The roles of Directors and Officers (D&O) within companies are increasingly being scrutinised and further liabilities and responsibilities are being identified. Recent regimes, regulations and statutes have focused on:
- The role of Senior Managers within financial institutions.
- The making of compensation orders pursuant to the Small Business, Enterprise and Employment Act 2015.
This Briefing discusses these new developments and what they mean for the individuals who may be the subject of scrutiny, and the insurers who underwrite D&O coverages.
The Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA) are proposing changes to the regulatory regime for senior bankers in the UK in order to "make individual responsibility in banking a reality" in the words of the report of the Parliamentary Commission on Banking Standards whose recommendations formed the basis of the new regime. This included:
- The role of the behaviour and culture within banks and its effect on the 2008-09 financial crisis.
- The PPI mis-selling scandal.
- The manipulation of LIBOR.
- Failings in respect of the spot foreign exchange market.
The statutory and regulatory framework in place had been inadequate. It did not clearly provide for individual accountability and consequently public trust was lost in the banking system and its regulation. Initially, the Parliamentary Commission on Banking Standards recommended making amendments to the Financial Services and Markets Act 2000. This was effected through the Financial Services (Banking Reform) Act 2013 which introduced structural reform of the banking industry and measures aiming to increase the capacity of banks to absorb losses. The new Senior Managers Regime is the next step in the new regime.
In July 2014, the PRA and FCA published joint consultation paper CP14/14, which proposed the following changes:
- A new Senior Managers Regime (SMR) for the most senior people working in banks.
- A Certification Regime that applies to a larger number of individuals who could potentially harm the firm or its customers.
- New Conduct Rules, divided between those which apply to all non-ancillary staff and those which apply only to senior managers.
This Briefing focuses on the SMR.
The proposals apply to UK-incorporated banks and investment banks. HM Treasury may also expand the scope of the regime to non-UK-incorporated banks and investment banks.
SMR – principal changes
- Chairmen and non-executive directors (NEDs) will be included as “Senior Management Functions” (SMFs): the SMR amends the current FCA Approved Persons Regime and intends to focus accountability on a smaller number of senior individuals in a bank. This means that not all of those currently holding a “Significant Influence Function” are expected to be SMFs under the SMR. This change will cause those with SMFs to be explicitly held to account for boardroom decisions and held culpable for any poor decisions.
- “Prescribed Responsibilities” will be introduced: firms will need to allocate clear lists of responsibilities to the most senior individuals performing SMFs. This list must reflect the responsibilities outlined in the FCA Handbook and PRA Rules and will be tailored to the governance structure of each firm. Once prepared, “Statements of Responsibilities” will need to be provided to the FCA and PRA as part of any application for approval. When jobs change, senior managers must formally hand over their “Statement of Responsibilities”.
- A “Management Responsibilities Map” will be introduced: both the PRA and FCA will need to map the responsibilities and reporting structures within each firm in a single document called the “Management Responsibilities Map”. This will include showing how the “Statements of Responsibilities” have been allocated. The measure is designed to highlight where areas of responsibility are shared, missing or unclear. Each firm’s board must provide annual confirmation to the regulators that there are no gaps in the allocation of responsibilities within the firm.
- Reversal of burden of proof: until now, a regulatory breach by a firm only implied misconduct by an individual if the individual was “knowingly concerned” or in breach of statements of principle for approved persons. The new SMR changes this position radically. Now, if a breach occurs in an area for which a particular senior person is responsible, that person is guilty of misconduct unless he can show he took reasonable steps to avoid the breach. The burden of proof will therefore be reversed and fall upon the senior manager to show his innocence. Thus, it will be vital for senior mangers to ensure appropriate systems and controls are in place, such as appropriate reporting lines and management information arrangements.
- Duty to notify the regulator if disciplinary action occurs: firms must notify the regulator if it takes disciplinary action against a senior person, so that the regulator can decide whether it should also take action against that person. “Disciplinary action” includes issuing a formal written warning, suspending or dismissing the senior individual or recovering any of their remuneration.
- Annual review: firms will be required to formally review, at least once a year, whether there are any grounds on which the PRA or FCA could withdraw its approval of a senior person. If it believes there might be such grounds, it must notify the regulator.
- Extended time limits for disciplinary action from three to six years: the time limit for disciplinary action by the PRA or FCA where a person commits misconduct or carries out his functions without obtaining the required approval from the relevant regulator has been extended from three years to six years. This date runs from the date upon which the regulator first knew of the misconduct, or the date the person began performing the relevant functions.
- “Group Entity Senior Manager” will be introduced: this will be introduced to bring those employed by a parent, group or holding company that exercises significant influence over activities in the UK into the scope of the regime. This is the case whether the parent company is based in the UK or overseas.
As stated above, the FCA and PRA issued their consultation paper CP14/14 in July 2014. They stated that they would consider feedback on responses received to this paper.
On 16 March 2015, the FCA and PRA published consultation paper CP15/9, in which they set out their policy intentions as a result of the feedback received.
HM Treasury has announced that the new regime will need to come into force by 7 March 2016. The FCA and PRA therefore plan to publish final rules in either the late spring or summer of 2015.
In the meantime, the FCA invites firms to provide comments on its proposals by 16 June 2015 using their online response form at http://www.fca.org.uk/your-fca/documents/consultation-papers/cp15-09-response-form.
What does this then mean for D&O insurers?
- The Prescribed Responsibilities and the Management Responsibilities Map will give insurers a far more detailed overview of the activities of certain directors and officers.
- The reversal of the burden of proof is likely to lead to a considerable increase in legal costs given that the director is required to prove his innocence where a prima facie breach occurs in an area for which that individual was responsible.
- The time limits for disciplinary actions has been doubled from three to six years.