FTX Bankruptcy, D&O Insurance, and the Insurance Industry’s Crypto Underwriting Challenge

Insurance stories don’t always make it into the mainstream press but, when they do, we can’t help but take some inspiration and bring you ripped-from-the-headlines coverage of important insurance lessons. The latest example of an insurance showdown making front-page news is with the recently embattled cryptocurrency exchange FTX. 

To summarize, FTX’s founder and former CEO Sam Bankman-Fried has been charged with old-fashioned embezzlement. There’s nothing high-tech about the alleged crimes: Bankman-Fried is accused of using $8 billion of FTX’s customers’ assets to pay for everything from real estate to political donations.

Update: On Nov. 2, 2023, Bankman-Fried was found guilty by a Manhattan federal court of two counts of fraud and five counts of conspiracy. The jury found that he had stolen $8 billion in funds from his cryptocurrency exchange, FTX’s, users. 

As the company itself fell into bankruptcy in Nov. 2022, FTX executives may have briefly held some comfort in knowing they were covered by Directors & Officers (D&O) insurance. The reality, however, is far more complicated. Read on as we cover some background on D&O insurance, why it may not help Bankman-Fried and the FTX situation, and how this meltdown is ultimately raising questions about how the insurance industry will underwrite cryptocurrency exchanges and adjacent businesses moving forward. 

As always, remember that we’re experts in streamlining and automating insurance producer license management – not the law. If you’re wondering about your own need for D&O insurance or details of an existing policy, please refer to the appropriate authorities. 

Directors and Officers insurance

What is D&O insurance?

D&O insurance is a type of liability insurance that protects the personal assets of company leaders and board members from legal action taken against them in their professional capacity. This includes protection against lawsuits related to mistakes or errors in judgment made in the course of their duties as leaders of the company.

Who does D&O insurance cover?

D&O insurance typically covers the directors and officers of a company, as well as the company itself. In some cases, it may also cover other employees or volunteers who have management responsibilities within the organization.

What types of risks does D&O insurance protect against?

D&O insurance can protect against a wide range of risks, including lawsuits related to allegations of wrongdoing or misconduct, shareholder disputes, and regulatory investigations. It may also cover the costs of defending against these types of legal actions, including expenses like legal fees and settlement costs.

Are there any exclusions to D&O insurance coverage?

Yes, most D&O insurance policies include exclusions for certain types of risks. These may include intentional wrongdoing or criminal acts, financial fraud, and personal profit-seeking activities. In an ideal world, directors and officers of companies wouldn’t be engaging in the types of activities that are excluded from their D&O coverage, so they wouldn’t need to worry about these exclusions. 

Is D&O insurance required? 

No, D&O insurance isn’t generally required by law. The decision whether to purchase D&O insurance or not is typically made by the company or organization. There may be certain circumstances, however, in which a company is required to have D&O insurance as a condition of doing business. For example, some banks and other financial institutions may be required by regulators to have D&O insurance as a condition of obtaining a license to operate. Similarly, some companies may be required to have D&O insurance as a condition of winning certain government contracts.

Will D&O insurance help FTX?

FTX’s leadership allegedly mishandled customers’ invested funds. The company’s value crashed, assets were frozen and unable to be withdrawn, and account holders lost billions of dollars. People are understandably upset, and the “wave of lawsuits” has only just begun. These lawsuits are precisely the type of events companies expect their D&O insurance to cover. But whether that will happen is far from a settled matter. 

Companies commonly rely on their D&O policies to defend directors and officers of the company against accusations like breach of fiduciary duty, negligent misrepresentation, and misappropriation of funds, among others. Accusations of fraud are certainly defensible using a D&O policy, but it becomes much more complicated if the accused is found guilty or admits to intentional wrongdoing. A typical D&O policy won’t pay a claim if the director or officer acted in an intentionally criminal or fraudulent manner. It turns into a very gray area when a company wants its D&O insurance policy to cover legal settlements before the accused’s name is cleared, or if the company pays, and the accused is found criminally liable later. 

As of this writing, it remains to be seen whether FTX has any D&O policies that will help defend its former CEO who’s charged with a list of crimes ranging from wire fraud to money laundering and violating campaign finance reform laws. Business Insider reports that Bankman-Fried is unsure and concerned about how he’ll pay his defense lawyers in light of potential D&O insurance claims denial. 

Update: According to reporting by the Law Society Journal, Bankman-Fried and other FTX officers have received, and will continue to receive, insurance payouts for their legal defense despite their policy’s excluding (as is standard) fraud and criminal activity. This is because those exclusions depend on a non-appealable conviction, which means Bankman-Fried and others can continue to receive insurance money until if, or when, they exhaust all appeals and end up with final convictions.

The fact that their D&O insurance policies are required to pay, as of now, doesn’t mean anything about the situation is simple. For one thing, FTX had four different D&O insurance policies in place, each of which would pay $5 million with each subsequent policy acting in effect as reinsurance for the policy before it. 

While the money may be nice for paying legal fees right now, recipients may find themselves owing it back to the insurers in the future. Also, not all directors and officers are getting the same benefits. The Law Society Journal reports, “The insurers have been paying out defence costs as they are received, meaning that former FTX employees who were previously unaware they had insurance coverage did not apply early enough to claim a fair share of the insurance money.” Consequently, Bankman-Fried has collected the vast majority of the available insurance money thus far, leaving other former employees and defendants high and dry.  

Insurers respond to the FTX meltdown 

The question of who’ll pay for the damage FTX’s downfall caused is one that’s rippled across the financial and insurance industries since news of the bankruptcy broke. In the world of cryptocurrency, it isn’t just FTX’s personal “retail” account holders who lost massive amounts of money. Many other companies either invested in, or were trading on, the exchange. On top of their current financial losses, these companies also may be less protected, or even uninsured, against other types of losses like hacks, theft, or lawsuits.

Reuters reports that insurers across the globe are taking a closer look at any company that had dealings with FTX, and the crypto market as a whole. Insurers are mandating their clients to disclose any dealings with FTX, and in response limiting or even denying coverage to companies they deem too risky. 

Ultimately, the impacts the FTX meltdown will have on the insurance industry are likely to include:

• Stricter underwriting – Insurers are limiting or denying D&O and other liability coverage to companies that had dealings with or assets invested in FTX. They’re asking more questions before issuing policies and including more exclusions. 
• Increasing rates – D&O rates in the crypto industry are already high because it’s such a new market. The lack of historical data makes it difficult for insurers to accurately predict future risks. With such a big debacle occurring in crypto’s short history, insurers are likely considering it an even higher-risk market than before. 
• Discontinuing products – Some insurers just may not be up for the risk of underwriting D&O and other liability policies for crypto companies. Reuters reports at least one insurer is taking the stance of simply not offering coverage if the policy is risky enough that they’d need to contain crypto or regulatory exclusions. 

How technology can reduce risks

Most D&O policies are there to cover times when a director or officer makes a mistake or a lapse in judgment that results in harm to someone else. They’re also there to help defend directors and officers of a company against accusations, although as mentioned above, not necessarily to cover intentional criminal acts. 

In terms of mistakes and oversights, these often occur simply because directors and officers are human. Like all people, they can get distracted or forget something important. If you work in insurance, compliance is one of those areas where you can’t afford to leave room for human error. 
While we can’t automate away your D&O risks (unless your directors and officers are managing producer license compliance, state appointments, or producer onboarding) we can take the chance for human error out of these often manual and tedious processes. If you’re an insurance agency, carrier, or MGA/MGU take a look at how modern insurance infrastructure with AgentSync can virtually eliminate the chances of a license compliance misstep.