Westfield Specialty’s Ray Ash on the D&O and EPLI Implications of Recent Regulatory Decisions

“Cyber is a huge topic in our industry and the world these days. Even Warren Buffett recently mentioned it as one of his ongoing fears in managing his businesses, especially his insurance business.”
By: | June 4, 2024
Portrait of Ray Ash

At RISKWORLD 2024 in San Diego, Dan Reynolds, editor-in-chief of Risk & Insurance, spoke with Ray Ash, EVP at Westfield Specialty, about a range of topics, including the FTC’s decision on noncompete clauses, the SEC’s climate change disclosure requirements, the new cyber breach disclosure rules, and the concept of Item 303 violations.

What follows is a transcript of that conversation, edited for length and clarity.

Risk & Insurance: Please tell us about the recent FTC decision regarding noncompete clauses and its potential impact on EPLI and D&O insurance.

Ray Ash: The FTC’s decision on noncompete clauses, which came out on April 24th, has generated significant discussion due to its widespread impact on workers across various industries. Remarkably, 10% of fast food workers and 18% of all employees in the country are currently subject to noncompete agreements.

The FTC aims to minimize the impact of these clauses, but some argue they have gone too far. The U.S. Chamber of Commerce has already filed a lawsuit to prevent the ruling from moving forward, and the legal proceedings could take 12 to 18 months or longer to resolve.

In the EPLI context, the immediate ramifications should be minimal. However, executives whose compensation threshold is relatively low, at around $150,000, are exempt from this rule. This raises concerns for industries such as banking, insurance, finance and pharmaceuticals.

Companies may attempt to force noncompete agreements with senior executives before the ultimate decision is challenged and ruled upon, effectively holding these employees at bay for an additional 12 months before they can seek employment elsewhere. This uncertainty surrounding recruiting and retaining talent is likely to create challenges.

On the D&O side, private company policies are broad and cover allegations of unfair trade practices. Although unfair trade practices are not explicitly included in the FTC’s decision, the agency argues that if an unfair trade practice allegation is substantially similar to a noncompete or non-solicit agreement, it will also be enforced.

This creates additional gray areas that will likely lead to legal contests in court.

R&I: What is your perspective on the SEC’s recent climate change disclosure requirements and their potential impact on the industry?

RA: The SEC has been working on these disclosure requirements for some time, releasing draft versions in March 2022 and finalizing its decision in March 2023. Initially, companies were to disclose their scope 1 and 2 emission standards, with scope 1 covering their own emissions and scope 2 covering emissions from their energy suppliers.

Scope 3, which would have included emissions from supply chains and customers, was initially excluded. However, due to significant feedback, the SEC has now put a stay on the entire decision. It remains to be seen whether they will attempt to reinvigorate the requirements or if individual states, such as California, will implement their own aggressive environmental edicts.

Additionally, there is uncertainty around whether the European Union will try to get ahead of American standards, and if institutional investors will start pushing their own environmental agendas. The situation is complex and the ultimate outcome is still unclear.

R&I: How do a company’s public statements and disclosures relate to its potential liability exposure?

RA: The plaintiff’s bar is always on the lookout for inconsistencies in a company’s filings and disclosures to the investing public. Transparency is key, and any material omission or misstatement can lead to legal action.

The FTC and SEC are raising standards with good intentions, aiming to improve the overall functioning and operations of companies. However, there are arguments that some of these measures may be going too far.

R&I: How impactful are the new cyber breach disclosure rules?

RA: The new disclosure rules, which came out in December, require companies to issue an 8-K and disclose to the public whenever they experience a material cyber breach. So far, we’ve seen that companies are adhering to these laws and disclosing breaches accordingly.

Cyber is a huge topic in our industry and the world these days. Even Warren Buffett recently mentioned it as one of his ongoing fears in managing his businesses, especially his insurance business. The question of materiality was my biggest concern, because when it’s a gray area, it often ends up in court to determine who’s right.

While companies are currently disclosing breaches, they’re not yet being contested regarding the level of materiality. This is good news, but it’s still worrisome that someone will eventually get it wrong. Whether it’s the plaintiffs’ bar or the SEC, someone will likely be made an example of, and this will have a massive impact on our industry, with swift and severe ripple effects.

R&I: Can you explain the concept of 303 violations and how they relate to the disclosure of material information?

RA: Item 303 violations are based on an existing requirement for companies to disclose all relevant information about their financial conditions. This allows investors to assess the company’s future prospects and make informed decisions about investing.

It ties into the 10b-5 rule, which mandates that companies do not omit material facts. The case of Macquarie Infrastructure Corporation is a prime example. They had a terminal fuel business that relied heavily on a high-sulfur content fuel.

When a maritime organization announced plans to phase out this fuel over a decade due to its pollutant potential, Macquarie didn’t explicitly mention this in their disclosures, despite it accounting for 40% of their terminal space sales. Ten years later, when the phase-out was complete, Macquarie provided a poor financial projection and cut their dividend, leading to a lawsuit that reached the Supreme Court.

The key question was whether a company’s silence on a matter is actionable. The Supreme Court ruled that it is not. This decision is significant because if silence were deemed actionable, it would create a massive challenge for public companies in determining what information they need to disclose and how it might impact their business prospects and competitive advantage.

R&I: What are the implications of this decision for companies, particularly in the context of ongoing business operations?

RA: The recent court decision has significant implications for disclosure requirements, especially when it comes to a company’s ongoing business operations. In this case, the company failed to consistently highlight that 40% of its terminal storage was related to a business that was phasing out over time.

By not repeatedly disclosing this information, the company is now potentially liable for it. The key question that the Circuit court must now determine is whether this omission constitutes a true omission or a half-truth.

This distinction is crucial because it will establish whether the company’s silence on the matter is actionable. The case has garnered attention from prominent financial commentators, such as Matt Levine from Bloomberg, who often quips, “Everything is securities fraud.”

In the world of directors and officers (D&O) insurance, this case is particularly fascinating. It raises questions about whether this decision will open up a new front for plaintiffs, or if it will ultimately revert to traditional D&O lawsuits and claims. &

Dan Reynolds is editor-in-chief of Risk & Insurance. He can be reached at [email protected].

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