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The Top Legal Mistakes Financial Executives Make


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A Financial Executives International (FEI) Presentation on the top legal mistakes that are made by financial executives. (12/2/2015)

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The Top Legal Mistakes Financial Executives Make

  1. 1. STORIES YOU DON’T WANT TO TELL: THE TOP LEGAL MISTAKES FINANCIAL EXECUTIVES MAKE IRS Circular 230 Disclosure: To ensure compliance with the requirements imposed by the IRS, we inform you that any tax advice contained in this communication, including any attachment to this communication, is not intended or written to be used, and cannot be used, by any taxpayer for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to any other person any transaction or matter addressed herein. Roger Royse Royse Law Firm, PC 1717 Embarcadero Road Palo Alto, CA 94303 Skype: roger.royse
  2. 2. 2 Indemnification Notes: 1. Statutory Limits – Delaware • 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 be imposed.
  3. 3. 3 Indemnification (continued) Notes: 1. Statutory Limits – California • 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 Incorporation
  4. 4. 4 Indemnification (continued) Notes: 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 4. Exceptions 1. Claims Initiated by Indemnitee (except to enforce indemnity) 2. Lack of Good Faith 3. Insured Claims 4. Section 16(b) [Short Swing Profits]
  5. 5. 5 Notes: 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 executives. 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 coverage. – 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
  6. 6. 6 Notes: 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. 5. Limitations – Policies will have an aggregate dollar amount limitation, and once that amount is gone, it is gone. – Insurer will choose the attorney for the claim
  7. 7. 7 Notes: 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.
  8. 8. 8 Notes: Non-Competes, Non-Solicitations & Non-Interventions 1. Non-Competes – 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 2. Non-Solicitations – Generally enforceable if limited in duration (Loral Corp. v. Moyes (1985) 174 Cal.App.3d 268). 3. Non-Interventions – Enforceable to the extent ex-employee uses Company protected trade secrets
  9. 9. 9 Notes: 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.
  10. 10. 10 Notes: Trade Secrets 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.
  11. 11. 11 Notes: 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.
  12. 12. 12 Notes: 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 fraud’s materiality. – 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.
  13. 13. 13 Notes: Yates Memo 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 inception 2. Corporate resolutions should not protect individuals from criminal or civil liability 3. Corporate cases should not be resolved without a clear plan to address related individual cases
  14. 14. 14 Notes: 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
  15. 15. 15 Notes: Sexual Harassment 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 house” 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 explicit materials 3. Duties of Employers – Reasonable steps to prevent harassment – Investigate claims, encourage written complaints, protect employee from retaliation
  16. 16. 16 Notes: 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
  17. 17. 17 Notes: Equity on ExitVALUE TIMELetter of Intent Sign Purchase Agreement Closing
  18. 18. 18 Notes: 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. 2. 401K 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. 4. Annuity 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.
  19. 19. 19 Notes: Privacy/Cyber Security 1. Target Security Breach 1. 40 million payment card records and 70 million other customer records were stolen. 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 notification laws. 4. Congress summoned Target’s CFO to appear before the Senate Judiciary Committee.
  20. 20. 20 Notes: 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 consumer lawsuits. 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.
  21. 21. 21 Notes: 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
  22. 22. 22 Notes: 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 accounting firm.
  23. 23. 23 Notes: 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 requirements.
  24. 24. 24 Notes: 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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