Directors and officers face liability

After a lifetime of hard work and dedication, it is an honor to be selected as a member of the board of directors or as an officer of a major corporation. But with that prestige comes a great deal of responsibility and, now more than ever, great personal financial risk.

In recent months, two high-profile corporate fraud cases highlighted that risk and should serve as a bright neon warning sign to all current and prospective board members and officers.

Ten former directors of WorldCom agreed to personally pay $18 million to settle a lawsuit by stockholders in the failed telecom company. (This settlement was later thrown out by a judge, opening the door for even greater liability for the directors after a jury trial.) At Enron, 18 former directors agreed to pay $13 million to settle stockholder claims arising from the well-publicized demise of the energy giant.

Those two cases of corporate malfeasance resulted in several criminal indictments of corporate officers and spawned several lawsuits by angry investors and other interested parties. But they are only the tip of an ever-growing iceberg of criminal and civil actions by government agencies and shareholders against companies suspected of using false information to inflate profits and share prices.

Although these two settlement agreements attracted a great deal of attention in the financial media, most company directors contacted said the cases would not prevent them from continuing with their board service or from accepting seats on other boards. For the most part, their lack of concern was based on their confidence in the honesty and integrity of their fellow board members and their companies’ management.

We would all like to believe that the companies we are associated with would never engage in the financial machinations that brought down WorldCom and Enron. But prospective board members or officers must realize that they are potentially putting all of their own assets at risk and should take aggressive action to eliminate or reduce that danger as much as legally possible.

Director and officer (D&O) insurance is the main line of defense against potentially ruinous jury awards and legal settlements. Although your personal funds may still be at risk — the Securities and Exchange Commission is seeking settlements that specify money come from personal funds rather than insurance — a good D&O insurance policy can provide important protection for an innocent director and officer from honest mistakes and even fraud committed by others.

However, many directors and officers have never closely examined their D&O policies and may falsely believe they are immune from personal financial liability. The big corporate scandals of recent years, the ensuing crackdowns on corporate malfeasance and fraud by government regulators and prosecutors, and the threat of sky-high criminal fines and civil judgments have caused D&O insurance providers to place many restrictions on policies. Some have even attempted to rescind policies altogether.

Anyone serving as an officer or director, or considering taking such a position, should make certain a D&O policy is in place and get expert advice — even consider paying for an independent review — on the adequacy of their corporation’s D&O coverage.

Ensure that all information provided to the insurer is as accurate as possible. Outright misrepresentations and mistakes could give the insurer all the ammunition it needs to have a policy rescinded. That’s exactly what insurers attempted in the Tyco and HealthSouth cases and, although those efforts failed on narrow legal grounds, they have been successful in winning rescisions in several other large cases.

There are other important questions to ask yourself. Do you have adequate coverage based on the potential value of any claims? Is your coverage rescindable due to the acts or omissions of others? Do you have the right to select your own counsel? What happens in case of bankruptcy? What are the effects of a merger or acquisition?

In this era of heightened regulatory supervision and shareholder unrest, it is vital to protect yourself, no matter how honest and successful you believe your corporation to be.

William R. Scherer Jr. is managing partner of Conrad & Scherer, which specializes in health care law and complex commercial litigation. Reach him at (954) 462-5500 or www.conradscherer.com.

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