Who Should Pay Directors' Fines?
from
November/December 2003
by Susan Caminiti
It sounds about right: If you admit or are convicted of something naughty—signing off on books you knew to be cooked, say—you pay your fine with your own cash. But what if you don’t admit to anything but your company settles anyway, on its behalf and yours? Until now, your directors’ and officers’ insurance policy probably came up with the money.
That could change. The Securities and Exchange Commission is now refusing to settle fraud cases unless individuals named as defendants agree to pay their penalties themselves, even if they never admitted guilt. “When it comes to penalties, the public policy imperative . . . is very clear: Penalties ought to be paid by those upon whom they are imposed,” SEC chairman William H. Donaldson told the Senate Banking Committee in May.
Some securities lawyers say the average investor will view the move as just punishment for financial misdeeds. Others see a likely unintended consequence. “People settle civil cases all the time without admitting any wrongdoing,” says David Schack, a partner at the law firm of Kirkpatrick & Lockhart in Los Angeles. “If the SEC is going to prevent companies from using their insurance to pay these fines for their employees in a settlement, then I think you’re going to see lots of directors and officers take their chances and go to trial. And the cost of litigating one of these cases is never cheap.”
A few individual defendants have already agreed to come up with some of their own cash without admitting wrongdoing. Six former executives of Xerox Corp.—including CEOs and past board members Paul Allaire and G. Richard Thoman—will pay about $3 million among them, as their part of a $22 million fraud settlement with the SEC. Xerox will pick up the balance.
Stephen Crimmins, a former SEC trial attorney and now a partner at Pepper Hamilton in Washington, D.C., says it’s understandable why the SEC feels the need for tougher enforcement policies. But he believes that they should apply only if people are found guilty of something, not as a condition of a settlement. Adds David Schack: “Sending a message that people who’ve done wrong will be punished is the right thinking. But all this recent SEC move does is make public companies pay a fortune for a D&O policy and then prevent them from using it.”
The SEC’s new rule could also add to the challenge of recruiting board members. Directors already feel vulnerable, and the new rule won’t help, says Andrew Vollmer, an attorney with Wilmer Cutler & Pickering in Washington, D.C.
Crimmins believes that over the next year, companies and their boards will look to see how broadly the SEC applies this tough settlement stance. “If the SEC only uses it in cases of clear evidence of wrongdoing by specific individuals, then directors will not feel unduly alarmed,” he says. “If they use it in all or many of their settlement cases, that spells serious trouble for companies trying to get the best directors.” Meanwhile D&O rates continue to soar.
