Legal Challenges Are Mounting Globally

Several trends are quickly transforming the nature of doing business internationally. First, the regulatory and oversight agencies of several key nations have beefed up crossborder cooperation and we are witnessing aggressive, U.S.-style litigation and regulation extended internationally. Two cases in point are the recent shareholder suits against an Italian company, Parmalat, for accounting irregularities and the extradition of three NatWest bankers from Britain to the U.S. on charges that they abetted the fraud at Enron. Secondly, the U.S. plaintiffs’ bar is aggressively expanding its franchise abroad, in part by forging alliances with local law firms. Their clear aim is to exploit changes in international regulations and bring a new wave of lawsuits against companies that operate globally. For plaintiffs, it is a growth business, but for directors, it spells potential trouble.

Another disconcerting piece of the changing mosaic is the potential consolidation of international stock exchanges. Although still in the early stages, consolidation could result in companies being listed on more than one exchange, with different governance and listing requirements, which could leave them vulnerable to lawsuits in multiple jurisdictions.

There are at least three different types of directors who may be vulnerable to these new risks: board members of U.S.-domiciled companies that operate internationally, American nationals serving on the boards of non-U.S. companies, and foreign-domiciled directors of the subsidiaries of multinationals. Risks for all are magnified if the company for which they serve is listed on multiple stock exchanges because of different accounting standards and guidelines, and complications in “translating” financial information from one market to another. Different governance structures add to the complexity. In civil law countries, including Germany and France, for example, subsidiaries of foreign companies have a dual board structure—typically a management board and supervisory board—both subject to indigenous laws and regulations.

The risks vary by geography. The litigation risk appears to be the greatest in Britain, Australia, Japan and parts of Europe, while regulatory requirements may be more stringent and complex in Germany, Brazil and India. In those latter countries, the regulators are increasingly vigilant on governance and, with the augmented presence of plaintiffs’ lawyers, a company that runs afoul of a country’s regulatory climate automatically makes it vulnerable to private suit. Plaintiffs’ lawyers are routinely shopping for major institutional investors to enlist them in legal challenges.

One key element in protecting management and boards is the proper Directors and Officers (D&O) insurance, which my company underwrites. You might think that any multinational corporation could come to us and say, “Give us one insurance policy that covers us in the 25 countries in which we operate,” but it’s not that simple. A company may not always be able to rely on a single “global” D&O policy.

For one thing, regulations governing what policies may provide to foreign insureds vary around the world. In many countries, policy forms providing coverage to risks in those countries must be submitted to and explicitly approved by local regulators (“admitted”), as consistent with local law, and issued locally. Accordingly, for example, the directors of a German subsidiary of a U.S. corporation may not be able to effectively rely on D&O insurance issued in New York, which would be written in English and premised on applicable local law, to cover their German risks, because coverage by the New York-issued policy may contravene German insurance regulations. Brazil, where a policy must be issued locally to facilitate the carrier ceding a piece of the risk to state-owned reinsurance companies, provides another example of bad consequences—where a New York-issued policy would possibly leave a coverage gap and might also produce regulatory exposure.

With large international D&O claims no longer uncommon and international D&O exposure continuing to mount, the consequences of not acting in compliance with local laws to close coverage gaps and comply with regulation seem likely to become increasingly severe.

In view of these new developments, many top U.S. corporate leaders are examining their international risks with a keener eye. Getting the right coverage in the most difficult markets is obviously the first line of defense. The art of managing risk has never been more important.