Reputational hazards are leaving companies exposed to costly perils including public outrage, civil litigation, and even criminal indictments against leadership. Legal counsel, who tend to anchor a firm’s crisis response, need to play a greater preemptive role in coordinating enterprise intelligence gathering to support reputation risk management operations and its governance.
Reputational damage occurs when companies fail to meet the expectations of stakeholders, whose disappointment and anger manifests itself in material ways, including impaired cash flows, diminished stock price, and increased cost of capital; and, of course, the pile on of litigators and regulators.
Understanding and addressing this risk requires a group led by counsel with resources and personnel who understand reputation risk’s true behavioral economic nature.
This group must have the authority to gather intelligence from every corporate silo, determine the costs of missed expectations, flag material risks and, with the support of executive leadership, coordinate the deployment of resources from other departments to both meet and manage expectations, or finance gaps and potential losses with captives and third-party insurance.
ESG Reputational Risks
An entirely new realm of expectations creating reputation risk is emerging from the corporate race to the most noble pledges on environmental sustainability, social justice, and responsible governance (ESG).
Sen. Elizabeth Warren (D-Mass.) made the cost of failure clear when she said recently that it was “just an empty publicity stunt” when executives in August 2019 signed the Business Roundtable pledge elevating stakeholders including communities, employees, and the environment to equal stature with shareholders. Even general counsels have made pledges, such as their Sept. 30 one on diversity.
Here’s the thing. When companies chase ESG scores and inclusion in ESG investment funds, all too often they are setting expectations without building them into operations and corporate culture. Too many boards are viewing these statements as mere marketing and investor relations exercises, rather than appreciating that these are disclosures of corporate objectives that will be taken seriously by plaintiffs’ lawyers and courts in the event of financial setbacks.
A recent review we conducted of a $15 billion company, for example, noted a lengthy ESG disclosure in the company’s SEC filings. There were multiple pages discussing the E and the S—environment and sustainability—but only one page discussing the G—governance. That governance section stated merely that it was the duty of the board to maximize shareholder returns, a common sentiment but completely disconnected from the other parts of that disclosure.
One board committee at this company was charged with overseeing ethics while another with overseeing legal and compliance, despite all weighing heavily on corporate reputation. Various documents refer to board consideration of the interests of “all stakeholders,” but no clear method for that information to find its way to the board. It was also unclear whether management across the organization had a common understanding of reputation risk.
Directors Are Being Held Accountable
This risk is not theoretical. Plaintiffs are increasingly seeking to hold directors accountable for reputational damage, with 39 federal securities lawsuits in the year ending June 2020 citing reputation—a nearly 60% increase from the year before, according to Agenda, a publication used by public board directors and company executives.
Courts are viewing directors’ duty of loyalty more expansively and are sustaining pleadings.
For example:
- In Re Clovis Oncology Inc. addressed a board’s failure to protect the firm’s reputation for (pharmacologic) innovation;
- Marchand v. Blue Bell Creameries involved a board’s failure to protect the company’s reputation for (food) safety; and
- Inter-Marketing Group USA Inc. v. Armstrong addressed a board’s failure to protect the firm’s reputation for (oil pipeline-related) environmental protection.
Criminal prosecutions against senior leadership is also on the rise in areas where charges were once levied only against firms. Blue Bell, Vale, Audi, Miami-Luken Inc., Rochester Drug Co-operative, and Volkswagen are just some of the firms indicted on criminal charges for safety or sustainability issues where the CEOs were swept along for the experience.
General counsel and other senior risk executives such as treasurers already have full plates. Reputation risk management, however, has too great an upside on protecting presumptive ESG value, and too great a downside, to set aside. And since updates to SEC Regulation S-K became operational Nov. 9, now is the perfect time to secure sound outside advice on tweaking a firm’s enterprise risk management apparatus.
The process requires honest self-appraisal; if necessary, protected by privilege, much the same as internal investigations would be, protecting confidentiality in the interests of self-improvement.
The value of this approach would be significant, giving marketers and investment relations professionals an excellent authentic story to tell about strong corporate governance, providing confidence to ESG raters, bond raters and investors and the underpinning of reputational insurance products—as well as providing protection of the personal reputations of individual board members and leverage in negotiating D&O liability coverage in this hard insurance market.
Corporate lawyers would serve their clients well by educating them on the emerging risks associated with reputational damage and assisting them in developing best in class protocols for mitigating those risks.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
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Nir Kossovsky is CEO of Steel City Re, a firm that provides reputation risk management and insurance solutions to enable companies to maximize owners’ value and leadership’s equanimity by mitigating perils of behavioral economic losses.
Denise Williamee is Steel City Re’s vice president of corporate services, where she heads client relations and education for integrated reputation groups.