As the scope of this publication shows, the flow of litigation involving financial institutions and their senior managers shows no sign of abating. It is also clear that, for the foreseeable future, the financial sector will continue to be the subject of intense regulatory scrutiny. In such an environment, the availability of insurance to meet liabilities as they arise takes on greater significance. For a financial institution faced with mis-selling claims as in Graiseley Properties v Barclays Bank  EWHC 67 (Comm), or with the possibility of a lengthy and expensive regulatory investigation, it will be important to know which liabilities and costs insurers will meet.
As a result of the Court of Appeal’s judgment in Graiseley, the claimants in that case may now introduce new allegations of deceit relating to the manipulation of LIBOR. This potentially raises questions as to what senior management may have known at the relevant time, with the defendant now facing claims based on dishonesty, as well as non-fraudulent misrepresentation. If this provides a template for future LIBOR-related claims against financial institutions and their directors, will their liabilities be covered?
From the financial institution’s point of view, its professional indemnity (“PI”) insurance policy is the policy which is most likely to meet liabilities connected with the sale of products linked to LIBOR. Typically, this type of policy provides cover for claims made against the insured arising out of any “Wrongful Act”, meaning (in summary) any error in the performance of the professional services which it provides. However, while liabilities of this type may appear to fall within the scope of PI policies, a number of market standard exclusions may be relevant. Most obviously, PI policies often exclude cover for losses on account of claims for acts of “market abuse”. The usual exclusion for dishonest or fraudulent acts may also apply to preclude cover.
From the directors’ point of view, the financial institution’s directors & officers (“D&O”) insurance policy is most likely to respond, whether it indemnifies the insured director (Side A) or reimburses the financial institution (Side B). If the scale of LIBOR mis-selling claims is such that the financial institution’s share price falls, derivative claims against its directors are possible. In this situation, the financial institution’s D&O policy may provide cover to directors for their liabilities and defence costs, which are generally advanced pending final resolution of the claim. Likewise, individual directors may be the target of other civil (or even criminal) claims – although cover will be withdrawn if fraud is established, at which point defence costs which have been advanced will become repayable.
Financial intermediary liability
In Forsta AP-Fonden v Bank of New York Mellon  EWHC 3127 (Comm), the Bank of New York Mellon (“BONY”) was found to have failed to inform Forsta AP-Fonden (“Forsta”) that there was a serious risk of loss associated with securities for which it acted as custodian. This failure to inform was found to constitute a negligent misrepresentation, as well as a breach of its contractual and common law duty of care. On this basis, BONY was held liable to Forsta for its losses resulting from the decline in value of the securities. Although the outcome was different in Torre Asset Funding v RBS  EWHC 2670 (Ch), the basis for Torre Asset Funding Limited’s (“Torre”) claim was similar to Forsta, being the alleged failure of the agent, Royal Bank of Scotland Plc (“RBS”), to inform Torre of discussions constituting an event of default. Such failure was said to constitute a breach of RBS’s contractual duties as agent.
While coverage would depend on the wording of the policy, liabilities of the type incurred by BONY and RBS (as regards defence costs) would most naturally fall to be considered under a FI’s PI policy. This is because breaches of duty of the type alleged in both cases would be likely to fall within the definition of Wrongful Act, as summarised above. However, cover might be denied if there is an exclusion for losses arising from a breach of duty that exists solely under contract. In certain circumstances, the application of this common exclusion can be the subject of debate concerning the basis of the insured financial institution’s liability. While the position in Torre would seem more clear-cut in terms of the likely policy response, given the Court’s findings in relation to breach of duty, it may not be the same in all cases. Though not a case of financial intermediary liability, the same argument may also arise on facts similar to those in Green & Rowley v Royal Bank of Scotland Plc  EWCA Civ 1197 where, in a mis-selling context, the Court of Appeal confirmed that a common law duty of care did not arise concurrently with RBS’s obligations under s.138D of FSMA.
And what of those mis-selling claims where the financial institution is sued for recommending an investment on which a loss is then incurred? In such cases, an interesting question can arise – do representations as to the risk of the investment amount to an express guarantee or warranty of its performance? For example, the original pleading in Al Suleiman v Credit Suisse Securities (Europe) Limited  EWHC 400 (Comm) featured a claim based on an alleged representation that the notes in question involved “very little risk”. Although this allegation had been abandoned by the time of trial, losses connected with representations of this type are generally excluded under PI policies arranged for financial institutions.
Notwithstanding Rubenstein v HSBC Bank  EWCA Civ 1184, in many cases losses arising from the global financial crisis are too remote to be recoverable (see Camerata Property Inc v Credit Suisse Securities (Europe) Ltd  EWHC 7 (Comm)).
However, where the defence is successful, legal costs may not, in fact, be covered under the financial institution’s PI policy. This is a topical issue in insurance law circles following the Court of Appeal’s decision inAstraZeneca Insurance Company Ltd v (1) XL Insurance (Bermuda) Ltd & (2) ACE Bermuda Insurance Ltd EWCA Civ 1660. In that case, the Court of Appeal confirmed that, because of the way in which the policy had been drafted, the policyholder could not recover its costs of successfully defending the claim, even though costs would have been recoverable if liability had been established. Following this decision, financial institutions would therefore be well-advised to review their PI policy wordings in order to avoid any possibility of what is, in the Court of Appeal’s words, a “surprising” and “profoundly unsatisfactory” outcome.
Investigation costs, fines & penalties
It is well-known that legal costs associated with regulatory investigations can be, and often are, very significant.
For the financial institution, costs relating to an investigation into its affairs may be covered under its PI policy, possibly via an extension. However, the scope of such cover does not generally extend to financial industry reviews and may also not include the cost of engaging a skilled person to produce a report under Section 166 of FMSA. Particular attention should also be paid to the definition of “Investigation Costs”, or the equivalent term used in the policy, which may be ambiguous as to whether certain advisory costs are covered. For financial institutions calculating their exposure to regulatory examination as a result of LIBOR fixing allegations, the limitations of their insurance cover for such costs will need to be considered carefully. As for fines and penalties which may be imposed by a regulator, these are unlikely to be indemnifiable as a matter of English law and are likely to be excluded by the policy in any event. The same applies for financial institutions which are investigated for bribery – note that claims relating to profit to which the financial institution is not entitled are commonly excluded.
For directors requiring representation, perhaps in relation to a LIBOR regulatory investigation, their costs are likely to be met by the financial institution’s D&O policy. In connection with the scope of this indemnity, the same considerations arise as are discussed above in relation to the civil liability of directors for LIBOR-related mis-selling, as well as fines and penalties.
The circumstances of the loss and the wording of the policy will always be key. PI and D&O policies are the types of policy most likely to be relevant to cases arising out of the global financial crisis, but it is also worth considering the scope of cover under other types of policy, such as Bankers Blanket Bond, which provides cover for a financial institution’s own (‘first party’) losses. It is also clear that, while the liability of financial institutions for losses incurred by clients and other third parties may fall within the scope of PI and D&O policies, the scope and operation of exclusions will be critical.