Top five risks facing directors and officers

Directors and Officers coverage has taken on a new priority, with high-ranking officers in public and privately-held corporations working under an unprecedented level of scrutiny.

Directors and Officers coverage has taken on a new priority, with high-ranking officers in public and privately-held corporations working under an unprecedented level of scrutiny.

A survey conducted by Allen & Overy and Willis in September 2014, titled ‘Directors’ liability – D&O: Blurring the lines,’ explored shareholder pressure, perceptions of public interest, heightened regulatory vigilance and a hostile enforcement and litigation environment: some of the forces that corporate leaders have to manage on a daily basis.

Francis Kean, executive director in Willis’ Financial and Executive Risks Practice (FINEX), shares his findings from the survey:

Directors can now be held personally liable in the U.K. for offences that include bribery, corruption and fraud; competition and antitrust matters; environmental law; health and safety; tax; international sanctions; money laundering; financial reporting requirements; the Dodd–Frank Act and other long-arm U.S. legislation.

Yet, there is still a lack of awareness of this among many directors and other senior officers.

Sixty-three per cent of them are unaware of the proposed expansion of the directors’ disqualification regime. The proposals, set out in a paper published by the U.K. Department for Business, Innovation and Skills titled Transparency & Trust: Enhancing the Transparency of U.K. Company Ownership and Increasing Trust in U.K. Business, will introduce ‘broader and more generic’ provisions in relation to the matters determining the unfitness of a director. The proposals will outline several factors that could be used to justify disqualification, covering misfeasance, breaches of duty, legislation and sector regulations. (continued.)
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For example, it would be possible to take a director’s overseas misconduct into account in disqualification proceedings in the U.K., meaning that risks facing directors overseas are transported back into the U.K.

How corporate leaders rank their business risks
More than twice as many executive directors as non-executive directors (NEDs) rate anti-corruption legislation, including the Bribery Act, as of concern.

“This may be due to NEDs assuming (perhaps dangerously) that they are less likely to be called to account than management for the company’s systems and controls to prevent bribery in the event of a corruption investigation or proceeding,” says Andrew Barton, counsel at Allen & Overy.

- 47% worry about the risk of being sued abroad;
- 26% worry about the risks associated with foreign directorships; and
- 19% worry about the risk of extradition of company directors, mirroring the extraterritorial threat.

“Ten years ago extraterritorial claims were brought against the directors of Parmalat, but, with today’s more sophisticated global litigation techniques, both regulators and claimants are more alive to the potential. Antitrust regulators, for example, are considerably more joined up in their approach to wrongdoing across borders,” says Barton.

Thirteen-and-a-half per cent (13.5 per cent) worry about the threat of environmental claims – an issue that should perhaps be moving up the agenda. Greenpeace claims the risk of climate-related lawsuits is rising, and has launched a campaign that takes the form of ‘Dear CEO’ letters, which invite answers from business leaders to specific questions relating to their exposure and coverage for these types of claims.

The premise appears to be that, as the threat of litigation increases, so too does the threat that company executives will be made personally liable and that their insurers will be vulnerable to large pay-outs.

Some directors and officers (D&O) policies exclude cover for clean-up and pollution costs, and those exclusions can also extend to the provision of defence costs in relation to allegations of pollution – suggesting that Greenpeace has highlighted a risk more directors and risk managers should be alive to. (continued.)
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Twenty-two per cent (22 per cent) worry about the risks associated with insolvency and corporate collapse. This is the risk where there is most divergence between directors and NEDs, with more than a third of NEDs considering insolvency a significant risk to them.

“This may be because NEDs may feel more removed from the day-to-day workings of the companies on whose boards they sit,” says Barton, “and thus more concerned about their failing.”

Over the years there has been a marked tendency in D&O insurance policies to try to spell out each new embellishment to the product. This has resulted in an insured perils approach to the cover, which has bred length and complexity. It is not unusual for D&O policies to be 40 pages long, with as many defined terms, whereas errors and omissions insurance, a close cousin, is typically half the length.

As the threat of litigation increases, so too does the threat that company executives will be made personally liable. A call to restrict insurers’ ability to refuse a claim based on non-disclosure has grown louder in 2014.

“Directors and senior officers worry they might not have been asked the right questions when the policy was taken out, or that they may not have thought something was relevant that it later turns out should have been disclosed,” says Barton.

Fifty per cent (50 per cent) see this as a major worry, yet we are aware of only very few instances of rescission for non-disclosure involving D&O policies.

“Well-drafted wording should in any event protect innocent directors from the consequences of non-disclosure or deliberate misrepresentation by others,” says Barton. (continued.)
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Every year directors and senior officers worry about coverage for the cost of advice incurred at the early stages of an investigation, prior to any main hearing. This would include regulatory visits and notification obligations where, from an insurer’s point of view, it can often be difficult to distinguish between routine investigations and those where the personal liability of directors is a realistic possibility. Costs racked up for legal advice for individuals at the start of investigations can be substantial.

With regulatory and enforcement so heavily focused on senior management this is a growing area of expense, particularly as matters become more complex and increasingly international.

It can prove tricky to distinguish between the costs of defending the entity and of defending the individual before formal proceedings have started.

Yet insurers do not like covering the pre-claim stage of an investigation because they worry about the potential for them to have to sign a blank cheque for legal fees up to the policy limit. It can also prove tricky to distinguish between the costs of defending the entity (which would not typically be covered by D&O insurance) and the costs of defending the individual before formal proceedings have been issued.

This is a classic blurring of the lines between entity and individuals in a coverage context – individuals can potentially find themselves caught in a gap between the two.

Cover at an early stage of an investigation is a key issue for the compliance officers and for the NEDs. There is a strong and interesting correlation between these findings and those relating to conflicts of interest in which the compliance functions and the NEDs also signal the greatest concern. This suggests that, for both these classes of corporate leader, there is a clear focus on the potential need for separate legal representation.

Forty-two per cent (42 per cent) of executive directors rate cover at an early stage of an investigation as a priority. This is less than the proportion of NEDs and also well below the proportion of executive directors who rank regulatory investigations and anti-corruption legislation as areas of key concern – suggesting it may not have the attention from executives that it deserves.

Companies should try to make a clear decision regarding who should and should not benefit from D&O insurance and/or indemnification and that this is made clear (and kept up to date) in relevant documents. (continued.)
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“This means paying attention not just to directors but also to officers in D&O policies and indemnities,” says Barton, “it is often clear which statutory directors benefit from cover, but the term ‘officers’ can be applied and interpreted much more broadly.”

Companies should therefore have a process of recording changes in directorships, job titles and roles, and to ensure individuals are given full information on their cover when they assume new positions or move through the organisation.

Individual directors and officers and their employers should place great value on getting D&O policies and indemnifications correct at the outset, and keeping them up to date through the course of an individual’s career.

“Things that are overlooked in the good times can cause big problems should problems arise, not only for the individual left exposed, but also for the company,” says Barton, “which will never benefit from a messy situation with its own employees during regulatory investigation or litigation.”

This article first appeared in Willis’s Resilience Magazine, winter 2015.
 

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