A recent report found that two-thirds of C-suite executives in the UK are suffering cognitive fatigue and overload leading to decision paralysis. It is against this backdrop that boards face a perfect storm of emerging risks centred around environmental, social and governance (ESG) threats which are landing in the boardroom.
There may not be universal agreement on the definition of ESG, but there is no doubt that there is increased focus on it. The important point for boards is that this umbrella term is becoming mainstream. It is a spotlight on the way a company acts and executes on its business strategy. leading to reputational and D&O risks.
The Environment and climate change
A broad range of stakeholders including investors, regulators and other interested parties are paying closer scrutiny to the steps directors are taking to address and mitigate environmental and climate risks. There were regulatory signs in 2019 when the Prudential Regulation Authority (PRA) mandated that financial services businesses inform them who was responsible for identifying and managing climate change risks. Regardless of who is responsible accountability sits with the board.
It has been estimated that 1300 climate change cases have been brought in 28 countries. These are wide ranging – from firms in the USA held liable for wildfires to dam failures in Brazil and a Polish firm sued for building a coal-fired power plant. Meanwhile, in Australia a $57 billion pension fund settled a case after it was sued by a member over its climate change disclosures. More concerning is research by the ClientEarth Legal Group. They found that 40% of companies had not referred to climate change-related risk in the ‘principal risks and uncertainties’ section of their annual reports, and fewer than 25% of companies had clearly referenced the impact climate change will have on their business.
While no business has yet to be found liable for the effects of climate change directors cannot be complacent and ignore this emerging risk.
Social and cultural
Societal and cultural pressures have manifested in movements like #MeToo which brought the subject of harassment and abuse to the forefront of public and media attention as the case against Harvey Weinstein unfolded in 2017. The issue was put into sharp focus earlier by TUC findings that over half of women had experienced sexual harassment at work.
More than half (52%) of women, and nearly two-thirds (63%) of women aged 18-24 years old, said they have experienced sexual harassment at work. TUC/Everyday Sexism report
On a broader level, if there is a culture where sexism, a lack of diversity, racism and bullying take hold within an organisation then the board could be held responsible. They are expected to set the tone and a toxic culture could be a driver for D&O claims. As a result, directors could face litigation or prosecution if they fail in their duty of care to staff or ignore and allow a culture of abuse within a firm to become endemic. Lawsuits have also targeted boards themselves. In 2020 alone, companies including Gap, Norton, Facebook, and Oracle faced and Oracle faced D&O suits over a lack of diversity at board level.
We are still in a global pandemic, yet numerous Covid-19 class actions have already been filed and are more are expected.
Cases tend to fall into four categories. Companies that experienced a Covid-19 outbreak, for example cruise ships. Second, companies that made expected profit statements like vaccine, test equipment and PPE. The final group are those who have experienced disruption or loss of income due to the pandemic. Then, sadly there are those companies who have not survived at all.
As the world economy has suffered during the pandemic bankruptcies have been on the increase. There has been a surge in mega bankruptcies (those over $1 Billion) in the second and third quarters of 2020. As economies start to emerge from the pandemic Fitch has predicted a steep rise in insolvencies for SMEs which will hit the wider supply chain and lead to losses for the financial services industry.
It is the job of Insolvency practitioners to recoup and recover losses – which will often include D&O claims against directors. Did the board fail to prepare adequately and put risk management plans in place for a pandemic or extended period with reduced income?
Mergers & Acquisitions
On the flip side of businesses going to the wall are those on the acquisition trail. Here too, there has been an increase in stakeholders chasing an opportunity to object and seek to recover losses leading to D&O claims. In fact, in recent years according to Cornerstone it is more likely that there will be a lawsuit than not – with some 80% subject to shareholder litigation. Typically, these claims allege that directors conducted a flawed sales process with a resulting loss of shareholder value, or that there were failures to disclose or conflicts of interest. While many of these claims are dismissed, they are on the increase and expensive to defend against to the point that they are priced into any M&A deal.
Cyber security threats are constantly evolving. This last year saw a rise in data breaches, cyber and ransomware attacks. An example of an emerging risk is more remote and homeworking because of the pandemic. Businesses may not have paid adequate attention to mitigate the associated security threats.
“Over the past year, the industry has encountered cyber claims that are involving directors and officers for their cyber business decisions." Oren Schemool in Canadian Insurer
It is easy to consider cyber claims in isolation and as a risk that sits within a cyber insurance policy. However, as Oren Schemool, our head of financial lines underwriting in Canada, told Canadian Underwriter recently, this would be a mistake. Over the past year, the industry has encountered cyber claims that are involving directors and officers for their cyber business decisions. He also identified another associated emerging risk as lawyers are becoming wise to D&O wordings and identifying gaps which they can target.
It is reasonable to expect a rise in event-driven litigation leading to more D&O claims. The event, or trigger could be any of the issues in this blog – Covid-19, cyber, corporate culture, M&A, insolvency or more. However, as businesses around the world come under increasing scrutiny, ESG issues will be at the fore.
If you would like to know more about how HDI Specialty can help you with D&O insurance, please contact the team: