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Three critical risk areas for boards to consider in 2023

There are no shortage of perils for company boards to navigate in 2023; record inflation, high interest rates, labor shortages, and more.

As risk abound, boards should focus on three main challenges

There are no shortage of perils for company boards to navigate in 2023. Record inflation, high interest rates, labor shortages, and supply chain constraints are a few of the many headwinds boards must confront to keep their companies positioned for success. In addition, event-driven litigation remains a significant concern for companies that experience large-scale loss events involving products or services, and class-action litigation — based on employment-related matters, consumer harm, and cybersecurity — often results in follow-on shareholder litigation.

As highlighted in the World Economic Forum’s Global Risks Report 2023, companies also face a historically complex and challenging macroeconomic and geopolitical environment. In order to respond effectively to evolving and emerging challenges, organizations need to build on and improve their resilience strategies.

As boards strengthen and expand their companies’ resilience, conveying their efforts to underwriters can help improve directors and officers (D&O) liability insurance pricing and coverage terms. A broad and cutting edge D&O program is a critical way to transfer risk off of companies’ balance sheets. Some prominent risk areas on the minds of board members in 2023 are outlined below, along with strategies to address underwriter concerns and best position their businesses at insurance renewals.

Macroeconomic threats can cause shareholder litigation

A strained labor market and supply chain constrictions amplified macroeconomic concerns for companies in 2022. The conflict in Ukraine, in particular, had a ripple effect across industries, and contributed to global trade and supply chain challenges. These issues can delay manufacturing, product and service delivery, and more.

Shareholder claims and regulatory enforcement actions typically center on a company specific challenge. However, risks that affect virtually all companies — such as supply chain issues — may also lead to lawsuits. For example, an electronics company experienced a sharp stock price decline and securities fraud class action when it revealed supply chain and labor shortage problems resulting from facilities in China temporarily closing due to COVID-19. The company was certainly not alone in experiencing these issues and had outlined these very risks in its filings with the US Securities and Exchange Commission (SEC).

In other cases, two clothing companies have been sued by investors for allegedly being overly optimistic in pre-IPO filings about their ability to confront supply chain and shipping issues. Both companies did, however, include detail about specific supply chain challenges in their IPO registration documents. And, again, these companies were only a small fraction of impacted retailers.

To best protect against similar claims, boards and executive teams should create an extensive record of communication on the inevitable challenges they confront. It is critical for boards and executives to consult with outside disclosure counsel on all messaging, even where a particular risk factor is experienced across industries or the broader economy.

Insurers are increasingly focused on how boards and management teams stay educated on mission critical risks. Risk mitigation efforts should be shared with D&O underwriters during renewals. Company details on these matters — such as the formation of committees, frequency of meetings, outside consultation, and the chain of information sharing among the legal department, business units and the management team — often face as much, or more, scrutiny by underwriters as financial metrics.

Ability to confront heightened regulatory environment

The SEC has been especially active over the last few years. For example, the ESG Task Force, set up by Chairman Gary Gensler at the beginning of his tenure, has already brought enforcement actions. As part of a stated focus on investor protection, the SEC has also proposed comprehensive new disclosure rules on cybersecurity and climate matters and has updated rules on insider trading and Dodd-Frank compensation reimbursement. The Department of Justice (DOJ) has also revised its enforcement guidelines to focus more on personal accountability.

Proposed regulatory rules often generate skepticism and backlash from the private sector. The SEC’s rules are comprehensive and have drawn pointed, and even strident, criticism.

It is however critical that insureds do not share negative or dismissive commentary about proposed regulatory action with underwriters. Instead, board members and executives should demonstrate to both investors and underwriters that they have positioned their organizations to fully comply with the final adoption of all aspects of proposed rules — no matter how onerous or unpopular — and that they take all of these matters seriously. This may include internal tabletop exercises, the formation of working groups or subcommittees, or hiring personnel with subject matter relevant expertise. A forward-looking attitude conveys maturity and responsibility. Projecting such an approach is particularly important for newer public companies that do not have a lengthy track record confronting regulatory changes.

Communicating the “tone at the top”

Company culture remains crucially important to investors and insurance underwriters. It is common for companies facing class-action litigation relating to harassment, discrimination, privacy issues, or other forms of misconduct to be accused of enabling a broader, problematic work atmosphere.

Cyber, privacy, and product safety are among the several risk areas where boards have faced an uptick in shareholder litigation in recent years. The crux of these types of lawsuits is the allegation that boards failed to monitor so-called mission critical risks.

Additionally, boards of companies facing a range of catastrophes have been accused of ignoring red flags, even in cases where they had a system to monitor serious exposures. While some of these lawsuits have had mixed results, others have led to large settlements. This means boards must set a clear tone of open communication, conscientiousness, and collaboration to confront both internal and external risks.

Finally, a leadership posture is not solely the responsibility of the chairman of the board. The SEC’s new universal proxy rules will likely cause each individual board member’s contributions — or lack thereof — to come into focus during board elections. This is because the rules permit shareholders to “mix and match” their votes between the slate of directors nominated by the company, and those individuals backed by dissident or activist shareholders. If a particular board member is not conveying the appropriate leadership tone, they are more likely than ever before to lose their seat.  

Board members have multifaceted obligations. They must work to maximize their organizations’ potential, but also approach risks thoughtfully and conservatively. When board members signal a culture of vigilance on all range of risks, there is an increased likelihood that the insurance underwriting and investment community will respond favorably.

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