IPOs open flood gates to D&O risks

IPOs open flood gates to D&O risks | Insurance Business

IPOs open flood gates to D&O risks

Initial public offerings have been making headlines in the past few weeks after Lyft’s stock slumped following a busy first day of trading, and have yet to rebound to the initial offering price, revealing some of the risks of taking a private company public. Now, the online inspiration board darling Pinterest is looking to raise as much as US$1.28 billion in its own IPO, according to Bloomberg, far below its valuation of US$12 billion back in 2017.

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Before companies get listed on a stock exchange, their leadership first has to file a prospectus with the securities commission, which lets potential investors know about detailed information they need to make an informed investment decision, followed by an application for a public listing.

“In that prospectus, they outline a lot of things – what the proceeds of the IPO will be used for, the risk factors, and the competitive environment of the business, so they outline their entire business plan and executive comp based upon that premise, [and] they go out and try to raise money based upon that business plan,” said Jennifer Sharkey (pictured), Gallagher area executive vice president of insurance and risk management.

In the US, the Jumpstart Our Business Start-ups (JOBS) Act that was signed into law by President Barack Obama in 2012 made it easier for smaller, emerging growth companies to go public because it allowed them to file with the SEC confidentially, and “test the waters” to see if investors would be interested in the company based upon this early draft of the prospectus. In Canada, however, any company preparing for an IPO is already permitted to “test the waters,” as is any Canadian company that is preparing for a cross-border IPO in the US.

Meanwhile, the D&O claims trends that Sharkey sees arising from IPOs include disclosure cases and fiduciary responsibility cases.

“You said that you were going to do this and you didn’t within the first year of going public. You said that you’re going to use the proceeds of that IPO for R&D, manufacturing, [or] building a plant, and you changed what you decided to do with those proceeds of the company, so it’s really breaching your fiduciary responsibility,” said Sharkey.

The potential for lawsuits against directors and officers also goes up when a company goes public. According to Marsh, the majority of litigation brought against directors and officers of public companies in Canada is a result of “actual or alleged violations of the applicable provincial securities act, such as the Ontario Securities Act.”

As a result, before leaders take their companies public, they have a lot to think about beyond their initial offering price.

“What they need to consider is making sure they’re managing expectations because the marketplace has become challenging, [and] making sure that they’re working with a broker who has a good understanding of IPO placements,” said Sharkey. “There are very limited insurers who will write primary on IPOs. It depends also [on] trying to define yourself [from] other IPOs that have been going out, and what you’re going to do differently.”

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Brokers, on the other hand, need to know the market through and through because it’s not easy to put placements together. 

“There’s very limited capacity and sometimes, it takes 15 to 20 insurers to put together a tower. The self-insured component of putting together IPO placements now is different, and so looking at alternatives and different product designs [is important],” said Sharkey, “and then just making sure that because the odds of being sued are higher, that you’re aligned with an advocate that can really help you.”