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Executives and directors accused of wrongdoing are in danger of being left without insurance to fund some of their defence, brokers and lawyers have warned. Changes to the investigation of misconduct allegations put senior corporate staff, who can be held personally responsible, at risk of having to meet the costs themselves.

As a result of pressure from regulators, companies are tending to probe staff internally before outside bodies launch formal inquiries or prosecutions. This may open up holes in the insurance that supposedly covers defence costs.

“For directors and officers caught in this, it can be personally catastrophic,” says James Wing, chair of the American Bar Association’s director and officer liability insurance subcommittee. “It’s a very real problem.”

Directors and officers (D & O) liability insurance is designed to cover expenses if they face external investigation by regulators, or are sued by disgruntled parties such as shareholders, creditors or suppliers. Demand for the insurance policies has grown as more directors and officers insist their employer takes out the insurance on their behalf.

Whether it is a dispute over an alleged misrepresentation in an initial public offering prospectus, failure to comply with environmental protection standards or a breach in health and safety rules, corporate leaders can be targeted for all sorts of supposed shortcomings.

The risks have become more acute since the financial crisis as authorities in several jurisdictions have sought to make managers and board members more individually accountable. Corporate executives must comply with a range of recently toughened rules and regulations, from bribery laws to financial disclosure requirements.

The market in the US for D & O insurance was worth $9.2bn in premiums last year, according to Advisen, the data provider — up 13 per cent since 2011. The market in Europe, which is considerably less litigious, is far smaller at less than €2bn, although brokers say demand is also growing there.

On both sides of the Atlantic, directors at large organisations increasingly consider D & O insurance to be so important they will refuse to serve on boards unless the company buys it for them. Without cover, their personal assets could be on the line.

In the second quarter of this year, actions by regulators — as opposed to shareholders — were by far the largest source of D & O “loss events” in the US, accounting for almost two-thirds of the total, Advisen says. Securities class actions — cases brought by private parties alleging negligence, fraud or other violation of rules that govern financial markets — accounted for only about 14 per cent, while merger objections accounted for 13 per cent.

Insurance brokers and lawyers say they have come across several cases in which the policies have failed to respond as company bosses expected.

Leslie Kurshan of Marsh

Leslie Kurshan, head of product development in the financial and professional practice at Marsh, an insurance broker, says providers of traditional D & O cover often “wouldn’t respond at the point the individuals feel they need legal advice”.

“There can be problems with the individual enforcing their right to have the company pay the expenses.”

The problem arises because the insurance tends to “trigger”, or begin paying out, when an external body takes action against an individual, for example when a regulator issues a director with a subpoena to provide testimony.

Now, however, individuals are more likely to be investigated by their employer before an outside investigation or prosecution begins.

“We’re seeing an increased emphasis on whistleblowing and self-reporting,” Ms Kurshan says. “Regulators are under pressure to hold wrongdoers to account, so they’re in turn putting companies under pressure to conduct investigations of wrongdoing within their organisation.”

An example of such pressure came in September in a memo to American attorneys from Sally Yates, the US deputy attorney-general. “One of the most effective ways to combat corporate misconduct is by seeking accountability from the individuals who perpetrated the wrongdoing,” she wrote. She added that if companies wanted to continue to benefit from co-operating with the authorities — such as receiving discounts from fines — they would need to meet stringent criteria.

To earn “co-operation credit”, she wrote, companies must “identify all individuals involved in, or responsible for, the misconduct at issue, regardless of their position, status or seniority”.

Mr Wing says it is part of a “co-operation revolution” and the US Department of Justice will give companies “no credit unless they pull out all the stops — and turn on their own employees”.

He says of the insurance implications: “The real need of executives for defence costs is before anyone is charged. That is the gap in cover.” He adds the insurance market is beginning to launch products that fill the gap.

As Francis Kean, a D & O insurance expert at insurance broker Willis, puts it: “Once you’ve been formally targeted by the regulator, most D & O policies will provide you with cover. But what we’re talking about here is the pre-investigation, pre-claim phase. By the time there is a formal claim or investigation, it may be too late.”

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