Diversity related lawsuits impact D&O policies

Diversity
Momentum created by the Black Lives Matter movement is the latest factor in a recent trend of increased legal action by shareholders, which is impacting directors & officers (D&O) policies.

A flurry of lawsuits have recently been filed in the US against major technology firms like Facebook, Oracle, Qualcomm and software firm NortonLifeLock, alleging that the companies failed their fiduciary duty by not hiring black board members. 

Plaintiffs are filing these lawsuits against a backdrop of a wave of protests against police brutality and calling for social justice in the US following the death of George Floyd in Minneapolis. Racial diversity and inclusion issues are currently high on the media agenda. Adding further pressure on companies, Newsweek has recently published an article with a list of the 20 largest public US companies without a black person on their board, which could trigger more lawsuits. The movement is gathering momentum across the world and it is possible that similar D&O liability suits could also arise elsewhere.  

 

The allegations

In the filings, plaintiffs allege the companies’ boards of directors violated federal securities laws and breached fiduciary duty by making misrepresentations about their commitment to diversity and inclusion on boards and in senior ranks.

The plaintiffs suggest that while existing on paper, policies were disregarded in practice and that board members’ failure to diversify, despite claims to the contrary, deceived shareholders and the stock market. 

The suits demand a variety of remedies, including current board members’ resignation before the companies’ next annual shareholder meetings to make space for black directors, among others.

 

Consequences for corporations

The plaintiffs face significant hurdles in the court proceedings, but independently of the outcome, the lawsuits require that the boards of directors appoint expensive defence counsel to file motions to dismiss which can cost $5m or more and will fall to the D&O policy. If a company’s stock drops as a result of a diversity/equal opportunities incident this can again result in a spate of claims for loss in value of shareholding. 

Depending on the momentum that the diversity issue generates, the regulators may take a more formal review of corporate behaviour in this arena over time, similar to that seen with the growing concern on the environment and the impact of climate change. In a move called “corporate therapeutics,” regulators could impose governance improvements including monetary penalties. 

Directors’ rising concern over climate change is instructive when considering the likely impact of  increased momentum on diversity issues at board level. Against the backdrop of higher social awareness and focus on climate change, the G20 established a task force on climate-related disclosures encouraging companies to make such voluntary climate related financial disclosures. The UK's Prudential Regulation Authority (PRA) issued a supervisory statement last year requiring banks to have in place updated senior management function forms, addressing clear roles and responsibilities for boards in managing financial risks from climate change, indicating a clear intent to bring this within the auspices of the senior managers’ regime. A regulator could take a similar approach with diversity and inclusion issues to move them to the top of boards’ agendas through financial penalties for non-compliance.

 

Taking public statements seriously

While motives may differ, a major driver for D&O liability claims will be shareholders and investors’ suits attempting to force the board to follow up on the public disclosures a corporation has made and the ethical template the company publically purports to follow.

Shareholders can always allege, with merit or not, to have invested in a particular company primarily because of certain public disclosures which can relate to a company’s environmental/sustainability policies or diversity/equal opportunities’ policies.  Whilst such shareholder driven cases might struggle to reach the pleading standard to be successful, they can costs millions just to be dismissed, and carry considerable nuisance factor with regard to management time and attention, and potential reputational damage. 

Such suits impact Side A-only policies, which specifically indemnify directors and officers and can become expensive if they lead to settlement costs, financial damages, fines and penalties, in addition to the legal fees. 

While litigation cannot be fully prevented, directors can reduce their liability, and even their chances of having to defend against derivative suits beyond the motion to dismiss /summary judgment stage, by closely following and enforcing governance procedures and taking reasonable precautions.

Partially driven by inflationary litigation cost, D&O insurers have been raising rates and adding exclusions to policies to curb their risk exposure and improve their financial performance. Companies can benefit from a good claims track record and evidence of clear and enforced corporate policies as it makes it easier to find appropriate and reasonably priced D&O cover at renewals. 

For further information, please contact: 
Michael Lea, Partner, Global Professional & Financial Risks
T: +44 (0)20 7933 2669 
E: michael.lea@uk.lockton.com
Or:
Alexander Traill, Partner at risk and insurance law firm, BLM LLP
T: +44 (0)20 7865 8054
E: alexander.traill@blmlaw.com
 

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