Individual Accountability for PE Executives Continues to Increase Under Legal and Regulatory Changes

Latham & Watkins LLP

Corporate accountability has been a key focus for UK legislators and regulators since the credit crisis, as authorities have taken action against corporate failings. In our view, this focus is evolving to emphasise individual accountability. Developments enacted by the Small Business, Enterprise and Employment Act (SBEE) and forthcoming changes to the Senior Managers and Certification Regime (SMCR) both seek to hold individuals to account, increasing the level of personal risk for PE executives.

New Dynamics to Encourage and Incentivise Claims Against Directors of Insolvent Companies

Changes enacted by the SBEE are expected to increase the likelihood of claims against PE executives sitting on portfolio company boards. While government has not sought to change the law on directors’ duties, it has responded to criticism for not formally holding more directors to account, by lowering barriers to individual enforcement action. Liquidators and administrators can now sell claims against directors to any person, including claims for fraudulent and wrongful trading, transactions at an undervalue, and preferences.

Historically, successful challenges against the actions of insolvent UK company directors have been relatively low, partly due to limited resources to fund claims. The new law heightens the probability of challenges — whether by disgruntled unsecured creditors (potentially financed by third-party litigation funders) or by third-party claims companies (using expertise to make a return).

UK Financial Regulator Targets Senior Individuals

The Financial Conduct Authority (FCA) has adopted a new enforcement strategy that will involve pursuing more senior individuals at regulated firms and opening more cases (without overly considering case strength or the likelihood of eventual success). This new approach coincides with the extension of the SMCR to cover all FCA-regulated companies, including PE firms and financial sector portfolio companies.

The SMCR requires senior managers, including active partners or directors of PE firms, to agree to personal statements of responsibility and to accept a defined duty of responsibility, that enables the FCA to more easily take action against individuals for perceived regulatory failings. PE executives that sit on an FCA-regulated portfolio company board will also be classified as senior managers. SMCR cases can lead to unlimited fines, financial services employment bans, and reputational damage. Amid a growing number of financial services deals in the market, PE executives must be mindful of the changes to be implemented by SMCR.

What Should Individuals Do to Protect Themselves?

While PE houses typically possess the right to appoint and remove directors throughout a buyout structure, they should consider both the merits and risks of making such appointments. Furthermore, any person may be deemed to be a company’s shadow director, enabling claims to be brought against individuals who, whilst not actually formally appointed as a director, assert a level of influence over the board. Therefore, all executives should recognise that they are subject to a greater risk of claims, even if the claim is brought vexatiously in order to achieve a settlement for professional claims companies.

Executives subject to the SMCR must monitor the FCA’s guidance and ensure they understand the duties and responsibilities of their role at a company, whether at the buyout firm management entity or portfolio company.

In our view, this developing trend toward individual accountability means that senior PE staff should continue to consider personal risks arising from their roles. Insurance is unlikely to fully address the risks associated with SMCR and SBEE. PE firms and portfolio companies should check policy details and consider coverage gaps and caps. Our guidance to PE executives is simple: seek professional advice early and document actions to aid defences to potential future challenges.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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