STORIES YOU DON’T WANT TO TELL: THE TOP
LEGAL MISTAKES FINANCIAL EXECUTIVES MAKE
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1. Statutory Limits
• Permits Indemnification of expenses, including attorneys’ fees, in
defense or settlement of a derivative or third party action. However,
no indemnification where person is found liable in performance of
their duty to the corporation.
• Permits indemnification in excess of statute.
• Does not require authorizing provisions in certificate of
incorporation, and does not contain express prohibitions on
indemnification in certain circumstances, however limitations may
1. Statutory Limits
• Permits indemnification of expenses, including attorneys’ fees in
defense or settlement of a derivative or third-party action. With
respect to derivative actions, no indemnification for amounts paid or
expenses incurred in settling or disposing of a pending action with
respect to any person who is found liable to the corporation in their
performance of their duty to the corporation and its shareholders.
Requires indemnification only when the individual was successful
on the merits.
• Permits indemnification beyond statute so long as such additional
indemnification is authorized in the corporation’s Articles of
1. Notice as a Condition: Many agreements require notice in writing to the
Company as a condition precedent to the right to be indemnified
2. Selection of Counsel: Many agreements provide, that if the Company is
responsible for the defense of the Indemnitee, the Company shall be
entitled to choose counsel with the approval of the Indemnitee
3. Partial Indemnification: Some agreements provide for partial
indemnification to which the indemnitee is entitled
1. Claims Initiated by Indemnitee (except to enforce indemnity)
2. Lack of Good Faith
3. Insured Claims
4. Section 16(b) [Short Swing Profits]
Directors & Officers Insurance
1. Why do you need D&O Insurance?
– D&O insurance provides protection for company officials when corporate indemnification
is not available, whether due to insolvency or legal prohibition. D&O insurance also
provides a mechanism for corporations to be reimbursed when they do indemnify their
2. What is Side A/Side B Coverage?
– The coverage provision in which the D&O policy provides individuals with insurance
protection when indemnification is not available is commonly referred to as Side A
– The D&O insurance policy’s provision for reimbursement of a company’s indemnification
obligations is referred to as Side B coverage.
3. Who is covered?
– Not only directors and officers, but also other executives can be covered as well
– There may be more than one policy covering a person
Directors & Officers Insurance (continued)
4. What is excluded?
– Insured v. Insured
– Certain civil, criminal, punitive fines/penalties, exemplary/multiplied damages
– Defamation, Libel and Slander Claims
– Discrimination/Wrongful Termination
• Employment Practices Liability Coverage (EPL)
– Change in Control Provisions
• Often policies will contain provisions that in the event of a change in control, the
policy will either terminate, or only cover events prior to such change in control. If
your D&O insurance policy contains such a provision you should seek a new policy
that will cover your directors and officers post-change in control.
– Policies will have an aggregate dollar amount limitation, and once that amount is gone, it
– Insurer will choose the attorney for the claim
Protecting Intellectual Property
1. Scope of Assignment
2. Invention Assignments - Schedule
– Even if Invention Assignments obtained, often times the
Exhibit/Schedule to the Invention Assignment listing carve outs not
assigned to the Company left blank, leaving potential ambiguity as to
what IP belongs to the Company and what IP belongs to the individual.
3. Representations regarding use of Prior
Employer’s time, resources and facilities
– Must obtain representations from the person who developed or created
the IP that they did work on the IP on their prior employer’s time and
they did not use their prior employer’s facilities or tools, etc.
Non-Competes, Non-Solicitations & Non-Interventions
– CA Bus. Prof. Code §16600 – broad prohibition
– CA Bus. Prof. Code §16601 & §16602 – Permit covenants not to
compete when: 1) Person sells the good will of a business or 2) Partner
agrees not to compete in anticipation of dissolution of a partnership
– Generally enforceable if limited in duration (Loral Corp. v. Moyes (1985)
174 Cal.App.3d 268).
– Enforceable to the extent ex-employee uses Company protected trade
Non-Competes, Non-Solicitations & Non-Interventions
1. Edwards v. Arthur Andersen
– Employment agreement provision restrained employee from: (1) performing
work for clients previously serviced at Andersen for 18 months following the
termination of employment; and (2) soliciting any client for 12 months after
termination, (3) soliciting employees for 18 months after termination
– Appellate Court confirmed that any restraints on lawful competition would be
unenforceable unless they qualify under one of the enumerated statutory
exceptions which are agreements in connection with the sale or dissolution of
corporations, partnerships or LLCs
– Court left intact the non-statutory trade secret protection meaning a non-
compete cannot prevent a former employee from working for a competitor, but
it can prevent that employee from using a client list or other trade secret
information from his former employer to compete.
1. Cal. Labor Code Sec. 2860
– “Everything which an employee acquires by virtue of his employment, except
the compensation which is due to him from his employer, belongs to the
employer, whether acquired lawfully or unlawfully, or during or after the
expiration of the term of his employment.”
2. Using Former Employer’s Facilities
1. In CA, an employee owns any “invention” developed entirely on his/her own
time without using the employer’s equipment, supplies, facilities, or trade secret
information except for those inventions that either: (i) relate at the time of
conception or reduction to practice of the invention to the employer’s business,
or actual or demonstrably anticipated research or development of the employer;
or (ii) result from any work performed by the employee for the employer.
Personal Liability for Certification
1. Dodd-Frank: Control-Person liability – a person who directly or
indirectly controls another who commits a securities violation is responsible
for that violation
– Nature’s Sunshine Products – CFO charged as part of Foreign Corrupt
Practices Act for a wholly owned Brazilian sub who bribed customs officials.
Was not aware of scheme but charged because SEC filings and financials
disclosed payments as legitimate import expenses.
2. Sarbanes-Oxley – Disgorgement of compensation
– Executive may be forced to return compensation earned in years the company
had to restate its financials.
– Beazer Homes – CFO faced disgorgement because Chief Accounting Officer
directed fraud by recording improper accounting reserves to decrease net
income and meet estimates of diluted EPS, despite CFO having no
involvement in the misconduct.
Post Enron/WorldCom Auditor Reliance
1. SOX Sections 404 and 302
– CFOs must certify they have implemented and evaluated the
effectiveness of disclosure and internal controls over financial reporting,
and disclose any changes to those controls, including disclosure to
external auditors all material weaknesses and fraud regardless of the
– Management is not permitted to rely on external auditors work for
purposes of 404 and must have a system of internal control that is
sufficient without relying on the external auditor.
2. QSGI – CFO and CEO charged by SEC for withholding information from
external auditors regarding the adequacy of their internal inventory controls
leading to misrepresentations on the Company’s financials.
1. DAG Yates issued a memo calling on federal prosecutors
to focus on individual misconduct and to withhold
cooperation from corporations unless a thorough internal
investigation is conducted and corporation implicates
executives suspected of wrong doing.
2. Yates Memo Factors
1. Criminal and civil investigations should focus on individuals from
2. Corporate resolutions should not protect individuals from criminal or
3. Corporate cases should not be resolved without a clear plan to
address related individual cases
Piercing the Corporate Veil
1. When will courts pierce the corporate veil and impose
personal liability on executives?
– No real separation between company and owners/officers (ex.
commingling assets, owners’ alter ego)
– Company’s actions were wrongful or fraudulent (ex. made business
deals knowing Company couldn’t pay)
– Failure to follow corporate formalities
• Keep accurate, detailed records (hold board meetings and draft minutes, or
get written consents of the board)
– Inadequate Capitalization
– Closely-held (one person or small group of related people) higher
potential for lack of separation
1. Quid pro quo: Express or implied demands for sexual favors by an authority
figure, in exchange for some benefit or to avoid some detriment
– Direct – “Sleep with me or else” OR Implied – “Let’s discuss over wine at my
2. Hostile Work Environment: Unwanted conduct which is so severe or
persistent it creates an intimidating, hostile or offensive environment. Conduct may
be physical, verbal or nonverbal.
– Touching; kissing; hugging; remarks about clothing or body; repeated date
requests; conversations, jokes or stories of a sexual nature; display of sexually
3. Duties of Employers
– Reasonable steps to prevent harassment
– Investigate claims, encourage written complaints, protect employee from
Equity and Deferred Compensation
1. Options, Stock and Bonus/Incentive Plans
2. 409A Violations
1. No Valuation/Insufficient Valuation
2. Non-Qualified Deferred Compensation
3. Bonus and/or Incentive Plans
1. Tax considerations
2. Once wages are “earned” they cannot be forfeited
3. Be careful of unlawful deductions
Equity on ExitVALUE
Personal Financial/Tax Planning
1. ROTH IRAs
– Peter Thiel - Bought 1.7 million shares as CEO of PayPal in 2001. After 2002 eBay
acquisition, $31.5 million profit. Investments are tax free while they sit in Roth IRA,
and as long as you wait until age of retirement (59.5) withdraws aren’t levied either.
3. Defined Benefit Plan
– Cash Balance Pension Plan – Pay Credit from employer and Interest Credit.
Annuity based upon participant’s account balance or take lump sum which can be
rolled over to an IRA or another employer plan if it allows rollovers.
1. GRAT – irrevocable trust to which the grantor transfers assets in exchange for a
fixed payment, or annuity, for a term of years chosen by grantor. Mark Zuckerberg
and Dustin Moskovitz GRATs that estimate will allow them to transfer at least $185
million to future children or others, gift tax free.
1. Target Security Breach
1. 40 million payment card records and 70 million other customer records
2. Target’s Board and senior managers faced a shareholder derivative
suit for their “responsibility for, release of false and misleading
statements concerning, and the bungling of the aftermath of the worst
data breach in retail history.
3. The DOJ stated it was looking into potential criminal charges, and state
attorneys general have instituted actions under state security breach
4. Congress summoned Target’s CFO to appear before the Senate
Privacy/Cyber Security (continued)
1. Accretive Health: In July 2011, an Accretive laptop containing over 600 files with
information relating to 23,000 patients was stolen from an employee’s car in Minnesota.
The data on the laptop included sensitive personal and health information, such as
patient names, billing information, diagnostic information, and Social Security numbers;
information beyond what the employee needed to do his job. Consequently, Accretive
faced a lawsuit brought by the Minnesota attorney general; investigations before two
congressional committees, the FTC and state regulatory agencies; and securities and
2. Hillary Clinton
1. Federal Records Act – requires agencies hold onto official communications,
including all work-related emails, and government employees cannot destroy or
remove relevant records. Clinton used private email account on private server
which was wiped.
2. FOIA – by keeping private email account on private server, emails were insulated
her official emails from FOIA.
Foreign Corrupt Practices Act (FCPA)
1. Violations of FCPA reaches CEOs, CFOs and employees, not
just the companies.
2. Two provisions:
1. Anti-Bribery: Crime for any US individual or entity to offer or provide,
directly or through a 3rd party, anything of value to a foreign
government official with corrupt intent to influence an award or
continuation of business or to gain an unfair advantage. Burden of
Proof: Intent and Knowledge (inferred if bribery took place)
2. Accounting: illegal for a company that reports to the SEC to have false
or inaccurate books or records or to fail to maintain a system of internal
accounting controls. Burden of Proof: Preponderance of the evidence
Foreign Corrupt Practices Act (continued)
1. Baker Hughes Case
1. The SEC and DOJ filed a joint civil action against the former Chief Financial Officer and
former Controller of Baker Hughes Incorporated
2. Following an audit, Indonesian tax authorities notified the Baker Hughes subsidiary,
PTEC, that it owed $3.2 million. Shortly afterwards, an Indonesian tax official requested a
payment in exchange for reducing PTEC's tax assessment. PTEC's accounting firm
rejected the request for a bribe, as a senior partner at the accounting firm recognized this
would be a violation of FCPA. Notwithstanding his recognition of the FCPA issue, the
partner allegedly indicated that if Baker Hughes, the U.S. parent, were to indicate that it
wanted the accounting firm to make the payment on its behalf, it would do so and that the
accounting firm would generate a false invoice that would include money for the payment,
in addition to payment for the accounting firm's actual fees.
3. Baker Hughes U.S. general counsel: under no circumstances should any payment be
made, whether directly or through the accounting firm. Nevertheless, according to the
SEC and DOJ, Baker Hughes' chief financial officer and controller authorized the
Indonesian subsidiary to proceed with the plan to make the payment through its
Anti-Money Laundering (AML)
1. Brown Brothers Harriman & Co. (BBH) and its Chief
Compliance Officer (CCO) Crawford
1. FINRA pursued Brown Brothers Harriman & Co. (BBH) and its
compliance officer Crawford, directly for anti-money laundering
program compliance failures. Crawford failed to establish and
implement an AML program reasonably designed to detect and cause
the reporting of potentially suspicious activity. Suspended Crawford for
one month and imposed $25,000 fine.
2. MoneyGram & CCO Thomas Haider
1. Dept. of Treasury assessed $1 million civil money penalty against
Thomas Haider, the compliance officer of MoneyGram, for failing to
ensure that his company complied with anti-money laundering
Mark Hurd – Everything you shouldn’t do
1. Sexual Harassment
• “Interviewed” woman on several occasions for a part-time position. Interviews consisted
of dinner, drinks, and hotel room stays. Invited woman to his hotel suite to see
“documents”. Occasions occurred over two years while he made inappropriate advances
towards the woman.
2. Falsified Expense Accounts
• Covered up meetings with woman as dinners with the HP head of Security
• Used Company funds for his personal meetings which lead to sexual harassment claim
3. Unauthorized Use of Confidential Information
• Signed Settlement Agreement that he would not engage in conflicting business
obligations that resulted in his unauthorized use or disclosure of HP’s confidential
information. When he accepted employment for Oracle, HP sued to enjoin him as is his
position would necessarily disclose HP trade secrets.
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