Introduction

In recent years, increasing emphasis has been placed on personal accountability in the financial services sector. Regulators have become increasingly willing to take action against senior executives in their personal capacity as well as against the institutions within which they operate.

A raft of proposed regulatory changes in the UK, which will fundamentally change the way in which individuals operating in the financial services sector are regulated, means that this trend is set to continue. These changes affect a range of individuals in financial institutions, including senior executives who will require as much protection as possible from the potential liabilities they face.

Directors’ and Officers’ liability (D&O) insurance, which indemnifies company directors and officers for certain costs and liabilities which they incur in relation to the performance of their duties, is in the process of evolving to provide additional protection.

The new regulatory landscape

‘Too many bankers, especially at the most senior levels, have operated in an environment with insufficient personal responsibility. Top bankers dodged accountability for failings on their watch by claiming ignorance or hiding behind collective decision-making … A more effective sanctions regime against individuals is essential for the restoration of trust in banking.’

Parliamentary Commission on Banking Standards (PCBS)

The recommendations made by the PCBS last year have led to proposals for a more stringent system of accountability for the senior executives of banks. Reform in this area, once it is fully implemented, will have a fundamental impact on the risks faced by those senior executives.

One consequence of the recommendations made by the PCBS is that the FCA and the PRA are now consulting on the introduction of a new senior persons regime for deposit-taking institutions. For those firms, this regime proposes to do away with the significant influence functions which currently exist as part of the Approved Persons Regime, which was heavily criticised by the PCBS. Under the new regime, senior individuals who manage (or take or participate in decisions concerning) an aspect of a bank’s affairs that involves, or might involve, a risk of serious consequences for the bank or for business or other interests in the UK will require prior regulatory approval.

An application for approval as a Senior manager will have to be accompanied by a statement of responsibilities, setting out the aspects of the affairs of the authorised person which it is intended that the senior manager will be responsible for managing in performing the function. The result of this is that the senior manager can no longer ‘hide behind the business’; he or she will be directly and personally accountable for all activity within the relevant part of the business.

If the regulator takes enforcement action against a firm, the onus will be on the relevant senior manager responsible for the area where the contraventions occurred to demonstrate that they took reasonable steps to prevent or stop the breaches. This effective reversal of the burden of proof in regulatory enforcement actions will pose an additional challenge for senior managers.

A new criminal offence of reckless misconduct in the management of a bank is another source of potential exposure for senior executives. While it seems likely that this offence will only be relevant in the most serious of situations, senior executives should be aware that a conviction could lead to an unlimited fine or a prison sentence.

While the above reforms are essentially aimed at banks, insurers should note that there is appetite for a similar regime to be introduced in their industry. The Governor of the Bank of England, Mark Carney, stated in May 2014 that ‘… alongside reforms that Parliament has asked us to make to hold senior bankers to account, we will create a similar regime for senior managers in the insurance industry.’

Increased potential liability for senior executives across a range of industries therefore seems to be an inevitability. D&O insurers will no doubt look to offer appropriately enhanced cover to protect senior executives, as far as possible, against these risks.

The evolution of D&O insurance

Senior executives will need to obtain comfort that, in the event that regulatory enforcement action is brought against them, protection is in place to ensure they do not need to fund their own defence or, as far as possible, to account for any other liabilities which they may incur. D&O insurance has a key role to play in this process.

For example, it will be imperative that D&O policies step in to provide cover where the senior executive is not being indemnified by the financial institution in question. The limits on cover in these circumstances will need to be sufficiently high to cover heavy defence costs and potentially large liability exposures. Senior executives may also look to obtain ring-fenced cover or appropriate excess cover to ensure that the protection available to them is not eroded by claims made by other insured persons in relation to the same or related policies. Demand for cover of this type is likely to grow considerably following the implementation of the proposed new regulatory regime.

The new regulatory climate means that senior executives face the very real prospect of losing their personal assets if they become involved in expensive enforcement action. Many D&O policies are evolving to cover personal expenses in these circumstances, such as mortgage payments, utility bills and even school fees, which could provide vital support to senior executives and their families. However, it is important to bear in mind that neither an indemnity nor insurance will be able to pick up the tab for some matters, such as criminal fines or regulatory penalties.

Triggers for cover under a D&O policy also need to be considered in the context of today’s regulatory climate. The new regulatory regime will require financial institutions and their senior executives to be proactive in identifying and mitigating potential breaches of regulatory obligations. These processes can involve substantial costs, for example, if individuals within a financial institution obtain legal representation to assist them with their role in an internal investigation. Senior executives will look for costs of this type to be covered by their D&O insurance. These costs will, however, be incurred before the traditional trigger of an ‘Investigation’ (usually being a formal step taken against an insured person by a regulator or similar official body) has been commenced. Insureds will therefore look for early triggers for cover and comprehensive cover for the costs incurred in relation to, for example, purely internal investigations in respect of alleged wrongdoing.

Conclusion

The risks and potential liabilities of senior executives have never been greater. However, D&O insurance will need to evolve in response to the forthcoming changes in order to fulfil its crucial role in managing board-level risks within financial institutions.