To protect and serve

Who would be a director of a company? Gone are the days of afternoon golf, long boozy board lunches and innumerable perks. Recent changes to the Companies Act have broadened their responsibilities while successive corporate governance reports by Cadbury, Greenbury and, most recently, Higgs, have increased the need for compliance.

Meanwhile a series of high-profile events from the scandals surrounding the collapse of Enron and WorldCom to the shareholders’ revolt over remuneration for the GlaxoSmithKline board have presaged a new era of litigious behaviour. People and corporations are now prepared to act against directors who are perceived to have failed in their duties.

As a result directors are now exposed to greater personal risk than at any time since the first major joint stock company, the Muscovy Company, was founded in London in the mid-16th century. Anyone who is a company director or manager has to be aware of the threats they now face and plan accordingly. That involves putting risk management and business continuity procedures in place. It also involves getting directors’ and officers’ insurance cover sorted out urgently.

Ian McCallum, director of Marsh, the world’s leading provider of risk management and insurance services, points out that board members must consider not only the weight of their fiduciary duties but also their statutory obligations. For example, there are over 200 offences under the Companies Act and other legislation such as the Health & Safety for which they can personally be held liable.

The recent UK government white paper on company law, hailed as the most far-reaching reform of corporate law since the dawn of the industrial revolution, recommends that directors’ duties be fully codified. The paper covers issues such as directors’ propriety of conduct and standard of skill and care, and it suggests imposing substantially higher degrees of responsibility to ensure that they act in the best interests of shareholders. It is proposed that directors will also owe the auditors a duty to volunteer information that they think the auditor may need. According to Patricia Hewitt, Secretary of State for Trade and Industry, directors who mislead auditors may face up to two years in prison and unlimited fines.

Worryingly, a recent report from the Institute of Directors found that even in this increasingly hostile climate 45% of respondents said they were “not especially” or “not at all” familiar with their directors’ and officers’ insurance policy.

Indeed it has been calculated that of the 6,000 non-executive and executive directors of UK plcs, as many as 5,000 have inadequate protection in the event of being sued by shareholders.

Put simply, directors’ and officers’ liability provides financial protection for any director or employee acting in a managerial capacity in the event of their being sued in relation to the performance of their duties as they relate to the company.

It is not new – Lloyds of London has been underwriting the cover since the 1930s – but it has come to prominence in recent years as the business climate has become more litigious. McCallum confirms this trend: “People will now sue whereas 30 years ago they wouldn’t bother. These days all lawyers will name the company and all the directors as a matter of course.”

The policy is an umbrella policy that should cover everyone in the company. An officer is deemed to be anyone in a managerial or supervisory capacity – and that could include the person who signs for deliveries at the factory gate.

Cost of cover is increasing but only the very brave or foolhardy would do without in the current environment.

As the shockwaves from the collapse of Enron continue to reverberate in boardrooms across the world, the cautionary tale of Lord Wakeham serves to highlight the need for companies to ensure that they have adequate D&O cover in place.

The former Tory Energy Minister joined the board of Enron in 1994 when it was a highly successful energy trading company. However, after it was revealed in November 2001 that the company had overstated its earnings by $586 million, the company collapsed.

A class action was brought by 430 former Enron staff, seeking to recover hundreds of millions of dollars lost from their pension funds. With claims against Enron and its directors estimated at some tens of billions of dollars the US Senate’s committee for investigations censured Lord Wakeham and his fellow directors, leaving them open to potentially ruinous actions by former employees and other stakeholders.

Acccording to the committee report: “Much that was wrong with Enron was known to the board, from high risk accountancy practices and inappropriate conflict of interest transactions to excessive undisclosed off-the-books activity and excessive executive compensation.”

Lord Wakeham was named personally in the staff class action. It is understood that up to 60% of pension funds were invested in Enron shares. Also named were Kenneth Lay, former chairman and Jeff Skilling, the former chief executive. They are alleged to have broken their fiduciary duty to employees investing in company-sponsored pension schemes, and also to have broken rules governing the manner in which accounts were set up and managed.

According to Randy McClanahan, the chief attorney for former Enron employees, any defendant found liable will theoretically be liable to the extent of his or her personal wealth.

The problem is that the claims will be far in excess of Enron’s $435 million insurance cover, which apparently included directors’ and officers’ insurance of $350 million and a separate policy of $85 million covering breaches of fiduciary duty connected to employees’ pension funds.

Marsh’s McCallum points out that: “In cases where fraud is alleged the D&O insurance can pay for a director’s defence costs but only until such times as he is found culpable”. However he adds that insurers will seek to recover defence costs already paid out if the director is found guilty.

Normally in major cases like these the claimants will settle out of court for the maximum settlement available under the defendant’s policy cover. Currently a major corporation would have around £200 million of D&O cover in place with an oil company perhaps having double that amount of cover. Altogether it is estimated that there are now more than 1,200 cases against companies in the US alleging negligence or fraud. Settlements average between $20m and $30m and premiums have risen by around 400% in the past year.

Earlier this year giant insurer AIG took a $1.8 billion charge against its accounts, a third of which was to boost reserves for policies for directors. Claims related to everything from ill-conceived acquisitions policy to insider trading.

However the case of Lord Wakeham is far from unique. Colin Marshall, former chief executive of British Airways, was pursued personally by lawyers for Virgin Atlantic in the aftermath of the so-called Dirty Tricks campaign that Marshall was alleged to have waged against Richard Branson’s airline. Directors of Townsend-Thoresen were named in legal actions brought by survivors, and families of victims, of the Herald of Free Enterprise ferry disaster in the English Channel.

Equitable Life and Marconi are currently facing legal action from policyholders and shareholders in the UK while both Vodafone and Cable & Wireless are embroiled in lawsuits from shareholder action groups in the US.

Several UK investment institutions have joined the class action against Cable & Wireless, its auditors and directors, which is seeking up to $3 billion in damages. The lawsuit alleges that the telecom group made false statements by failing to disclose a potential tax liability of £1.5 billion arising from the sale of its stake in mobile operator One2One.

But it is not only directors of major international corporations that are in the firing line. Any company with directors could be affected. Marsh’s McCallum relates the chilling story of a small UK engineering firm which was visited by health and safety inspectors. During a tour of the factory floor they pointed out that a safety shield missing from a guillotine machine should be replaced. The company was given 40 days to comply. However an employee got caught in the machine and died before the shield was installed.

The company was hit on three counts: an employers’ liability claim for the death of the employee; a fine from the Health & Safety Executive for failure to heed the notice served on it; and a criminal prosecution against the director whose responsibilities included health and safety in the workplace. The action was raised by the dependants of the man who died.

McCallum concludes that any company with shareholders, an international exposure, or a presence in the US should take out D&O cover while everyone else should consider it: “Worryingly, many still have a firmly held conviction that they are not exposed”.

The case for protection is straightforward: companies are bodies with limited liability whereas company directors and officers are not. Directors cannot avoid their responsibilities.