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Directors' and officers' - A clean sweep.(Post Magazine Via Thomson Dialog NewsEdge) The 'Natwest three' - extradited to the US on fraud charges arising from the Enron collapse - caused angst in many UK boardrooms, lest directors' and officers' policies failed to bite. But insurers have been keen to stress that these policies would. Royal and Sun Alliance's management assurance manager for Profin, Nick Allen, comments: "This is not so much an issue now, as insurers have amended wordings and clarified that policies would cover this." And according to Rick Welsh, management liability unit head at Novae, it was never really was an issue: "A lot of controversy was stirred up by brokers. Most underwriters would have accepted it, but brokers wanted certainty." The Companies Act (2006), which comes into force in October 2008, ought to provide a greater degree of certainty about what the law expects of directors. But could codifying their duties expose them to greater liability? "There is little in the new Act that increases the risk of damages claims against directors by shareholders," observes Francis Kean, head of Barlow Lyde and Gilbert's D&O team. Nigel Pearson, UK underwriting manager for executive protection at Chubb, echoes this, noting: "Theoretically, it can change things, but practically, it may not." An area of uncertainty, according to Mr Allen, is that while codification has changed directors' duties only slightly in terms of language, it is unclear how much emphasis they will have to give to wider stakeholders like employees, customers and shareholders. Shareholder activity Shareholder activity is always a potent area of concern for D&O insurers, although Paul Schiavone, D&O chief underwriting officer for Zurich Global Corporate, notes that it is commoner in the US than the UK. Hence, rates for D&O insurance in the US are significantly higher than in Europe. But that could change if the strategy proposed by the European Union's commissioner for consumer protection results in US-style group actions across the 27 member states. However Victor Rae-Reeves, a partner in Clyde and Co, says the latest word from the Commission is that it will be adopting a European model. He also comments that consumer claims are about 'small money', whereas the big class actions involving large shareholders like pension funds are the real threat to D&O insurers. Coupled with US attorneys bringing the plaintiff bar to Europe, shareholder activism could be notched up a peg. A specialist kind of shareholder activity is the derivative action. Taken for the benefit of the company, it is not commonly used, but it is an important mechanism by which the minority can challenge corporate wrongdoing by directors who might stifle action by majority voting power. The current archaic law - the rule in Foss v Harbottle - will not be altered in substance, but a statutory procedure will be introduced. Mr Pearson speculates on the spectre of pressure groups exploiting this, such as Greenpeace bringing a derivative action on environmental grounds. Proceedings will still need court approval, and: "there is some backstop if actions are frivolous, but it still takes up management time and front-loading of legal costs", comments Nigel Plant, a partner with Plexus Law. In the view of Roddy Graham, a director of THB, courts are more likely to approve these actions because they are directed at better corporate governance rather than shareholders seeking financial benefit: "Judges are sympathetic to someone forcing a company to clean up its act." Company clean-up on the health and safety front is something trade unions have spent years lobbying for, which is why the TUC has condemned any House of Lords amendments "led by Tory peers" that could destroy the Corporate Manslaughter and Homicide Bill. The fledgling legislation is flying back and forth between the House of Lords and the Commons over whether the new offence will apply to deaths in state custody. If an agreement is not reached by 17 July, it will have to be scrapped, unless the government invokes the Parliament Act. The statutory offence would apply to failings by senior managers, either individually or collectively, but the government has said the Bill will target corporate (not individual) liability and would not be a suitable vehicle for prosecuting individual directors or others, although where a particular person is directly to blame, prosecution on an individual basis will remain possible for existing offences. Hiscox has noted that a standard D&O policy will not be sufficient since it only covers a senior individual within a company, and not the company's defence costs. The whole point of the Bill is to make it easier to prosecute the company as a corporate entity, without having to identify its directing mind and will, so it follows that a D&O policy - unless it has a specific entity endorsement - would not cover the company. Mr Allen points out that entity cover is not what a D&O policy is designed for: "It is for the directors as individuals, and adding entity cover would lower the limit of the amount available to cover the individual directors. If the accountability is the company's, it may be that there are more appropriate insurers to protect them." Mr Reeves, who acted for a number of directors and officers in the Hatfield rail crash case, agrees: "Directors need their own cover, whereas the entity would look to its usual insurance channels for criminal defence costs. Separate entity cover is a cleaner way of doing it." Potential lines Callum Taylor, management liability underwriter at Hiscox, points out that the potential fines against the company could be large enough to see many firms collapse. While it would be against public policy to insure fines themselves, Hiscox has devised a management liability portfolio to plug the entity gap. This would pay the cost of defending the company against the allegation, as well as covering the directors for the other health and safety breaches. "Directors in small to medium-sized enterprises can have a large amount of personal assets that are integral to the company, so an attack on the company could wreck them financially." He makes the point that, even with the current law, the chances of bringing home a corporate manslaughter charge against a small company are higher because of the greater ease with which its directing mind and will can be identified. But the Bill, supposing it gets onto the statute book, is unlikely to see a huge number of prosecutions, which is why Mr Taylor stresses that it is cover for the defence against allegations of health and safety breaches that is the main selling point of this cover to the SME sector. As to whether there is scope to extend cover in new scenarios, Nigel Brand, head of D&O at Allianz Global corporate and specialty, notes that the D&O market is constantly evolving. "As clients' needs change, so must our products, but there is also the issue that the D&O policy is designed to react to actions taken against the insured directors and officers. Insurers are constantly re-evaluating their product offering in light of a constantly changing legal environment." He explains that this isn't limited to executive directors: "Independent non-executive directors are increasingly demanding more cover as a price for joining a board. There is a shrinking pool of talent, and attracting them is becoming more difficult, leading to more demand for more robust D&O cover." Cover exposure Insurers have found it very difficult to interest directors of SMEs in this cover, and a Hiscox survey estimates that only 15% have D&O insurance. According to Mr Brand, directors of SMEs are increasingly aware of their D&O exposures, "and there is a clear demand from this sector", but a survey of 100 SMEs by D&O specialist Angel Underwriting gives a different message. It found awareness of D&O within the sector to be very low, with 94% of SMEs questioned not having cover, and a massive 68% wholly unaware of the existence of the cover. With almost half of SMEs buying their business insurance products direct from their local broker, someone clearly needs to communicate with the high street. David Walters, director of Professional Risks at Miller Insurance, says: "There is no doubt that in the current climate of corporate scrutiny, SMEs are increasingly under the spotlight, and it is becoming easier for their directors to be targeted. Unlike larger, listed PLCs, this is more likely to be in the form of regulatory and investigative interest, rather than shareholder actions. So, demand is growing as SMEs know they need to buy cover and to increase the breadth of that cover to ensure that their policies are adequate." Perhaps, however, the term SME should be more clearly defined. As Steve Carroll, managing director of Markel's retail division, observes it is an over-used abbreviation. "In fact, SMEs represent 90% of the market," he observes, adding that Markel has stuck with smaller private companies - with turnovers of less than GBP25-GBP50m and a lot is down to pricing and scope of cover. Because the potential liabilities of directors of private companies are different to those with a public listing, a one-size-fits-all approach seems misconceived, and more bespoke policies are needed to persuade directors that this is relevant to them. As Mr Carroll observes: "It is horses for courses." He adds that a contract covering D&O, entity and employment practices liability makes it easier to sell. It also provides information about the management of the company, such as whether there a good management culture in employment terms. Market segmentation This is all about market segmentation, which requires an understanding of the target market as it really is, and not as insurers would like it to be. It seems pointless to bang on about the threat of class actions to SME directors if they are more likely to be hit by debris from a meteor. Mr Carroll comments: "Some of the multinational insurers look at the 'Natwest three' and say 'it could happen to you', but it won't, and SME directors know it." Insurers need to ask their target market what keeps directors awake at night. Instead "insurers are trying to sell a complex coverage to those who are used to buying an office package. We need to package it in a way that would contextualise the policy to the exposures SMEs have", adds Mr Welsh. Hiscox's survey of 500 SMEs revealed that threats of spurious litigation, regulatory red tape and employment claims are what worry directors. "They are unlikely to have shareholder actions, and D&O alone does not provide the answer. They are up against the risk of unlimited awards in discrimination claims, and the whole health and safety issue, so they need a seamless policy." Zurich Commercial is another company thinking hard about a segmented approach. "We need to offer a bespoke policy, and have to change the emphasis according to who we are selling it to, making it relevant," explains Jim Gaskin, its financial lines manager. The other aspect is education. "What does one mean by SMEs? There is a lot of resistance with small companies, and we need to educate brokers and run market classes for them." Many commentators believe most claims are triggered by regulatory pressure on directors and wrongful trading allegations, where a liquidator tries to establish that before the commencement of a winding up, a director knew or ought reasonably to have concluded that there was no reasonable prospect of avoiding insolvent liquidation because assets were insufficient to meet liabilities. This is more likely to happen during an economic downturn. The biggest threat, according to Adam Codrington, executive director at Aon, is increased litigation against directors, including for misrepresentation and non-disclosure in the prospectus. "We have seen significant growth in stock market activity, with capital raised in pretty benign conditions. Money has been cheap, but a downtown would put a lot of focus on companies and directors." Well, that should see them dusting off their policies - if they have them. Copyright 2007 Timothy Benn Publishing Ltd, Source: The Financial Times Limited |