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Key management liability issues for investment advisers

The insurable risks facing financial services firms do not stop with investment firms having a form of PI cover.

Business insurance for investment firms inevitably includes the professional indemnity (‘PI’) cover required by Rule IPRU-INV 13.1.5 contained in the FCA Handbook. However, while the FCA requires investment firms to hold PI cover to protect the interests of consumers in the event of a breach of professional duty, the insurable risks facing financial services firms do not stop there.

Like any other business, the directors of a personal investment firm will be exposed to liability for breaches of the duties owed to the company in the course of managing the business. These include fiduciary, common law and statutory duties such as the general duties of directors set out in Chapter 2 of Part 10 of the Companies Act 2006 (“the 2006 Act”). Directors may also face allegations of breach of trust, negligent misstatement or misrepresentation, defamation, wrongful trading, or breach of warranty of authority. Claims may be pursued by the company itself, the company’s shareholders via a derivative action (with the court’s permission) pursuant to s.266 of the 2006 Act, or insolvency practitioners. The English jurisdiction is also not a safe haven from securities class actions, traditionally seen as a US phenomenon, thanks to the scope for the courts to make group litigation orders pursuant to Part 19 of the Civil Procedure Rules.

The risk of management liability in a financial services context is emphasised by the detailed regulatory framework in which such firms operate. The FCA Handbook contains wide-ranging provisions concerning the High Level Standards to be met by investment businesses (including Senior Management Arrangements, Systems and Controls), Prudential Standards (including the Interim Prudential Sourcebook for Investment Businesses referenced above) and Business Standards (including the Conduct of Business Sourcebook Rules which are generally relied on by claimants in professional negligence claims against IFAs).

Failure to comply with these requirements could lead to supervisory intervention by the FCA, such as a requirement for a Skilled Person Review pursuant to s.166 of the Financial Services and Markets Act 2000 (“FSMA”), at significant financial and/or reputational cost to the business. Firms may also face liability pursuant to s.138D of FSMA, which entitles a private person to pursue a claim to recover damages for losses suffered as the result of breaches of the FCA’s rules. Subject to the availability of adequate insurance cover, such circumstances may give rise to personal liabilities for directors if the exposures result from negligent management of the business.

The potential personal liability of an investment firm’s directors, the cost of reimbursing the company in relation to any indemnification of the directors’ personal liability, exposure to securities claims and (importantly) legal defence costs can be covered by management liability or Directors’ and Officers’ (“D&O”) insurance, which can also extend to cover employment practices liabilities such as discrimination, harassment and wrongful termination.

Executives considering D&O cover in recent years may have been put off by the sometimes extreme increases in premiums driven by a market correction and the impact of costly securities litigation and COVID. However, while the market has hardened considerably and capacity has dwindled, these circumstances may be expected to attract new entrants to the market, increasing supply and reducing cost. Specialist brokers will be able to help financial services executives consider the options available to them.

In any event, insurance is only one element of the business risk management toolkit and directors can take other steps to protect themselves, their companies and their shareholders. Self-insurance is one option, but of course prevention through strong governance remains better than any cure. 

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