Insurance stories don't always make it into the mainstream press but, when they do, we can't help but take some inspiration from the ripped-from-the-headlines coverage of important insurance lessons. One recent example is the recently embattled cryptocurrency exchange FTX. 

FTX's founder and former CEO Sam Bankman-Fried has been charged with embezzlement, accused of using $8 billion of FTX's customers' assets to pay for everything from real estate to political donations. Bankman-Fried is pleading not guilty to fraud and conspiracy, according to CNBC. However, three former associates—former Alameda co-chief executive Caroline Ellison, former FTX technology chief Gary Wang, and former FTX engineering chief Nishad Singh—have all pleaded guilty. The trial is scheduled for Oct. 2. 

FTX executives may have briefly held some comfort in knowing they were covered by directors & officers insurance coverage when the company fell into bankruptcy in Nov. 2022. The reality, however, is far more complicated. D&O coverage may not help Bankman-Fried and the FTX situation and ultimately raises questions about how the insurance industry will underwrite cryptocurrency exchanges and adjacent businesses in the future. 

D&O Insurance

D&O 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.

D&O typically covers the directors and officers of a company, as well as the company itself, offering protection 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.

Coverage may also extend to other employees or volunteers who have management responsibilities within the organization.

Most D&O insurance policies include exclusions for certain types of risks, including 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. 

While D&O insurance isn't generally required by law, the decision of whether to purchase such coverage is typically made by the company. 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 were unable to be withdrawn, with account holders losing billions of dollars. While FTX has since recovered over $7.3 billion in cash and liquid crypto assets, an increase of more than $800 million since January that may allow the company to survive, according to Reuters, so far only FTX customers in Japan have been able to withdraw any of their funds due to the country's strong crypto regulations. 

The lawsuits that ensued after the crash are the type of events companies expect their D&O insurance to cover. Nevertheless, this matter is far from being settled. 

Companies commonly rely on their D&O policies to defend directors and officers of the company against accusations like a 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. 

The question of who will pay for the damage FTX's downfall caused investors is one that's rippled across the financial and insurance industries since news of FTX's 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.

Insurers across the globe are taking a closer look at any company that had dealings with FTX as well as the crypto market as a whole, according to Reuters. 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. 

The impact of the FTX meltdown on the D&O market is expected to be threefold:

1) 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. 

2) 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. 

3) Discontinuing products. Some insurers may not be up for the risk of underwriting D&O and other liability policies for crypto companies. 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, Reuters reports. 

Ellen Lichtenstein is senior content specialist at AgentSync.