As a CFO of a small-cap public company, protecting your organization from the myriad of risks that come with being publicly traded is likely high on your priority list. One of the most significant risks comes from shareholder lawsuits, regulatory investigations, and other claims against your company’s leadership. Directors and officers (D&O) liability insurance is designed to shield your executives and your company from the financial burden of defending these types of claims. Yet, many CFOs, particularly those at small-cap companies, make costly mistakes when shopping for D&O insurance. These mistakes can leave the company vulnerable when it matters most.
Navigating the world of D&O insurance can feel complex, but avoiding these common errors can save your company from financial disaster. Let’s take a look at three mistakes CFOs often make—and how you can avoid them.
Mistake #1: Focusing on Price Over Coverage Quality
We all know that CFOs are number-crunchers. Cost management is a huge part of the job, especially in small-cap companies where budgets are tight. It’s easy to look at D&O insurance and think, “Let’s find the cheapest option that meets our basic needs.” But what is “basic” coverage? When you’re dealing with D&O insurance, the fine print matters more than the price tag.
Stat to consider: According to a 2022 Willis Towers Watson report, 60% of D&O claims for small-cap companies involve shareholder class actions, and the average settlement for these claims is around $13 million. If your policy doesn’t cover USA class-action lawsuits (common for policies written in Asian), you have Ds or Os operating in a dual capacity at multiple companies without a Dual Capacity endorsement, you find yourself with bad allocation wording or a Uncooperative Insured exclusion, then you will quickly experience how a cheaper policy could lead to major financial exposure.
It’s tempting to look at a policy with a lower premium, but often, these low-cost policies come with restrictive exclusions, lower sub-limits for defense costs, unreasonable Hammer Clause terms, or even co-insurance requirements, where the company ends up paying millions out-of-pocket for the loss. A key component of D&O insurance is paying for legal defense costs, which can quickly spiral into the millions. Many cheaper policies will restrict these payments, leading to higher out-of-pocket expenses in the event of a claim.
How to avoid it: Instead of focusing on price alone, review policies with an experienced D&O broker like Churchwell Insurance Agency to understand the exclusions and limitations of each option. Ask questions like, “What’s covered in a shareholder lawsuit?” or “Does the fraud exclusion give consideration to intent when deciding whether to cover or exclude?” Understanding these nuances can make all the difference when a claim is filed. Quality coverage is an investment in your company’s future stability.
Mistake #2: Assuming One Size Fits All
Another common mistake is assuming that all D&O policies are the same, or that what worked for a larger company will work for your small-cap business. Small-cap public companies are unique and face different risks than their larger counterparts. For instance, smaller companies tend to have less predictable cash flow and rely heavily on a handful of key executives. This makes them more vulnerable to financial instability or lawsuits tied to leadership decisions.
Stat to consider: According to Cornerstone Research, small-cap companies are twice as likely to face securities class action lawsuits compared to large-cap firms. The vulnerability of these smaller firms makes customized D&O coverage essential.
Many CFOs think that any D&O policy is good enough and might even copy the insurance strategy of a larger firm in their industry. But this approach overlooks the specific exposures small-cap companies face. Publicly traded companies of this size tend to have concentrated shareholder bases, making them more prone to disputes with investors or activist shareholders. On top of that, regulatory scrutiny can be more intense, especially for businesses growing rapidly or transitioning through critical phases such as mergers, acquisitions, or stock offerings.
How to avoid it: Work with a broker who understands the unique needs of small-cap companies. Ask them to tailor your D&O insurance program to your company’s specific risk profile. You may need higher limits for securities claims, broader coverage for regulatory investigations, or even specific enhancements for key executives. A customized policy ensures your business is protected from the unique risks it faces.
Mistake #3: Overlooking the Importance of EPL Coverage
CFOs often look at D&O insurance and think they’re fully covered for any claims involving the company’s leadership. But one area many overlook is the importance of supplementing D&O with Employment Practices Liability (EPL) coverage. D&O insurance typically doesn’t cover employment-related claims such as wrongful termination, discrimination, or harassment unless EPL coverage is included or added as an endorsement.
Stat to consider: A study from the Equal Employment Opportunity Commission (EEOC) found that employment-related claims against small companies have risen by 12% in the past five years. Not having EPL coverage in place could expose your company to significant risk.
Employment-related claims can often be intertwined with D&O claims. For example, an executive accused of wrongful termination may also face claims of breach of fiduciary duty if the plaintiff is a former high-ranking employee. Without adequate EPL coverage, your company could be left covering legal costs and settlements out of pocket. In small-cap companies, where resources are more limited, a single claim can be financially devastating.
How to avoid it: When shopping for D&O insurance, ensure you discuss EPL coverage with your broker. Some policies will include it, others will require an endorsement. However, when discussing with your broker discuss if it makes sense to endorse EPL to your D&O or to have a stand alone policy that allows for the protection of D&O limits to not be exhausted by the actions non-Ds & Os within the company. Make sure you understand how your coverage works in employment-related scenarios. Comprehensive D&O insurance should cover not just external threats from shareholders but also internal risks related to the company’s workforce.
A Final Thought
CFOs of small-cap public companies are faced with a challenging balancing act. On one hand, you have the responsibility to protect your company’s financial future; on the other, you must manage costs effectively in a resource-constrained environment. But when it comes to D&O insurance, cutting corners is a risk you can’t afford to take. Talk to the Executive Liability Team at Churchwell Insurance Agency to see if it makes sense for our team to pay for your organization to have a top D&O coverage attorney audit your existing D&O program today to ensure you have best-in-class terms today.
Recap of Common Mistakes:
1. Focusing on price over coverage quality: Look beyond the premium; make sure your policy covers key exposures such as defense costs and shareholder lawsuits.
2. Assuming one size fits all: Your company has unique risks that require customized coverage. Don’t copy larger companies’ strategies.
3. Overlooking EPL coverage: Don’t forget to add Employment Practices Liability to cover internal employment-related claims.
D&O insurance is more than just a regulatory necessity—it’s a critical component of your company’s risk management strategy. By avoiding these three mistakes, you can secure better protection for your executives and your company, ensuring long-term stability and confidence in the face of potential litigation.
As CFO, you’re the guardian of your company’s financial health. Making the right choice in D&O insurance is just as important as managing cash flow or controlling expenses. It’s a decision that could one day save your company millions, but you do not have to make it alone. Call our advisors today 844.604.1357.
