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Directors and Officers – Are you covered for Fraud?


In today's volatile financial market, companies and their management are increasingly scrutinised by shareholders, employers, competitors and regulators. Accordingly, there is a sharper focus on accountability. The UK's Financial Services Authority's ("FSA") priority is to look closely at the individual director/officer's roles, particularly for market fraud, market manipulation, market abuse and insider trading.

Fraud is frequently commented on by the media. This month the London Financial Times reported that fraud levels were increasing as the international markets crisis deepens and that further rises were expected amid the turmoil in the banking industry. The UK Government, has in the past, been accused of failing to recognise incidents of fraud and failing to deal with them efficiently. As a result the UK is considered to have a poor record of tackling fraud in comparison to our US counterparts. One response to such criticisms has resulted in the UK government setting up the National Fraud Strategic Authority (NFSA). The NFSA is a GBP 29m UK Government investment to counter such criticisms of failings in laws and institutions and hopes to improve the UK track record.

However, fraud is a global problem. An index that has been able to provide a global perspective on this issue is the Corruption Perceptions Index (CPI) by Transparency International which measures the perceived levels of public sector corruption in countries. The CPI scores 180 countries on a scale from zero (highly corrupt) to 10 (highly clean). It can be a useful tool in determining the extent and risk of corruption in countries where companies conduct business. The US is ranked 18th (7.3) tied with Belgium. Countries experiencing significant declines in their CPI scores from 2007 to 2008 include Norway and the United Kingdom. According to Transparency International "the weakening performance of some wealthy exporting countries, with notable European decliners in the 2008 CPI, casts a further critical light on Governments' commitment to reign in their questionable methods of their companies in acquiring and managing overseas business..…..The continuing emergence of foreign bribery scandals indicates a broader failure by the world's wealthiest countries to live up to the promise of mutual accountability in the fight against corruption."

D&O Insurance policies and the Fraud Exclusion

All directors of public and private companies incorporated in England & Wales are subject to duties and responsibilities under English law. These responsibilities will apply whether an English company's place of central management and control is within or outside of England & Wales. The duties apply equally to all directors/officers regardless of whether they are executive or non executive directors, although a director's experience and specific functions in a company will influence the standard to which he/she is expected to exercise reasonable care skill and diligence in the performance of his/her duties.

D & O Insurance policies are now considered a business necessity and in effect provide funds where the director/ officer commits a wrongful act in the capacity of a director/officer or an employee in a managerial/supervisory position. Wrongful acts can include a breach of duty/ trust, neglect while acting in such a capacity.

Claims can be brought by the company's stakeholders (owners, investors, lenders, employees and securities holders, including bondholders). Claims may also be brought by customers, consumer groups, competitors, business partners (vendors and suppliers) and Government enforcement/ regulatory groups.

Most D&O Insurance policies exclude from policy coverage any loss as a result of a dishonest, fraudulent or criminal act. However, it is not as simple as that. This exception will only apply if there is a final judgment or a written admission that the individual acted fraudulently. This is described as an "in fact finding." Therefore, the insurer is obliged under most D&O policy wordings to advance legal costs associated with the investigation of the fraud allegations until such time that there is (if ever) a finding in fact of dishonesty and fraud. The "in fact" wording will require a judgment, admission, evidence or a witness statement which clearly shows dishonesty on behalf of the director or officer. It is unclear whether the insurer may apply this unilaterally or whether a court is required to make a finding of fact as to the dishonest and fraudulent act. Generally, it is considered that a finding of fact or a determination of fraud/dishonesty must be made by a decision making body. Allegations of fraud/dishonesty will not suffice.

A point to note is that the majority of investigation into a director/officer's alleged wrongdoing are usually settled without an admission of wrongdoing which usually does not trigger the exclusion. This means that the fraud exclusion is of limited benefit to an insurer unless there is an actual finding of fraud.

Market abuse and insider trading fall within the definition of dishonest/fraudulent acts. If a D&O policy requires a finding in fact then a judgment or final adjudication of dishonesty or fraud is required. A Final Notice issued by the Regulatory Decisions Committee (RDC) of the FSA will constitute a finding in fact, since this marks the conclusion of an investigation and the RDC would be considered a Regulatory body.

However, it is also important to note that because defence/legal costs incurred for such a claim are typically covered by the policy D&O insurance policy until such time as the wrongful conduct is determined to have "in fact" occurred, those directors and officers who are not found guilty continue to be covered even after others may have confessed or been adjudged guilty.


The current financial climate is likely to have an adverse impact on share price and shareholder relations. One direct effect has already appeared - the collapse of several large financial institutions has turned preferred shareholders into securities class action plaintiffs. Business leaders believe that the scale of liability claims from the credit crunch will exceed those arising from the dotcom crash thereby increasing the chances that individual company directors/ officers will become targets of lawsuits made by disgruntled shareholders. This issue is of increasing importance as without corporate indemnity or insurance, directors and officers would be reduced to relying on their own personal assets to pay for the costs of defending these allegations and any resulting settlement or judgment against them. In these situations, personal estates and livelihoods often hinge on insurance policy language, and sometimes, on a single sentence or phrase buried within a D&O insurance contract or endorsement. Therefore, it is important to become aware of the type and parameters of the exclusions in the D&O policy, as it may be critical to a director or officer and their insurers in the event of a claim.

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