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The UK’s Economic Crime and Corporate Transparency Act 2023: Part 2

Impact of identification doctrine reforms on D&O insurance

The UK’s Economic Crime and Corporate Transparency Act 2023 (the Act) aims to make it easier to bring prosecutions against large organisations when an employee commits fraud for the benefit of the business, as discussed in our first article on this new law. This is part of the Act’s wider goal of preventing economic fraud and stopping criminals exploiting the UK’s open economy using UK corporate structures.

The Act implements several measures to achieve this. These include creating a new criminal offence — the failure to prevent fraud — which entities can be prosecuted for, and reforms to the “identification doctrine” — the legal means by which intent can be attributed to a company or partnership — which facilitates establishing an entity’s legal liability for economic crimes.

In the first article in our two-part series on the Act, we discussed the new failure to prevent fraud offence and identified ways in which Marsh can support organisations in mitigating fraud risk. In this second article in the series, we examine how changes to the identification doctrine impact organisations and what that might mean for directors and officers (D&O) liability insurance.

Changes to the identification doctrine

Under English Law, a company is a separate legal entity capable of acting in its own right. A company is therefore capable of committing a crime, entering into a contract, or being negligent, even though it is inanimate. The identification doctrine is the legal means by which intent (for example, the intention to deceive, or to take money that isn’t yours) can be attached to a company or partnership as opposed to a natural person, for the purposes of prosecuting a crime that requires evidence of a state of mind; such as theft.

Historically, a company or partnership could only be held legally liable for crimes that require dishonest intent if prosecutors could identify a sufficiently senior individual, typically C-suite, who could be said to represent the “directing mind and will” of the company, whose criminal conduct and state of mind could therefore be attributed to the company. This made it difficult for enforcement agencies to tie fraudulent acts to entities, particularly in large and complex organisations.

The Act changes this. With effect from 26 December 2023, the knowledge of any “senior manager… acting within the actual or apparent scope of their authority” can be imputed to a company or partnership for the purposes of prosecuting a wide range of economic crimes. Prosecutors no longer need to find a guilty party who represents the “directing mind and will” of the entity. This is a fundamental change to English law that will have far reaching implications for all organisations operating in the UK.

Senior managers include anyone who plays a “significant role” in the decision making, management, or organisation of the activities, or a substantial part of the activities, of the company or partnership. Note that it is not a question of the title held by an individual, but the substance of their role. In a large organisation, this could include lots of regional directors, departmental heads, team leaders, or managers. This change applies to theft, fraud, false accounting, tax evasion, bribery, and other financial crimes. It will make it much easier to bring criminal prosecutions against companies and partnerships.

What does this mean for your D&O cover?

The changes outlined above are intended to make it easier for organisations to be prosecuted for economic crimes. This is likely to increase the number of investigations and prosecutions by the Serious Fraud Office (SFO). The incoming director of the SFO, Nick Ephgrave, made a point of saying that changes to the law introduced by this Act offer new tools to facilitate prosecutions. This creates a number of risk areas that might impact directors and officers, and in turn, their D&O cover.

In the event of an SFO investigation or prosecution, the following considerations apply:

Insured persons: The broadening of the people whose knowledge can be attributed to the company or partnership is likely to lead to an increase in the SFO’s interest in such individuals in the event of a criminal investigation. This, in turn, increases the risk of them being named in a criminal prosecution or other legal action arising out of the allegations. Insureds should check their definition of insured person in their D&O policies to see if senior managers are covered by their policy, and if there are any restrictions or limitations on this cover. If in doubt, speak to your Marsh representative.
Defence costs: SFO investigations into organisations require individuals to provide evidence, for which they may well want or need legal representation, leading to Side A or B claims. Those individuals can (if they are not already) become targets for the SFO, if evidence points to their wrongdoing, which can lead to their incurring legal defence costs that may fall to be covered by the D&O policy.

As a reminder, Side B D&O insurance is intended to indemnify the policyholder where it has paid the defence or investigation costs, or other losses, incurred by a director or officer. Side A D&O insurance protects directors and officers when their organisation cannot or will not indemnify their costs or losses in the event of a claim.
Side A ramifications: In some situations, there may be a conflict between an organisation and an individual that an organisation views as a potential bad actor. This could arise if interests and defences between the organisation and the individual are not aligned. In such instances, an organisation may be able to negotiate a Deferred Prosecution Agreement (DPA) with the SFO which effectively “settles” the organisation’s liability but not that of the individual. The organisation may separately bring claims or make allegations against an individual relating to the subject matter of the investigation or carry out its own internal investigation. An organisation is unlikely to indemnify an individual’s legal costs in a potential conflict scenario. This is where having sufficient Side A D&O cover becomes particularly important, as well as cover for internal investigation costs.
Investigation costs: The SFO has also been given increased power under the Act to require disclosure before a formal investigation is opened. Policyholders should consider the definition of investigation and similar or related terms in their D&O policies, and consider if they have sufficient protection, including for internal investigations arising from a regulatory inquiry of request for documents, and if there is cover available for pre-investigation costs.
Other claims: If an organisation is prosecuted by the SFO for economic crimes, or for failure to prevent fraud as discussed in our first article, the directors could face allegations by shareholders or other stakeholders that they have failed to take reasonable steps to conduct appropriate fraud risk assessments or take adequate prevention measures. This is therefore a new risk area that could lead to claims under the D&O policy.

How Marsh can help

To establish whether your D&O policy provides sufficient protection given the increased legal and regulatory risks created by the Act, and how it would respond in the event of one of the claims set out above, please speak to your Marsh contact.

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The UK’s Economic Crime and Corporate Transparency Act 2023: Part 2