Taking part were Martin Beagley, executive director global finance and executive risks practice at broker Willis; Mark Butterworth, chairman of the UK risk management association, AIRMIC; Jane Hobson, a partner in Baker & McKenzie; Kenneth McKenzie, a partner in Davies Arnold Cooper; Peter Taylor, a partner in Lovells and Owen Tudor, senior policy officer of the Trades Union Congress (TUC). The lunch took place at the Baltic Exchange in the City of London and the moderator was Lee Coppack.
To begin, Lee Coppack asked the guests to explain their interest in relation to directors' responsibilities and liabilities.
Peter Taylor: I am a partner in Lovells in the insurance and reinsurance group. I now do pretty well all reinsurance work. It is a mixture of contentious and non-contentious. The non-contentious work tends to be unravelling messy situations, so you could say it has a contentious bent, things like pools, agencies, and so on, at which point the issue of D&O responsibility or professional negligence, generally, may well come in
The other main concentration is on reinsurance coverage, so for me one of the issues is whether a director or an officer is an event, an occurrence or merely part of one of those things. In other words is it basically a primary insurer's problem or how far does it penetrate into the reinsurance. So I come at it slightly once removed at a reinsurance level.
Martin Beagley: I work for Willis. I am an executive director in the professional liability side, primarily looking after directors' and officers' liability insurance but also other areas that spin off from that, namely warranty and indemnity insurance which we are increasingly getting work on. We also do employment practice liability which, again, is something I think we will see a lot more of, and pension fund trustees coverage, as well.
Jane Hobson: I have been at Baker & McKenzie for five years in the corporate department, so my work is exclusively non-contentious. I advise on mergers and acquisitions, mainly for private companies although I have, in the past, advised public companies, including drafting prospectus and the duties of directors in that arena. I also advise directors generally on their duties, and I am a member of our insolvency practice group, where we advise directors of their duties where a company looks like it is about to or has actually gone into insolvent liquidation.
Mark Butterworth: I am here in my capacity as chairman of the Association of Insurance and Risk Managers (AIRMIC), which is the UK's leading risk managers' association. AIRMIC has been particularly interested in corporate governance developments in the last few years and contributed to the Turnbull2 consultation process. Indeed, we had a close working relationship with Nigel Turnbull in the latter stages of the guidelines he produced.
We are obviously interested in how corporate governance and the expectations of shareholders and, indeed, the obligations on shareholders will translate into directors' obligations and liabilities in the future. As we start to see directors go public on what they are doing in corporate governance matters, it is going to be interesting to see how the risk landscape changes.
My day job, if you will, is with Prudential, and one of the other areas that I am particularly interested in is the Financial Services Authority's (FSA) changing stance on obligations of senior managers and particularly consultation paper 35, making very clear that senior executives of regulated entities are going to be focussed upon for good risk management and corporate governance in their organisations.
Kenneth McKenzie: I am a partner in Davies Arnold Cooper's reinsurance, professional indemnity, directors' and officers' group. I have been involved in D&O cases on a fairly regular basis for ten or more years now, both from a contentious point of view and occasionally on an advisory basis, I act for a lot of D&O underwriters in the Lloyd's and London market. In the last 18 months, I have been involved in D&O matters in, among other places, Africa, the Channel Islands and most recently as part of the team in the Banesto case which concluded a couple of weeks ago in Spain.
Owen Tudor: I am senior policy officer at the Trades Union Congress (TUC), mostly responsible for prevention, rehabilitation and compensation. I am a member of the Health and Safety Commission and also of the government's Industrial Injuries Advisory Council and the Civil Justice Council that deals with all aspects of civil law, so I have a particular interest in corporate responsibility, partly because this is going to be a key issue when the government issues its response to the revitalising health and safety strategy statement.
My interest is mostly in corporate responsibility in terms of health and safety but as a TUC bureaucrat - I have been there about 15 years - corporate responsibility is fairly high on our agenda anyway.
Lee Coppack: Would you all say that the general climate means that directors' personal accountability will be increasing? And if so, is it a quantum leap or more gradual?
Martin Beagley: It seems to me that what pushes it in the United States is the contingency fee system. I think six or seven law firms brought 60% of the claims a couple of years ago and one law firm brought 30% - something along those lines. It is a whole industry there to sue directors. Fortunately, we have not got that here. Until, I suppose, the lawyers think there is money to be made out of this, claims will be few.
Kenneth McKenzie: It is partly the contingency fees and partly the class action system in the US which permits shareholders to act in a way which is not, fortunately or not, depending on your viewpoint, permissible here, so much so that D&O insurance there is part of the corporate armoury. If you are a director, you do not go out and do your daily job unless you have D&O insurance. I am led to believe that loss ratios there are at the high end of the 90s, as opposed to probably single figures here.
Peter Taylor: Forum shopping opportunities is the other thing that drives the US. I think we may get that within Europe, because the attitude toward directors' responsibilities in certain of the European countries is very different from here. You get a lot of jealousy. Directors of companies - well, they ought to pay. There is a lot of that, particularly in France. There is an attitude and if that translates through to the judiciary, you have got a problem.
The way it works in the US is that you get some state court judge and a local jury. I think we are going to see more of that, certainly in the further flung bits of Europe. I include France in that description of far flung bits. The commercial court there is very much a layman's tribunal. They are not trained lawyers as judges. They are taken from the local chamber of commerce. If they think somebody is falling below their standards, then they are quite liable to come down against him.
Owen Tudor: If you look at the corporate governance documents, the combined code and Turnbull, I think there is clearly a greater expectation on the personal accountability of directors. Certain matters are reserved for the board only and cannot be delegated. That is an indicator that boards cannot just meet three or four times a year, give opinions out and expect the firm to be running. They have to be more hands on, meet more regularly and take personal responsibility for a number of matters, including risk management, treasury operations and so on. It is a sign that at least others expect directors to be more accountable, and I think it will develop in the future.
Peter Taylor: Is that regardless of size of company?
Owen Tudor: That is listed companies. But there are a number of non-listed companies that are following the combined code and Turnbull guidelines because they make good sense anyway.
Jane Hobson: In the DTI consultation paper on directors' reporting and accounting obligations, they consider applying similar guidelines for listed companies to non-listed companies which have, say, a £500 million turnover or more. These are the sort of companies, which even though not listed, would be expected to follow the best practice. Whether that is true, given that they are privately held ...
Peter Taylor: Why should that make a difference ?
Jane Hobson: I actually agree with that view. I think it should just be listed companies.
Owen Tudor: Owners of small companies have always been extremely accountable, anyway. The direct effect on their company of what they do is a lot clearer than if you are running a major listed company. Certainly, in health and safety terms, for instance, criminal prosecutions for manslaughter have focussed almost exclusively on people who run very, very small companies, because it is so much easier exactly to prove that direct relationship between what the director did that day and what happened to the worker the next day.
Jane Hobson: Also the proposed reporting requirements are much more relevant to listed companies, where you have a lot of shareholders not only wanting to measure performance, but also they clearly want to see reporting as a means for holding the directors responsible and checking that the directors are managing the business properly. That is just not relevant in a private company that is owned and managed by the same people.
Peter Taylor: I notice the requirement that new directors should be given training in what their obligations are. Do you think directors really do understand what their obligations are? To which shareholders - now, next year? From Owen's point of view, it is easy to say: You should not behave like this because someone is going to get injured. But you are paying directors to take a risk with your investment. How far? It is a bit like suing underwriters. The underwriter writes a bad account, so you sue him. You are paying him to take risks. He is not guaranteeing that he is going to write every one a winner.
Kenneth McKenzie: There are different kinds of risks. There is the risk that you may make a bad business decision. There is the risk that through not implementing proper safety financial, strategic or management procedures you will compromise the integrity of your company. That is the shareholders' interest, but the public at large has an interest in whether companies are able to do their business in a way that does not damage individuals, the environment, the economy generally or the community in a narrow sense either.
But whether that is an insurable issue is a far more difficult question. I was going to ask Martin from a broker's perspective whether he has seen a change in, say, the last ten years in the kind of profile of companies that purchase D&O insurance.
Certainly the ones that I come across most are either very large companies or financial institutions, and I do not know if there is any reason for that or whether it is just because they are the biggest and richest.
Martin Beagley: Probably about ten years ago, all the public companies (PLCs) that had US exposure, not just shareholders but subsidiary companies in the US, would buy the cover. Then gradually it broadened out to most PLCs. Probably 80 or 90% of the FT 500 now buy the cover. So do a lot of smaller limited companies. They can get £1 million for less than £1000 for a very small limited company. Why not do it? It just gives you peace of mind. It is not just companies but organisations, like charities, that are buying the cover.
I think also directors are now looking for the indemnity from the company, as well as the D&O liability insurance. Probably the best form of financial resource, in most large companies, is going to be the indemnity from the company. You are the legal types. Is that changing in the Companies Act? The main holding company directors cannot agree to indemnify themselves. Everyone else is indemnified, so their interest is in the D&O cover. The subsidiary company senior executives are protected by the indemnity, so it is an anomaly there, I think.
Peter Taylor: It is obviously an anomaly that a company can authorise the purchase of D&O insurance at an enormous premium, potentially, but not give the indemnity themselves.
Martin Beagley: To the main board.
Peter Taylor: Presumably it a policy decision to take it out of the company.
Jane Hobson: That issue was touched upon in the DTI consultation paper. It recognises that D&O is an alternative and it is expected that companies will put D&O in place.
Martin Beagley: With the indemnity, you have all the problems with aggregate limits, inadequate limits, eroded amounts, past directors, continuity of cover in the future. It has still got problems, and I am seeing directors looking in more detail at the indemnity and then if there is insurance behind it, that is good, too.
Kenneth McKenzie: Even so, insurance can give broader indemnity than a company would be able to, because the company is very proscribed in the extent to which it can indemnify an errant director. That is why D&O was founded, in a way.
Lee Coppack: Is there still any public interest argument about D&O? Owen, what about in terms of your interests?
Owen Tudor: I know there are worries inside the insurance industry as well as outside that whatever insurance products are levered in, they are in direct competition with the concept of personal responsibility. Various people treat insurance differently, and very often it is an individual matter. But there are arguments that the more insurable a circumstance is, the less personal responsibility we are going to exercise. I do not think it is quite as easy as that, but that is a concern. One of the responses to the growth of insurance products going on is people are looking for different ways of introducing corporate responsibility. There is then a sort of leapfrogging approach.
Kenneth McKenzie: Are you looking for accountability as an end in itself or the compensation as being the end suitable for people who are damaged by corporations or...
Owen Tudor: My concern is prevention and the encouragement to prevention that any system of accountability presents. However, one of the problems we have got at the moment in the debate about corporate accountability is that there is no consensus about what it is for. There is a whole set of people who have various different reasons for wanting to increase corporate accountability; sometimes I think they are almost mutually exclusive.
Peter Taylor: Can I just introduce a slightly counter-intuitive side to what you just said. In my experience, companies and their directors and officers tend to analyse what they have done and what is likely to come down the track at them much faster than they would necessarily otherwise do when they have annual renewal of their D&O policy, because they have to declare the circumstances. They know that if there is something in their corporate records which should have been declared and they go to buy insurance the next year, that insurance is not going to pay and the old insurance is going to be excluded.
Owen Tudor: I do not think it is even that rational. There is, indeed, a position where sometimes the very existence of the insurance encourages people to do things they would not otherwise do were that not insurable, to make sure they do not have to take out that insurance.
Kenneth McKenzie: You must get this problem in terms of trying to identify somebody in the company. Where does the responsibility fall? You do not yet have the professional risk manager in the same way as you do in the US.
Mark Butterworth: That is my opportunity to disagree, isn't it? If you look at today's Financial Times supplement in the mastering series on risk, there is an article in there about the growth of the role of the risk managers. In the US, there are a growing number of chief risk officers. In the UK, we have certainly not got to that point where we have the risk manager on the board. In fact, the corporate governance regimes are silent on this particular point, interestingly. They say the board must attend to risk management matters or risk management matters are reserved to the board, and yet they have not expressed an opinion whether a chief risk officer is appropriate for an every board of x size company. I think it is horses for courses, here.
Peter Taylor: Do you find they turn to you, Martin? I have certainly had people say: We do not have a risk manager but we have a report annually from our broker.
Martin Beagley: We tend to deal with the major PLCs, almost all of whom will have a risk manager. Where he reports to is a different thing. Some report to the company secretary, some to the finance director.
Mark Butterworth: AIRMIC has carried out surveys on the reporting lines of its membership and the majority report to the corporate or group finance director, then treasury, company secretary, even engineering directors and a sprinkling of other types. It is due to the fact that risk, insurance and losses are all associated with financial consequences.
Here, we are moving towards directors' responsibilities. Sure, there are financial consequences, but it goes one step beyond that to losses of reputation, position, earning power for the future and so on. A lot of risk managers, while they may report to the finance director or treasurer, actually work closely with the head of legal services/company secretarial on this particular issue. This must be a collaborative exercise.
Owen Tudor: Does it not depend to a certain extent whether the company sees its risk management policy as a question of compliance with legal requirements, which obviously drives you down the road of looking to the company secretary or legal director.
Or whether you fall into the committed camp where you are trying to avoid those risks because it is a good idea to avoid those risks, in which as you say, they report to the finance director because very often risk is anticipated merely in terms of its financial consequences.
Mark Butterworth: Many company secretaries actually do see themselves as a major risk management player in the organisation and advise and brief directors.
Owen Tudor: Controlling the risks of having those directors...
Butterworth: ...non-executives as well, making sure they are properly briefed, producing directors' handbooks and training, facilitating external advice.
Lee Coppack: To what extent do the increasing responsibilities, whether coming from UK law, EU law, corporate governance, translate into legal liabilities for directors, whether civil or under statutory code? Do we expect to see more actions against directors?
Owen Tudor: Yes. There simply will be. In terms of health and safety, for instance, it cannot have been more than five or six years ago there had been no actions against directions whatsoever. In other words, anything that has happened since about 1995 has been entirely new ground. That is set to continue strongly. That was under a quite libertarian, Conservative administration. In the current administration, although some bits are libertarian, if you look at people like the Department of the Environment, then there is undoubtedly going to be increased pressure.
One of the things ministers are currently considering is having named directors to deal with health and safety. Whether that spreads into having named directors dealing with other things, I do not know. One thing which interests me is the problem with identifying a person as being responsible for risks that very often result from the decisions of other people within the structure.
Peter Taylor: I was reviewing a health and safety policy for a Japanese company which identified the individual right the way down to the third line manager, the individual who had responsibility for that aspect.
It would be a nightmare to keep the thing up to date in a huge company. You get it wrong. A claim arises because somebody has been negligent somewhere - and you have given to the claimant lawyer on a plate the fact that not only have you committed this ghastly accident, but that you have not got your health and safety policy up to date, and you have documented that fact.
Looking at Turnbull as a litigator primarily, I thought: There is not a litigator on this committee, because what you have required the company to do is to draft the points of claim for the claimant's lawyer. You have identified what the weaknesses and failings are within the company. You can imagine coming across the sort of memo that is required by Hampel and Turnbull. You say: where do I go with that as a defence attorney?
Kenneth McKenzie: Thinking about the point about the Japanese designated individual with whom the buck stops effectively, as I understand it under the current law here, that is what you need to establish corporate manslaughter.
Owen Tudor: You have to demonstrate a controlling mind.
Kenneth McKenzie: There has to be an individual, as well as the company. The Law Commission in 1996, the recommendations of which still have not been implemented, was saying: Why can we not just point to a failure in management rather than an individual failing. I do not know how that ties in with your feeling that it is a matter of public policy, perhaps as a matter of personal legal accountability, too.
There is no financial incentive, is there? The D&O policy almost inevitably excludes personal injury claims. What it will do is give the director in question cover for defending those cases a claim brought against him personally, be it on a criminal charge - although that is not invariable, but depends on the policy - transgressions of company legislation or civil action by some third party. He may be covered for the expense of that, but if he is found guilty of some health and safety offence, it is unlikely that the penalty would be covered, and personal injury issues are conventionally excluded from D&O policies in any event. You are still looking for a disincentive to be created by making a person accountable if you can. Would that be right?
Owen Tudor: The criminal law is really the only avenue for doing that in reality, if you want to make absolutely clear that you have got individual responsibility in law. But there are other things. Most environmental responsibilities, for instance, are non-legal. Obviously, there is environmental legislation, but in terms of company reputation and so on, the main problem is naming and shaming, rather than any juridical system.
Lee Coppack: In what areas do you think directors' responsibilities are most likely to increase?
Jane Hobson: I do not think the trend will be as marked for shareholders to make claims. It has been made difficult for them to do it so far, and the trend is that they have not and are not making those claims. I do not envisage any change. The only area where I, as a corporate lawyer advising directors, see a concern is the scope of the information that is needed to be included in the operating and financial review (OFR) and the verification process that the directors will have to go through in order to make sure that it is accurate so that it does not lead to any misstatement claims by shareholders who have invested on the grounds of misleading information contained in the OFR.
Kenneth McKenzie: How do you feel about the pluralism debate, whether the company should remain, more or less, but on a slightly more inclusive basis, the main entity to which the directors' duty is owed?
Jane Hobson: I fall down on the non-the pluralism side. I think internal regulation is still the way forward. If directors have to look to a myriad of people to protect, they will end up at some point down the line in a direct conflict of interest. They cannot always be seen to be acting in the best interests of the company and the best interests of, say, the creditors. The directors are there to safeguard the shareholders' investment as opposed to external protectors, for example of the environment. That is my view.
Peter Taylor: In insurance, to pay a claim would be seen as your obligation to the policyholder and not to pay the claim is probably your duty to the shareholders, reputation issues apart. You have got a classic conflict.
Lee Coppack: One of the times when shareholder value is worst affected is if there is an abortive or ill judged takeover bid. Has that resulted in many claims or actions, Martin?
Martin Beagley: Not in the UK. The number of shareholder claims in the UK are just so few and far between that you can hardly count them on one hand. All the shareholder claims against PLCs resulting in any big payments are all in the US. That is still a real risk to a UK PLC where they have ADRs or a full listing in the US.
Owen Tudor: Are they from institutional investors?
Martin Beagley: They are largely driven by one man who works for a law firm which is responsible for 30% of the claims against directors in the US. As we mentioned earlier, about seven law firms bring something like 60% of the claims against directors over there. The whole thing is lawyer driven.
Kenneth McKenzie: The principle in US law is that the director owes a duty to the shareholder as well as to the company. In this country still, although the latest report is sort of nudging at the bounds of that and suggesting it might be extended in various ways, the object is the best interest of the company with the interest of a majority of the shareholders.
Owen Tudor: But surely in terms of American shareholders or British shareholders, you are talking about a different sort of market. Our experience is that if the shareholders of a major British public listed company want to do something about it what they do is they remove some of the directors.
Jane Hobson: I do not think a lot of directors get removed. It is only when the companies are extremely poorly performing that it is even considered or where new finances are to be raised and it, therefore, comes under scrutiny.
Mark Butterworth: I mentioned before the FSA's position. The consultation paper on the responsibility of directors, although it is only within the financial services business, it does pose the question whether this is setting a standard for the personal accountability of directors that might spread into wider areas.
If the FSA believes that good risk management in a company, corporate governance, will only happen if you make individuals clearly and personally responsible and it works, surely it could spread to other areas of business. I do not know if you look at this in the TUC, Owen.
Owen Tudor: It is also part of that thing that people do not remove poorly performing directors and this is why people go looking for different ways of doing it.
Peter Taylor: To remove a director you are really are declaring war. It is a very serious step. Who is going to do it? Do you start a huge boardroom battle which does not produce the result that the person wants to do something actually wanted? It becomes a circus and it does not actually resolve anything, because it can just be delayed and delayed.
Jane Hobson: Nor does it help share value. If there is a huge boardroom battle going on, it is not doing anything for shareholders.
Mark Butterworth: I think in 2001, it is going to be very interesting to see what companies put in their annual reports about compliance with the combined codes and Turnbull guidelines. A couple I can remember off the top of my head, who in their last annual report explained why they did not comply with the combined codes' requirements on non-executive directors and that they were moving toward restructuring. Laura Ashley's annual report just published, so it must be 1999, talks about the directors having the ability to seek external guidance and then notes that no director at any time during the year sought any external guidance.
Perhaps there will be changes in individual shareholder activism, not just the institutional investors, but particularly with e-commerce, day trading and so on. Individuals can call up the annual report for a company and within minutes be purchasing shares in that company on the internet. If they have relied either on specific statements or, perhaps, what is not said within the last annual report, they may get miffed if they lose money, and the internet is a way of bringing people together into a group to seek some compensation. That is why I believe the corporate governance scenario is increasing the risk profile to directors. I do not think it will be long, particularly in 2001 and beyond, before we start to see at least a few test cases.
Peter Taylor: In the US, if you want to bring a claim for a particular drug or product that has gone wrong, you just dial it up on the internet or various lawyer-driven sites and you will be given a standard pleading, which in this country is simply not available. If you want to run that sort of profile, you can go and get that from the US and adapt it to a UK pleading. I was amazed at the specificity of the publicly available pleadings against drug companies, because everything is open.
Lee Coppack: It was suggested that the amount of civil litigation against directors in the UK is minimal and that most action against them has been taken under statute, in which case they would not be able to recover fines or penalties only their defence costs under their D&O insurance. Is D&O the appropriate policy the way it is currently written?
Martin Beagley: It is against public policy to insure fines and penalties which the regulatory bodies will seek to bring. I think the D&O policy has evolved over the time to cater for the needs of directors. The D&O policy now compared is far, far broader than it was five or six years ago. Take pollution, for instance. Five or six years ago, you had an absolute pollution exclusion. Now you can get pollution covered. The market is responding to the need but they obviously cannot respond where it is against public policy or illegal to provide the cover.
Kenneth McKenzie: It has to be the right model. It varies from jurisdiction to jurisdiction, but to the extent that directors have different personal exposures in different jurisdictions, the D&O policy is the only available model that can protect them from those. As Martin says, it is getting broader and broader as the market has been getting softer and softer, and the trend for personal accountability is going to intensify that risk. There have been a number of D&O cases, not many have got out into the public domain, but it has been going on quietly. There is a need for that protection. Again, as the recent review has said, there seems to be some confusion or debate, anyway, about precisely what limited liability means. What it protects is the shareholder, the member of the company, not the director. That might be worthy of some clarification in some future legislation.
Peter Taylor: If the D&O market ever really took off, you would find me trying to sponsor a D&O mutual. The sort of directors and officers that you want to insure are going to be the sort of people you would want to insure as a club. The mutual approach, it seems to me, to be for most people the best route in D&O, rather than the high profile, PLC mega-explosion. There is such a huge difference between the real exposure. The liability may be stated in the same terms, but there are a huge number of directors out there that would be fantastic risks. There would never be a claim. But they have to have D&O cover.
Martin Beagley: Although all directors say: It is never going to happen to me. But the best directors can still be sued, and the D&O policy at the end of the day will pay for defence costs, which can be very considerable, indeed. That is largely why people are buying the cover.
Kenneth McKenzie: Not just defence costs these days. Again as the market softens, it is inquiry costs as well. The DTI come round and say: We do not actually want to ask you any very searching, serious questions, but do you mind if we just have a bit of a chat? Does the director who has a D&O policy then ring up his lawyer and say: I would like you there for this little, gentle chat I am going to have or doesn't he? It is going to cost him a lot of money to have his hand held from day one. If he does not do that, it may well be that if there is some more hostile scrutiny to which he is subjected later on, he will wish he had done it and could have claimed it back on his D&O policy at the time.