|  |  |  |  | |  | Resources Are “prospectus liability” policies worth it?Generally, companies buying D&O insurance in connection with their IPOs used to treat a large percentage of the first-year premium as an offering expense. They accounted for it as a cost of raising capital and therefore it would not affect the company's bottom line.
Companies can also extend this accounting benefit by purchasing separate three year "prospectus liability" policies or endorsements from their D&O insurers. Three years is the statute of limitations on prospectus-based claims. The principal benefit of this type of coverage is the accounting treatment of the premium.
There are some notable risks associated with this type of policy. One is that the amount of prospectus liability coverage is "shared" with the coverage for all other D&O policy exposures. So, a company may buy a three-year policy, pay a substantial additional premium for doing so, and then find its coverage diluted, or even exhausted, in the first year by employment practices or other D&O claims.
The other principal risk of this type of policy is that, in the last two years of a prospectus liability policy term, it can be difficult for the company to move its ‘underlying’ annual D&O coverage away from the insurer that provides the prospectus liability coverage. When we say ‘underlying’ here, we mean the D&O coverage for all other matters. So, when a company buys a prospectus liability policy, it will also buy a standard D&O policy that covers its other risks and which is renewed annually.
It is certainly possible to move this underlying D&O coverage to a different insurer, in years two and three. But if a company does move the underlying coverage, and there is then a claim alleging violations under both the Securities Act of 1933 and the Securities Exchange Act of 1934 (each of which is covered by a different insurer), the company is likely to face nightmarish allocation issues.
The resolution of allocation issues is difficult enough with one insurer. But with two, it will be especially difficult. So, before committing to a policy, any company considering the purchase of a prospectus liability policy should consult its accountants, to determine if they will support the desired accounting treatment. | |
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