Going Public in 2021? Watch for These IPO Risks

Even as the slow economic recovery continues, the IPO market is as strong as ever. Global IPOs raised $220 billion through March 31, a first-quarter record and six times the amount of capital raised in the same period in 2020, according to data compiled by Bloomberg. And many observers expect that the IPO frenzy will not let up any time soon.

Going public represents a significant milestone for a company, the culmination of years of work by its owners and senior executives. But it is not a simple exercise. There is a lot at stake, especially for directors and officers, who must carefully consider the potential risks they face during and after the IPO process.

New Responsibilities and Liabilities

In transitioning from private to public, a company’s risk profile will materially change because it will be subject to federal securities laws. The Securities Act of 1933, Exchange Act of 1934, Sarbanes-Oxley Act of 2002, Dodd-Frank Wall Street Reform and Consumer Protection Act, and other laws are designed to enhance public trust and strengthen corporate governance.

The risks stemming from these laws arise as early as when soon-to-be-public companies first make their case to potential investors in the form of registration statements, prospectuses, and roadshow presentations. These documents and discussions will naturally include information about a company’s operations, its financial wellbeing, potential risks, and other material matters — and any purportedly misleading statements contained or arising therein could result in post-IPO securities claims.

A Range of Risks

Post-IPO securities litigation and other claims are often made within three years of an IPO and can take several forms. Among the concerns for newly public companies and their directors and officers are:

• Class-action suits brought by shareholders alleging misstatements or omissions during the IPO process. Under Section 11 of the Securities Act of 1933, plaintiffs bringing such suits are not required to show that directors and officers intended to defraud investors. What’s more, the Supreme Court’s 2018 ruling in Cyan, Inc., et al. v. Beaver County Employees Retirement Fund, et al. allows investors to file Section 11 litigation in federal and state courts simultaneously, increasing the complexity and potential costs for companies.
• Regulatory enforcement actions for misstatements or omissions in 10-K, 10-Q, and 8-K filings. Rule 10b-5 of the Exchange Act of 1934 allows the Securities and Exchange Commission and Department of Justice to hold companies responsible for efforts to defraud investors, including making untrue statements of material fact or omitting material facts in company filings.
• Derivative suits brought by shareholders on behalf of companies against individual directors and officers, typically alleging violations of fiduciary duties or other wrongdoing. Derivative actions are growing in frequency and becoming costlier, often resulting in substantial monetary recoveries. And an increasing share of these cases are so-called “event-driven” suits prompted by high-profile events and trends, such as cyber-attacks and sexual harassment allegations.

Robust D&O Coverage Is Crucial

In addition to ensuring that directors and officers discharge their duties effectively and in compliance with applicable securities laws, it is important that companies build effective insurance programs.

A critical question is how to structure your directors and officers liability (D&O) insurance program. A traditional D&O policy provides a shared limit of liability that protects both the company and its directors and officers. This means a single claim made against the company — if large enough — can exhaust the limits that were available to individual executives.

This is why businesses often also purchase what is known as dedicated Side-A coverage. A Side-A policy has separate limits dedicated solely to individual directors and officers — with no applicable retention — and it cannot be depleted by claims against the company.

As you make these and other decisions, it’s essential that you work with a risk advisor that knows the intricacies of D&O risk — prior to an IPO, during the offering process, and post-IPO. The right advisor can help you:

• Choose the optimal program structure and approach based on your organization’s needs and risks.
• Determine appropriate limits based on peer benchmarking, analysis of your potential exposure to securities litigation, detailed claims trends, and other factors.
• Understand critical policy features, including exclusions for certain forms of misconduct and for claims brought by an insured company against insured directors and officers, along with priority of payment provisions.
• Understand how D&O coverage is designed to respond in specific circumstances, such as the company’s insolvency or a board’s refusal to indemnify an individual director or officer.