Let’s honor your time here, and dive into the evolving environmental, social, and governance (ESG) trends, and their impact on Directors & Officers liability insurance (D&O) for MicroCap companies.
Purpose of my post is threefold:
1. Emphasize the increased risk that ESG brings to companies.
2. Show how ESG risk impacts D&O.
3. Give companies tools to reduce/transfer risk.
ESG initiatives at their core are rooted in the hope that we can all be better, but good intentions do not mean the ESG movement is without challenges. Recent ESG trends have been:
· Politically polarizing.
· Subject to conflicting definitions.
· Add an additional layer of risk and responsibility for public companies.
Up to this point, leadership at most MicroCap companies have been lackadaisical or even dismissive regarding ESG. Here is a hard truth: The ability to operate in such ways is fast coming to an end. Companies need to comprehend ESG trends, their potential implications, and begin to take action.
D&O Underwriters – Why would they care about ESG?
The surge in ESG litigation, regulatory fines, EU reporting rules, NASDAQ requirements, SEC shifts, and investor preferences has created a landscape where directors and officers face unprecedented challenges. Allegations of reverse discrimination, inaccurate carbon calculations, and unimplemented high-level policy decisions can result in significant financial consequences.
A recent poll at the Professional Liability Underwriting Society – D&O Symposium identified ESG as the primary concern among public D&O underwriters. The ambiguity in defining ESG, conflicting regulatory requirements, and the growing anti-ESG litigation backlash are unsettling, often translating into increased insurance premiums.
Recent Anti-ESG Backlash Litigation Examples:
ESG policy is being tested in the courts. Here are some 2023 examples of how the court is being used to combat ESG initiatives commonly called anti-ESG litigation:
Environmental
Delta Airlines leadership suffered a class action lawsuit for their questionable claims of carbon neutrality.
Social
Ben & Jerry’s took a socially sensitive, political stand to not sell ice cream in Israel citing illegal occupation, triggering shareholder litigation.
Governance
Target’s leadership landed in shareholder litigation due to recent LGBTQ+ position, resulting in the company’s largest historical stock price decline.
ESG Defined Generally and by Regulators
ESG itself lacks a universally agreed-upon definition, creating interpretation variations and challenges. Misleading statements and false ESG reporting, known as greenwashing, further complicate matters.
For more on greenwashing including content for public MicroCap companies, check out What is Greenwashing? The Importance of Maintaining Perspective in ESG Communications by Pamela Styles.
EU Reporting
The European Union has led the charge in offering a clear target with one problem; the target keeps moving. ESG is fluid, and the EU has recognized this. Their philosophy seems to be, “let’s get something out there, test it in the market, and adjust as necessary.” When regulation is changing rapidly it creates additional risk exposure that could trigger litigation or regulatory probes; further underscoring the importance of clear and compliant reporting by a strong IR firm and ESG reporting team.
The good news for US MicroCaps operating in the EU is that you have time to get things in order according to Jeff Christensen, Managing Director at Darrow IR. He shared that “Darrow is monitoring what is happening globally with ESG, and knows that it will become increasingly important over the next two years.” He further noted that EU-headquartered companies categorized as small and midsize enterprises (SMEs) need not submit their financial reports until January 1, 2026. Global corporations outside the EU start reporting by 2028.
SEC Regulations
For US-based MicroCaps not operating in the EU, attention is likely on the SEC. Reporting requirements planned for 2023 are now out in 2024, and far more mild than early indications led us to believe. Some attribute this delay to recent anti-ESG court rulings, prompting a reevaluation of the regulator’s agenda. For those already reporting, the SEC established an ESG Task Force to begin holding companies accountable. Keep in mind, the SECs FY 2022 was record breaking for SEC fines. They have their foot on the gas and new rules should be seen as new opportunity for even more fines.
Voices like NYU professor Aswath Damodaran predict ESG is Beyond Redemption, believing dollars will steer away from ESG-supported companies. Despite potential financial impacts, this author anticipates the SEC rules in place by summer 2024. The current presidential administration will push the SEC’s ESG agenda ahead of the upcoming election cycle, unaffected by purely capitalistic considerations mentioned by Damodaran.
NASDAQ Board Requirements
How is this possible when in liberal California such a standard was struck down? It comes down to Private v. Public. A private company like Nasdaq can make this requirement, but a government cannot. This issue has the potential to make it to the Supreme Court, so we will see if SCOTUS decides to hear on this issue down the road.
An October article by Justia Legal News discusses the Fifth Circuit Court of Appeals upholding a decision requiring Nasdaq-listed companies to have minority and female directors or disclose reasons for non-compliance. The article states, “More specifically, the rule requires companies listed on the exchange to disclose certain voluntary self-identified information about a company’s board of directors related to their gender, racial characteristics, and LGBTQ+ status. If a listed company does not have at least one director who self-identifies as female and one who self-identifies as an underrepresented minority or LGBTQ+, it generally must explain why it does not.” For NASDAQ-listed corporations, this case is crucial. I reached out to NASDAQ to test the waters. I specifically asked them if a Caucasian jewish male could fit their guidelines as an underrepresented minority.
Bottom line: You are going to need help to get this right! If not in compliance, companies will require assistance navigating regulations. Mark Stoller at Eventus Advisory Group was spot on when sharing, “While (SEC) standards are not yet complete, companies still need to take the initiative to identify their ESG gaps, remediate those gaps and report on their progress to all of their existing stakeholders.”
ESG Risk Management Tools:
The MicroCap sector is expected to face increasing pressure to align with ESG standards in 2024 due to legal precedents, the push for ESG fund investments, and impending SEC regulations. Regardless of our personal or political opinions, ESG is imminent, company leadership must address it. Events in 2023 like Delta facing criticism for inaccurate carbon calculations and a landmark Supreme Court decision involving Harvard and UNC Chapel Hill, reversing affirmative action, have brought ESG loss controls into D&O conversations. So what can your company take positively impact D&O pricing and reduce risk?
Transparent Reporting
Joe Holman, ESG Practice Leader at Withum, recently wrote “Practical Steps for Developing an ESG Strategy”, stressing the significance of ESG today stating, “Internal controls are not confined to just accounting and financial reporting. ESG information is becoming equally important and requires an equally robust control structure.” Holman’s position on ESG reporting needs more attention. Be it litigation or regulatory fines, the era of sloppy reporting or neglecting to report on ESG at all is coming to an end. MicroCap D&O is starting to price for ESG variables. Further stressing the value of an insurance agent who understands the complexity of ESG for a public MicroCap to secure the most favorable D&O terms.
Consider Greenhushing
“Greenhushing” – the practice of lowering the volume, to evade the unwelcome scrutiny of conservative politicians and activists, and due to a growing perception that regulatory authorities and various stakeholders are intensifying their focus on companies’ ESG-related assertions. Your board must discuss and decide how loudly or quietly the company’s voice needs to be on ESG topics and should present a unified front.
The Wall Street Journal’s summer article, Companies Scale Back Communication on Diversity and Sustainability Amidst Culture War Backlash, revealed a corporate shift from outspoken ESG initiatives to a more reserved stance due to increasing anti-ESG backlash. Business concerns about broadcasting ESG efforts are well-founded, not only to avoid PR challenges but also to steer clear of legal disputes related to anti-ESG sentiments.
Good Governance Practices
Holman stresses the importance of good governance stating, “The importance of a solid corporate structure cannot be understated. Senior management must control messaging, establish policy, and identify ESG factors driving corporate value. The value of a company can be negatively affected when ESG messaging goes amuck, ESG risks are ignored, or opportunities are wasted.” Directors and Officers of public MicroCap companies must proactively work to understand ESG risks specific to their business as a loss control measure against scrutiny by regulators, shareholders, and insurers.
Practical Risk Management Steps:
1. Develop a concise ESG strategy by identifying and integrating key risks and opportunities into strategic planning. We all know that when we fail to plan we plan to fail, right?
2. Implement the strategy before marketing it to avoid the pitfall of Deutsche Bank. They told the world about their new “DWS ESG Engine” strategy, yet received $25M in fines from the SEC for failing to implement what they put on paper.
3. Establish robust ESG governance with clear roles and accountability for ESG management. The devil is in the details.
4. Transparently communicate ESG performance regularly to demonstrate commitment to stakeholders. Trust a professional to help you get this right.
5. Discuss Greenhushing. Disney is still suffering because of the stand they took. What mountain is your leadership willing to die on.
