We consider below how advancement of legal fees, indemnification, and insurance operate when officers and directors become involved in regulatory investigations and proceedings. Part I addresses the enhanced risk officers and directors face today in an Age of Accountability. Part II addresses advancement of legal fees, which may be discretionary or mandatory depending on a company’s by-laws. Part III covers indemnification, which generally requires at least a conclusion that the officers and directors acted in good faith and reasonably believed that their conduct was in, or at least not contrary to, the best interests of the corporation. Part IV examines insurance coverage, which varies from carrier to carrier and may or may not provide meaningful protection. Finally, Part V summarizes the principal lessons from the analysis. Although there is significant overlap with similar principles that apply to private litigation, we limit our discussion here to advancement, indemnification, and insurance for regulatory investigations and proceedings.
Posts Tagged ‘Accountability’
The Walmart bribery scandal is one of the most closely-watched cases of alleged malfeasance by a global company. It broke into the open in April, 2012, when the New York Times published a lengthy investigative piece alleging Walmart bribery in a Mexican subsidiary and a cover-up in its Bentonville, Arkansas, global headquarters. The piece, which won a Pulitzer Prize for reporter David Barstow, raised a host of personal accountability and corporate governance issues for the company.
Late last month, on the second anniversary of the story nearly to the day, Walmart released its first Global Compliance Report (GCR). The report describes the company’s governance response and changed compliance framework—from holding 20 audit committee meetings in 2014, to substantial organizational restructuring, to enhanced education and training. On paper, Walmart appears to have adopted many best practices and to have set out a sound plan for moving forward. However, questions of accountability remain unanswered, when it comes to determining what actually happened in the past, what systems failed, and who was responsible for possible violations of the Foreign Corrupt Practices Act, which bars bribery of foreign officials. A lengthy internal inquiry continues, as well as investigations by the Justice Department and the SEC, with the scope broadened to include possible Walmart improprieties in Brazil, China and India.
Corporate governance has always been an important topic. It is even more so today, as many Americans recognize the need to develop a more robust corporate governance regime in the aftermath of the deepest financial crisis since the Great Depression.
Although the recent financial crisis—aptly named the “Great Recession”—has many fathers, there is ample evidence that poor corporate governance, including weak risk management standards at many financial institutions, contributed to the devastation wrought by the crisis. For example, it has been reported that senior executives at both AIG and Merrill Lynch tried to warn their respective management teams of excessive exposure to subprime mortgages, but were rebuffed or ignored. These and other failures of oversight continue to remind us that good corporate governance is essential to the stability of our capital markets and our economy, as well as the protection of investors.
Berkshire Hathaway Vice Chairman Charlie Munger is well known as the partner of CEO Warren Buffett and also for his advocacy of “multi-disciplinary thinking”—the application of fundamental concepts from across various academic disciplines to solve complex real-world problems. One problem that Munger has addressed over the years is the optimal system of corporate governance. How should an organization be structured to encourage ethical behavior among organizational participants and motivate decision-making in the best interest of shareholders? His solution is unconventional by the standards of governance today and somewhat at odds with regulatory guidelines. However, the insights that Munger provides represent a contrast to current “best practices” and suggest the potential for alternative solutions to improve corporate performance and executive behavior. In our paper, Corporate Governance According to Charles T. Munger, which was recently made publicly available on SSRN, we examine this solution in greater detail.
Greg [Tanzer, ASIC Commissioner] suggested that I talk about my perspectives on international cooperation in the enforcement context, as well as what we at the SEC are doing to try to make our own enforcement program even more robust and responsive to the issues presented by interconnected and fast moving markets. I am happy to do that. But, before I do, I would like to share a couple of thoughts on the topic of your first session—“Enforcement—does the punishment fit the crime?”
Much of my professional background has been in enforcement and strong enforcement was one of my primary focuses when I became Chair of the SEC almost a year ago and it remains so. Vigorous enforcement of the securities laws in the United States, in Australia and around the world is obviously a critical component of our investor protection mission.
In the paper, Breaking Bad? Too-Big-To-Fail Banks Not Guilty As Not Charged, forthcoming in the Washington University Law Review, Vol. 91, No. 4, 2014, I focus on the benefits that the largest financial institutions receive because they are too-big-to-fail. Since the 2008 financial crisis, rating agencies, regulators, global organizations, and academics have argued that large banks receive significant competitive advantages because the market still perceives them as likely to be saved in a future financial crisis. The most significant advantage is a government implicit subsidy, which stems from this market perception and enables the largest banks to borrow at lower interest rates. And while government subsidies were the subject of a November 2013 Government Accounting Office report, in the paper I focus on a specific aspect of the benefits the largest banks receive: the economic advantages resulting from exempting the largest financial institutions from criminal statutes. I argue that this exemption—which has been widely discussed in the media over the last few years, following several scandals involving large financial institutions—not only contributes to the subsidies’ economic value, but also creates incentives for unethical and even criminal activity.
Delay in confronting crises is deadly. Corporate leaders must have processes for learning of important safety issues. Then they must seize control immediately and lead a systematic response. Crisis management is the ultimate stress test for the CEO and other top leaders of companies. The mantra for all leaders in crisis management must be: “It is our problem the moment we hear about it. We will be judged from that instant forward for everything we do—and don’t do.”
These are key lessons for leaders in all types of businesses from the front page stories about Toyota’s and GM’s separate, lengthy delays in responding promptly and fully to reports of deadly accidents possibly linked to product defects.
The news focus has been on regulatory investigations and enforcement relating to each company, but the ultimate question is why the company leaders didn’t forcefully address the possible defect issues when deaths started to occur.
For nearly 80 years, the Securities and Exchange Commission has been playing a vital role in the economic strength of our nation. Year after year, the agency has steadfastly sought to protect investors, make it possible for companies of all sizes to raise the funds needed to grow, and to ensure that our markets are operating fairly and efficiently.
That is our three-part mission.
But, while commitment to this mission has remained constant and strong over the years, the world in which we operate continuously changes, sometimes dramatically.
When the Commission’s formative statutes were drafted, no one was prepared for today’s market technology or the sheer speed at which trades are now executed. No one dreamed of the complex financial products that are traded today. And, not even science fiction writers would have bet that individuals would so soon communicate instantaneously in so many different ways.
The JP Morgan Chase board of directors has vexed the world with its terse announcement in a recent 8-K filing that CEO Jamie Dimon would receive a big pay raise—$20 million in total pay for 2013, up from $11.5 million for 2012, a 74 percent increase.
Not surprisingly, the news sparked strong reactions, from indignant critique to justification and support. Dimon’s raise obviously has special resonance because JP Morgan’s legal woes were one of the top business stories last year as it agreed to $20 billion in payments to settle a variety of cases involving the bank’s conduct since 2005 when Dimon became JPM CEO. But the ultimate question that gets fuzzed-over in the filing and response is one of culture and accountability—whether a long-serving CEO is accountable for a corporate culture that has spawned major regulatory inquiries and settlements across a broad range of legal issues, even though the firm has otherwise performed well commercially.
On October 30, 2013, the Office of the Comptroller of the Currency (the “OCC”) issued updated guidance to national banks and federal savings associations on assessing and managing risks associated with third-party relationships, which include all business arrangements between a bank and another entity (by contract or otherwise).  The new guidance introduces a “life cycle” approach to third-party risk management, requiring comprehensive oversight throughout each phase of a bank’s business arrangement with consultants, joint ventures, affiliates, subsidiaries, payment processors, computer network and security providers, and other third parties. Rather than mandating a uniform set of rules, however, the guidance instructs banks to adopt risk management processes commensurate with the level of risk and complexity of its third-party relationships. Accordingly, the OCC expects especially rigorous oversight of third-party relationships that involve certain “critical activities.”
The revamped guidance reflects the OCC’s concern that the increasing risk and complexity of third-party relationships is outpacing the quality of banks’ risk management over these outsourcing arrangements. The guidance cautions that a bank’s failure to implement appropriate third-party risk management processes may constitute an unsafe and unsound banking practice, and could prompt formal enforcement actions or a downgrade in a bank’s CAMELS management rating to less than satisfactory. The severity of these consequences suggests that third-party risk management practices are becoming an increasingly important focus of OCC supervisory efforts.