Emperor Has No Clothes: Going Naked on Environmental D&O Exposures

By Rogers, Greg | Risk Management, September 2004 | Go to article overview

Emperor Has No Clothes: Going Naked on Environmental D&O Exposures


Rogers, Greg, Risk Management


The Sarbanes-Oxley Act of 2002 and other developments in the aftermath of recent accounting scandals significantly increase both the probability and severity of potential environmental claims against corporate directors for failure to exercise appropriate pollution risk oversight. "Pollution risk oversight" is the process by which board members attain reasonable assurance that the company's environmental objectives will be met. It comprises the legal responsibilities of directors to provide oversight of the corporation's compliance with environmental laws, financial reporting of environmental liabilities, and management of environmental risk. Pollution risk oversight exposure is particularly acute for audit committee members who are typically charged with responsibility for overseeing legal compliance, financial reporting and risk management.

The potential situations giving rise to director liability can vary, as injured shareholders or creditors may seek legal recourse against directors in the following circumstances:

* During the company's internal control audit under Section 404 of Sarbanes-Oxley, the auditor finds material weaknesses in internal control over financial reporting of environmental estimates and accruals. As a result, the auditor issues a qualified internal control opinion.

* The company is forced to restate its reserves for environmental liabilities when the company's auditor discovers material undisclosed asset retirement obligations for asbestos abatement and groundwater remediation.

* A series of violations of environmental regulations result in criminal prosecution of the company and certain employees. A Justice Department investigation reports the absence of an effective program to prevent and detect violations of law, specifically citing the board's failure to take appropriate remedial action in response to repeated legal violations.

* Major institutional investors begin divesting the company's stock due to the company's perceived failure to proactively address climate change risk and to fully disclose the material adverse impact of global warming on continuing operations.

* Known but undisclosed (and uninsured) loss contingencies associated with the manufacture of hazardous materials result in environmental product liability litigation that threatens the future viability of the company.

* The board authorizes distributions to shareholders at a time when the company, unbeknownst to its directors, is insolvent due to undisclosed environmental liabilities.

* Cost overruns on environmental cleanup at several former operating sites unexpectedly force the company into bankruptcy.

Insurance Protection

Like standard business insurance, most D&O policies today contain a pollution exclusion that denies coverage for any claim that has as its underlying cause the release or threatened release of pollutants. As illustrated by recent case law, the pollution exclusion can also extend to securities claims arising from environmental matters. In the past, carriers have been willing to negotiate cutbacks on the exclusion, in effect allowing limited environmental coverage under the policy. More recently, D&O insurers are taking steps to reduce their exposure on environmental-related claims. For example, Swiss Re recently announced plans to mail questionnaires asking buyers of D&O insurance what they are doing to prepare for anticipated government restrictions on greenhouse-gas emissions. If a company isn't doing enough, Swiss Re will consider refusing to offer coverage. …

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Emperor Has No Clothes: Going Naked on Environmental D&O Exposures
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