After Enron, insurers have to address corporate governance. In the UK safeguards are tight, but redress is lacking. Lawyers Ed Smerdon and Bonita Hill reportwhen us energy giant Enron filed for bankruptcy on 2 December 2001 a search for answers was instantly launched. The focus was firmly on the directors and the auditors.
Enron shareholders, naming the directors and Arthur Andersen as defendants, have already filed a number of class action complaints. These lawsuits will attempt to recover damages for the alleged negligence of the directors and/or auditors. If these class actions are successful, it is likely substantial awards will be made.
Consequently, the directors and auditors will be looking to their directors' & officers' (D&O) policies to cover their liability.
In the US directors face the spectre of shareholder claims made against them personally, because they are answerable not only to the company, but also to the shareholders.
Severely impacted
While the lack of regulation in the US is being blamed in part for the failure to spot Enron's difficulties sooner, could such a corporate collapse happen here and if so, what remedies would be available?
Also, what impact would the Enron case have on D & O insurance, which will be severely impacted if claims of this nature occur in the UK?
UK corporate governance has been extensively reviewed variously by the Cadbury, Greenbury and Hampel reports (now the combined code), whose remit was to look at the role of directors and auditors in protecting investors. The basic governance regime in the UK relies on a system of internal controls, through the appointment of independent non-executive directors and the creation of board sub-committees.
In Enron's case, the non-executive directors and the remote sub-committees apparently failed to act as a check. It could be that with increasingly complex corporate structures and global companies, over-reliance on non-executive directors is risky, especially when information can be easily kept from them.
While the safeguards in place to prevent a corporate collapse in the UK may be more robust, the remedies available directly to shareholders are far more limited. At present, directors are largely spared the prospect of personal liability.
There are exceptions. First, fraud on the minority shareholder, arising where those controlling the company have acted in such a way as to prejudice the interests of the minority shareholder, although this is difficult to establish in practice. Second, a majority of shareholders may bring a derivative action in the name of the company. Finally, the new Financial Services & Markets Act (2000) allows shareholders to bring an action where listing particulars in a public offering are misleading, although directors will have a defence if they reasonably believed the particulars were true.
Directors' liability
Other sources of liability in the UK include directors' liability when a company becomes insolvent. In this country, the powers given to liquidators are remedial, although they do not necessarily benefit the shareholder directly. Most notably, they can bring a claim on behalf of the company against a director for mismanagement and under Section 214 of the Insolvency Act for wrongful trading.
The situation may be set to change, however, with a Law Commission report looking at extending shareholder remedies, so minority shareholders could bring actions on behalf of the company against the directors for negligence. Statistics show shareholder class actions increased from 216 in 2000 to 415 in 2001.
If Enron did happen here, such a remedy would allow shareholders to pursue directors for damages. With an increasing proportion of the population holding shares and with a number of recent high profile company collapses, there is sure to be pressure for further claims of this nature, the target being the directors, and their D&O policies.
The culture here may also be changing. Enron's collapse, widely reported in the UK, demonstrates the use of complex corporate structures, a feature of a global economy, may expose auditors, inexperienced executive directors and particularly non-executive directors.
When pension funds worth millions are rendered virtually worthless and thousands of jobs are lost, someone has to pay.
Ed Smerdon and Bonita Hill are solicitors at Reynolds Porter Chamberlain
Enron: what went wrong?
Enron transformed itself from a business buying and moving gas to one with its focus on commodity trading. To facilitate this, the company structure became huge and complex. Its directors face criticism for losing sight of the fundamental concepts of corporate governance and questions are being asked about the system of checks and balances put in place to protect employees and investors.
This global conglomerate, once the seventh largest corporation in the US and one of the biggest e-commerce companies in the world, appears to have remained largely unfettered by government regulation, auditors, credit agencies, wall street analysts, lawyers and its own board.
Only when the energy markets faltered and market confidence fell away did anyone begin to scrutinise the structure of the Enron or its accounting procedures.
It began with the board of directors voting to suspend their own code of ethics in order to set up a series of limited partnerships. These partnerships were used to offload debts and assets the company did not want. Crucially, they did not appear on the company balance sheet, raising questions about the transparency of the financial reporting.
When Enron's auditors, Arthur Andersen, did include some of the partnerships within the company accounts, it resulted in Enron recording a loss of $618m (£432m) and wiped off $1bn (£699m) in stockholders' equity.
The game was up on 2 December 2001 when the company filed for bankruptcy.
