Risks facing directors & officers
October 2022 | ROUNDTABLE | BOARDROOM INTELLIGENCE
Financier Worldwide Magazine
October 2022 Issue
Directors and officers (D&Os) have perhaps never faced a higher level of risk and liability than they do today. Among a raft of disruptive scenarios, coronavirus (COVID-19), climate change and environmental, social and governance (ESG) issues are shaping the risk landscape like never before. The playing field has changed significantly, and D&Os are under heightened scrutiny from shareholders, creditors, employees and other stakeholders, taking their personal liability to new and different levels.
FW: Could you outline how the risks facing D&Os have evolved recently? What key factors are shaping the risk landscape?
Frémat: The coronavirus (COVID-19) pandemic and the increased awareness of climate change and increased importance of environmental, social and governance (ESG) are key factors currently shaping the risks landscape for directors and officers (D&Os) in today’s market. The pandemic caused financial distress to a wide range of companies. Directors have been taken out of their comfort zones repeatedly, having had to take decisions which, in normal circumstances, might not always be considered as decisions that a normal and prudent director would reasonably have taken. This financial distress has unfortunately been prolonged due to the increasing price of raw materials such as oil and gas, and the conflict in Ukraine. The COVID-19 pandemic also forced many companies to make a sudden shift to an online office environment. The increase in online activity, combined with often subpar protective measures, made many companies the perfect target for cyber attacks, resulting in numerous data breaches. These data breaches may result in an increase in third party liability claims, and possibly even directors’ liability claims, for failing to provide adequate protection against such data breaches. ESG also became a topic that companies can no longer ignore. An increase in regulatory and legislative initiatives – both national and European – and awareness among consumers, shareholders and investors, is pushing directors to put ESG at the top of the corporate agenda.
Da Silva: In addition to traditional risks facing D&Os, such as securities, class action, regulatory exposure, event driven and derivative litigation, we are seeing increasing global litigation related to the environment and climate change, as well as ESG risks. Stakeholder pressure is forcing boards to look closer into their ESG risks and to take adequate measures. Another evolving area is cyber, with a growing claims volume due to increasingly severe ransomware attacks. Prevention and remediation cannot be left exclusively to the IT department anymore; these need to become a boardroom priority. Even though a cyber event may be resolved successfully, a lack of or insufficient planning against cyber risks at board level could constitute a breach of the D&O’s inherent duty of diligence and give rise to shareholder actions against them. Finally, managing a company in a high inflation environment with the constant threat of a global economic crisis adds further exposure. We are still facing the economic fallout from the COVID-19 pandemic – the full impact of the withdrawal of the temporary support measures is yet to be seen – and political instability in the UK, France, Italy and other countries on the continent, as well as elsewhere in the world, is on the rise. In addition, we are now in the midst of a conflict in Europe that is magnifying the impact of the worldwide economic slowdown, disrupting activity and investments, exacerbating the overreliance on cheap debt, as well as exposing countries’ lack of alternatives for energy independence in the short term.
Johnston: The governance landscape in the UK is developing into a more rigid framework of obligations on directors, with an increasing focus on enforcement of disclosure. The Department for Business, Energy and Industrial Strategy’s (BEIS’s) White Paper on ‘Restoring trust in audit and corporate governance’ proposes direct accountability of D&Os over financial reporting and other areas including ESG criteria, supplier payment policies and anti-fraud arrangements. The paper also proposes attestation requirements, mandating that D&Os acknowledge their responsibility for establishing and maintaining adequate internal controls and procedures for financial reporting. In addition to proposed legislative controls, D&Os are under scrutiny from a growing scope of stakeholders. Shareholders are becoming more vocal, if not overtly active, with several high-profile companies having to amend remuneration, revise internal policies and, in extreme cases, remove executives.
Suskin: Regarding securities litigation, shareholder class actions against publicly held companies and D&Os continue to be filed at a steady rate arising from a wide range of circumstances. The lawsuits are both event driven, with stock drop cases following a disclosure of adverse news, for instance, as well as litigation following announcements of M&A activity. Among the trends shaping the landscape are an increased number of shareholder lawsuits against special purpose acquisition companies (SPACs) and companies involved with cryptocurrencies. As more SPACs are faltering and crypto companies experience sharp declines in valuation, shareholder suits likely will continue against those targets at an elevated rate. Additionally, cases continue to be filed against companies alleging misleading or inadequate disclosures relating to COVID-19 issues and ESG investing. In contrast, lawsuits against non-US issuers and companies in the financial sector have declined compared with filings in 2021.
“Increasing social and governance scrutiny on companies’ and individual directors’ activities leads to higher exposures, which materialises in more investigations.”
FW: To what extent are high-ranking executives being held personally responsible and liable for transgressions occurring within their company?
Da Silva: It is still rare for D&Os to be held personally liable for transgressions. Of course, they are constantly exposed to lawsuits, be these based on misrepresentation, breaches of fiduciary duties, loyalty duties, among others. In these cases, they are indemnified by the company – relying on their corporation’s bylaws – or covered by D&O insurance. Generally speaking, D&Os are only exposed to personal liability in situations of proven fraud. If they are not covered by insurance or an indemnification agreement, which mitigate or eliminate their exposure, their personal assets are exposed. That said, shareholder activism is increasingly holding executives liable by way of shareholder derivative lawsuits, and, in many territories, corporations are not allowed to indemnify D&Os in case of derivative actions. It is also important to consider that for US-listed companies, defence costs – usually considerable for both the company and their D&Os – will relevantly reduce the limit available for settling or resolving claims. We should note that defence costs are also becoming more significant elsewhere, owing to the long-tail nature of indemnity claims.
Johnston: As well as legislative and regulatory controls, media and social media are also influencing decision makers more than previously experienced, with social media campaigns adversely impacting share prices and changing priorities for companies. A high-profile example was when P&O Ferries made 800 seafarers redundant in March 2022. A social media and media storm erupted and was escalated to the UK Department of Transport, putting pressure on the chief executive to resign over the lack of notice of the redundancies. There is also an increase in derivative claims in the US. The public termination of senior executives used to be confined to chief financial officers for misstatement of accounts, but now the net is cast wider.
Suskin: It remains rare for high-ranking executives to be personally liable in civil litigation. Companies generally provide robust D&O coverage, and shareholders’ counsel generally do not seek more than policy limits in settlements. However, in the criminal arena, several high-profile prosecutions have been successfully brought against high-ranking executives for misrepresentations to investors, the Theranos convictions being a prime example.
Frémat: The playing field for D&Os has changed over the past few years. Companies and their directors have been put under heightened scrutiny from shareholders, creditors, employees and other stakeholders on many different levels. Companies and their directors have been facing increasing financial distress, which is very likely to continue as numerous sources have announced a recession for the fourth quarter of 2022. Companies and their directors have become increasingly vulnerable to cyber attacks and data breaches. The increased awareness of climate change and increased importance of ESG also made companies and their directors rethink their corporate strategy and agenda. This change in the corporate landscape changed the notion of what is considered a normal and prudent director and changed the personal liability risk faced by D&Os.
“When something bad occurs, stock prices fall and shareholders sue, the D&O policy is often the one ‘deep pocket’ available for recovery.”
FW: Could you highlight any recent claims against D&Os in which the outcome proved to be particularly significant?
Johnston: One matter that springs to mind is the claim Client Earth brought against Shell, which was successful – not against the directors of Shell, but the second round was a derivative claim. The Client Earth letters to major pollutants are expected to name individual directors and be brought as derivative actions, if not already filed. I see the climate litigation being brought by two groups: shareholders for lost value and climate activists on behalf of individuals impacted by climate change. In the same way there was a flurry of claims against directors following cyber attacks a few years ago, it will become difficult to argue boards are not aware they are polluting or aware of the expectations of the public to reduce emissions. But conversely, there are now moves by US states and actions by shareholders expressing concern that too much capital is being invested into reducing greenhouse gas emissions.
Frémat: To our knowledge, there have not yet been any high-profile D&O claims cases in Belgium as a result of the new and changing corporate and corporate liability landscape, as is the case abroad, such as in the Netherlands. That said, the changing landscape and the contentious climate abroad is likely to set the tone for a rise in D&O liability claims in Belgium.
Suskin: One of the most significant recent claims relates to the recent convictions against senior executives in the Theranos cases. Those trials captured significant media attention, and the underlying stories inspired a television docudrama, because it is so rare for such criminal cases arising from alleged fraud against investors to go to trial. On the civil side, one study reports that only 26 securities fraud cases have gone to verdict since 1996. That is due, in large part, to D&O insurers not wanting to roll the dice and risk a large jury verdict.
FW: How important is it for D&Os to ensure they have appropriate levels of D&O liability insurance coverage in place? How can D&Os accurately determine whether or not their insurance coverage is equal to the range of risk scenarios that exist?
Suskin: It is very important that D&Os, before accepting their positions, investigate and ask questions to confirm they are appropriately covered. They should confirm that their company is taking a holistic approach to ensuring it offers its D&Os an appropriate level of coverage. This includes having the D&O insurance programme provide, in addition to Side-A only coverage, other coverage programmes for errors and omissions, property, products, as well as cyber and general liability. Consulting with outside insurance coverage counsel and insurance brokers is important to making an accurate determination whether insurance coverage is adequate.
Frémat: It is vital for both companies and their directors to ensure appropriate levels of D&O liability insurance coverage. The changing corporate liability landscape increases the scrutiny and pressure on companies and their directors. Having an appropriate liability insurance policy in place might provide directors with a certain level of comfort in their role as leaders and decision makers. Getting an adequate insurance policy starts with a good understanding of the actual risks and liabilities to be covered. We therefore always advise our clients to ensure that they have a good understanding of concerned risks, before entering into an insurance policy. Deciding on an appropriate level of coverage for a D&O insurance policy will require a thorough risk assessment of the concerned corporate, and its directors, to determine on what levels the corporate and its directors are exposed to a certain risk or liability, to ensure that these risks are appropriately covered under the D&O insurance policy. It is always useful to include a broker or underwriter in the risk assessment, to further align the possible risks and coverage in the insurance policy.
Da Silva: There is no perfect method to accurately determine the ideal D&O insurance cover in terms of limit purchased, deductibles and coverages. However, there are factors that can help determine the appropriate insurance level. For example, claims and benchmarking studies – considering same sector and size – help determine the limit to purchase. In the end, limits need to be sufficient to pay for a relevant claim for all the D&Os and perhaps the company, especially in the case of insolvency, when you cannot rely on the company’s funds. It will always be a trade-off between terms and conditions and budget. The terms of D&O policies are negotiable, but it is difficult to ask if you do not know what to ask for, which is why it is very important to rely on the advice of specialised counsel and experienced, well-informed brokers. All we can say for certain is that claims frequency, court awards and settlement values have been increasing.
Johnston: It is extremely important for the board of a company to have the appropriate D&O insurance programme in place because they are personally liable for claims against them. If the limit of liability purchased is too low to cover potential claims, then a director’s personal assets may be at risk. A company should work with a specialist firm of insurance brokers to ensure that their D&O programme has an appropriate limit of liability with a broad wording to cover the company’s and board’s exposures. The limit needs to take into account both the settlement amount and the defence costs, plus the fact that there could be claims against numerous members of the board.
“Assessing the specifics of a D&O policy requires a prior assessment of the relevant company and its D&Os, to map out the specific risks.”
FW: What aspects should companies and their D&Os focus on when assessing the specifics of a D&O liability policy? Are there any common pitfalls, for example?
Frémat: Assessing the specifics of a D&O policy requires a prior assessment of the relevant company and its D&Os, to map out the specific risks they are most vulnerable to and to ensure that these risks are adequately covered in the insurance policy. A proper understanding of relevant liabilities is needed before assessing the merits of a particular D&O policy. Assessing a particular D&O policy also requires a good understanding of applicable exclusions and coverage limitations, to avoid any unnecessary or unwanted discussions afterwards. Coverage disputes often revolve around the interpretation of such exclusions and coverage limitations.
Da Silva: First, companies should evaluate their most sensitive exposures and make sure their coverage is as broad as possible, with a sufficient limit of liability to protect their personal assets. A D&O programme – made up of a primary policy and several excess policies – is normally issued by many different insurers, coming in at various attachment points. D&Os should look at these attachment points and ensure that policies fit together cohesively, leaving no gaps. In a multijurisdiction policy, always assess multinational D&O liability exposures and the need for local coverage – it is challenging to deal with complex local regulations. Second, D&Os should look for insurers with a robust, collaborative and experienced claims team, a solid market reputation, internal claims payment policies, adequate agency ratings and solvency. A settlement process can take up to 10 years, and it is important to choose a strong insurer that will be there in the case of a claim. Third, on the surface, it may seem more efficient to opt for a broader coverage that includes entity cover in the D&O policy. However, this can go against the individual D&Os’ best interests. Claims against companies are extremely costly and can deplete policy limits, leaving the D&Os themselves with little to no possibility of future indemnification in the case of a claim. Side-A excess insurance should be considered. Finally, the services of an experienced broker are crucial, even more for complex placements. A good broker will definitely have a broader view of what the market is offering as well as on claims trends.
Johnston: The golden rule is that the policy provides adequate protection to the directors themselves in the event that the company cannot or is unable to indemnify them. Coverage is key. It is also important to use a reputable insurer that understands D&O and has a proven track record. The extensions are less important than the exclusions and key definitions in the policy wording. One pitfall is to have too wide a definition of ‘insured person’ and include cover for all employees of the company, because this may erode protection for the main board or those that need it most.
Suskin: It is important to pay close attention to key terms, exclusions and limitations of a policy and how the towers interact, particularly in a situation where a settlement occurs below one tower level, but exposure remains for other related cases. One aspect that is also particularly important, and is often overlooked, regards insurer control over selection of counsel. D&Os normally prefer to be defended by counsel with whom they are familiar. But D&O policies often give the insurer significant influence or control over selection of counsel, frequently in connection with the insurer having negotiated significant rate discounts with select panel counsel. D&Os should examine whether their regular outside counsel will be on the insurer’s approved list and, if they are not, negotiate their inclusion at the policy inception. It is usually difficult to get counsel approved later, and approval may be tied to significant concessions on rate discounts that the counsel may be unable or unwilling to accept. It is also important to make sure that policies include coverage for investigations. Not all policies do, and some that do have limitations that unrealistically underestimate the costs of conducting such investigations. Additionally, many policies do not cover responding to government subpoenas, including as non-party witnesses, but such responses can entail exceptionally high costs, particularly where identification, recovery and production of electronically stored information is involved.
FW: What advice would you impart to D&Os on regularly revisiting and reviewing their D&O policies to account for new developments and changing circumstances?
Da Silva: My advice is for D&Os to have constant contact with their brokers, insurers and reinsurers for a global perspective on market changes and claims trends. Any changes in the company’s risk profile that may have an impact on the cover, such as new subsidiaries, change of control or shares issuance, have to be communicated to the broker to make sure that the policy reflects these new exposures. It is also important to understand the wording on cover, exclusions and specific relevant clauses such as coverage triggers, claims definition and language impacting underlying insurer limits depletion. Companies should rely on their advisers to assist them in this assessment. If a claim arises, the policy should operate in the right way to respond. Finally, I encourage clients to start the process early to identify and evaluate changes in risk exposures and cover gaps, and to negotiate with insurers to obtain the most favourable terms and conditions, which can easily take months. Long-term partnerships with insurers will more likely benefit an insured should there be any wording or claim uncertainties.
Johnston: In my experience, clients want consistency and to work with their primary D&O insurer as a partner. This will involve reviewing the policy wording when there are changes to legislation or market dynamics, allowing for broader cover rather than going through a lengthy remarketing process every year. It is important for companies to build a strong relationship with their primary D&O insurer so they can work in partnership in the event there is a claim.
Suskin: D&Os need to review their policies at least annually for new developments and changing circumstances. A couple of years ago, developments such as the collapse of crypto and the challenges facing the SPAC market had not been widely anticipated, and therefore coverage may not have been viewed as important. Litigation trends and hot new issues arise frequently, so the annual review of D&O coverage is important.
Frémat: A review of adequate insurance coverage starts with a thorough understanding of concerned liabilities. Reviewing a D&O policy requires regular, thorough and critical assessment of the concerned company, to map out the specific risks it is most vulnerable to and to ensure that these risks are adequately covered in the insurance policy. Directors should be aware of any significant changes in the companies’ activities and the relevant economic climate and should inform their broker or insurer in this regard, to continuously align the possible risks and coverage in the insurance policy.
“The level of risks and exposures facing D&Os may not necessarily increase, but the risks will certainly evolve.”
FW: Looking ahead, do you expect the level of risk and liability facing D&Os to increase? How do D&Os themselves need to respond?
Johnston: The level of risks and exposures facing D&Os may not necessarily increase, but the risks will certainly evolve. At the moment D&Os are dealing with a lot of potential risks, including supply chain disruption, the recessionary environment, higher interest rates, a heightened ESG focus, increased regulatory investigations and cyber security threats. The best way for D&Os to respond is to be alert to all of these risks and ensure that they are regularly addressed and reviewed with controls in place. For example, are cyber security issues discussed at board meetings, and is there a chief information security officer and external appraisal of protection?
Frémat: It is always difficult to predict precisely how the personal risks of D&Os will evolve. The playing field for D&Os and the corporate liability landscape have changed significantly over the past few years. Companies and their directors have been put under heightened scrutiny from shareholders, creditors, employees and other stakeholders, and D&Os’ personal liability will likely be challenged on many new and different levels, so the need for adequate D&O insurance will likely only increase. Therefore, it is important for directors to regularly review the corporate landscape and the particular risks and liabilities their company may face, to take appropriate action and ensure adequate insurance coverage is in place.
Suskin: There has never been a time when D&Os have not faced a high level of risk and liability. When something bad occurs, stock prices fall and shareholders sue, the D&O policy is often the one ‘deep pocket’ available for recovery. What the particular risk will be is not always easy to predict, so making sure that there is holistic coverage, minimal exclusions, careful coordination of towers, and the ability to select counsel are all important considerations for D&Os to inquire about and be comfortable with the answers.
Da Silva: Over the last decade, D&Os of private and public companies have increasingly become targets of civil litigation. Stakeholders with different interests in the company are now more aware of their rights and the company’s leaders are always prejudged by those stakeholders that are negatively impacted by their decisions. In addition, increasing social and governance scrutiny on companies’ and individual directors’ activities leads to higher exposures, which materialises in more investigations and more claims. Finally, exposures will most probably be exacerbated further by increasing shareholder activism supported by litigation funding firms.
James Johnston is head of the management liability team at Aviva. He joined the firm in March 2018 to establish the management liability team and write large corporate business. He began his insurance career as a professional indemnity insurance broker and then switched to D&O broking. He has been underwriting for over 12 years and has extensive experience underwriting D&O, POSI, Crime and PTL for large companies in the UK, Europe, Middle East, Canada and Asia Pacific. He can be contacted on +44 (0)20 7157 2055 or by email: james.johnston1@aviva.com.
Virginie Frémat is a partner in the Antwerp corporate team at CMS Belgium. She advises on all aspects of general corporate law and has significant experience in managing complex transactions. She is highly regarded by clients for her hands-on approach, and she advises across a wide range of sectors. She has a specialisation in insurance law and is used to handling complex litigation cases, both for insurers and corporates. She can be contacted on +32 (3) 206 0157 or by email: virginie.fremat@cms-db.com.
Howard S. Suskin is a partner in Jenner & Block’s litigation department and co-chair of the firm’s securities litigation practice and its class action practice. He has substantial first-chair experience representing individuals and business entities in civil and criminal securities matters, including class actions alleging securities fraud and misrepresentation claims, derivative actions claiming breach of fiduciary duty, contests for corporate control, insider trading investigations and broker-dealer issues. He can be contacted on +1 (312) 923 2604 or by email: hsuskin@jenner.com.
Sandra Da Silva manages Tokio Marine HCC’s financial lines insurance underwriting for Spain, Portugal and Latin America. She joined the company in 2004 as an assistant underwriter, covering southern and eastern European territories, and was promoted to financial lines manager in 2014, having held various underwriting positions and gained vast experience and profound insurance knowledge in her markets. Prior to joining the company, she enjoyed an extensive career in journalism and copywriting. She can be contacted on +34 93 530 7364 or by email: sdasilva@tmhcc.com.
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