Senior managers could face criminal sanctions for failing to perform due diligence under new banking and insurance regulations taking effect in January in Germany.

The German Ringfencing Act, which amends the country's Banking Act and Insurance Supervision Act, includes detailed requirements senior managers must meet in order to establish “a proper system of business organization.”  The act, detailed by Germany's financial supervisor BaFin, marks the first time senior managers face the prospect of criminal liability.

The sanctions would apply if managers fail to fulfill their duties.

According to information published by BaFin this week, senior managers must be responsible for establishing strategies, processes, procedures, functions, and concepts set forth in the existing Banking Act (KWG) and the Insurance Supervision Act (VAG).  “These requirements are so essential for proper business organization and effective risk management that their breach can jeopardize the stability of an institution or undertaking,” the regulator said. The due diligence measures are specific to senior managers.

Although the requirements were previously spelled out for senior managers, the act marks a change in that those requirements become legally enforceable.

BaFin's report said the current resources available to hold senior managers accountable in cases of mismanagement were inadequate. Failure to establish a proper business organization, including risk management systems, currently only triggers regulatory sanctions. Such breaches, BaFin said, can pose a threat to not only the particular institution but to the financial system as a whole.

Because specific needs vary among businesses, any infractions will be reviewed on a case by case basis.

Criminal liability will be triggered if a senior manager “willfully and culpably” breaches the due diligence requirements laid out within the law, and causes:

·         a threat to the existence of the institution, its parent company or another institution in the same group;

·         the undertaking to become insolvent or over-indebted;

·         a situation in which the institution can only avoid insolvency or over-indebtedness by accepting state aid.

Criminal sanctions will be applied only if BaFin had previously issued an enforceable order and that order was not followed.

Punishment can range up to five years in prison or fines in cases in which a senior manager is found to have willfully caused financial difficulties for an institution or undertaking. Prison terms of up to two years or fines would be imposed in cases when a senior manager negligently causes a threat to the existence of an institution or causes its insolvency or over-indebtedness, or negligently causes the institution to require state aid in order to avoid insolvency or over-indebtedness.

The law takes effect 2 January 2014.

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