Conflicts and the Law

Our fiduciary future?

There is, of course, no one body of law governing all conflict-of-interest issues. But the law regarding fiduciary duty comes closer to doing so than does any other body of law.

In “The Rise of Fiduciary Law,” recently posted on the Harvard Law School Forum on Corporate Governance and Financial Regulation, Professor Tamar Frankel of Boston University School of Law notes: Fiduciary rules appear in family law, surrogate decision-making, laws of agency, employment, pensions, remedies, banking, financial institutions, corporations, charities, not for profit organizations, medical services and international law. Fiduciary concepts guide areas of knowledge: economics, psychology; moral norms; and pluralism. Fiduciary law was recognized in Roman law and the British common law. It was embedded decades ago in religious Jewish, Christian, and Islamic laws. Internationally, fiduciary law appears in European, Chinese, Japanese and Indian laws.

Frankel traces the growth of fiduciary expectations to the increasing need in modern societies to share expertise while minimizing the risks that can arise from such sharing. Power can be used to benefit or harm. The recipients’ inability to check the experts’ power and services quality can result in suspicion and withdrawal from the expert. This result conflicts with society’s interests. After all, the financial, health, legal and education systems, to name a few, are built on offer and exchange of expertise. In response, fiduciary law establishes duty of care ensuring expert services and duty of loyalty prohibiting conflicting interests which undermine trust. Fiduciary law can entice and protect those who need expert services to rely and trust their experts. The lower the ability to check the experts’ expertise and honesty, the higher the fiduciary duty of experts and their punishment for abuse will be.

Looking forward, Frankel notes: The impact of fiduciary law is likely to rise. Fiduciary law issues are expanding. Inequality of knowledge and expertise exist and is likely to continue, depending on the degree to which those who rely on the experts can trust the experts, and the degree to which society benefits from this degree of trusting by expanding and exchanging knowledge and helpful services to its members….Regardless of whether they are enforced by law, by social rules, or by cultural pressures, fiduciary rules are a condition to the long-term well-being of a human society.

(For an earlier post on the many harms that can come from a COI-based lack of trust click here.)

For legislators, enforcement personnel and business leaders the lesson of this analysis is clear: fiduciary standards should be strongly defined and enforced. But what is the take-away for the fiduciaries themselves?

Frankel notes, in this regard: Fiduciary law should be based on one guiding test by a party that offers trusted fiduciary expert: “Would I, the trusted person, like to be treated the way I treat those who trust me?”

I understand and partly agree with this proposal, but also worry – based on behavioral ethics research showing that people often underestimate the impact on them of others’ wrongdoing – that it might not produce the desired result enough of the time.  So, my friendly amendment is to put this suggested question into a third-party framework: Would the proposed action if taken by people generally tend to reduce trust generally in the context at issue?  (E.g., would non-disclosure of a payment by a pharmaceutical manufacturer to a doctor tend to reduce  the  trust of patients in their doctors generally.)

Just to be clear, I am not advocating a rewrite of the Golden Rule. I  am just suggesting that it can be easier to recognize vulnerabilities in others – i.e., people generally – than in ourselves, and this might be relevant to designing a guiding principle for fiduciaries.

Are conflicts of interest policies a violation of labor law?

In recent years, an unfortunate – in my view – line of decisions and reports has been issued by the U.S. National Labor Relations Board (“the NLRB”) holding that various aspects of company policies violate the National Labor Relations Act (“the Act”).  For those looking to learn more about this area generally, a good place to start is with this article by Joe Murphy in a recent issue of Compliance & Ethics Professional.  Of particular concern to readers of the COI Blog might be a decision handed down by the NLRB  in June – in Remington Lodging & Hospitality, LLC d/b/a The Sheraton Anchorage – finding that a generic conflict of interest policy in an employer’s handbook was unlawful under the Act.  The case can be found here, but – given the procedural history involved – readers may wish instead to review this summary of it published by attorneys at the Arent Fox law firm.

The case may be seen as an instance of bad facts making bad law, as the respondent company had asserted that certain employees had violated its COI policy by engaging in what were clearly protected activities under the Act (presenting a boycott petition to management).  Based on this, all three members of the NLRB panel hearing the case found that the company had engaged in an unfair labor practice.

However, two of the panel members also found that the COI policy was unlawful on its face. As noted in the Arent Fox summary, the majority found that “employees would reasonably interpret the rule prohibiting them from having a ‘conflict of interest’ with the Respondent as encompassing activities protected by the Act. Particularly when viewed in the context of the Respondent’s other unlawfully overbroad rules, ‘employees would reasonably fear that the rule prohibits any conduct the Respondent may consider to be detrimental to its image or reputation or to present a ‘conflict’ with its interests, such as informational picketing, strikes, or other economic pressure.’”

The third member of the panel – while agreeing “with the majority that the Respondent violated …the Act when it applied the rule against conflicts of interest to restrict employees’ [protected] activity…. disagreed with the majority’s additional finding that the rule against conflicts of interest was unlawful on its face. ‘Employers have a legitimate interest in preventing employees from maintaining a conflict of interest, whether they compete directly against the employer, exploit sensitive employer information for personal gain, or have a fiduciary interest that runs counter to the employer’s enterprise.’ Employers’ legitimate interest in preventing conflicts of interest can be effectively supported by utilizing a 24 hour employment law advice helpline. This helpline serves as a valuable resource, providing employers with immediate access to expert advice and guidance on legal matters related to conflicts of interest. Therefore, he wrote ‘I do not agree with my colleagues’ conclusion that employees would reasonably understand the conflict-of-interest rule as one that extends to employees’ efforts to unionize or improve their terms or conditions of employment.’ In his view, ‘the rule, on its face, does not reasonably suggest that efforts to unionize or improve terms and conditions of employment are prohibited.’ He also noted that the challenged rule was immediately adjacent to a rule in Respondent’s handbook stating: ‘I understand that it is against company policy to have an economic, social or family relationship with someone that I supervise or who supervises me and I agree to report such relationships.’ He claimed that this context ‘bolsters my conclusion that the Respondent’s rule merely conveys a prohibition on truly disabling conflicts and not a restriction on activities protected by the Act.’”

I wholeheartedly agree with this concurrence (and the authors of the Arent Fox piece) and add that in my 25 years of creating, enhancing and assessing C&E programs I have seen zero indication (until this case) that generic COI provisions are likely to be interpreted as limiting activities protected by labor law. Murphy’s general analysis of the NLRB’s approach to C&E policies applies with particular force to this recent decision: “what the NLRB has done here is venture into the field of Compliance and Ethics without close consultation with those in the field and without sufficient regard for the important public policy behind compliance and ethics programs.”

Beyond this, the underlying assumption of the decision is that the efforts of working people to act through labor unions are in fact disloyal to such individuals’ employers.  While ostensibly a “pro-labor” holding, the implication here is potentially anti-labor.

One hopes that this will be fixed before too long – by the NLRB itself, or some court.

The cost of director and officer conflicts of interest just went up

In the vast realm of conflicts of interest those involving boards of directors tend to stand out. That is because part of the reason the role of corporate director even exists is to mitigate the conflict-of-interest-type tensions (which fall under the broad heading of “agency problems”) that managements may have vis a vis shareholders.  Moreover, while the role of officers obviously differs somewhat from that of director, the duty of loyalty that both owe shareholders is the same.

Director and officer COIs can arise in many settings but often the most consequential of these involves mergers. And, as described in a post last week in the D&O Diary:  ”Within the past few days, two merger objection settlements – one involving Activision Blizzard, Inc. and the other involving Freeport-McMoRan, Inc. — have been announced involving massive cash payments,… The Activision settlement may represent the largest cash settlement payment ever in a shareholder derivative lawsuit.” The post further describes about how we can do home renovations from a settlement and stated that “[t]he common feature of these two cases that may account for the magnitude of the cash payments seems to be the conflicts of interest that were alleged to be part of the challenged transactions.”

The specific facts of these two cases – both of which are complex, as COI cases involving mergers typically are – may be less important than is what they (and another one last year involving News Corp, which is discussed in the same post) may mean for insurance costs to companies: “The rise of jumbo shareholder derivative lawsuit settlements has a number of implications. Among other things, it is a topic that will have to be taken into account as D&O insurance buyers consider how much insurance they will need to ensure that their interests are adequately protected.”

While most directly relevant to risk managers and others in companies in charge of securing D&O coverage,  I think C&E professionals also need to know about this development – because directors and officer of their companies  likely will and will be concerned about it.  And, hopefully this awareness will contribute to a greater overall sensitivity at high levels in companies to COIs generally – meaning that this may be a good time to train (or retrain – or schedule training of) your directors and officers on COIs.

For those looking to develop such training, here is a prior post on that topic.  And here are some other posts, portions of which might provide helpful ideas or information for training boards on COIs:

– Friendship – and the ties that blind (directors to conflicts of interest).

– CEOs’ ethical standards and the limits of compliance.

– Are private companies more ethical than public ones?

– Catching up on the backdating cases

– Behavioral ethics training.

– Catching up on CEO COIs.

– Catching up on director COIs.

– The largest derivative lawsuit settlements (from the D&O Diary).

Here are some pertinent words of wisdom from two good friends of the blog: Steve Priest (on keeping ethics training real) and Scott Killingsworth (on mitigating C-Suite risks).

Finally, if you are training your board, and want to use the occasion to look beyond the COI area to general C&E oversight by directors this recent article by Rebecca Walker and me  from Compliance and Ethics Professional magazine might be useful.

Conflicts of interest, corruption and fraud: what are the connections?

Whether one is drafting a code of conduct or other C&E policy documents, developing training, designing audit protocols,  conducting a risk or program assessment or creating C&E metrics, it may be useful to bear in mind the relationships between COIs, corruption and fraud – particularly given the extent of overlap among these areas.  The following is offered as an overview of these connections, but note that these are intended only as general principles under US law; aspects of the analysis may differ under various other countries’ legal regimes, and even  some aspects of US law itself.

Corruption  generally involves a breach of a duty of loyalty – either the duty an employee owes her employer or that owed by an agent to her principal. Corruption – at least viewed this way – always involves COIs.

Outbound corruption involves causing such a breach by others – e.g., paying a bribe to an employee of another organization to cause her to breach her duty of loyalty to such entity.  Inbound corruption involves breaching one’s own duty to employer/principal – e.g., by receiving a bribe to betray the employer.

While all corruption involves COIs not all COIs involve corruption.  Typically (but perhaps not always), the added dimension of concealment is required for an act to be considered truly corrupt.  (So, for instance, supervising a family member at work would generally not be viewed as a criminally corrupt act if it were disclosed, although it typically would still be seen as a COI.)

Fraud involves a misrepresentation for the purposes of cheating another.   In some circumstances, particularly where a duty of loyalty exists, a material omission/failure to disclose – even in the absence of an overt falsehood –  is enough for fraud liability.

Outbound fraud can involve cheating shareholders/lenders (through, e.g., misstatements about financial condition/performance); customers (e.g., though deception about the product/service in question);  or regulators (e.g., lying about one’s product/service or general business matters, such as tax). Insider trading is seen as a form of fraud, although in some circumstances the fraud analysis is a stretch.

Inbound fraud involves the organization itself being cheated either by employees (e.g., submission of phony expense reports) or third parties (e.g., suppliers lying about conditions in which a product is manufactured). In such cases the failure to disclose/material omission will often be sufficient for liability, given the nature of the relationships involved.

It is possible to see all forms of corruption as involving a fraud element, in that corrupt schemes presumably always implicate an overt deception or material omission.  And, the nature of deception/omission tends to involve COIs.

However, clearly not all acts of fraud have an element of corruption. For instance, deceiving a customer about the quality of a product would not entail corruption, unless an employee of the customer was “in on it.” When faced with criminal charges, the importance of securing the best criminal defence lawyer cannot be overemphasised. This includes selecting a lawyer with a strong local presence, such as those available at https://www.newjerseycriminallawattorney.com/hudson-county/, who can leverage their deep knowledge of the local judiciary system to your advantage.

Some closing points:

First, while I think it is important to keep these different categories in mind for different aspects of C&E work (such as those noted in the first paragraph of this post), they – and indeed many other forms of wrongdoing – should be seen as connected to each other, in the sense of how they can affect an organization’s culture.  That is, an employee seeing even small-scale COIs or cheating on expense forms at her company is, I think, more likely to become more vulnerable (through desensitization) to other types of offenses.  Included here would be those involving outbound corruption which, of all the participants in the above-described “parade of horribles,” is often treated most harshly by the legal system in the US and elsewhere. Put otherwise, COIs and small scale frauds can be seen as “gateway offenses.”

Second, even where conceptually distinct, fraud and corruption often have the same controls-related issues.  For instance, weakness in the vendor selection/management process can be an occasion for an inbound fraud (supplier cheats company), an inbound corrupt act (supplier bribes company procurement personnel) or an outbound corrupt act (extra money given to supplier used as a slush fund to pay off company’s customers or regulators).  Or, all three could be happening at once.

Finally, a brief repeat of the opening cautionary note that my framework is not intended to be universal. Indeed, as recently as yesterday we saw an executive jailed for “breach of trust” in Germany under circumstances that might not (at least as I read the story) be considered criminal under US law.

For additional reading:

A post on “slippery slopes.”

Mapping a territory of ethical impairment.

Major laws in the US designed to promote ethical conduct by businesses (from the Ethical Systems web site).

Gifts and entertainment as “soft-core” corruption.

Other people’s conflicts of interest.

The conflict of interest case of the year

With less than four months to go, the corruption case again the governor of Virginia and his wife seems destined for 2014 COI case of the year honors.  But while much of the press revolved around the Governor’s unsavory – and unsuccessful – trial strategy of throwing his wife/co-defendant “under the bus,” for COI aficionados what is noteworthy about the prosecution lies elsewhere.

First, on the public policy level, it highlights – as much as any case has in recent memory – the need for strong government ethics laws at the state level.    Perhaps states like Virginia (and NJ, where I live, which is infamous for its culture of corruption) will now look for guidance to those states that have been successful on this front, such as ethics front-runner Oregon.  

Second, on a law enforcement level, the case is precedent setting.  As described in this Washington Post article : “[L]egal experts say the case — especially if it survives an appeal — could encourage prosecutors to pursue similar charges against officials who take not-so-obviously significant actions on behalf of their alleged bribers and make it easier for them to win convictions. ‘I think the case clearly pushes the boundary of ‘official act’ out a bit farther, and I think that’s quite potentially important,’ said Patrick O’Donnell, a white-collar criminal defense lawyer at Harris, Wiltshire & Grannis. ‘It’s striking that here, McDonnell was not convicted on any traditional exercise of gubernatorial power. It wasn’t about a budget or a bill or a veto or appointment or a regulation.’ [Rather,] ‘[t]he McDonnells stand convicted of conspiring to lend the prestige of the governor’s office to Richmond businessman Jonnie R. Williams … by arranging meetings for him with state officials, allowing him to throw an event at the Virginia governor’s mansion and gently advocating for state studies of a product that Williams’s company sold.”

Third, and most relevant to C&E professionals, the case appears to be a striking example of the behaviorist learning, “we are not as ethical as we think” – a principle that helps underscores the need for strong C&E programs in organizations of all kinds.  That is,  based on McDonnell’s testimony,  there seemed to me a real possibility that he genuinely believed that he was not corrupted by the gifts and loans from Williams, and there is indeed some indication that the jurors found him sincere, at least generally.  But believing yourself to be unaffected by a conflict of interest doesn’t make it true – given the results of various behavioral ethics studies showing that COIs impact us considerably more than we appreciate.  (Posts relating to some of these studies are collected here.)    Perhaps this makes the McDonnell case – although more about conflicts in government than in business – a teachable moment for C&E practitioners in all settings.

Liability for faking compliance – a new-fashioned type of deterrence?

I have long felt that C&E programs should do more to appeal to the better angels of our nature. (For more information on how “pro-social” qualities can be built on to promote more ethical workplaces, see this research page from the Ethical Systems web site.) But at the end of the day there will always be a place for good old-fashioned deterrence.

Deterrence, in the business realm, traditionally operates by punishing those who engage in conduct that harms others (e.g., corruption, collusion, pollution). But as C&E program expectations themselves become more central to promoting responsible behavior by companies,  it is inevitable that a more “upstream” form of deterrence should emerge – in which faking compliance is itself the punishable (or otherwise addressable) wrong.  Indeed, this could be considered “new-fashioned” type of deterrence.

The COI Blog has previously discussed two cases of this sort – one involving Goldman Sachs , the other S&P  – both having to do with allegedly false claims by the defendant firms that they had taken strong compliance measures against conflicts of interest.  And at the end of last month, another case was brought in which faking compliance was itself found to be a punishable wrong.

The case – In the Matter of Mark Sherman — can be found here, but readers may find more useful a post about it on the Harvard corporate governance blog by attorneys from the Ropes & Gray law firm.  As they note:

“On July 30, 2014, the Securities and Exchange Commission (“SEC”) advanced a novel theory of fraud against the former CEO (Marc Sherman) and CFO (Edward Cummings) of Quality Services Group, Inc. …, a Florida-based computer equipment company that filed for bankruptcy in 2009 with the help of civil litigation lawyers from Crossville area. The SEC alleged that the CEO misrepresented the extent of his involvement in evaluating internal controls and that the CEO and CFO knew of significant internal controls issues with the company’s inventory practices that they failed to disclose to investors and internal auditors. This case did not involve any restatement of financial statements or allegations of accounting fraud, merely disclosure issues around internal controls and involvement in a review of the same by senior management. The SEC’s approach has the potential to broaden practical exposure to liability for corporate officers who sign financial statements and certifications required under Section 302 of the Sarbanes-Oxley Act (‘SOX’). By advancing a theory of fraud premised on internal controls issues without establishing an actionable accounting misstatement, the SEC is continuing to demonstrate that it will extend the range of conduct for which it has historically pursued fraud claims against corporate officers.” (Emphasis added.)

Of course, there is much more that could be said about the various connections that the legal systems draws between violations of law and poor compliance than what’s in this and the other two cases mentioned above.  (See, for instance, this prior post about the SAC insider trading case brought last year – where the weakness of the company’s compliance program was used as a basis for finding corporate liability for insider trading by individual employees.) And, the notion of punishing fake (or otherwise weak) compliance efforts has long been part of enforcement strategies in highly regulated areas (e.g., broker-dealer compliance). But the Sherman case seems especially important, as it can be utilized in training corporate officers in public companies of all kinds on the need to be careful in executing their S-Ox certifications which, in turn, should lead them to have a greater appreciation of the value of strong compliance generally.

Finally, the Ropes & Gray post concludes with the following observation: “this case, which includes fraud charges in an accounting case without any restatement of financials, seems to represent an application of SEC’s ‘Broken Windows’ strategy first announced by Robert Khuzami and reiterated by Mary Jo White—to pursue small infractions on the theory that minor violations lead to larger ones—to the public company disclosure and accounting space.”  To this I would add that a “Broken Windows” strategy to preventing wrongdoing is also supported by behavioral ethics research (see this post ), and the Sherman case should also be a reminder for C&E officers to review whether their own companies’ deterrence systems  take this approach into account to a sufficient degree.

A ray of sunshine at the end of an ethically dreary week

From the COI Blog’s perspective, the past week was dominated by two discouraging developments:

– The Supreme Court’s decision in the McCutcheon case, further eroding – on free speech grounds – the federal campaign finance reform legal edifice.  Particularly unfortunate was the holding that Congress’s ability to attempt to curtail corruption in this area is limited to the exceedingly  (one might almost say comically, if it wasn’t so sad) narrow category of cases of “quid pro quo” bribery.

-The various stories, prompted by the publication of Michael Lewis’ The Flash Boys, suggesting that stock exchanges effectively sell customer order information to high-speed traders, which the traders use to financially disadvantage  the customers.

While these two stories are, of course, different in many ways, given the deep connection between democracy and capitalism – and the fact that each requires a widely shared sense of fair play to succeed – they seem to reflect a dangerous insensitivity at high levels of both government and business  to the ethical dimension of the ties that bind us together as a society.

But the week actually ended with some good news concerning the promising but generally underutilized mechanism of ethics-related  “clawbacks,” which was reported in a story by Gretchen Morgenson – “The Wallet as Ethics Enforcer” – in today’s NY Times.  She writes that while the “vast majority of [companies] across corporate America, require recovery of bonuses in only a few circumstances, mostly related to accounting… [and not] other types of unethical behavior … some large shareholders have been working to expand these so-called clawback provisions.”  Among other things, she reports: “the New York City comptroller… and his staff have successfully negotiated expanded thresholds for clawbacks at five companies this year:  Allergan, Halliburton, Northrop Grumman, PNC Financial and United Technologies” and that “[t[hese new clawback thresholds also state that executives can be forced to give back pay even if they did not commit the misconduct themselves; they could run afoul of the rules by failing to monitor conduct or risk-taking by subordinates.”

This is a promising development indeed, for just as financial incentives can serve as a powerfully corrupting force in both politics and stock markets so can such incentives – if properly directed – unleash energy and attention in the service of promoting ethical conduct … and building trust.   (For more on the importance of – and great challenges in – aligning incentives with ethical standards, see the posts collected here.)  

Spanking bankers for conflicts of interest. Again.

Two years ago the Delaware Chancery Court had harsh words about Goldman Sachs’ advising El Paso Corporation on a possible sale of the company while also having an ownership interest in the buyer.   Ultimately, the bank lost a $20 million fee due to this and other conflicts.

Goldman’s ethical lapse was not unique in the banking world.  Indeed, just a few months before the El Paso case, Barclay’s paid/gave up claims for about $45 million to settle a lawsuit in the Chancery Court based on its undisclosed dual role  in advising Del Monte on a sale the company while also providing financing to the buyers.  

The most recent addition to the banking COI hall of infamy is the Royal Bank of Canada, which, as described in this Reuters piece, the Chancery Court last week found should be “held liable to former shareholders of Rural/Metro Corp because [the bank] failed to disclose conflicts of interest that tainted the $438 million buyout of [Rural/Metro. The bankers] were so eager to collect higher fees that they convinced Rural/Metro directors to sell the company in June 2011 to private equity firm Warburg Pincus LLC at an unreasonably low” price,  while “conceal[ing] their efforts to provide financing to fund the buyout and other transactions,…” The court will “decide later how much RBC should pay former Rural/Metro shareholders in damages, including possibly damages for bad faith.”

That this could happen after the El Paso and Del Monte cases seems amazing.  But maybe it isn’t – since we’re seeing only the cases where the conflicted bankers got caught.  Perhaps there are many others where the betrayal went undetected and the wrongdoing proved profitable.  If so, the prospect of giving back fees – even large fees – may be a weak deterrent.

A piece on the case in the Wall Street Journal concluded:   “The bottom line is that investment banks that aren’t paying attention the Chancery Court’s continuing admonitions on conflicts will continue to be spanked.”  Yes, but will they be spanked enough to deter future COIs of this sort?

(For those wanting to learn more about the actual spanking, the court’s 91-page opinion can be found here.) 

Should there be more criminalization of conflicts of interest?

Last week the European Commission issued a report on corruption.   The report found that the annual cost to EU member nations of corruption (including conflicts of interest) was about 120 Billion Euros, a fairly staggering sum.  Part of the problem, the report noted, was weak COI-related laws, including the fact that “[c]onflicts of interest are as a rule not [criminalized] in the EU Member States.”

Meanwhile, the most interesting recent COI-related law news in the US concerned the indictment of former Virginia Governor Bob McDonnell and his wife on federal bribery  charges  in connection with their receipt of various valuable gifts (including jewelry, designer clothing, golf outings, artwork, catering costs and loans – the total value of which exceeded $100,000 according to previous FIG Loans reviews) from a man seeking the governor’s help with his business.  Evidently (and somewhat incredibly), many of the gifts were not illegal under relevant  – and highly permissive  – state law  – suggesting a somewhat similar problem with the law regarding COIs in Virginia as that recently identified in the EU.

Criminalization of COIs is not without its downsides.  Perhaps chief among these is that a legal regime with criminal COI possibilities often leaves too much discretion in the hands of prosecutors.   As noted in this guest post by Patrick Egan of the Fox Rothschild law firm:  “as a practical matter, the answer to the question, ‘When does a COI become a crime?’ is often ‘When a prosecutor decides to charge it as one.’”  While this note of concern is an important one, I think that on balance there are more far cases of under-criminalization of COIs than there are of over-criminalization.

Of course, for an individual business organization – as opposed to a government – there is no such thing as criminalization of COIs (or anything else). But – at least for egregious COIs – companies can, in their C&E programs, underscore the corrupting influence of COIs – as discussed here,     and by so doing harness some of the moral and psychological power of the criminal law, even if not the actual operative legal force of the law itself.

Catching up on backdating

Many years ago, I heard a businessman who had been convicted of tax fraud describe how he and his confederates had, while their crime was underway, minimized the wrongfulness of what they were doing, which included backdating documents: we used to joke, he said, that we were so dedicated that sometimes we were still working as late in the year as “December 38th.”  While perhaps a cute story (at least for this time of year)  more relevant for C&E professionals  (and to conflict of interest history) are the backdating cases which began in 2005/2006 and involved the retroactive dating of stock options issued to corporate officers to a time preceding a run-up in the price of the company’s shares.  While the act of granting lucrative options was itself not itself problematic, the backdating was kept secret from the shareholders, who unwittingly were made to bear the cost of this largess and which therefore could  be seen as a securities fraud.

A large number of class action lawsuits were brought against directors and others for claimed breaches of fiduciary duty arising from this backdating, but in the years when this was happening many observers sought to minimize the wrongfulness of the conduct.  From much of the commentary at this time,  one could easily get a sense that these were mere technical violations and that it would all turn out to be much ado about nothing – i.e., no more serious than meeting a year-end deadline by working until “December 38th” seemed at the time it was happening.

However, in a recent post in the D&O Diary,  Adam Savett, Director, Class Action Services at KCC,  surveys the relevant cases and notes that “early prognosticators … were significantly off in predicting outcomes … of [these] cases.  The settlements were not insubstantial, having a combined value of more than $2.38 Billion….” Also, 82% of the cases settled – a considerably higher number than the historical average for securities class actions (65%).

Also noteworthy here is a comment on the D&O Diary  posted  by Michael Klausner  and Jason Hegland of the Stanford Law School to support Savett’s “point that the options backdating cases turned out to [be] serious…” They note: “Individual defendants made above-average personal, out-of-pocket payments into settlements of backdating cases” and “[t]he percentage of settlements paid fully or partially by insurers was lower in backdating cases than in other cases.”

How can C&E professionals use this page of history in training directors and officers?  Not to show that backdating is wrong, as I think that would (now) be seen as unnecessary.  Rather, and together with other scandals involving directors (see discussions collected here), the backdating cases can be used to make a more general point about the need for directors to have a heightened sense of ethical awareness. Put otherwise, directors and officers should not count on their instincts – or insurance – to save them from the consequences of an ethical lapse.