When Officers and Directors Face Government Suit

Corporate Counsel

In the last three years there has been an explosion of civil cases brought by the Securities and Exchange Commission and other government agencies related to the financial crisis, the Foreign Corrupt Practices Act (FCPA), or both. In the last five years, the SEC has charged 66 CEOs, CFOs, and other senior corporate officers in connection with the financial crisis. The SEC has the stated mission of pursuing former officers and directors deemed to be "rogue," often seeking millions of dollars in penalties and disgorgement from those individuals.

The FDIC, too, is pursuing claims against directors and officers to recoup significant losses incurred during the financial crisis, which saw hundreds of banks fail. In December 2012, a Los Angeles jury returned a unanimous verdict of nearly $169 million against three former bank officers of IndyMac Bank on claims of negligence and breach of fiduciary duty—the jury reached its verdict after deliberating for only four and a half hours after a four-week trial.

With the rise in claims and, in the case of the FDIC, success after trial, what lessons can or should be learned for officers and directors facing claims by the government in this environment? This article explores several legal and tactical considerations that often arise.

Go With the Group?

In many cases, the government sues several of the current or former directors and officers in the same proceeding. If you're one of those individuals, one of the first questions you'll need to ask is whether some or all of the defendants should be represented by the same law firm.

Joint representation has several obvious benefits. First, it could result in less attorney time and fewer legal expenses. One voice can often present a clear and consistent position. And a single law firm, with one set of testifying experts, can avoid finger pointing between defendants, and instead concentrate on the perceived weaknesses in the government's case.

But joint representation may have several drawbacks. First, jointly represented clients may have a conflict of interest. The evidence may be stronger against one client, or one client's best defense may be to legitimately blame a co-defendant. These differences are especially pronounced where some defendants are outside directors, while others are senior officers.

Sometimes the conflicts are obvious. In the recent IndyMac Bank litigation, the district court judge questioned counsel jointly representing two of the defendants:

THE COURT: You're arguing that one of your two clients has no liability. How does your other client feel about that?

[Defense Counsel]: Your Honor, we represent . . . both clients.

THE COURT: That's what I said.

COUNSEL: I'm sorry to be repeating Your Honor. I mean, Mr. [Client] is aware of the fact that we're asserting this defense on Mr. [Other Client's] behalf. We have not—we do not believe that there is any conflict in that respect.

THE COURT: Seriously?

The court went on to suggest that the clients provide written waivers. California's Rules of Professional Conduct, like the ABA Model Rules and most state rules, require informed written consent when representing multiple clients whose interests actually or potentially conflict. (Cal. R. Prof. Conduct 3-310 (C)(2).)

But even if individual clients can consent to joint representation, should they? Joint representation may limit an early settlement opportunity by one of the clients or threaten the presentation of a client's best case at trial.

A good alternative that provides independent counsel to each defendant, but preserves joint efforts where appropriate, is the joint defense agreement between one or more individually represented parties. In such situations, each defendant enjoys the benefit of independent counsel, while sharing strategic confidential information—and perhaps the expense of jointly retained experts and other consultants.

An Early Settlement—From the Board Room to the Court Room

Savvy lawyers faced with government suit will invariably explore the possibility of early settlement. At least three factors generally need to fall into place before an early settlement is possible.

First, each side needs to make an objective assessment of the risks of proceeding to trial, usually before depositions have been taken or experts retained. That evaluation can be difficult. Former executives or their attorneys may be reluctant to appreciate the full measure of how their actions or inactions will be judged by a jury. They may downplay the power and persuasion of the economic data and trial graphics. They invariably resist paying personal assets towards any settlement. But the process can be aided by a good mediator and a focused exchange of important information.

Second, early settlement is impossible without flexibility by both the government and the executives. When the government's best offer is identical to its best outcome after trial, settlement is unlikely, especially when defendants secure a funded defense. Further, the SEC has explained its need for more trials to send a message: "If you don't have a legitimate trial threat, if you don't communicate to the targets of your investigation that you're prepared to go to trial, then you can be exploited." (Robert Khuzami, SEC Enforcement Director, House Financial Services Committee testimony, 5-17-2012.)

Third, early settlement may require individual defendants to step away from the group of other defendants. The CEO who also chaired a loan committee and received incentive bonuses is probably in a far riskier litigation position than a part-time loan officer. In SEC v. Sabhlok, for example, a backdating of stock options enforcement action, the CEO settled relatively early, followed by the CFO; the former controller proceeded to trial and the jury rejected all of the SEC's fraud claims. Each of the defendants benefitted from independent counsel, based on the risks and evidence applied to their unique roles.

Unique Legal Issues

Government suits against individuals usually present several unique legal issues, from limitations on affirmative defenses to different standards of proof. In an SEC enforcement action, for example, the government is not bound by the same pleadings requirements imposed on private plaintiffs by the PSLRA. The SEC also argues it need not prove causation or damages—so long as the misstatement or omission is material, a host of remedies will be available, from disgorgement to civil penalties. (See generally, SEC v. Rana Research, Inc., 8 F.3d 1358, 1364 (9th Cir. 1992).)

When the FDIC sues as receiver for a failed bank, most affirmative defenses are barred as a matter of law. (See, for example, FDIC. v. Van Dellen.) The so-called affirmative defense of the business judgment rule applies only to outside directors, not officers; further, the defense is not an immunity, but rather requires proof of gross negligence in those cases where the outside director meets the elements of the defense, which include that the director must show that she took reasonable steps to inform herself and actually exercised her business judgment.

And of course, civil claims by the government against individuals often raise issues of indemnity and insurance coverage. Carriers who deny coverage risk liability beyond policy limits if the insured later establishes coverage under the policy.


While one robin may not make a spring, nearly 500 failed banks and the lasting impact of the worldwide financial crisis have changed the landscape of our national dialogue when it comes to individual liability of officers and directors. It has also significantly altered the attitudes and expectations of jurists and juries. A $169 million judgment against three former bankers, combined with the dramatic surge in the SEC's civil enforcement actions, settlements, and trials, provide significant data from which important lessons can be drawn. As with history, those who ignore the lessons may repeat the outcomes.

Patrick J. Richard is a partner in the San Francisco office of Nossaman, with more than two decades of experience as a commercial trial lawyer.  He was a member of the trial team for both Federal Deposit Ins. Corp. v. Van Dellen and SEC v. Sabhlok. 

Reprinted with permission from the October 11, 2013 edition of Corporate Counsel © 2013 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-257-3382 or reprints@alm.com.

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