Directors and Officers (D&O) coverage protects company and individual assets from claims regarding the management professionalism of the upper levels of companies.
The leading cause of D&O claims and payouts concerns financial reporting. The books don’t have to be cooked necessarily, as they just need to be inaccurate to provoke a claim.
Relatively new accounting standards require real property values to properly reflect environmental impacts and potential clean-up costs. For example your company purchases a piece of land for $50 knowing it is environmentally impacted with an anticipated clean-up cost of $950. The book value of the property is $50 because that is what you paid, and it is the net value including clean-up. Now let’s assume new regulations require an additional $49 of remediation. You must either write down the value by $49, or if the property is held for sale, you can optionally write down only actual costs reflected in the sales price.
Of course, as with most future conditions, how do we predict what costs will be when we remediate the site?
Unfortunately, directors and officers must make management decisions in real time while arm-chair stakeholder quarterbacks get to review results with the power of hindsight. Will the Chief Financial Officer (CFO) decide a conservative cost structure and reduce the value of the stock? Or, will he choose a more optimistic scenario and not reveal the full extent of the environmental impact thus falsely inflating values?
The answer is: in today’s regulatory and transparent business environment, adequate D&O limits are a requirement of good management. Also, the CFO should consider environmental impairment insurance.
In the spirit of insurance and great risk management, the CFO can swap a premium (known expense) for a future potential claim (unknown loss). Thus transferring the loss on the asset, to an expense. The asset value remains unchanged.
These valuation rules are very complex and you should consult with a CPA about your specific situation.
