The leading cause of D&O claims and payouts concerns financial reporting. The books don’t have to be cooked necessarily… 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, it can be difficult to predict what costs will be when we re-mediate 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 on 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?
In today’s regulatory and transparent business environment, adequate D&O limits are a requirement of good management. Also, the CFO might want to 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 both a licensed insurance agent and a CPA regarding your specific needs. Give us a call… we’ll be happy to make introductions.