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Governance reforms have serious implications for D&O liability insurance

The UK Government has launched a wide-ranging consultation on reforms designed to modernise the country’s audit and corporate governance regime in a bid to restore confidence following a series of high-profile failures that have serious implications for directors and officers liability insurance.

Investor and public confidence in how UK businesses are governed has been undermined by large-scale company failures, such as Carillion, Thomas Cook and BHS.

The Government is looking at the impact of the Sarbanes-Oxley regime, which is seen as having improved reporting standards for listed US companies. The Sarbanes-Oxley Act came about as a direct result of the Enron/Arthur Anderson scandal and imposes harsh penalties for destroying, altering or fabricating financial records.

The UK Government’s suggested option is less burdensome than the US Sarbanes-Oxley system and aims to provide companies and shareholders greater flexibility.

One of the main suggestions would see the Financial Reporting Council replaced with the Audit, Reporting and Governance Authority (ARGA), a regulator whose objectives, governance and funding will be underpinned by legislation.

The Government’s stance is clear with Minister for Corporate Responsibility Lord Callanan stating: “Auditors and rogue directors who have been asleep at the wheel must be held accountable. So, as part of our plans, we will look to ensure the new regulator is fully equipped to take action where serious lapses have occurred.”

The increased availability of litigation funding in the UK and changes to UK insolvency laws would make it easier for investors to pursue claims against directors and officers for breaches of corporate reporting duties. ARGA will want to demonstrate that it is prepared to exercise any new powers, given the criticisms levelled at its predecessor, the Financial Reporting Council.

The costs of defending claims and responding to regulatory investigations could be substantial. Where claims and investigations occur in an insolvency context, the scope and monetary limit of any D&O liability insurance cover will be of paramount importance to any directors and officers that are implicated.

The reforms would extend the duties owed by directors and officers of listed companies and public interest entities to investors. Breaches of these duties would provide new avenues for a company’s investors to pursue claims against directors and officers.

Proposed Reforms

In an effort to make directors more accountable if they have been deemed negligent in their duties it is proposed that:

  • Directors of large businesses could face fines or suspensions in the most serious cases of failings – such as significant errors with accounts, hiding crucial information from auditors, or leaving the door open to fraud.
  • Under the UK’s Corporate Governance Code, companies could be expected to write into directors’ contracts that their bonuses will be repaid in the event of collapses or serious director failings up to two years after the pay award is made, clamping down on ‘rewards for failure’.
  • Large businesses would need to be more transparent about the state of their finances, so they do not pay out dividends and bonuses at a time when they could be facing insolvency. Directors would also publish annual ‘resilience statements’ that set out how their organisation is mitigating short and long-term risks, encouraging their directors to focus on the long-term success of the company and consider key issues like the impact of climate change.

The reforms outlined would impact directors and officers of both companies listed on the London stock exchange, and “public interest entities”. At present, there are around 2,000 such entities, many of which are listed companies. The proposals would extend the definition of “public interest entities” so that it includes large private entities which satisfy certain financial thresholds.

Impact on Directors and Officers

The main proposals that may impact directors and officers of listed companies and “public interest entities” are the introduction of new reporting requirements. These include: 

  • Reporting annually on the effectiveness of a company’s internal controls. This is expected to include details of the relevant benchmark used in measuring the effectiveness of the controls and any external assurance obtained by the company.
  • Stating that any proposed dividend is within known distributable reserves and that payment of it will not, in the directors’ and officers’ reasonable expectations, threaten the company’s solvency over the next two years. Directors and officers are expected to have regard to their obligations, including their duty under the UK Companies Act 2006 to promote the success of their company.
  • Publishing annually a Resilience Statement which assesses their company’s prospects, and addresses matters which may threaten its ability to meet its financial liabilities as they fall due. This is within a timescale of at least five years. It is expected that such statements may address matters such as business continuity in response to major disruptive events (for example pandemics), digital security risks, and potentially climate change risk.
  • Producing an Audit and Assurance Policy detailing what independent assurance their company intends to obtain over the next three years regarding their Resilience Statement, other risk related disclosure and the effectiveness of their company’s internal controls framework. This is to assist investors in understanding what independent scrutiny has been applied to a company’s reporting.

 Any new powers would not be at the expense of powers held by other UK regulators, such as the Insolvency Service’s ability to pursue disqualification proceedings against company directors and officers. The intention is that the new Audit, Reporting and Governance Authority would work closely with other UK regulators, including the Financial Conduct Authority and the Serious Fraud Office.

W Denis Insurance Brokers has a dedicated ProFin team, based in London, that can offer specialist technical advice on management liability issues. To discuss this further with an expert at W Denis, please make arrangements with Richard Bowdidge at richard.bowdidge@wdenis.co.uk or on 0203 713 3982.

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