New risks such as cyber incidents or data privacy, rising regulator and shareholder activism and the influence of third party litigation funders are putting corporate leaders under more pressure than ever of falling foul of investigations, fines or prosecution over alleged wrongdoing, says Allianz Global Corporate & Specialty (AGCS), a leading provider of Directors and Officers (D&O) insurance globally.
Directors and officers are walking a managerial tightrope as executive liability continues to increase annually. There is a growing trend towards seeking punitive and personal legal action against executives for failure to follow regulations and standards which could result in costly investigations, criminal prosecutions or civil litigation putting the company’s assets, or their own, at risk, AGCS says in its new report D&O Insurance Insights: Management liability today. “While the legal landscape differs strongly from country to country, increasing shareholder or regulatory action has become a global phenomenon that needs to be given top priority within companies’ internal risk management departments,” says Bernard Poncin, Global Head of Financial Lines, AGCS.
D&O litigation – lengthier and more costly
According to AGCS analysis, non-compliance with laws and regulations is now the top cause of D&O claims [1] by number, followed by negligence and maladministration/lack of controls. The average D&O claim for breach of duty costs over $1 million (€1 million). However, in large corporate liability cases D&O claims can be valued in the hundreds of millions of dollars. AGCS observes a general trend for D&O claims to be dismissed or resolved more slowly, meaning lengthier litigation, increased defense costs and higher settlement expectations. For example, the average US securities class action case takes between three and six years to complete while legal defense costs average around $10 million, rising to $100 million for the largest cases. In the past six years defense costs have almost doubled for large D&O claims in the US. The influence of third party litigation funding is also changing the global litigation map, with it being pivotal in the development of collective actions against financial institutions and commercial entities and their directors and officers.
Management in the UK could be prosecuted for failure to prevent fraud by staff
Speaking at the Cambridge International Symposium on Economic Crime in September this year, the Attorney General reiterated the Prime Minister’s priority of expanding economic opportunities - meaning businesses "of all sizes" should be better held accountable for their failures. The Attorney General also restated the intention to consult on extending the criminal offence of 'failure to prevent' to other economic crimes such as fraud and money laundering so that firms are properly held to account for criminal activity that takes place within them.
“If a new corporate offence of failing to prevent economic crime is introduced in the UK, it will represent a huge expansion in corporate criminal liability,” said Terry FitzGerald, Head of Commercial D&O and Financial Institutions, UK at Allianz Global Corporate & Specialty. “Although these particular reforms are focused on corporate liability, there is, of course, a broader drive to hold individuals accountable in the event of criminal conduct or regulatory breaches at their companies. In recent years, increasing emphasis has been placed on personal accountability across all business sectors, with Deferred Prosecution Agreements now a means to further increase cooperation with regulators and encourage best practice. Reform in this area could ultimately have a fundamental impact on the risks faced by senior executives.”
The risks and potential liabilities of senior executives have never been greater
Litigation against companies and their officers is on the rise. In the US, the number of security class action filings is rising and, at mid-year, was on course for its highest annual total for 12 years [2]. Many Asian countries such as Japan, Hong Kong, Thailand and Singapore are also moving towards a more litigious culture. The increase in claims has also been pronounced in Germany where the number of D&O claims for AGCS alone has tripled in the past 20 years.
Cyber risks on the board agenda
The landscape for executives is further complicated by a number of emerging perils, such as liability around cyber-attacks and data privacy. In the US; several class actions have already been filed related to data breaches. Data protection rules around the world are becoming increasingly tough, with severe penalties for non-compliance. As a consequence, AGCS experts anticipate cyber security-related D&O litigation more widely in the US, but also in Europe, the Middle East and Australia – if there has been negligence in any failure to protect data or a lack of controls. “Many directors used to see cyber as an IT issue and not an exposure for the board to consider,” explains Emy Donavan, Regional Head of Cyber Liability North America, AGCS. “But there is no escaping cyber risks and directors need to be adequately informed, otherwise they will leave themselves exposed.”
Other new management risks include negative disclosures or allegations around environmental pollution, climate change and modern slavery which could result in reputational risks and shareholder activism, public outcry or governmental action.
Mergers and acquisitions (M&A) continue to be a key driver of D&O litigation and is predicted to continue at rapid pace in future. “M&A, but also divestitures, belong to the more riskier moments in the life of a company,” says Poncin. “Expectations are always high, and synergies are easier planned than realized.”
Highly sophisticated risk management required
In order to tackle the increase in executive risk in future directors need to develop a highly sophisticated risk management culture. Examples include instilling first-class cyber and IT protection, keeping records of all information relevant to a managerial role and maintaining open communication with authorities, investors and employees. Executives should ask tough questions about compliance related topics such as sanctions, embargoes, domicile registrations, price-fixing and fraud and also learn more about “classic” D&O exposures such as M&A, capital measures and IPOs. The AGCS report contains best practice advice and checklists outlining how executives can mitigate risk.
D&O insurance has become a regular part of companies risk management in the past 20 years. It provides financial protection for managers against the consequences of actual or alleged “wrongful acts”. Common D&O risk scenarios include HR issues, shareholder actions, reporting or disclosure errors. Coverage does not include fraudulent, criminal or intentional non-compliant acts or cases where directors obtained illegal remuneration, or acted for personal profit.
[1] AGCS analysed 576 claims between 2011 and 2016
[2] 119 new federal securities class action cases filed during 1H 2016, Cornerstone Research and the Stanford Law School Securities Class Action Clearinghouse’s report
(Source: Allianz Global Corporate & Specialty)
