An increasingly aggressive plaintiff’s bar, coupled with a dramatic increase in the number of Employee Retirement Income Security Act (ERISA) lawsuits, is creating new litigation worries for boards. The number of suits stemming from ERISA, legislation passed in 1974 which set standards for retirement plan fiduciaries, has resulted in a new class of lawsuits originating from current and former employees. Directorship recently assembled a panel of corporate directors and experts to discuss these and other litigation risks, facilitated by Larry Fine, senior vice president and chief technical officer for AIG Domestic Claims; Brian Cousin, partner at Seyfarth Shaw; and William McGuinness, partner at Fried Frank.
The panelists agreed that the risks of litigation arising from issues related to ERISA are as high as they have ever been. And the decline in the value of stocks, pension assets, and 401(k) plans will only increase these risks.
Although directors do not normally select investment options for the retirement plan, they often participate in the appointment of officers or other members of a fiduciary committee who perform this function, which opens directors up to legal risks under ERISA. That means they need to have the proper protection in place.
One of the best legal defenses, according to Fine, is to prevent lawsuits in the first place. This can be done with proper organization and anticipation of legal issues before they arise. Cousin concurred, suggesting that the investment decision component for employee pension plans “be farmed out so that the issue becomes proper delegation.” Good record-keeping begins with having some objective analysis about the selection of an independent fiduciary and a paper trail that establishes the appropriateness of the decision to hire such an advisor. Also useful in thwarting litigation is well-written criteria outlining the strategy the independent fiduciary is to follow in making investment decisions on behalf of the employer. “It’s then a lot harder to raise questions with respect to the company,” suggested McGuinness.
Coverage to Count On
Should a board have a separate insurance policy for independent directors, known as Side A coverage, to address the sometimes-competing insurance needs of directors versus corporate officers? The consensus was that such coverage is up to the discretion of the board and is a full board responsibility. “Directors and officers should take a very personal interest in understanding what protections exist for them, and increasingly, they are insisting on Side A protection,” said Fine.
A question was posed by one panelist about mandatory versus non-mandatory advancement of legal fees. Doesn’t that put the board in a position of being both judge and jury when trying to determine whether money for legal fees should be given to an executive who might be corrupt?
The scope of an individual’s advancement rights is an issue frequently raised only when it is needed the most: when a criminal, regulatory, or internal investigation is underway. The situation gets particularly complicated when a company is concerned about advancing expenses to someone who might be guilty. Cousin noted that Delaware case law dealing with mandatory advancement rights has consistently held that mandatory provisions must be enforced according to their terms.
“What happens to a director’s indemnification when there is a change in control?” asked Allan Grafman, president of All Media Ventures, who serves on the board of Majesco Entertainment. “What should we be looking for?” “Based on my experience,” said Gail Lieberman, managing partner of Rudder Capital, “once a company is sold, the buyer will continue to cover and indemnify the directors for a period of time.”
Leadership consultant Stuart Levine, who like Lieberman has served on multiple public-company boards, suggested a different change-in-control scenario: when a board member retires, does the company continue to indemnify him for a period of time? “This came up on one board and it’s a really important question to ask, because it needs to be written into the bylaws,” he said.
Check your D&O policy, advised AIG’s Fine. “The good news is that most D&O policies have change-in-control [provisions] and continue to indemnify directors for a period of time after such an occurrence,” he said.
Paying for Counsel
“What if independent counsel is sought by a director? Who are those bills submitted to and when do you submit them?” asked Grafman.
Robert Barbanell, a director at Cantel Medical and founder of a financial advisory practice, suggested that if a director chooses to seek independent counsel, that director should bear at least 15 to 20 percent of the cost, “because otherwise, officers and directors will go and find the most well-known, highly rated lawyer and the amount of my money he or she is going to spend could be excessive. It stands to reason that if [any director] wants independent counsel, he has to pay some share of that.” To which McGuinness, the litigator, quipped: “I want to be on record that I’m in favor of anything that gets the lawyers paid.” More seriously, McGuinness advised that the desire for independent counsel is an option that needs to be flagged because “it doesn’t come up all that often and when it does, usually there’s a specific reason for it. You have to be cautious.”
Veteran director Thomas Wajnert recommended building flexibility into the bylaws on the advancement of legal fees. “The board’s determination on advancement of fees may be very different on Day 1 or Day 10 or Day 30. You have to provide staging so that you can pull back that advance. Once the U.S. attorney gets those documents and you now believe the former CEO is a crook, you may want to change your determination based on the new evidence. A lot of times what happens is that shareholders get involved, asking why $10 million of our $15 million profit has been used to pay legal fees.”
Fine advised that a director under investigation might consider having an independent lawyer to serve as a “shadow” counsel, if there is a possible divergence of interest between that individual board member, the rest of the board, and the company. Cousin suggested a simple precaution: “Read the plan document. Get it and read it and if you don’t understand it, get an independent adviser to help you understand it.”