process during which it can ask other firms about the regular outside firm’s conflict (taking into account those firms’ interest in being hired) — a process that, as noted above, has advantages for the company anyway. Alternatively, the company can engage securities litigation defense counsel who isn’t under consideration for the defense role to advise on the issue. Under either procedure, the company should also seek advice from its insurers and broker, who have a unique and helpful perspective as “repeat players” in securities litigation, having typically been involved in a very large number of securities litigation matters.

Whoever does this analysis needs to think past the initial complaint to the claims that are likely to be asserted by the lead plaintiff in a consolidated complaint. For example, if a class-period 10-K contains disclosures that are causally related to the reason the stock dropped, the analysis should consider the 10-K even if it isn’t mentioned in the initial complaint, because the lead plaintiff is likely to challenge it. Or if there are class-period stock sales, the analysis should take them into account, even if the initial complaint doesn’t mention them.

If regular outside counsel were to advise their corporate clients to obtain counsel-selection advice through an audition process or an independent firm, as well as from their insurers and broker, they would do great service to their clients, in ensuring that the clients received the maximum amount of protection possible from their appropriate reliance on the advice of counsel to navigate the difficult waters of disclosures and stock sales. Significant potential harm, albeit largely invisible and unmeasurable, can be avoided by simply insisting upon an impartial counsel-selection process that allows the client to evaluate the full spectrum of potential conflicts.

Even if the company and its directors and officers end up selecting the company’s regular outside counsel, the benefits of the selection process will most certainly serve the company well throughout the litigation.