How D&O Coverage Fits into Diversity Claim Mitigation
If you've continued to follow post-election political news, you've likely noticed that President Joe Biden has ushered in the most diverse Cabinet in our nation's history.
The recently elected president has frequently noted that he wants his Cabinet to represent the American demographic. In large part, he's made good on that promise, with nearly half of his Cabinet members identifying as persons of color. Fifty percent of Biden's Cabinet additionally identifies as female, and he further succeeded in appointing the first openly gay Cabinet member, Secretary of Transportation Pete Buttigieg.
This shift in the political approach to diversity mirrors the change occurring in the private sector as well. While executive teams plan, implement and oversee new diversity initiatives, D&O insurance is paramount in protecting companies against potential liabilities that may arise during this transitional period.
Heated debates on discrimination and racism in America have led to increasingly conscious consumerism. Many companies implemented diversity and inclusion programs, promising buyers and investors alike that diversity was an issue that they aimed to address proactively. These efforts promised to rise to the occasion of the demands of buyers and shareholders.
Where companies haven't lived up to expectations, however, those in charge find they're vulnerable to added liability. Ultimately, these directors, officers and other C-level executives are increasingly faulted for falling short in their diversity initiatives.
The Rise of Shareholder Diversity Lawsuits
In seeking to hold companies to their promised diversity commitments, shareholders concerned with internal and external responses to equality demands have initiated unique lawsuits under federal securities law. These rather creative and new kinds of diversity lawsuits create costly areas of potential liability.
The primary allegation leveraged in these new legal actions hinges on Section 14(a) of the Securities Exchange Act. Essentially, shareholders claim that executives breached fiduciary duties by failing to adequately diversify at the board and executive levels despite promises to do so in their company proxy statements.
Notably, Section 14(a) of the Exchange Act prohibits material misrepresentations or omissions in proxy statements sent to company shareholders. Thus, shareholder derivative lawsuits claim that while companies have touted their inclusivity in proxy statements, they've not substantively addressed diversity internally. Ultimately, claimants state that board members and C-suite executives continue to lack diversity.
One such diversity lawsuit brought against Cisco Systems Inc. in the U.S. District Court for the Northern District of California in September 2020, levied claims that Cisco's board breached fiduciary duties because there were no African American board members.[1]
Another suit aimed at Micron Technology Inc., which was filed on Feb. 9 in the U.S. District Court for the District of Delaware, argued that, even though the company's CEO was a person of color, Micron had still breached its fiduciary duty because the CEO was the only racially diverse senior executive.[2] Further, the diversity suit alleged that executive compensation didn't comport with the relative diversity achievements at Micron.
On March 19, the U.S. District Court for the Northern District of California granted Facebook Inc.'s motion to dismiss the diversity lawsuit that was filed in July 2020.[3]
Notably, Magistrate Judge Laurel Beeler dismissed the lawsuits with leave to amend, in part, on the basis that the plaintiff failed to make a pre-suit demand or allege that such a demand would have been futile; failed to identify false or misleading statements that were not aspirational; and failed to allege loss to the corporation even if the diversity, equity and inclusion statements were materially false.
This ruling certainly raises the bar with respect to the lack of diversity allegations made against corporations; but the costs of defending and investigating such claims remain a serious risk that should not be ignored.
Reverse Discrimination Suits
The diversity lawsuits described above represent just one side of the coin. On the other side, we've seen increased potential liability issues relating to claims of reverse discrimination. Recently, the U.S. Department of Labor stoked the fires of those who've long felt affirmative action impinged on the rights of white individuals.
In making an inquiry to Microsoft Corp. last fall, the DOL asked the company to explain how it could meet its affirmative action commitments without discriminating against nonminorities. Notably, the DOL now operates under a different presidential administration, and while there is no shortage of dissenters to this reverse racism question, the issue remains that companies accused of reverse racism must still mount a costly legal defense when accused.
When parties bring suit against a company for reverse racism, they often employ Title VII of the Civil Rights Act, which bars employers from preferential hiring based on sex or race. The result is that companies must walk a fine line in executing their diversity initiatives, and class action attorneys consistently target this fine line.
In recent years, states have enacted their own legislation that mandates diversity on executive boards.
California, for example, requires all public companies headquartered in the state to meet benchmark numbers for women and underrepresented minorities in leadership positions by the end of 2021. Failure to do so can result in hefty fines.
In another example of state-mandated diversity awareness, companies headquartered in the state of New York must report the number of women on their boards under the Women on Corporate Boards Study Act, effective as of June 2020.
These changes in law and policy don't so much serve to clarify the parameters by which companies should be hiring so much as they give rise to new litigation. Even Nasdaq, a historically male-dominated group, filed a proposal with the U.S. Securities and Exchange Commission in 2020 to adopt rules requiring most exchange-listed companies to elect at least one female director and one director who identifies as LGBTQ+ or is otherwise from an underrepresented minority group.
As such, corporate counsel face uncharted territory in their attempts to quell employee discrimination complaints or shareholder concerns about the sufficiency of diversity initiatives. It should come as no surprise to learn that class action lawyers are locked and loaded with the ammo provided by new legislation and shifting political priorities.
The Hard Market of D&O Insurance Coverage
As a result of this new legal terrain, tantamount to a minefield, directors and officers, or D&O, insurance carriers have become increasingly concerned. The cost of diversity lawsuits rooted in either side of the racism/reverse-racism coin can be exorbitant. Plaintiffs and their legal teams will contest executive compensation and require restitution of sorts to be paid, including but not limited to stock gains and bonuses.
These costs are, of course, in addition to attorney fees and other ancillary expenses. In some cases, executives are asked to step down from their roles altogether, and demands are made for the company to institute diversity training programs and other significant policy changes. Even when shareholder derivative claims fall short of proving the accusations, there are unpredictable collateral consequences associated with the defense.
To offset losses, D&O insurers have resorted to modified practices before supplying coverage to their clients due to the influx of diversity lawsuits.
Before issuing coverage or providing policy quotes, it's becoming common for D&O providers to meet with executive leadership to understand how their board succession practices might play into diversity initiatives. If D&O coverage is ultimately offered, clients can expect to see an increase in policy prices resulting from the flood of diversity lawsuits.
Due to the wave of diversity litigation from plaintiffs claiming a company is falling short of minority inclusion and plaintiffs asserting reverse racism, the D&O insurance market is hard. A "hard market" means premiums are rising, and insurers are less inclined to negotiate terms of their offered policies.
Historically, D&O insurers were already reluctant to negotiate terms, and now there is even less room for discussion. The effects of the hard market mean that executives may be in for a shock when it comes time to renew their D&O insurance coverage, finding that their premiums have increased while capacity has been reduced.
Policy Recommendations and Best Practices
There are ways both private and public companies can prepare for the shift in the D&O coverage market. It helps to be proactive and institute inclusive hiring and succession policies if companies haven't already done so.
Importantly, it's not enough to have the policies in place — companies must also practice these policies. To avoid becoming the target of diversity litigation, companies should emphasize hiring, training and recruiting talent from many backgrounds. Importantly, managers and directors need to keep in mind best practices under Title VII to avoid liability and costs associated with defending against reverse discrimination claims.
In addition to applying inclusive recruiting and training practices, companies should consider bolstering their traditional Side A, B and C coverage to avoid claims disputes from their insurance providers. Each side plays a specific role in protecting a business from litigation, and it's important to understand how Side A, B and C will apply when accusations are made against your company.
Accordingly, it's paramount that policyholders thoroughly review their policies to ensure coverage for diversity lawsuits is provided. In some instances, coverage is limited to traditional discrimination allegations. A proactive review of your policy is the best early defense.
It's also worth discussing Side D coverage as it protects against costs resulting from internal investigations related to shareholder derivative claims. The standard drop-down coverage of $250,000 is more often than not insufficient in covering these investigations, which delve into whether or not a director acted in good faith when violations of the law or corporate policies are asserted.
These investigations require an in-depth review of employee records and candidate applications over extended time frames.
For example, as a result of sweeping allegations in a diversity lawsuit filed in September 2020, in the U.S. District Court for the Central District of California,[4] Monster Beverage Corp. needed to investigate its entire workforce to determine why it hadn't become more inclusive while experiencing growth. Given the targeted allegations concerning the CEO of Monster Beverage, the investigation likely included reviewing the ancestral records of the billionaire CEO Rodney Sacks, a white man raised during apartheid in South Africa.
Ultimately, companies are best served by not only touting inclusive policies but also practicing them. Diverse executive teams are repeatedly shown to perform better than their less diverse counterparts. When companies practice what they preach, they often find better overall performance while mitigating their vulnerability to the new wave of diversity lawsuits.
While internal policy change is ideal, companies should ensure they are effectively covered in the meantime. D&O insurance is paramount in protecting a company while the executive teams oversee diversity initiatives that will shore up potential liabilities in the long term.
“How D&O Coverage Fits into Diversity Claim Mitigation,” by Natasha Romagnoli and Hannah K. Ahn was published in Law360 on May 10, 2021.
[1] Complaint, City of Pontiac General Employees' Retirement Systems v. Bush et al., Case No. 5:20-cv-06651 (N.D. Cal. Sept. 23, 2020), ECF No. 1.
[2] Complaint, Foote v. Mahrotra et al., Case No. 1:21-cv-00169-UNA (D. Del. Feb. 9, 2021), ECF No. 1.
[3] Ocegueda v. Zuckerberg et al., No. 20-cv-4444, 2021 WL 1056611 (N.D. Cal. Mar. 19, 2021).
[4] Complaint, Falat v. Sacks et al., Case No. 8:20-cv-01782 (C.D. Cal. Sept. 18, 2020), ECF No. 1.