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New FCA diversity and inclusion rules could pose a D&O risk for companies

The Financial Conduct Authority (FCA) has published new rules requiring listed companies to be more transparent about the ethnic and gender diversity of their boards.
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By Zelda Pitman , 

Retail Client Executive, Management Liability

12/08/2022 · 4-minute read

The Financial Conduct Authority (FCA) has published new rules requiring listed companies to be more transparent about the ethnic and gender diversity of their boards. The rules take effect for accounting periods starting after 1 April 2022, meaning that disclosures will start to be seen from the second quarter of 2023.

The new rules require publicaly listed companies to disclose in their annual reports the status of their board’s diversity and inclusion efforts. Progress will be measured against the following specified targets:

  1. At least 40% of the board should be women.
  2. At least one senior board position should be a held by a woman, for example, Chair, CFO, or CEO.
  3. At least one member of the board should be from a minority ethnic background, excluding white ethnic groups.

There is not a requirement to meet these targets. However, if companies have not met them, they must explain why their board may not be representative of the wider employee base and the society in which they operate.

Companies must also provide a numerical table detailing the diversity of their board and executive management by gender and ethnicity. This puts additional onus on companies to be honest about their board diversity and inclusion efforts. Failure to disclose or the provision of inaccurate diversity and inclusion information in the annual report could lead to FCA-imposed fines or a breach of listing rules.

This move by the FCA mirrors similar action taken in the US by the Securities and Exchange Commission (SEC) in August 2021. The SEC’s rules require Nasdaq-listed companies to have at least two diverse directors, including one woman and one member of an underrepresented minority or of the LGBTQ+ community. This rule is also on a comply or explain basis, albeit that companies with fewer than five board members need only have one diverse member.

The FCA’s stated aim is to increase transparency for investors and other stakeholders, and to encourage scrutiny and consideration of diversity and inclusion more broadly. This reflects the overall increased societal emphasis on diversity, equity, and inclusion.

That said, while the FCA rules will put more pressure on companies to take diversity and inclusion seriously at board and senior management levels, it will not necessarily translate, on its own, to more board diversity.

The impact of these rules on D&O insurance

D&O underwriters are placing increasing importance on the ESG credentials of potential insureds, and this has now become an important factor when evaluating a risk.

While there has been considerable focus on environmental and governance issues to date, social issues are now also gaining prominence. According to the Financial Reporting Council, companies with diverse boards have been shown to have better corporate cultures and financial performance, making them a better risk from a management liability perspective. Insurers may, therefore, consider diversity and inclusion declarations when reviewing a public company’s annual report as part of the D&O insurance submission process going forward.

Failing to comply or providing inaccurate information would expose companies to the risk of a fine for breaching the listing rules. Perhaps, more significantly, disclosing a failure to meet diversity and inclusion targets may expose companies to shareholder or other action. Shareholder activism has increased in recent years, with a particular focus on board diversity. For example, an institutional investor recently criticised a leading DIY/home improvement company in the US for stagnating board diversity gains, and investment managers have been pushing for more diversity at a number of global companies, many of them household names.

US courts, meanwhile, have continued to see board diversity lawsuits, although they have so far failed to progress to trial. Recently, a derivative lawsuit against a leading software company was dismissed after the court ruled that the plaintiffs failed to prove that statements about racial diversity at the board level were knowingly misleading. The plaintiffs were unable to show a sufficiently clear and reliable statement of intent, or that a loss was caused. However, lawsuits such as this one have resulted in significant expense and negative publicity for defendant companies.

It remains to be seen whether plaintiffs will continue to initiate these types of lawsuits with a view to effecting change or whether the new listing rules in the UK and the US will alter their strategy. What is clear is that this increased focus on ESG by regulators, insurers, and other stakeholders continues apace with little sign of abating and companies must be prepared to manage this risk.

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