Is diversity the next big D&O risk?

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Is diversity the next big D&O risk?

The big question for agents and brokers is whether a client’s D&O policy will respond should they face litigation over diversity practices.

Diversity and inclusion issues are firmly in the spotlight on the world stage.

Litigation against directors and officers over diversity was once a fairly uncommon occurrence. But that all changed in 2020 when a number of lawsuits were filed against several high profile companies including Facebook and The Gap, Inc., regarding the lack of diversity on their boards of directors, senior executive leadership teams and overall employee base.

At a time of heightened awareness of the many issues and obstacles that black people and ethnic minorities face every day, directors and officers are facing greater scrutiny of how their companies respond to the call for greater diversity and inclusion. Recent lawsuits against large, public companies suggest that the escalating chance of a company being sued over its diversity practices.

In each of the lawsuits, there is a recurring theme: The companies in question and their boards have been idle when it comes to taking action in increasing diversity and inclusion, despite having the policies in writing.

Words vs. deeds

Similar to environmental issues, inaction by a company’s governing figures has been, and will likely be, a common complaint and cause for litigation. Inaction in this sense can mean a company’s failure to step back and reflect on its current approach to diversity (or lack thereof). It can also mean that a company fails to implement changes and enhancements to the diversity policies and procedures that it has promised to enact, which could be perceived as knowingly making false and/or misleading statements.

Failure to fulfil fiduciary duties with regards to diversity is another recurring theme throughout the lawsuits. Senior leadership teams will likely be under scrutiny with regards to diversity, as will the diversity policies and procedures already in place (and when they were put in place), including those pertaining to HR and hiring. Outdated frameworks with weak commitment to diversity won’t be tolerated, and allegations of breaches in directors’ fiduciary duties can follow.

The big question for agents, brokers and their clients is whether a D&O policy will respond should they face such litigation.

Possible coverage exclusions

Where a shareholder brings the suit on behalf of the company against the directors, many states (particularly Delaware, which is a popular incorporation state) do not permit companies to indemnify their directors for the settlement. This means that the settlements are typically paid for by the directors themselves or by insurance. D&O policies will usually respond via the Side A, or via a Shareholder Derivative sub-limit if endorsed onto the policy. In the case of a securities action against one or more directors, a company can indemnify its directors for both legal costs and settlement indemnity. Subject to financial capability and an indemnification provision, the Side B would respond.

The main exclusion would be the Conduct exclusion. This excludes claims arising out of the gaining of financial advantage, personal profit or by committing a fraudulent act or omission. The latter is the most pertinent, as plaintiffs may allege that a company’s directors and officers knowingly disclosed false or misleading information about a company’s commitment to diversity. However, this exclusion is usually only enforceable after a final, non-appealable adjudication determining this to be the case. Policies would likely look to defend the accused against these allegations during the litigation process, but if a guilty verdict was issued, then the exclusion would be brought into play.

Underwriting pressure

So with D&O and EPL insurers becoming increasingly aware of the rising risk of diversity and inclusion lawsuits, agents and brokers can expect underwriters to include an analysis of a their clients’ diversity and inclusion controls, procedures and training in their underwriting rationale.

While they may not be diversity and inclusion specialists, brokers and agents can help their clients allay D&O and EPL insurers’ concerns over potential future lawsuits by encouraging them to review their policies and procedures. For example:

  • Nominate a board member with clear accountability for achieving the company’s diversity objectives. Establishing a diversity sub-committee at board level, as well as a diversity committee at employee level, can encourage discussion, engagement and action.
  • Remove gender or ethnicity specific information from CVs and cover letters and ensure there is at least one black or ethnic minority interviewer as part of a panel to help ensure a fairer interview process.
  • Implement training in anti-discrimination, diversity and inclusion for all employees, executives and board members by outside consultants.

Diversity and inclusion issues are firmly in the spotlight on the world stage. If companies aren’t proactive at reviewing and/or strengthening their controls and frameworks, underwriters will likely take a dim view given the potential risk of a hit to reputation, lawsuits, and in extreme cases, share price.

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