Inside This Article:
- Federal regulators are claiming that former Lottery.com Inc. executives misled investors by falsely inflating revenues, according to reports.
- The Securities and Exchange Commission lawsuit follows guilty pleas by two former executives reportedly involved in a fraudulent $30 million financing deal, Bloomberg Law reported.
- Directors & Officers (D&O) Insurance can respond to these types of allegations, though coverage may depend on fraud exclusions and final non-appealable adjudication language in policies.
- Companies considering public offerings or complex transactions should review their D&O Insurance with an experienced broker to confirm limits and coverage.
Federal regulators have filed a lawsuit accusing several former executives of Lottery.com Inc. of misleading investors about the company’s financial performance as it prepared to enter the public markets through a merger with a special purpose acquisition company, or SPAC, a shell company formed to take firms public, Bloomberg Law recently reported.
The Securities and Exchange Commission (SEC) complaint, filed in federal court in Manhattan on Jan. 22, alleges the executives were involved in a fraudulent $30 million financing deal and an overpriced acquisition of a gaming company — both transactions reportedly designed to inflate the company’s revenues, according to the outlet. The lawsuit names multiple former Lottery.com executives as well as the former CEO of the SPAC, Trident Acquisitions Corp.
“These are very serious accusations,” said Phillip Hawes, Broker, Professional Liability, Burns & Wilcox, Brokerage Division, Chicago, Illinois. “You made a representation to shareholders or investors about your revenues and operations, and it was not accurate. That is a problem.”
These are very serious accusations. You made a representation to shareholders or investors about your revenues and operations, and it was not accurate. That is a problem.
Companies facing this type of litigation may have coverage under their Directors & Officers (D&O) Insurance, a type of Management Liability Insurance that can help protect corporate leaders from personal financial exposure when shareholders or regulators make allegations such as misstatements or governance failures.
“Anyone can file a lawsuit, and directors and officers can face personal liability under certain circumstances, particularly for breaches of fiduciary duty. The more individual investors you have, the easier a target it makes you, especially as a publicly traded company,” said David Andreas, Senior Broker, Professional Liability, Burns & Wilcox, San Francisco, California. “If a company goes bankrupt, plaintiffs often look to directors and officers personally, especially when corporate indemnification is unavailable. D&O Insurance can be critical then.”
If a company goes bankrupt, plaintiffs often look to directors and officers personally, especially when corporate indemnification is unavailable. D&O Insurance can be critical then.
Lawsuits surged after SPAC transaction boom
Lawsuits tied to SPAC transactions have become more common in recent years, particularly following the surge in “blank-check companies” during the pandemic era. In 2021, the Wall Street Journal reported on a wave of legal action targeting SPAC-related transactions. In December, cybersecurity company Hub Security agreed to pay $11 million to settle claims that it misled investors before its SPAC merger in 2023, and crypto mining company Core Scientific agreed in November to a $14.75 million settlement after investors accused its SPAC partner of misleading shareholders before their merger.
“During COVID and right after, there was a huge rush to do SPAC-related transactions,” Andreas said. “A lot of the companies trying to do this really were not ready to be publicly traded companies.”
Though the frequency of these lawsuits has slowed somewhat, “we still see these cases every year,” Hawes said, and they are a reminder of the importance of D&O Insurance. “That is D&O 101,” he said. This type of insurance can cover initial defense costs while investigations unfold, which is often one of the most costly elements. “Everyone involved is going to have to talk to a lawyer,” Hawes said.
Beyond defense costs, the full extent of expenses “depends on what kind of lawsuit is filed, the legal environment, what you are accused of misrepresenting,” he said.
Another emerging risk for lawsuits against directors and officers is related to a company’s use of artificial intelligence (A.I.). “Some companies are overstating how they are using AI, when they are not really using it as much as they are saying,” Andreas said. This could mislead investors and artificially inflate stock prices, Hawes added.
The financial impact of regulatory claims
When a regulatory action or shareholder lawsuit is filed against a company’s directors, the length and complexity of the dispute can magnify the financial impact, particularly when multiple defendants are involved, Hawes said. “If the officers plead guilty and the lawsuit is buttoned up quickly, costs could be $1 million or less. If it drags on, there is no plea, multiple board members are named, and there are counterclaims, costs could be hundreds of millions of dollars.”
For companies with D&O Insurance in place, these policies may help absorb a significant portion of defense and settlement costs, though coverage and limits can vary based on policy language and how allegations are ultimately resolved. According to Hawes, key D&O Insurance features to consider include additional Side A limits, which provide coverage for directors and officers when companies cannot indemnify them in the event of a claim, as well as antitrust coverage, “even if it is only coverage for defense costs.”
“Fortunately, I have not really seen a lot of antitrust litigation in my own books, but it is a tough situation and could definitely cause a company to go bankrupt,” he said.
Hawes also said companies should look to remove product advertising and professional services exclusions, when possible, and pay close attention to network security or data breach exclusions. “That is not meant to cover a cyber claim, but if a cyber incident leads to a separate D&O claim, you want to make sure there is at least a Side A chargeback to that exclusion,” he said. “Otherwise, those claims could potentially cause them to go bankrupt or lose significant funds.”
Private companies face similar risks and should not assume D&O Insurance is only necessary for public firms, Andreas said. “You can still have individuals who are not investors that bring claims against the directors and officers of a private company,” he said.
Understanding fraud exclusions
Many D&O Insurance policies exclude fraudulent activity but may continue to fund defense costs while a case is pending. “In a lot of D&O Insurance policies, there is a final non-appealable adjudication clause tied to the fraud exclusion,” Hawes said.
In a lot of D&O Insurance policies, there is a final non-appealable adjudication clause tied to the fraud exclusion.
If fraud is alleged, Andreas said, D&O policies typically advance defense costs unless and until there is a final, non-appealable adjudication establishing fraudulent or criminal conduct. “Coverage generally ceases once fraud is established by conviction or admission, and advanced costs may be subject to recoupment,” he said.
Understanding D&O Insurance coverage is particularly important for companies pursuing public offerings or complex financing transactions. “They should be having these conversations with their broker long before they even go down that road,” Andreas said. “Review your insurance programs and make sure you are familiar with what is included and excluded.”
Given today’s softer market for D&O Insurance, with more competition in the marketplace, now is a prime opportunity to seek out coverage options, Andreas said. “It is the right time to look at coverage because you can get better pricing and better terms and conditions,” he said. “If a company does not have D&O Insurance or has not shopped it lately, now is a good time to do that.”
If a company does not have D&O Insurance or has not shopped it lately, now is a good time to do that.
Working with an experienced broker remains essential as liability risks evolve. “No two D&O policies are exactly alike,” Hawes said. “You want to work with a wholesale broker or retailer who is very sophisticated and understands the market.”
