D&O: Boardroom drama

UK D&O claims are increasing in both in size and frequency, with no sign of abating. Rates are hardening, with increases of between 10 per cent and 20 per cent both here and in the US so far this year. Graham Buck seeks to understand why

Shock waves caused by the MeToo movement are rippling through company boardrooms on both sides of the Atlantic. Topshop chief, Sir Philip Green hasn’t yet felt obliged to step down in the face of discrimination and sexual assault accusations, but alleged inappropriate behaviour eventually dislodged the Ted Baker fashion chain’s founder, Ray Kelvin, who resigned earlier this month – prompting the retailer’s depressed share price to rise sharply in response. The biggest corporate casualty is still the Weinstein Company, which filed for bankruptcy last year after multiple charges of sexual harassment and assault brought against ex-chairman Harvey Weinstein scuppered efforts to find a buyer or investor.

While the movement hasn’t yet caused too much alarm for UK directors’ and officers’ (D&O) liability underwriters, Marsh reported last November that several D&O-related MeToo claims had already surfaced in the US, where accusations of harassment against companies are on the rise. With that comes the potential for claims against directors, officers and companies deemed guilty of enabling, failing to prevent or covering up misdemeanours in the workplace.

However, a leading question is how receptive D&O claims handlers will be to harassment and discrimination cases, which are fertile ground for employment practice litigation.
America’s readiness to sue means that many US entities also buy employment practices liability (EPL) cover, which is carried by rather fewer UK companies. With many claims filed in employment tribunals subject to a cap on compensation awards, the outcome is as likely to be a growing EPL market.

From cyber attack to Brexit

MeToo is just part of an overarching theme for D&O claims, which has seen a transition from being primarily financially-related to becoming more event-driven, reports Rachel Turk, focus group leader and underwriter for Beazley.

“The past couple of years has also seen D&O claims related to climate change – for example a company being unprepared for related events such as the California wildfires,” reports Turk. “Cyber security is another growing area, with directors and officers accused either of allowing the company to become vulnerable to cyber attacks or failing to respond to [them] effectively.”

The prolonged uncertainties surrounding the UK’s departure from the European Union have predictably fed reports that Brexit-related D&O claims could also be in the offing for insufficiently prepared businesses. Motor insurer Direct Line, for example, is taking no chances and opted to halve its special dividend, using the saving to bolster its solvency capital ratio in response to the “high level of political and economic uncertainty.”

Insurance governance firm Mactavish warned early this year that companies had “massively overlooked” the potential for liability, although in many cases a D&O policy wouldn’t respond unless cover was specifically endorsed to include Brexit-related problems.

Turk is unconvinced that added to the headaches created by Brexit, directors need have too great a fear of resulting claims. “It’s more of a systemic issue and companies can rightly complain they haven’t been given the clarity needed to manage the risk effectively,” she suggests.

Instead, she sees two other areas with particular potential for future D&O claims to develop. The first is against firms with exposure to cryptocurrency and virtual currency dealing or trading – including initial coin offerings (ICOs); the second is companies that lag their peers when measured on environmental, social and governance (ESG) criteria.
“BlackRock’s chief Larry Fink wrote in his annual open letter to CEOs this year on the importance of taking a long-term view, their responsibilities to investors and the group’s intention to focus on companies that score well on ESG,” says Turk. “It’s an attitude likely to be increasingly taken up by other major investment groups.”

Toughening up

Another noticeable trend in the D&O liability market this year is that rates are hardening, with increases of between 10 per cent and 20 per cent both here and in the US.
“The past decade since the global financial crisis has been one of increasingly benign market conditions, with differentiation focused more around wordings than pricing,” says Eleni Petros, senior management liability specialist for Marsh.

“Companies have benefited from an extremely broad policy form with extensive cover for costs incurred in investigations and even extending to some fines and penalties where the director’s act isn’t deemed to be criminal.”

Two court decisions in the opening weeks of 2019 quashed any remaining hopes that the soft market might continue. The Superior Court of California approved a US$29 million settlement in consolidated derivative litigation brought against Yahoo’s directors and officers for breach of fiduciary duty, following two data breaches compromising sensitive information of over one billion of the site’s users. Meanwhile, credit reporting agency Equifax continues to face a slew of claims and regulatory actions over its own major data reach that exposed the personal information of customers to hackers.

“Renewals have seen rate hikes, higher deductibles and a combination of both in many cases,” says Petros. “While underwriters have usually maintained cover, there’s now a marked reluctance to provide extensions.” Pharmaceutical companies and biotechs are particularly exposed to the hardening market, as are chemical, healthcare and life sciences companies. Firms planning an initial public offering are also starting to find it harder to get cover.

Petros reports that in the D&O primary market, Lloyd’s syndicates have reviewed their involvement in the class and a couple opted to pull out. While other traditional primary players such as AIG remain a major presence, they have also assessed their books of business and sometimes trimmed them back.

“UK D&O claims have increased both in frequency and size over the past four or five years, with no sign of either reducing,” confirms Adrian Jenner, head of D&O at insurer Zurich. “Undoubtedly, in a more global environment and with increased regulatory pressures, directors and their companies have been facing greater scrutiny, often calling for legal costs and representation from their D&O cover providers.

“With many law firms charging four-digit fees per hour for this kind of representation, even without any fine or penalty being awarded, legal costs can quickly add up to huge sums of money.

Also on UK underwriters’ radars are current proposals for strengthening the powers of the UK’s Competition and Markets Authority (CMA), with the potential for disqualifications of directors who breach consumer laws.

“Undoubtedly the greater powers will lead to more investigation and, therefore, potential prosecutions,” says Jenner. “The D&O policy will respond to the individual directors’ need for representation and defence whether they be indemnified for such costs by their company or not.”

Add to this charges that the collapse of construction group Carillion in early 2018 was avoidable, had warning signs been picked up and acted on earlier. Mark Sutton, a partner at law firm Clyde & Co, reports a noticeable upturn in regulatory activity over the year since the collapse, with regulators adopting a more preventative approach and opening investigations at an earlier stage. “Regulators in different jurisdictions are working more in unison, particularly if any criminal activity is suspected,” he reports. “The Serious Fraud Office (SFO) has been asked to participate in international investigations, including the bribery and corruption probe into Roll-Royce, which was one of the biggest deferred prosecution agreements (DPAs) to date.”

The SFO announced last month that it wouldn’t pursue its long-running investigation further. Sutton notes that a probe into collapsed stockbroker Beaufort Securities saw the Financial Conduct Authority (FCA) work with German and Danish regulators to investigate alleged money laundering – a further example of the globalisation of investigations.

Militant shareholders

Focusing on potential new sources of D&O claims shouldn’t overlook the fact that more familiar ones are still experiencing plenty of activity. “Shareholder class actions – or collective redress – are on the rise in Europe, with a number of converging factors behind the trend,” reports Stephanie Manson, head of commercial institutions, UK, financial lines at AIG. “This includes the rise of shareholder associations and shareholders, working alongside litigation funders, using group litigation orders as a mechanism for shareholder redress.

“While Europe has no direct equivalent to the US class action framework, several European jurisdictions have similar mechanisms in place, with a number of high-profile shareholder class actions currently working their way through the European courts. The progress of these cases is being watched closely and depending on their outcome it could pave the way for similar shareholder actions to be brought in future.”

Yet despite the steady increase in claims activity the D&O market has yet to see any material reduction in capacity. Depending on the insurer, liability limits of between £5m and £25m are available and the ability to build towers of primary and excess layers to increase this capacity is still available for most UK companies.

This article was published in the March-April 2019 issue of CIR Magazine.

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