All banks are subject to operational losses associated with professional errors and omission by employees. These include losses through errors committed by staff such as unauthorized trading, erroneous transfer of funds to wrong accounts. errors in booking or recording securities transaction, etc. In the event where such losses are for the account of the bank itself i.e. for trades on the bank's own account, these type of losses are completely uninsurable and must be controlled by means of traditional methods such as strong internal controls, quality assurance programs, rigorous staff training programs and strong and active management

On the other hand if professional errors and omissions result in losses for the client, such events are insurable. In order to effectively assess risks in this area, it is necessary to understand the difference between professional liability risks which may affect the Board of Directors and Officer (D&O) and those professional liability risks which affect the bank itself.

Directors and Officer liability

This coverage is for the directors and officer of a hank, and not for the bank itself. One of the most complex problems facing any business is the liability of its directors and officers (executive or non-executive). The personal assets of directors and senior officers may be at risk for losses arising out of the alleged negligent or imprudent acts or omissions of such individuals. The D&O coverage provides payment to the bank as it is the bank which purchases the policy to indemnify its directors and officers..

In addition, the D&O policy will reimburse directors and officers for losses for which the bank was unable to indemnify them for legal, regulatory, or financial reasons.

Professional Indemnity

This coverage is designed to indemnify the bank itself against litigation by customers, and other third parties alleging errors, omissions, misstatement or imprudence committed by directors, officers and employees in the performance of their service.

These two areas encompass professional liability, and there is some overlap between the insurance coverages designed to address them. However, although D&O is narrower in scope in terms of the individuals covered, it is significantly broader in terms of the wrongful acts which it covers generally covering all wrongful acts not specifically excluded. On the other hand, PI covers only specific professional services provided by the bank - trust, brokerage, investment advisory etc. D&O policies may specifically exclude such services from coverage.

Professional liability is created by the relationship between various parties including clients, regulators, shareholders, employees, vendors, joint venture partners and the banks. The relationship is based on the legal system in which the bank's activities take place. In addition, the same act may result in a liability situation for both the bank (through the actions of employees) as well as the Board of Directors. Thus acts of negligence or misconduct by employees, inappropriate or prohibited investments in a customer portfolio, errors in securities processing, failure to execute contractual obligations with a client may result in a liability for the bank However, the legal system may also involve allegations of mismanagement by the Board of Directors, regulatory non-compliance, product fraud, insider trading, bad loans which materially effect share price. In this case the liability may also extend to the Directors both singly and severally. Professional liability arise from a number of sources.

Shareholder Actions - Globally, the largest single source of professional liability exposure arises from shareholder actions against management, officers and employees for negligence and misconduct.

Client Services - The most rapidly growing area of professional indemnity liability exposure is in the area of the provision of client services. Trust, custodian relationships, buy/sell agreements, and investment advisory services all provide a large and growing exposure for both directors and officers and the bank itself.

Employment Practices - Employment actions represent the second largest source of D&O liability globally. D&O claims arise from employees during major business transactions i.e. mergers, acquisitions, implementation of new technology, downsizing, as well as from hiring, promotion, transfer, and termination practices.

Environmental Claims - The growth of environmental liability has coincided with the trend to impose personal liability on directors and officers who, in the performance of their duties, become subject to civil or criminal penalties for violation of environmental tows.

Lender Liability Claims - Lender liability places directors and officers at risk both as defendants in the first instance or as indemnitors when their bank have been held liable. The range of lenders' liabilities includes contractual liability, product liability, personal injury, property damage, fraud, duress, and emotional distress.

During the initial negotiations with the borrower, lender can be held liable for revoking a loan commitment where no commitment was intended, charging the terms of the commitment, or fraudulently inducing a borrower to borrow. Once a loan is made, additional liability exposure may arise in situations when the lender refuses to advance funds or restructure debt, threatens to invoke covenants in the loan agreement, accelerates the loan, responds to credit inquiries, or institutes foreclosure proceedings. Should a loan go bad the bank will typically step into a more aggressive role in its relationship with the borrower. This more aggressive posture combined with a generally more strained relationship between lender and borrower creates a fertile environment for lender liability.

Lenders may face an assortment of exposures including workout negotiations, collateral liquidations, assets seizure, and actually taking control of the management of the borrower's business. In an increasingly more competitive global business environment, it is only reasonable to expect that the business of lending both within and outside the Kingdom will become more complex. This increased level of complexity will inevitably lead to a higher exposure to lender liability issues.

Since these exposures are entirely driven by the social, legal and business environment in which business operations occur, it is important to address these exposures not only as they relate to operations within Saudi Arabia, but also outside the Kingdom.

Within Saudi Arabia - Under Saudi Company Law (Royal Decree M/6 of 1385)* Articles 66 to 82, members of Boards of Directors are jointly responsible for compensating the company, the shareholders or others for damages resulting from their management of the company or contravention of provisions of company law. This seems to differ little from the provisions of the proposed European Community Fifth Company Law Directive and other European countries. Therefore, Saudi Company Law differs little from that of other developed countries with respect to the legal obligations of corporate directors and officers; and a substantial exposure to professional liability, particularly Directors and Officers liability, currently exists for banks within the Kingdom.

Outside Saudi Arabia - The third party legal liability situation outside Saudi Arabia is far more grave than that found within the Kingdom. Any Saudi bank operating in another sovereign jurisdictions will be subject to the laws, business practices, political and social conditions of that area. Thus any Saudi bank operating in the United States, the United Kingdom, or western Europe runs a significant risk of being sued for alleged illegalities and/or mismanagement in connection with the bank's activities in these areas.

Another area of exposure which Saudi banks must recognize is the exposure created by their outside directors, such as directors and officers of Saudi banks serving on the boards of joint venture companies or partnerships or other non-Saudi corporations. Outside or independent directors are now routinely threatened with potential liability and are sued along with the rest of the board. In the past, outside directors were not expected to be involved in a bank's day to day affairs. How, today the trend is for outside directors to be knowledgeable oven experts in bank's issues and are being looked upon by courts, regulators and litigants as the "watchdogs" of board activities.

Professional liability represent a fast growing and potentially damaging area of operational risk for activities outside Saudi Arabia. Thus it is essential that Saudi banks develop policies and procedures to carefully assess product and services risks in this area and take measures to manage these risks.

* The Saudi Company Law (Royal Decree M/6 of 1385) has been replaced by the Companies Law (Royal Decree M/132), dated 01/12/1443H.

One of the fastest growing and most intractable areas of operational loss exposure is that presented by contingent client-related liability. This relates to indirect responsibility for a client's business operations and products. Since major liability losses may bankrupt a client, plaintiffs will seek anyone connected with the client possessing sufficient funds to secure a financial settlement. Unfortunately, this is often a bank with whom the client had or has a relationship. These types of contingent liabilities may arise from a number of situations including.

• 1. Environmental Liability: Banks may incur substantial environmental liability when they become responsible for environmental damage or hazardous waste cleanup (i.e. an oil spill from a tanker for which the bank was a lender). This type of liability exposure is expanding globally at a tremendous rate as countries continue to enact ever more punitive environmental laws and regulations.

• 2. Product Liability: Product liability may occur when a client in which the bank has an equity position or financing interest is sued alleging negligence (i.e., class action suits against a pharmaceutical manufacturer).

• 3. Death and Bodily Injury : This liability may arise from an event involving a bank owned asset that is leased to or operated by others (i.e. commercial aircraft) or from an event involving a repossessed asset (i.e., fire at bank owned or controlled hotel).

Therefore, as global environmental and product liability laws and regulations becomes more stringent and tort liability becomes more widespread, all Saudi banks will become increasingly more exposed to this type of operational risk both inside and outside the Kingdom.