Directors and officers of publicly held companies are increasingly concerned with environmental, social and governance (ESG) issues, as these are becoming a large part of their jobs in recent years. While the main focus of every company’s leadership is profitability and delivering value to the shareholders, directors and officers are now realizing that ESG is fast catching up.
While ESG has been around for many years now, its importance is now at an all-time high. According to a recent white paper released by Zurich North America and RIMS, today’s businesses are expected to balance their emphasis on profit with “important and worthy non-financial considerations” that impact the environment and its people. Put more simply, businesses are under increasing pressure to be good corporate citizens.
“Among the driving trends challenging public boards this year (and beyond) are more assertive, demanding investors; higher standards for attention to climate change and sustainability; and a new urgency regarding diversity, equity and inclusion (DEI) within workforces and executive boards,” said paper author Steven Boughal, chief underwriting officer, US financial lines at Zurich North America. “This has been reflected in the 2021 proxy year: social and environmental proposals increased to 37% and 13%, respectively, from 2020, while governance proposals held steady at 37%. In addition, the always-evolving umbrella of general governance today includes such hot-button topics as cybersecurity and data privacy, which have also been a focal point for both investors and governmental bodies, including sweeping new regulations and enforcement mechanisms.”
What comprises ESG?
Each ESG category includes universal topics such as sustainability and diversity, as well as topics that are industry-specific or company-specific, Boughal said.
Environmental criteria evaluate a company’s role as a steward of natural resources. This includes its energy use, waste management, contribution towards pollution, impact on biodiversity, and raw material sourcing. With science revealing that the climate crisis is worse than previously believed, stakeholder pressure for companies to adhere to environmental standards is rising. More businesses are now releasing sustainability reports, with 92% of S&P 500 companies doing so in 2020.
Social criteria assess the company’s internal and external relationships, with diversity, equity and inclusion (DEI) principles as the most common. These include, but aren’t limited to, racial and gender equality in the workplace, employee safety and engagement, and support for human rights and social justice issues.
According to Zurich, the governance in ESG is somewhat of a catch-all category. These are typically understood to involve the organization’s leadership, executive pay, audits, internal controls and shareholder rights. Other important components are cybersecurity, product safety, accident prevention, and regulatory compliance.
“Certain hot-button topics within each of the ESG categories demand the attention of directors and officers and directors and officers (D&O) insurance providers because they represent perils that may increase the frequency or severity of existing D&O claim exposures — namely, securities class actions, shareholder derivative actions and regulatory matters,” Boughal said.
According to the paper, there are two main ways in which ESG is involved in a D&O lawsuit. The first is through event-driven litigation following an ESG-related event, while the second is through disclosure-related litigation concerning an ESG topic.
Event-driven litigation usually involves a report in the media that purportedly reveals adverse facts or allegations about a company’s business practices or products. According to Zurich, these types of cases are growing in prominence, leading to heavy litigation and settlement costs. On the other hand, disclosure-related litigation occurs when a business runs afoul of securities laws that require public companies to “regularly provide reliable, timely and accessible information about significant corporate matters.”
“All public companies are operating within an evolving ESG landscape,” Boughal said. “Challenges will undoubtedly arise as directors and officers identify, develop and strive to meet their respective ESG goals, and positively respond to a changing societal mindset.
“The litigation trend demonstrates that ESG decisions and disclosures will be challenged in court and that law firms representing shareholders will seek to compel substantial concessions, reforms and monetary commitments. These and future ESG lawsuits could potentially put the personal assets of a company’s directors and officers at risk. In addition to monetary compensation from the targeted corporations, recent lawsuits have sought to replace board members, recover their compensation and revise incentive plans.”