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Ed. note: As Monday is a federal holiday, we will not be publishing a blog then.

My colleague John Jenkins wrote about Board ESG risk on earlier this week:

“… some commenters have observed that the risk of potential liability for directors’ breach of their oversight responsibility is much higher than it used to be. In that regard, this Proskauer blog says that one of the lessons of recent Delaware cases is that the growing demand for board oversight on ESG issues may increase the chances of viable Caremark claims:

Recent cases finding complaints to have sufficiently pled Caremark allegations may dovetail with the ever-increasing role of ESG in corporate policy and strategy. Corporate boards may be required to oversee corporate conduct with an eye towards how the company’s financial health intersects with and relies upon its commitment to sustainability, transparency and regulatory compliance. But with these added oversight obligations may come a higher risk of liability if the Caremark standards are not met.”

In a similar vein, I ran across an insightful article from The Small Cap Institute, an organization that partners with NASDAQ “to enhance the education of small-cap executives.” The article discusses unique aspects of Director & Officer liability in a small-cap setting, saying “Seated and prospective board members commonly focus on one key risk of being a public company board member that isn’t statistically significant, and ignore two of the biggest risks they actually face.”

The overhyped risk according to the author is criminal/civil liability:

“Far less than 1/10th of 1 percent of public company board members who’ve served on corporate boards in United States history have ever been held civilly or criminally liable for their boardroom acts or omissions.”

That is an interesting data point. I’d like to learn more about the magnitude/severity of actions when they did happen, as that is a meaningful factor in addition to frequency of these events.

The article continues with risks ignored by directors and officers at small caps:

  • Reputation risk

“Small-cap companies … are often operated and governed by individuals with far less public company experience who lack the resources to garner quality outside assistance. And many small-cap businesses simply could not financially withstand a crisis.  When you add the fact that many of these companies have a shadow of the reporting, compliance, and governance infrastructures as larger public companies, small-cap board members have orders of magnitude more reputation risk than board members of larger companies.”

  • Inadequate D&O liability coverage:

“There are multitudes of small-cap directors serving on boards with D&O policies that might not be worth more than the paper they are printed on.” The article points to a lack of D&O expertise that is common when small caps select brokers and review coverage options/terms.

  • Inadequate D&O indemnifications:

“There are literally thousands of U.S. public companies that potentially lack the financial resources to actually hold indemnitees (officers and directors) harmless.”

The article states that costs for “third-party internal investigations (e.g., legal and forensic); state/federal government inquiries (e.g., subpoenas, depositions, document production, etc.); and, a blizzard of plaintiff’s lawsuits” related to claims agains board members/officers can “easily” exceed $10 million.

What This Means

John’s point is that with ESG being the shiny new object, the risk picture for Boards today is different from what it has been in the past. ESG matters directly impact supply chain disruption, consumer activism, investor actions/activism, media coverage, investment quality ratings/rankings and regulatory actions. That is a lot of risk and small cap companies typically lack the suite of resources – including Board expertise and oversight – for E&S governance that large caps have.

ESG competency on all Boards has become a big issue and it would be wrong for small-cap directors to believe ESG doesn’t apply to them just because the company is small. In reality, E&S governance risk may not be that much different between small, medium and large companies. Small cap directors should:

  • Become aware of the kinds of E&S risks that the company faces and why they are important to the company
  • Gain familiarity with ESG priorities of shareholders, especially issues where they may take activist positions
  • Understand how those risks are managed operationally and financially
  • Understand the board oversight role and their duties as directors when risks materialize into red flags
  • Understand the E&S governance structure at the operating and management levels
  • Engage professional advisors to ensure ESG risks are adequately addressed in D&O coverage terms, conditions and indemnifications.
  • Establish board processes on periodic assessment of ESG-related risks, adding a feedback loop to modify D&O coverage if needed.
  • Determine what specific needs there are for the Board to perform its ESG oversight role effectively, including looking internally for continuing director education

In the end, even small-cap boards can get bitten by big ESG risks.

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The Editor

Lawrence Heim has been practicing in the field of ESG management for almost 40 years. He began his career as a legal assistant in the Environmental Practice of Vinson & Elkins working for a partner who is nationally recognized and an adjunct professor of environmental law at the University of Texas Law School. He moved into technical environmental consulting with ENSR Consulting & Engineering at the height of environmental regulatory development, working across a range of disciplines. He was one… View Profile