June 1, 2021
June 1, 2021
Serving as a director on a public company board is a great opportunity, but the position also poses personal risk, with the threat of litigation from shareholders and government entities a well-established peril.
That threat is why the insurance industry developed directors and officers (D&O) liability coverage. A D&O policy protects the company and—perhaps more importantly—the personal assets of individual directors when the company cannot or will not indemnify them.
The frequency and severity of securities litigation has grown in recent times, while the number of public companies has shrunk to levels not seen in many years. That means the probability of a lawsuit has increased—a fact not lost on underwriters when setting premium pricing or deciding whether to offer insurance to a particular organization.
It is not just the frequency of this litigation that directors should note. While financial misrepresentations, accounting errors, and other traditional grounds for litigation are still present, broader societal issues—including environmental matters; diversity, equity, and inclusion; and data privacy, among others—are also now at play.
The bottom line is that directors must, more than ever, ensure their D&O program evolves with the litigation landscape and carries the optimal coverage, limits, and insurance industry partners. To do so, directors should have deep discussions around D&O insurance that include the following five evolving issues.
The investor community is increasingly focused on how public companies address diversity, equity, and inclusion, particularly within the board and executive ranks. Over the last year, shareholders have targeted several companies in class-action litigation alleging that companies misrepresented their commitments to a range of diversity initiatives, including those related to minority board representation and hiring practices.
Regulatory action on this issue can also be a minefield. California, New York, Illinois, Maryland, Washington, and other states have enacted laws to require that corporate boards reach specific diversity goals. The Nasdaq and New York Stock Exchange have also advanced diversity compliance initiatives.
Shareholder activism has long been a risk factor for public companies. Recently, we have seen activists put more emphasis on environmental, social, and governance (ESG) issues. This focus, along with broader social trends, has led companies to start taking action to improve their ESG profiles and increasingly address these issues in regulatory disclosures and through other channels.
Gary Gensler, the recently sworn-in US Securities and Exchange Commission (SEC) chair, has made ESG a priority, stating that investor demand requires an update to rules governing climate risk and human capital disclosures. In March, the SEC established a task force to confront ESG disclosure violations. Still, rating firms, investors, and regulators have not reached a consensus on how best to evaluate ESG efforts.
As various stakeholders continue to focus on ESG concerns, companies must be mindful not just of effectively addressing these issues and highlighting their efforts in this space but also of ensuring compliance with disclosure rules to avoid falling into the crosshairs of regulators and private litigants.
Along with an uptick in securities fraud cases, there has been an increase in the frequency of derivative suits. In these suits, plaintiffs claim breaches of duty by some or all members of a company’s board of directors and seek to redress resulting harm to the company.
In addition to governance changes and other so-called “therapeutics,” plaintiffs in derivative suits are increasingly seeking compensatory damages. Derivative settlements in 2019 and 2020 alone totaled around $1.5 billion, compared to $1.3 billion for the entire period from 2011 to 2018, according to Marsh tracking and analysis of settlement values reported in news media.
Individual director defendants are the targets of these suits, making it critical for companies to ensure they are purchasing sufficient Side A D&O coverage. This is a component of a D&O policy that applies when an individual director cannot obtain indemnity from their organization. (Side B coverage applies to reimburse a company when it indemnifies an individual insured; Side C coverage applies to a company’s own loss when it is a defendant in a shareholder class-action suit.)
Since derivative settlements typically constitute non-indemnifiable losses under state laws, directors facing a sizeable monetary settlement must have access to Side A coverage—or their personal assets could be in peril.
According to the Global Risks Report 2021, published by the World Economic Forum with support from Marsh McLennan, cyberattacks remain a top concern for business leaders in advanced economies. As this risk continues to accelerate, companies must demonstrate to both the public and the insurance community that they take the privacy of employees, customers, and business partners seriously.
A data breach or other cyberattack can lead to regulatory scrutiny, fines, and other significant costs. While many companies have dedicated cyber insurance, shareholders continue to bring claims against organizations alleging they misled them on cybersecurity and privacy matters. Shareholder derivative actions may also accuse boards of ineffectively overseeing privacy frameworks, making it all the more important to have robust D&O coverage.
The pandemic is not yet over, but many companies are returning to physical office spaces and resuming some operations that were suspended in 2020. As this trend plays out, insurers are focused on the fair treatment and safety of employees, among other issues.
Investors and underwriters are also asking how the economy’s reopening will affect companies’ revenues, expenses, and other financial factors. Corporate leadership must present a strong, coherent message on these matters to the underwriting community. Companies must ensure they have appropriate D&O limits, which may have been reduced as the market became more challenging over the past year, especially if they foresee sizeable growth due to the abatement of COVID-19.
Building and maintaining a D&O insurance program requires partnership with the insurance community. The more confident underwriters are that an organization is keeping up with litigation trends and key risk trends, the more likely they are to offer desirable coverage terms and pricing.
Companies should consider these and other exposures, and work with their brokers and legal advisors to better understand them. That can not only improve their standing with insurers but also help determine the appropriate limits of coverage and protect corporate balance sheets and directors’ and officers’ personal assets.
Matthew McLellan is senior vice president and the USA D&O product leader at Marsh.
NACD: Tools and resources to help guide you in unpredictable times.