D&O Price Increases Sting in a Hardening Market. Adopting ESG Best Practices Can Reduce the Pain

As investors and the public put a greater focus on ESG issues, businesses need to make sure their practices align with their values statements lest they open themselves up to liability issues.
By: | January 28, 2021

Alphabet, Google’s parent company, made headlines last fall when it committed to spending $310 million over the next decade on corporate diversity programs as part of a settlement for a series of shareholder lawsuits over its handling of sexual harassment claims.

The lawsuits stemmed from the fact that the company’s board of directors approved a $90 million exit package for executive Andy Rubin after an investigation deemed a sexual harassment claim against him credible. One of the suits brought by a shareholder alleged that board members had ignored their fiduciary duties and in the process had become enablers of sexual harassment and discrimination.

Alphabet is not alone in facing these types of suits. 

Securities class action and shareholder derivative lawsuits driven by current events are on the rise, and they’ve contributed to an increasingly hard directors and officers (D&O) market over the last few years. 

In 2019, carriers reported 20% premium price hikes were the norm in large part due to increases in exposure caused by a wave of event-driven, class action and shareholder derivative suits.

“If a company’s disclosures don’t match its actions, that could be low hanging fruit for a potential claim.” — Leo Daley, vice president of the public D&O division, Allied World. 

Many of these suits are related to a company’s behavior when it comes to environmental, social and governance (ESG) issues. Ranging from diversity, equity and inclusion and #MeToo-related litigation on the social side to lawsuits over a company’s role in global climate change on the environmental side, event-driven, ESG-related legal action is on the rise. 

“You now see more and more investment funds using this as investment criteria,” said John Fohr, co-founder and CEO of TrustLayer, Inc. 

“I think the real value comes in when there can be an alignment of interests between what is good for some broader purpose, whether it’s safety or whether that’s some sort of environmental goal and how that overlaps with the success of the business.”

These suits are frequently motivated by increased concern over companies’ ESG policies and practices by both the public and investors. If a business isn’t careful to make sure its statements on various ESG issues align with its practices, the business could be opening itself up to a litigation avalanche.       

ESG Is Here to Stay

Just five years ago, it would have been considered unusual for a company to consider ESG policies and values right alongside or, in some cases, even ahead of profits. Fiduciary duties began and ended with increasing the profits of shareholders.  

Jon Peeples, ARM, vice president, environmental division PHLY E&S insurance solutions, Philadelphia Insurance Companies

That all changed in 2018 when Larry Fink, CEO of the institutional investor BlackRock, published a letter telling business leaders that focusing on maximizing profits and shareholder returns wasn’t enough; if they wanted BlackRock’s support, they needed to make a “positive contribution to society.”

“Some of the largest investors in the world have made it known that they’re paying very close attention to companies’ ESG programs,” said Jon Peeples, ARM, vice president, environmental division PHLY E&S insurance solutions at Philadelphia Insurance Companies.

In 2020, BlackRock doubled-down on this mission. In his 2020 letter to CEOs, Fink noted that by the year’s end, all of the firm’s active portfolios and advisory strategies would be fully ESG integrated. BlackRock’s portfolio managers are responsible for overseeing ESG risk exposure and documenting how it affects investment decisions.  

At the center of these efforts is an increased focus on the “E” in ESG. Climate change, Fink said in his letter, has “become a defining factor in companies’ long-term prospects.”

And they’re not alone in these efforts. In a 2020 report distributed to clients, BlackRock noted in the first quarter of 2020 U.S. sustainable funds attracted a record $7.3 billion and global sustainable open-ended funds saw $40.5 billion in new assets over the same period.  

Companies Can’t Just Pay Lip-Service to ESG

With increased investor interest and public scrutiny, businesses are likely to continue focusing on ESG issues and releasing statements on their values into 2021 and beyond.

If an enterprise’s ESG commitments don’t match their values, they may be opening themselves up to event-driven securities class actions and shareholder derivative lawsuits from their board members. 

Darren Pain, director of evolving liability at the Geneva Association

“If a company’s disclosures don’t match its actions, that could be low hanging fruit for a potential claim,” said Leo Daley, vice president of the public D&O division at Allied World. 

One doesn’t have to look too far back to see how social and political events can have an influence on securities class actions and shareholder derivative suits related to ESG issues. 

After the #MeToo movement, companies saw a wave of shareholder derivative and securities class action suits. Similarly, Facebook, Oracle and Qualcomm all faced shareholder derivative lawsuits in the wake of the latest round of Black Lives Matter protests this past summer.  

These types of suits are expected to continue into 2021, with numerous insurance companies and brokerages, including Allianz Global Corporate & Specialty (AGCS) and Woodruff Sawyer, identifying shareholder derivative lawsuits as an issue to watch in the D&O space.   

“It’s very important that public companies get more and more aware of the level of disclosures that they are providing,” said Joana Moniz, global head of commercial financial lines, AGCS.

One area where event-driven litigation is expected to see an increase over the next few years is environmental issues. As global climate change continues to drive increases in severe weather events, people are taking legal action to hold companies accountable for their role in causing these types of events.

Driven by attribution science — which determines the degree individual companies contributed to climate change — several of these lawsuits targeting fossil fuel companies are already underway. 

In the years to come, they could become a massive liability for corporations, especially since nuclear verdicts and social inflation are on the rise.   

“Plaintiff’s attorneys have been much more aggressive over recent years in marketing their services and acquiring new customers, as well as in pursuing different ways in which they can build a case,” said Darren Pain, director of evolving liability at the Geneva Association.

Pain recently authored a report on social inflation and its effects on claims and litigation. “If environmental issues come to the fore that may well shape litigation developments.”

Aligning Values with Practice 

To protect themselves from litigation over ESG issues, companies should be careful about what they do and do not disclose, and they should make sure that any disclosures line up with their business practices. 

Determining what to disclose is no easy task. No universal standard exists for ESG disclosures, and currently they are not mandated by any organizations.

Leo Daley, vice president of the public D&O division, Allied World.

“There are several different frameworks and standards that exist, but there’s not one set of standards that everybody follows, and there’s nothing that’s mandatory,” said Tim Kviz, national assurance managing partner, SEC Services at BDO.

Still, there are best practices businesses can follow. Kviz noted that several groups, including the Sustainability Accounting Standards Board and the Global Reporting Initiative, have published their own standards which companies can use to measure their progress on ESG issues and to determine what to disclose.

Kviz emphasized that they will likely not be a universal standard until an organization like the SEC starts mandating ESG disclosures, however.  

Another way companies can make sure their ESG disclosures align with their practices is by having an expert determine whether or not they are complying with stated goals when it comes to issues like sustainability and diversity.

“If management says it is concerned about ESG, are they taking extra steps to reach their stated goals?” Daley said. “Seeking expert counsel is something that is encouraging to hear when speaking with a potential client.”

Focusing on getting ESG practices in line with a company’s stated values doesn’t just protect businesses from litigation risk; it could also bring their insurance costs down, both for lines related to legal risk like D&O and those like environmental where ESG policies could reduce exposures. 

“As companies stop using toxic materials and start using more non-toxic materials in their processes, their environmental risks do lessen,” Peeples said. 

“Not only is a focus on ESG good for society, those companies with strong ESG could potentially save money on costs, such as insurance,” Daley added. &

Courtney DuChene is a freelance journalist based in Philadelphia. She can be reached at [email protected].

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