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Memo from Justice Department puts corporate directors on notice

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Memo from Justice Department puts corporate directors on notice

A U.S. Justice Department memo calling for investigations of corporate malfeasance to put a greater emphasis on the conduct of individual board members raises broad and difficult questions. Stephanie Resnick and John C. Fuller, a partner and associate in the directors and officers liability and corporate governance practice of Fox Rothschild L.L.P. in Philadelphia, look at the memo and how it will affect corporate boards and their insurers.

A Department of Justice memo sent to all U.S. attorneys in September is reverberating through America's corporate boardrooms due to its revelation that federal prosecutors are being instructed to focus on the liability of individuals (including board members) when they're investigating allegations of corporate wrongdoing.

Even before the memo was released, many companies were reporting an increase in the number of executives declining to join their boards in the face of escalating corporate exposure. The government's aggressive stance is certain to exacerbate this trend.

Since the prospect of facing personal liability is perhaps the strongest disincentive for joining a corporate board, companies looking to attract top candidates must find realistic solutions that minimize the risk. The focus should be on ensuring indemnification even if such indemnification may not be included in traditional directors and officers liability insurance policies.

Adaptive insurance policies may offer the best solution, but there must be a dialogue between insurers and underwriters to achieve appropriate protections. And higher premiums are likely if insurers are expected to cover increased potential board member liability.

Authored by Deputy Attorney General Sally Quillian Yates, the memo was released Sept. 9, 2015, and sent to all federal prosecutors and investigators. It outlined new procedures for investigating and prosecuting board members and other individuals allegedly involved in acts of corporate wrongdoing. It also outlined a series of core goals — harmonizing civil and criminal investigations, ensuring that directors and officers are the focus of the government's efforts and making it more difficult for directors and officers to evade personal liability when their specific role in corporate misconduct is identified.

The six directives in the Yates Memo reveal that the new policy is mandatory and aggressive:

• A company under investigation can receive “cooperation credit” only if it identifies all relevant facts about potentially responsible directors and officers. The memo specifically instructs prosecutors to scrutinize board members' roles and review all disclosures from companies to ensure that no officer's or director's role has been downplayed or obscured.

• Prosecutors are directed to focus on officers and board members from the outset. This will increase pressure on the individuals and individual communications and decisions of the officers and directors instead of the narrative outlined in board minutes and the company's financial disclosures.

• Civil and criminal prosecutors are directed to work closely together, which is a directive clearly aimed at ensuring that the full breadth of remedies, including civil penalties and criminal charges, remains available in any case of corporate wrongdoing.

• In settlements, prosecutors must get written approval from the supervising assistant attorney general or United States attorney to release officers and directors from potential civil or criminal liability, and the memo directs that individual liability is not to be released absent “extraordinary” circumstances.

• Cases against companies are not to be resolved without an articulated plan to pursue potential individual claims and charges against the directors and officers.

• A director's or officer's ability to pay potential fines or penalties can no longer weigh into a decision on whether to pursue claims or charges against him or her.

The precise effect of these directives will be known only after they have been in practice for some time. Very soon, however, we may begin to see denials of cooperation credit and refusals by the government to release individual directors and officers from liability. These events will trigger new levels of personal risk for board members and increased costs for companies and their insurers.

Insurance premiums for D&O are likely to rise in response to any new wave of enforcement. To avoid steep increases, companies and insurers must anticipate how the Yates Memo will affect litigation.

The key issues for directors, officers, companies and their insurers to consider are: the appropriate scope of conduct exclusions; heightened conflicts of interest; new demands for independent counsel; increases in early, in-depth discovery; higher defense costs; and increases in judgments against individual directors and officers.

Conduct exclusions are perhaps the single largest concern for potential board members. While D&O policies may still cover some or all of the defense, some policies could leave individual directors and officers vulnerable for acts that have long been attributed to the corporate entity.

Conflict of interest analyses, for example, are sure to change, and directors must be aware of the need to re-examine with general counsel their relationships, because the new directives may put companies and their directors in conflict far sooner. The new policy on corporate cooperation credit means that significant potential conflicts of interest may now arise at almost the very moment when a company comes to anticipate litigation.

The Yates Memo directives will also surely add to litigation costs, and companies and prospective board members must know how the burden will be shared if policy limits are exceeded.

Larger judgments and added obstacles to settlements could also push defense costs beyond current policy limits. The directive that an individual's ability to pay should not affect prosecution decisions may lead to unprecedented judgments against individual officers and directors.

Insurance policy limits and corporate indemnification policies should be clearly communicated to prospective board members to give them a complete understanding of the risks they will assume upon joining the board. Companies aiming to recruit the best and brightest board members must tackle difficult subjects such as liability, policy limits and the other heavy burdens created by the Yates Memo.

Although companies must brace for increased premiums, insurers should be cognizant that the government's shift from corporate to individual targets may generally increase the scope of corporate liability and require new attention to claims against individual directors and officers, which may necessitate altering the structure of the policies they offer. The Yates Memo represents a truly significant increase in the potential liability for individual board members, and companies and insurers must work together to mitigate the individual risk to attract the most talented and capable board members.

Stephanie Resnick is a partner with Fox Rothschild L.L.P. and chair of its directors and officers liability and corporate governance practice. She can be reached at sresnick@foxrothschild.com or 215-299-2082. John C. Fuller is an attorney with Fox Rothschild L.L.P. and member of its directors and officers liability and corporate governance practice. He can be reached at jfuller@foxrothschild.com or 215-299-3815.

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