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Q1 2024 FINPRO Management Liability: Need to Know

Every quarter, our management liability team provides noteworthy trends and emerging issues to help US-based companies make decisions to manage their risks.

04/10/2024 · 10 minute read

Every quarter, our management liability team provides noteworthy trends and emerging issues to help US-based companies make decisions to manage their risks. We will cover topics related to directors and officers (D&O) liability and fiduciary liability risks and share insights on building an effective, customized insurance program that is fit for an evolving risk landscape.

Our Q1 2024 issue focuses on:

  • The SEC has adopted new climate-related disclosure rules, requiring companies to disclose material climate-related risks and include disclosures about severe weather events in their audited financial statements, despite legal challenges and the potential for increased compliance costs. 
  • The focus on ESG considerations in ERISA plans is raising questions about investment selection, participant options, and fiduciary duties, amidst conflicting rules and legal challenges, leading to increased scrutiny by fiduciary underwriters and potential disruption in the fiduciary insurance market.

Q1 2024 Management Liability update

D&O Liability

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Fiduciary Liability

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D&O Liability

The SEC’s new climate-related disclosure rules

After receiving a record 24,000 comments and following two years of review, on March 6, 2024, the SEC adopted the final climate-related disclosure rules. The new rules mandate disclosures about material climate-related risks that have had or may have a significant impact on a registered company’s business strategy, financial condition, or operational results.

In addition, organizations will now be required to include disclosures pertaining to severe weather events and other natural conditions in their audited financial statements. The rules will be phased in, starting with large accelerated filers in 2025 and ending with smaller reporting and emerging growth companies in 2027. 

In adopting the rules, the SEC acknowledged that these present “increased litigation risk and the potential disclosure of proprietary information.” Legal challenges have already been filed against the new rules – a motion to stay has been filed by two energy companies in the US Court of Appeals for the Fifth Circuit, while a number of states’ attorneys general, the Chamber of Commerce, and environmental groups have filed suits challenging the rules. The arguments are either that the rules go too far or that they do not do enough.

Despite the legal uncertainty arising from these challenges, companies should be prepared to begin complying with the rules. They also should be prepared for interpretive challenges of their assessments of materiality and quantified climate-related risks due to the lack of a standardized approach to measuring climate emissions.

Many organizations may also face significant new compliance costs. Organizations operating in multiple states or ones with a global footprint will need to navigate the complexities of complying with these new SEC rules, as well as the rules of various states (for example, California), the EU, or foreign countries. In light of this, we expect D&O underwriters to ask more questions about climate issues and how organizations plan to comply with various governments‘ disclosure rules.

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Fiduciary Liability

ESG considerations in ERISA plans

The focus on environmental, social, and governance (ESG) issues is raising a number of questions for investments in plans governed by the Employee Retirement Income Security Act (ERSA). Some of these include:

  • Should the selection of funds included in plans be solely based on the potential growth of participants’ investments? 
  • Should participants be given the option to invest in socially meaningful funds, even at the cost of returns?
  • Will fiduciaries be breaching their fiduciary duties of prudence and loyalty if they do not only consider financial returns? 

These questions have been the subject of ongoing discussion for several years and conflicting rules have been established. In 2023, the US Department of Labor adopted a rule allowing employee retirement plans to consider ESG issues in investment decisions, but 25 states attorneys have filed lawsuits to block this rule. The US Congress and individual states have also adopted rules, further complicating matters and making this issue harder for fiduciaries to navigate.

The issue has also been subject to legal debate. In February 2024, a Texas district judge denied a motion to dismiss a class action suit alleging a plan sponsor breached fiduciary duties by choosing investment managers that focused on ESG factors. The judge wrote in his opinion: These specific actions — selecting, including, and retaining ESG oriented investment managers — allow the court to reasonably infer that defendants' process is flawed because it allowed plan assets to be used to support ESG strategies.

In another case, employees are suing three New York City pension funds for their decision to divest funds from fossil fuel stocks. There was an expectation that the lawsuit would be dismissed early based on precedent set in Thole vs US Bank, which outlined that a plaintiff must have incurred damages to be able to sue. Plaintiffs in the current case are arguing that the fossil fuel stocks would have outperformed the market. A decision on this case is expected imminently.

The combination of rules and legal decisions are expected to lead to increased scrutiny by fiduciary underwriters. Insureds should be prepared to explain the basis of their decisions related to ESG funds and whether they sought the opinion of outside counsel opinion. It is good to remember that most underwriters prefer to take measurable and predictable risks and will tread carefully around a hot political and social issue.

ERISA lawsuits down in 2023

A total of 28 new excess fee and performance lawsuits were filed in 2023, almost half the 89 filed in 2022, according to a report by fiduciary underwriter Encore Fiduciary. The report, however, notes that filing frequency has remained elevated in the last eight years and the drop in 2023 was likely the result of large plaintiffs’ firms being preoccupied with handling of previously filed the cases. 

 

A number of cases went to trial in 2023, a year that also saw a record number of settlements — 42, up from 31 in 2022. The average settlement amount in 2023 was $8.4 million, although it is worth noting that this figure may be distorted by a single record settlement of $124 million — excluding this exception, the average settlement would decrease to $5.6 million. These figures do not include defense costs. 

More than half of the cases filed in 2023 — 28 — related to excessive recordkeeping fees. Other frequent allegations included excessive investment fees, investment performance/imprudence, wrong share class, and high fee/underperforming target date funds.

According to Daniel Aronowitz, President of Euclid Fiduciary, a third of large plans in America have faced excessive fees lawsuits in the last eight years. And when considering only plans with assets over $1 billion, the percentage sued for purported excessive fees rises to more than 50 percent.

Data shows that larger plans remain at higher risk of suits, although we have seen a few select cases of plan assets under $200 million being targeted. The focus on larger assets is likely due to the potential for larger settlements, especially since plaintiffs’ attorneys tend to be paid as a percentage — often 25% — of the settlement.

One could argue that the drop in the number of cases could be viewed as a positive development by fiduciary insurers. However, many of the main fiduciary underwriters were impacted by lawsuits settled in 2023. And since these claims were potentially filed when premiums and retentions were lower than the current market, many insurers’ fiduciary loss rations could still be negatively impacted.

Long-awaited ERISA healthcare fee litigation arrives

The first major lawsuit alleging excessive fees paid to ERISA healthcare plan providers was filed in February 2024. In what is considered a novel lawsuit, an employee is suing her employer for the alleged mismanagement of drug benefits.

The case comes in the wake of reports that some legal firms were using social media to solicit employees for retirement plan excessive fee cases related to health plans.

Although this case focuses on prescription drug costs, organizations with health plans could face similar allegations related to other medical costs. Also of note is that ERISA defines a fiduciary by their actions not by a designation; health plans tend to include less clarity on fiduciary roles than the formal pension or benefit committee structure of a retirement plan, potentially leading to increased arguments over who can be considered a fiduciary.

It is also worth noting that many of the accusations in the February case seem to be replicated from allegations made in most excessive fee retirement cases. Fiduciary insurers have already been hit hard by retirement excessive fee cases and similar suits to this complaint could lead to significant disruption in what had been a stabilizing fiduciary insurance market. Insurers will likely be stringent on which counsel can be used to defend these cases, and it is fair to expect high defense costs for specialist firms.

We expect that underwriters will begin to ask questions about the controls that plan providers have in place to evaluate the costs of health benefits and prescription drugs. And it’s important to remember that the question on the excessive fee questionnaires asking whether a company has received requests from law firms does not solely apply to retirement plans, but also other health and welfare plans.  

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Our people

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Kate Maybee

Fiduciary Liability Product Leader

La'Vonda McLean

La'Vonda McLean

Employment Practices Liability/Wage & Hour Product Leader, FINPRO

Matt McLellan

Matt McLellan

D&O Product Leader

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Previous editions

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Q3 2024 FINPRO Management Liability: Need to Know

11/04/2024
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Q2 2024 FINPRO Management Liability: Need to Know

06/28/2024
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Q4 2023 FINPRO Management Liability: Need to Know

01/04/2024
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Q3 2023 FINPRO Management Liability: Need to Know

10/15/2023

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