Directors and Officers: The Value of D&O Questionnaires and Insurance
Directors and officers insurance (D&O) has an interesting history. In the late 19th century, Lloyd’s of London, a conglomerate of insurance syndicates, developed the current model of D&O liability. But for many years, D&O maintained its popularity primarily within the United States. Around the 1980s, however, the benefits of D&O insurance spread across the ocean and it became popular in all parts of the world.
As part of the insurance application process, most insurers require that companies fill out a directors and officers questionnaire with some basic information about themselves. The goal of the D&O questionnaire is to improve corporate governance and keep it transparent.
Directors and Officers Questionnaires
Typically, companies distribute D&O questionnaires to their directors and officers just before the annual proxy season. Directors and officers need to answer questions about their background and experience, securities they own, independence of the board, insider transactions and compensation. The questionnaire highlights any potential conflicts of interest and insider dealings. It also reveals board members’ and key employees’ family and business relationships with each other and the reporting organization.
Companies need this information so they and their attorneys can confirm that they have accurately disclosed information in their registration statements, Form 10-K reports and proxy statements.
Most questionnaires include a glossary of defined terms to be sure the directors and officers understand the questions because the SEC regulations include technical requirements.
What Is D&O Insurance?
D&O insurance is a liability insurance policy that provides financial protection for directors and officers in the event of actual or alleged misdeeds when they are acting within the scope of their duties as board members or directors. Essentially, it covers them if the company gets sued because directors or officers make a mistake or neglect to take action they should have taken. Another common term for this is errors and omissions coverage.
Commercial insurance companies offer D&O insurance for several types of entities including:
- For-profit businesses
- Privately held firms
- Educational institutions
- Nonprofit organizations
Because of the litigious nature of our society, all organizations need D&O insurance.
Why Do Businesses and Other Organizations Need D&O Insurance?
Directors and officers carry more responsibility than ever before. Directors and officers face tough decisions every day. Those decisions may have a large impact on the company, employees, their vendors and others with whom the company partners.
Board directors generally do their best to make wise, informed decisions. Unfortunately, board directors and managers don’t always get timely information during times of mergers and acquisitions, and they may vote without having access to all the facts.
More and more, companies operate in multinational markets. Businesses with international markets are subject to U.S. laws, as well as the laws in the jurisdictions where they do business.
Who Does D&O Insurance Cover?
D&O insurance covers past, current and future directors. It also covers the company itself and the company when it is a defendant in securities claims.
What Does D&O Insurance Cover?
D&O insurance policies cover the defense costs for the company, the directors and the officers in the event of a lawsuit over a wrongful act. The policy also covers financial losses to the company.
It’s common for insurers to include extensions on D&O liability policies. Extensions are an add-on to an insurance policy and there may or may not be a premium charged for them. This type of coverage extends the liability to cover things like administrative proceedings, criminal proceedings, and costs incurred during an investigation by regulators or criminal prosecutors.
Extensions enhance the basic D&O liability policy so that directors and officers have access to a reliable and competent legal defense.
D&O policies differ from commercial general liability policies (CGL) in that defense costs reduce the policy’s limits on a D&O claim. This is important because defense costs are usually a substantial part of a claim. CGL policies cover defense costs in addition to the policy limits.
D&O policies are a claims-made policy. This means that the policy will pay a claim against the insured (directors, officers or the company) at the time of the claim, regardless of when the wrongful act occurred.
A policy for directors and officers covers monetary damages, but does not cover bodily injury or property damage.
What Does D&O Cover?
D&O insurance covers the most common occurrences such as employment practices, human resource issues and shareholder actions. It also covers reporting errors, misrepresentation in a prospectus, failure to comply with laws or regulations, and officers making decisions outside of their designated authority.
Are There Any Exclusions in D&O Insurance?
Like other types of insurance policies, D&O policies include additions, conditions and exclusions. Common D&O exclusions include fraud, intentional noncompliant acts, illegal remuneration or personal profit. D&O policies also exclude property damage, bodily harm, legal action that was already taken, claims made under a previous policy, and claims made by other insurance companies.
Do Nonprofit Organizations Need D&O Insurance?
Some nonprofit entities mistakenly believe that they don’t need D&O insurance. Nonprofit entities also have fiduciary and legal responsibilities for which they can be held responsible. Nonprofit board directors are especially vulnerable because they may be less familiar with laws, industry regulations and industry best practices.
Nonprofit organization boards may also be less automated and diligent than commercial boards of directors.
Some of the common types of exposures that nonprofit organizations have are:
- Wrongful termination of employees
- Weak administration
- Wasting assets
- Misleading reports
- Libel or slander
- Failure to deliver services
Even the best-intentioned board directors risk being the target of a lawsuit. Nonprofits will not want to wait until they have a claim before deciding to invest in the cost of D&O insurance.
D&O questionnaires should be designed to include all direct and indirect business relationships so that nothing goes unreported. Board directors may feel that some of the questions are intrusive, so it’s a good idea to remind them that the questions are necessary to ensure regulatory compliance. Comprehensive questionnaires will also avoid any appearance of a conflict of interest.
Boards of directors need to be diligent about making sure their internal procedures align with reporting measures. Boards need to be continually aware of emerging laws and regulations to make sure they stay in compliance.