Managing the risk

“The worsening economic conditions over the past 18 months have coincided with the implementation of several tranches of the UK Companies Act which unfortunately would suggest that the role of a company director is more perilous today than it was, say, five or six years ago.” This is the grim warning from Neil Mirchandani, partner in the dispute resolution practice at law firm Lovells. And the UK is not alone in introducing more stringent rules so the risk is a global one.

Corporate governance

The core to managing your D&O risk is good corporate governance encompassing, for example, disclosure, transparency, compliance and best practice.

David Walters, vice president, financial lines, AIG UK, believes that this involves “awareness of, adherence to and an absolute drilling down on corporate governance.” He explains, “You have to make sure when you’re making decisions that you do so in accordance with the governance structure you have set up. You have to ensure that those entities that are designed to act as ‘corporate governance reinforcers’, such as audit committees and remuneration committees, are truly independent of the main board and that you take heed of what your auditors tell you. If there could possibly be anything that might be seen as a conflict, you need to make sure you get some external counsel to advise because your internal counsel may not be objective enough.” Making sure that your non-executive directors are empowered and enabled to fulfil their functions is also essential, he adds.

Mirchandani agrees that the structure and terms of board committees should be kept under review to ensure appropriate consideration is given to the statutory duties. Looking ahead, he adds: “The key to avoiding or minimising risk is preparation: personal preparation for directors, preparation of policies and preparation of relevant company documents. The Association of General Counsel and Company Secretaries of the FTSE 100 (GC100), which brings together senior legal officers and company secretaries of FTSE 100 companies, recently issued best practice guidelines for boards of public companies. Broadly speaking, recommendations included ensuring directors are aware of their duties, and making sure that, in preparing papers in support of board and committee decisions, all relevant factors are considered so that directors are alive to key issues.”

Comments John Batch, senior vice president, Marsh, “An important part of the risk is the company’s communication with its shareholders and making sure that all disclosures are made to them. If there is price sensitive information directors need to disclose it to shareholders as soon as they are aware of it but they also have a duty to make sure that it is accurate. There is fertile ground here from the litigation point of view around issues of timing of disclosures. There may not necessarily be an actual claim from shareholders but there could be an investigation by the regulatory body into the timing.”

Doug Robare, D&O manager, Zurich Global Corporate UK, also stresses the importance of disclosure and transparency. “One of the things that we would look to on the risk management side of things is reviewing the robustness of compliance procedures,” he states. He recommends engaging third party advisers to look at best practice within the particular industry segment and to conduct some peer analysis.

Compliance with regulation is also a key issue. Robare warns, “We are not necessarily out of the woods as far as the recession is concerned. And we need to understand that there is going to be a greater increase in regulation Will it be self-policing or statutory?” He says that risk managers need to be aware of the legal developments in all the areas in which their companies trade – and understand the processes their organisations need to respond wherever a situation arises.

Walters agrees saying that regulatory authority investigations are an area that underwriters examine closely when assessing risks.

Another relevant aspect is crisis response. In connection with this, Robare recommends looking at the controls, policies and procedures that you have in place and then vetting the robustness of them by using qualified advisers to assess what directors’ roles and responsibilities are. “These have changed in the UK to some extent with the recently introduced new companies’ legislation and also internationally as regulation is ever changing,” he explains. He stresses the importance of everyone understanding their roles and responsibilities.

“Crises tend to be very sudden. It is how you respond to them which is more important than anything else,” he says. So a regularly reviewed crisis response policy is essential. “You need to spell out what people should do, review regularly and update directors on their response. Basically you need to know that your policy will work.”

Paul Hopkin, technical director, AIRMIC, stresses that the risk manager needs

the full cooperation and understanding of the company secretary. “The company secretary heads up the administration, acts as executive secretary to the board and often looks after the legal department. There needs to be strong liaison between the risk manager and company secretary to ensure good governance procedures are developed, implemented and monitored,” he explains. This will also enable the company secretary to fully understand the role of risk management and risk assessment in decision making, he adds.

&#8220A regularly reviewed crisis response policy is essential

 

Insurance and indemnities

Hopkin also advocates that the company secretary and perhaps other senior executives as well should get involved in the market presentations that companies make to the insurance market.

On the subject of insurance, he suggests a cautionary approach. “The way I describe D&O insurance is that it’s like buying a lump of cheese. It can be as high as you want (ie in terms of limits) but it’s Swiss cheese – it’s full of holes! These holes are created by the definitions in the policy and the exclusions. The first thing that risk managers should do when looking at the insurance component of D&O is to fully understand the holes in the cheese.

“Look at the definitions provided such as the definition of ‘event’ and of ‘officer and director’ and all those things that could restrict or reduce cover. Risk managers should make sure they have the broadest definitions they can and, where definitions do introduce restrictions, that they understand these. They should also look specifically at any exclusions, understand them and test the market to see whether these exclusions can be written out and whether different companies offer fewer exceptions.” Hopkin concludes that in current market conditions, depending on the industry sector concerned, there is scope to challenge the market on exclusions and definitions and obtain better cover.

Neil Mirchandani concurs. “Companies should ensure that appropriate D&O cover and indemnities are in place and that any exemptions have been fully explored.”

Indemnification – the ability of a company to reimburse directors for losses in certain circumstances – is an important aspect of directors’ protection in those countries where it is legally permitted. Matthew Rolph, managing director, FINPRO practice, Marsh, says that there is a surprising lack of understanding among risk managers about how indemnities work and a similar lack of understanding among some insurers.

Batch says that it is often the ex directors of a company rather than its current ones that can have the most problems here; specifically there may be issues with fraud allegations and whether indemnities apply. “It is a good idea to look to make sure that indemnities are in place in that situation,” he advises.

Hopkin also advocates looking at the terms and conditions of employment of directors and officers – particularly in the case of your non-executive directors – and incorporating indemnification provisions. “Ideally, these should allow the company to indemnify the individual director or officer to the maximum in every part of the world that the law allows. Most non-executive directors will ask for this protection.”

Claims trends

Walters says that there was major concern about 12 to 18 months ago as to whether there would be some contagion from the widespread problems of the financial sector to the commercial (non-financial) sector. “As recession bit more savagely, there were suggestions that we would see more financial crime within the commercial sector. We will be looking closely at that aspect within our portfolio, but it appears that any adverse contagion is not as dramatic as was postulated 18 months ago,” he states. As regards the financial sector, there have been claims over the last 12 months. “It looks like that is calming down now but it’s left insurers with quite a lot of work to do,” adds Walters.

He also says that personally he has not seen a large increase in shareholder claims in the UK. However, this could be the lull before the storm according to Mirchandani. The latter explains: “Since the credit crunch hit it is probably fair to say that most investors have kept their powder dry whilst they wait for the worst to come to an end. Once losses have crystallised, the fight for survival recedes and a litigation ‘war chest’ has been developed, we are likely to see more activist investors considering their options. As such some of the perceived increased risks for directors brought about by the Companies Act, such as divisive ‘derivative actions’, have generally been delayed- but this may only be temporary. It may well be that the duty to demonstrate that a director has acted in the ‘best interests of the company’ is severely tested over the coming months and years.”

Another predicted source of claims is in the area of employment practices liability with, for example, employees who have been made redundant alleging discrimination. Batch says that this is usually an exposure faced by the company that has issued the employment contract, but occasionally suits do name individual directors or managers. Walters also sees this as a potential danger. “Clearly with increasing redundancies there may be an uptick in that type of claim. It’s something we would look closely at when assessing risks.”