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Danger for directors

Directors are increasingly being brought to account for individual failings. Richard Crump looks at how they are protecting themselves

29 Mar 2012

By Richard Crump

Red scorpion standing out among black scorpions

WHO WOULD want to be a director at times like these? Prominent executives and board members are taking a hammering over remuneration packages, while the grim economic environment and tangled web of regulation stemming from the financial crisis has placed greater scrutiny on boardroom actions.

At the end of 2011, the directors in charge of the Royal Bank of Scotland (RBS), prior to its government rescue in 2008, were referred to the Financial Services Authority (FSA).

Following the referral, the chairman of the FSA, Adair Turner, suggested in an FSA report that it may be necessary to ban senior executives and directors of failed banks from taking up positions of responsibility in the financial services industry in the future.

This scrutiny at RBS is indicative of the increased problems faced by directors. Figures from Companies House show the number of disqualification orders against directors rose by 5% last year.

According to research by the Financial Times, the 1,615 director disqualifications recorded by Companies House in the 12 months to April 2011 are the highest figures since the aftermath of the dotcom bubble bursting in March 2000.

Under siege

In such an environment, it is no surprise corporate directors and officers (D&Os) are showing more interest in protecting themselves against potential litigation amid rising concerns over the range of exposures confronting them.

Towers Watson’s 2011 Directors and Officers Liability Survey - based on 401 organisations that purchased D&O liability insurance in 2011 - found 69% made an inquiry regarding the amount and scope of their D&O insurance coverage in 2011, up on the 57% in 2010.

“Whether it is traditional securities class action litigation, M&A-related activity, derivative actions or threats from a wide range of regulatory or law enforcement agencies, D&Os - and the companies they represent - are seemingly under siege from a wide array of potential claimants,” says Larry Racioppo, member of the executive liability group in Towers Watson’s brokerage business and author of the survey.

According to Francis Kean, executive director at Willis, regulatory investigations and enquiries is the risk that poses the greatest concern to directors. Evidence suggests regulatory investigations are on the increase, and media coverage of the scrutiny surrounding dawn raids conducted by the FSA, and Office of Fair Trading enquiries into price fixing have only served to worry directors even more. Often these cases hinge on the evidence and culpability of senior individuals within the companies in question.

Kean, who co-authored a Willis and Allen & Overy directors’ liability survey: Directors in peril - insurance indemnity in risk times, says regulators left “with egg on their faces” over the financial crisis are “doing their best to show that in this brave new world they are better able to regulate it. They are doing this by calling and hauling directors to account.”

While the volume of cases continues to rise in the UK, there is a simultaneous ramping up of cross-border actions involving multiple regulators, sparked by the increasing cooperation between the FSA, the US Securities and Exchange Commission and European member states.

This raises the very real spectre of investigations quickly escalating across several jurisdictions, says Kean. As a result, 67% of those surveyed by Willis cited a concern their D&O policy would not be able to respond in all jurisdictions.

Buying protection is not as simple as purchasing one policy for the parent company and hoping it provides global coverage. A UK-headquartered plc with operations around the world may purchase its D&O policy in London with UK-licenced insurers, but find it has no guarantee of international coverage.

“France and Italy are fundamentally different,” says Kean. “In Italy it is a far less benign environment for director liability and in the Netherlands directors get pulled up fairly easily if the plaintiff is domiciled there.”

Should these situations arise, directors look to their companies for support, and yet their companies are not (unless specifically negotiated provisions are in place) obliged to indemnify them and, where they do, are unlikely to remove all risk. Investigations can often lead to a divergence of interests between the director and the company itself, at which point separate legal representation may become necessary.

When it comes to D&O coverage for investigations and enquiries, it is worth being mindful of the policy small print, which will limit the insurer’s exposure, Kean says. For example, insurance often only applies with regard to investigations that are “formal and official”. In truth, directors are frequently advised to engage with regulators and seek to resolve issues at an early, informal and unofficial stage.

“It suits the regulator to conduct informal investigations,” he says. ■

 

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