Are You Covered? The Exposure of D’s and O’s for Diverse Reasons
In December 2020, NASDAQ submitted a proposed rule change to the U.S. Securities and Exchange Commission (“SEC”) to add a diversity requirement as a condition for listing on its electronic stock exchange. That proposal would require at least two “diverse” directors or officers and periodic disclosure of aggregate data on gender preference, race, ethnicity, and sexual orientation.
Much earlier, both State Street Investors and BlackRock had called for the appointment of more women to corporate boards and indicated they would not vote for board candidates of companies that had no women on them. In a series of high profile sex abuse cases, which gave rise to the “Me Too” movement, and the sequential deaths of Black Americans killed by police and private violence, which spurred the Black Lives Matter protests, business leaders of all ilks saw it as both necessary AND appropriate to emphasize their commitment to a society that is both more diverse and more open to participation by women and minorities.
The Exposure of Directors and Officers for Diverse Reasons
An unintended consequence of these assertions of civic virtue is the potential liability exposure if a company is not seen as SUFFICIENTLY “virtuous.” Claims for failing to do what a company says it does are a growing field of litigation, typically brought as class actions, which subject the company, its directors and officers, and its reputation to:
Financial loss both for legal fees and for damages
Potential court-ordered limitations on the operations and management of the company
The public “black eye” of an exposed apparent shortfall of virtue
To date, based only on an informal survey, at least the following companies have received such lawsuits: Cisco, Facebook, Micron Technology, Monster Beverage, and Oracle. The claim against Cisco asserted that the board breached its fiduciary duties to the shareholders by not having a single Black American director. The February 9, 2021, case against Micron sought to hold the company and its board liable for having only a single Black American executive, even though he is the CEO. The case also seeks damages for excessive compensation for its executives, as one of the announced measures of achievement was to improve diversity in the company’s executive ranks.
Insurance Coverage for Directors and Officers
Some of these cases have sought disgorgement of compensation, attorneys’ fees, the resignation of directors and officers, the institution of diversity training programs, and even the creation of special hiring committees charged with hiring diverse applicants. One key step that prudent management should take is to review carefully any existing policy of Directors and Officers (“D & O”) insurance that the company has, ideally with the assistance of counsel familiar with the intricacies of D & O coverage, AND an experienced commercial insurance broker.
Many business executives and their counsel understand that D & O insurance policies have three parts, called Sides. Side A provides coverage for the individual D’s and O’s; side B reimburses the company to the extent that the company has funded expense costs or liability of the individual D’s and O’s; and Side C provides coverage directly for the company for its legal expenses and/or liability. Typically, Sides A and B are essentially duplicative. Side C, as it is company coverage, frequently has more restrictive coverage, and given the probable availability of company financial resources, usually has a very high deductible or self-insured retention. The Side C coverage may be particularly helpful to fund the cost of investigations of claims, e.g., those conducted by a specially chosen outside law firm. Side C may also be a source of funding for court-imposed limitations on operations and/or management, such as the need to pay for diversity training, diversity audits, etc. In that regard, it is important to know how much Side C coverage is provided.
Are You Covered?
The insurance policy review should focus on several different areas of coverage. First, one must pay close attention to the scope of coverage, i.e., what things does the policy provide for directors and officers. Typically coverage is provided for a wrongful act (or omission); so, for instance, the Delaware Supreme Court has held that there is NO coverage for directors or officers called to testify in connection with an appraisal action, as a statutory shareholder right is being invoked, without any claim of a wrongful act. While a wrongful act is required to trigger coverage, most D & O policies do not provide coverage for certain intentional and other “bad” acts (on policy grounds that the D or O involved cannot avoid personal responsibility for those kinds of acts).
Hence, the scope and language of such a “bad” act exclusion must be carefully analyzed, and if need be a policy Rider purchased that clarifies any ambiguity that might favor the carrier. For instance, the claim could assert that the company’s statements in public filings or press releases were fraudulent, because the D’s or O’s, or both, knew or should have known that those statements of virtuous behavior were materially variant from actuality.
Policy Review of Diverse Directors and Officers
Efforts to categorize a diversity claim as akin to traditional discrimination claims may meet carrier resistance, as discrimination involves a wrongful act; failure to be diverse is much more a matter of passive neglect (perhaps indicative of, but not necessarily proving, implicit bias). It is also important to reduce, if not remove, any ability of the carrier to withhold payment until and unless there is a final, non-appealable adverse determination (typically by a court, but an arbitration tribunal holding is also possible). This is especially important, as many cases are litigated until a settlement is reached, which may not include any final determination as to liability.
The time to conduct this D & O policy review, and if need be to purchase Riders or even a replacement policy, is NOW, before the claim is made.
As the great 4th century (A.D.) Roman military thinker wrote in the Prologue to his Epitoma De Rei Militari III:
Let him who desires peace prepare for war.