Corporate governance scandals, like Enron and WorldCom, have made boardrooms jittery. In fact, these types of scandals have frightened off otherwise qualified board members from serving on boards of publicly held corporations. To further inflame this situation, many insurers are either not issuing new Director’s and Officer’s (D&O) coverage or are severely limiting the coverage on new policies that they write. What’s a board member, or a prospective board member, to do?
The State of Corporate Governance
Before I discuss the new trends in D&O coverage and the things you must watch to insure your personal protection as a board member, I must comment on the somewhat sad state of affairs in corporate governance.
Since the enactment of the Sarbanes-Oxley Act (SOX), many qualified individuals have turned away from actively participating in corporate governance because they are too concerned about the potential liabilities of serving on a board. In fact, some attorneys are advising their clients to keep away from board service altogether because of these risks.
Recently, I was asked to serve on a board of a publicly held company. I mentioned this to my attorney and he was rather negative about it. We checked the D&O policy that would cover my board service and decided that it was adequate to protect my family and me from untoward lawsuits.
The point is that many people would have quickly turned down such an offer. The U.S. economy greatly needs good people to serve on the boards of its companies. If too many prospective board members refuse to participate in corporate governance, then companies seeking board members will inevitably go to either less qualified or less moral individuals. This will certainly be a blow to the underpinnings of corporate governance.
The pitfalls in specific D&O policies vary. The first thing I must caution you to do is consult with both an insurance broker and counsel experienced with D&O coverage. Have them closely review the policy and ask them to be sure that it contains adequate and state-of-the-art coverage.
Some key D&O issues include:
- Shared limits. This is also called “entity coverage.” Put simply, it means that the company insurance policy names both the directors and the corporation as insureds. This can become a problem when a lawsuit arises and both the directors and the corporation are named in it. One option is to have different limits for the corporation and the directors/officers. I personally don’t care for this option. Your best alternative is to have completely separate policies for individuals with limits that can not be affected by claims against the corporation.
- Insured vs. insured exclusion. Ask your counsel if the D&O policy covers you if the corporation itself files a suit against the directors. Alternatively, ask if you are covered if the company files for bankruptcy and the trustee in bankruptcy files a claim against the directors.
- Excess executive liability insurance. You should make it a requirement that the corporation obtains non-rescindable excess coverage. This is like an umbrella policy in that it covers the situation when the underlying policy is rescinded, commuted, has its limits exhausted, or otherwise doesn’t protect you.
- Other issues and exclusions. Your D&O policy might deny coverage for criminal acts, punitive damages, and claims brought by a state or federal regulatory body, or for a variety of other reasons. My only advice here is that you should turn to a competent and experienced insurance broker and your attorney for specific guidance.
Board Service Is Important
When all is said and done, after you have assured yourself that the company has adequate D&O insurance, good board service is critical to the functioning of our national economy. SOX shouldn’t unduly frighten us.
Previously, I have given some guidance on board service: Serving on a Board After SOX: Opportunities and Perils, and Choosing Your Board of Directors. These articles give additional guidance to a prospective or current board member.
Board service can and should be honorable. We shouldn’t be unduly afraid of participating on a board because of potential liability. Check the company’s D&O policy, and if your advisors approve, go for it. Good luck!
Theodore F. di Stefano is a founder and managing partner at Capital Source Partners, which deals in bringing small-cap companies public. He also is a frequent speaker on the subject of financial advice for small businesses as well as the IPO process. He can be contacted at [email protected].